Are We In A Bear Market? Here’s How To Tell

Key takeaways

• Bear markets occur when prices drop more than 20% from recent highs
• Bear markets can last a few weeks, months or even years, depending on the cause and underlying economic conditions
• With inflation at a 40-year high and the Fed eyeing future rate hikes, a recession isn’t out of the question
• Between investor sentiment and economic factors, market indices currently border on bear market declines – but we’re still in correction territory

Are we in a bear market?

That’s the question on everybody’s mind as inflation hovers at 40-year highs, interest rates climb and stocks drop.

And as the market so elegantly demonstrated in 2007, bulls can’t charge on forever. Now, after a decade of bullish markets – and two years of particularly astronomical returns – it’s time to consider whether bears are on the march.

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What is a bear market?

Bear markets occur when the stock market experiences at least a 20% drop from recent highs. While we often associate bear markets with the S&P 500 or Nasdaq Composite, individual stocks can also see bearish losses.

Bear runs often come with a healthy dose of investor pessimism and poor economic or corporate performance. Widespread negativity encourages investors to quit investing or sell out, perpetuating downward conditions. When enough of the market becomes bearish, even companies that report strong performance get swept up in the decline.

Bear markets may begin with a gradual decline or sudden plunge, followed by weeks, months or even years of stagnant or falling stock prices. During this time, the market may enjoy a few “relief rallies” as prices jump on good news before slipping again. Generally, they end when investors become interested in attractively priced stocks that drive rising sentiments and higher trade volumes.

Bear markets versus corrections

Bear markets and corrections both indicate falling stock prices. However, they differ in scale. Corrections occur when stocks or indices decline 10% from recent highs, while bear markets decline at least 20%. And corrections tend to last a few days or weeks, while bear markets can continue for months, years or decades.

Historic bear markets

Many of the most famous stock market crashes in U.S. history resulted in bear markets.

Take the Great Depression, which began with a market collapse in October 1929 and kicked off a decade of bear markets and relief rallies.

Then, there’s the 2007-2009 financial crisis, when the S&P 500 lost half of its value in 17 months.

Most recently, we encountered the Covid-19 bear market, in which indices dropped into bear territory in March 2020. However, the markets bounced back quickly, with the major indices posting new record highs before the year ended.

What causes bear markets?

Bear markets often follow bull markets and may precede recessions. They can occur after or be caused by sudden or long-developing events, such as:

• A slowing economy
• Bursting asset bubbles
• Geopolitical crises
• Government intervention in economic matters
• National or global events like pandemics or wars

Historically, significant economic shifts – such as moving to an internet-based economy – have also precipitated bear markets.

Signs of a bear market

Before stocks drop, investors may pick up on several signs that indicate an ending bull run or upcoming decline. Here’s what to watch for:

1. Extreme optimism

Bear markets often follow asset bubbles or bull runs that see investors become enthusiastic about the market. Unfortunately, extreme positive sentiment can often cause investors to overestimate the market, causing them to make investments that are ill-timed or unsupported by underlying metrics.

2. Rising borrowing costs

Rising rates means higher borrowing costs and less available capital. This has a direct impact on the capacity for companies to take on more investment, hurting economic output. Even if a specific company is not directly affected, higher rates decrease the value of many investments, including stocks because investors will apply a higher discount rate to future cash flow..

3. Decreased consumer confidence

Consumer spending drives economic growth. But if consumers stop spending, the economy slows, hampering business profits and investor sentiment while driving bear market cycles.

4. Increased likelihood of a recession

High interest rates, low economic activity, poor company performance, and government action can all discourage consumer spending and business growth. Combining these factors – with or without high inflation – can all lead to economic recession.

In turn, recessions may drive or worsen bear markets as investors lose faith in their investments and sell out.

Phases of a bear market

Bear markets often occur in four distinct(ish) phases:

• High prices and investor sentiment. During this phase, investor optimism causes prices to rise. When stocks peak, they may sell out to collect profits.
• Capitulation. Next, prices drop sharply, possibly preceded or followed by below-average economic activity, corporate earnings, and trading activity. Investors may sell in a panic.
• Speculators swoop in. Some investors use bear markets as opportunities to make risky trades or buy in while prices are cheap. Trading volumes may rise while stocks experience relief rallies.
• The bears ease up. Lastly, declining prices slow down. Low prices, good news and changing economic prospects attract investors, pulling equities back into the black.

Are we currently in a bear market?

Currently, part of the market resides in bear territory. For instance, as of May 17th, the tech-heavy Nasdaq Composite is down 24.3% since 3 January.

But much of the market remains in correction territory. The S&P 500 is down 14.75% since 3 January, while the Russell 3000 is down 15.85%. The Dow Jones Industrial Average has fared best, declining just 10.74% since the start of 2022.

And while the stock market at large may not be in for a bear of time (yet), economic indicators suggest consumers will have a rough go for at least a few more weeks.

According to the Bureau of Labor Statistics, consumer prices were up 8.3% year-over-year in April. While prices rose a mere 0.3% increase from March, inflation continues to rise, pinching Americans’ wallets. Meanwhile, producer prices jumped 0.5% between March and April, roaring full steam ahead at 11% YOY.

Already, the Federal Reserve has hiked interest rates 75 basis points (0.75%) this year to combat high inflation. But if these numbers are any indication, it’s not enough. Fed Chair Jerome Powell has also stated that he will back continued interest rate increases until prices return to healthy levels.

Unfortunately, the longer that inflation runs rampant, the more likely the U.S. will slip into a recession – and the more likely stocks will recede into bear territory. Thus far this year, both Deutsche Bank and Goldman Sachs have predicted a “meaningful risk” of recession by mid-2023.

How to invest during a bear market

Whether or not an official bear market occurs, investors are currently feeling the pinch in their portfolios. So, how do you protect your investments in bear country?

1. Shuffle your holdings

Some companies and sectors struggle more than others during bear markets. Trimming the losers while moving funds into defensive or hedging positions can reduce losses and even buff returns.

2. Diversify

Portfolio diversification reduces investment risk by spreading your capital among different:

∙ Asset classes

∙ Market capitalizations

∙ Industries

∙ And sectors

By leveraging your capital in non-correlated assets, you can reduce the impact of downturns while profiting off the upside.

3. Buy into dividends

Dividend-paying stocks and bonds generate extra cash flow to boost your earnings when stocks drop. Reinvesting your dividends in bear markets also provides an opportunity to purchase quality shares at a discount.

4. Try dollar-cost averaging

Dollar-cost averaging involves investing at regular intervals to “average” your purchase prices over time. Long-term, dollar-cost averaging smooths over your highs while ensuring you still buy the dips, generating greater gains than trying to time the market.

5. Focus on your long-term strategy

Bear markets can test your risk tolerance and mental health. While it’s difficult to watch your portfolio decline week after week, it’s easier to stomach losses if you keep your long-term strategy in mind. Taking a deep breath, reminding yourself of your future earnings potential, and taking a walk (or screaming into a pillow – we won’t judge) can help you resist the temptation to sell out.

Protect your portfolio when the bears come a-knockin’

It’s impossible to truly know if we’re headed for a bear market or not. But with Q.ai’s Downside Protection, you don’t have to worry either way.

Our Downside Protection strategy leverages AI-powered risk detection to predict and respond to market risk. When our AI detects current or upcoming risk factors, it implements data-backed hedging strategies to offset potential negative impacts.

While your gains may shrink slightly, so will your risk – helping you retain capital and peace of mind when you need it most.

Download Q.ai for iOS today for more great Q.ai content and access to over a dozen AI-powered investment strategies. Start with just $100. No fees or commissions.