The words themselves sound ominous — if not scary: “bear market.”
The S&P 500 entered a bear market in June, marking a 20% decline from the peak in January.
Bear markets often coincide with fear and uncertainty about financial markets in general. But what does history tell us about how long they last and how far the markets can drop? And how should you treat your investments during a bear market?
Table of Contents
- What Is a Bear Market?
- How Long Do Bear Markets Last?
- Is It a Good Idea To Buy During a Bear Market?
- Why Did We Reach Bear Market Status in 2022?
- Is There Any Reason To Sell During a Bear Market?
What Is a Bear Market?
According to the Securities and Exchange Commission (SEC), a bear market occurs when an individual stock, index (such as the S&P 500), or an entire asset class drops in price by at least 20% for at least two months.
Note everyone is as strict about the two-month timeline, but it’s a prolonged price decline of at least 20%.
Often, but not always, a bear market points toward a coming recession. Bear markets go hand-in-hand with negative investor sentiment. That includes pessimism and even panic.
Usually, companies are making less money. Future profit expectations decline. Media companies start writing stories about people who have been financially wrecked and individual stocks that have declined in price by dramatic amounts.
It can feel like things are only going to get worse.
The 20% number isn’t significant in a material way. It’s just an imaginary boundary that helps track and understand market performance. We also call a decline between 10 and 19.9% a “correction.”
No two bear markets are alike. But history can help us get an understanding of what to expect.
How Long Do Bear Markets Last?
The S&P 500 became an entity in 1957. However, we have historical records for the performance of the 500 biggest U.S. companies dating back to 1928.
There have been 27 bear markets since 1928 including the one this year, according to Hartford Funds. The average bear market has lasted 289 days — or about 9.5 months — with an average decline of 36%. (The longest, which stretched from 1973-74, lasted 630 days, or a little less than 21 months.)
Before World War II, the S&P 500 went into bear territory once every 1.4 years. Since then, we see the bears out only every 5.4 years.
The worst bear market saw the S&P 500 decline by 61.8% in 1931-32 during The Great Depression. Unfortunately, it was one of many significant market downturns in a window of about a decade.
The toughest bear market in my lifetime came during the financial crisis, highlighted by a 51.9% decline between Oct. 9, 2007, and Nov. 20, 2008.
Is It a Good Idea To Buy During a Bear Market?
Now that you know what a bear market is, you may be thinking of a popular investing trope: buy low, sell high.
The bad news? It’s virtually impossible to predict and time the top and bottom of the market.
The good news? You don’t have to time the market perfectly in order to profit.
First, know that money expert Clark Howard believes investing for retirement should be your top financial priority after taking care of your day-to-day needs. He thinks you should spend less than you earn. That way you can spend years putting a portion of your paycheck into your investments for decades.
Clark doesn’t think you should change your investing strategy whether the market is in bear or bull territory. (A bull market takes place when market prices are rising, typically for a period of months or years. The average bull market since World War II has lasted 991 days and led to a 114% increase in the S&P 500.)
Just because the S&P 500, NASDAQ or some other index has dropped by at least 20% doesn’t mean it won’t continue even lower. However, more than 80% of the S&P 500’s best days in the last 20 years happened during a bear market or in the first two months of a new bull market.
Three Ways To Invest in a Bear Market
There are three ways to invest during a bear market:
- Dollar-cost average. Rather than shoving all of your cash into the market in one fell swoop just because it has entered bear territory, consider contributing an equal amount every month or every paycheck. You’ll lower your cost basis — or the average price at which you entered the market — by continually buying during a bear market. And you won’t have to worry about timing it perfectly. Because you’ll slowly, steadily accumulate a bigger position.
- Diversify your portfolio. You don’t have to wait until a market downturn to diversify. Also, if you invest in a target date fund — Clark’s most common investment recommendation — you’ll have the diversification you need. But a bear market is a great time to make sure you’re properly allocated for your goals and timeline.
- Focus on the long-term. Don’t try to make any sudden, drastic moves or change your strategy significantly just because the prices are down.
How To Make Money During a Bear Market
There are a few ways to profit when the market is declining. The most common is what’s called shorting a stock. This is essentially a bet on the stock price falling.
Selling put options and buying inverse ETFs are other similar options.
All of these strategies are incredibly risky. You can lose the shirt off your back trying to pull off these aggressive gambles, so it’s generally not advisable.
Big market makers often short stocks when sentiment is bad and the market is falling. And lower prices also force those investing with leverage to sell at certain points.
So just be aware that sometimes the price action continues downward because of some of these market forces playing out rather than any material change in value for the companies.
Why Did We Reach Bear Market Status in 2022?
Aside from a short-lived bear market at the onset of the COVID-19 pandemic, we’ve enjoyed one of the longest, most lucrative bull markets in the history of the United States.
That all ended in January thanks to a confluence of several major factors. In hindsight, it probably should’ve been obvious that a significant market decline was very possible.
Here are a few of the major factors that caused the NASDAQ, and later the S&P 500, to enter bear market territory earlier this year:
- Overheated market. Stocks entered the year historically overvalued based on the typical ratio between a company’s actual earnings and stock price.
- Inflation. The most recent inflation number, 8.6%, is the highest we’ve seen in the United States in more than 40 years.
- Rising interest rates. The Federal Reserve raised interest rates for the first time since 2018. It has done so aggressively, raising the rates a combined 1.25% at the last two meetings alone, while signaling for more rate hikes on the horizon.
- Threat of a recession. More and more people suspect that the U.S. will enter a recession — if we aren’t in one already.
- Supply and demand. We’ve seen continued supply chain issues because of the pandemic. We’ve also seen a wonky oversupply of certain items, especially during unusual or out-of-season times of the year.
- Russia-Ukraine conflict. The war in Ukraine has impacted gas prices, among other things, contributing to the supply issues that the pandemic created.
Is There Any Reason To Sell During a Bear Market?
The IRS allows you to offset up to $3,000 in taxable income every year by realizing a loss in the stock market.
In other words, let’s say you make $100,000 in taxable income in 2022. But you bought $10,000 worth of Amazon stock, which you then sold for $7,000 when the market started to drop. Because of that $3,000 loss, you can offset some of your taxable income, reducing it to $97,000.
You can also roll over any realized losses in excess of $3,000 and apply them against your income in future years.
Now, you don’t want to sell all your long-term investments just to lower your tax bill, thus missing out on future market gains. There are rules about when you can re-buy stocks that you’ve sold at a loss for tax purposes.
The other legitimate reason to sell during a bear market? If you need the money to put food on the table, pay your bills and take care of your basic needs. Ideally, with discipline and careful planning, you can avoid this scenario. But life doesn’t always work off of a perfect script.
The simplest definition of a bear market is when the S&P 500 or NASDAQ declines 20% or more from its most recent high point.
Although bear markets have become infrequent since 2009, they’re common — and even necessary — for the long-term health of the markets. They offer an opportunity to buy at cheaper prices. And they eventually end.
It’s important not to panic even when the news media and your peers are in a tizzy about the prices and your nest egg loses some zeros. Investing is a decades-long game and requires patience and discipline to stick to your plan.