What is a Bear Market?
The terms "Bull Market" (upward trending) and "Bear Market" (downward trending) are believed to have come from the way each animal attacks- Bulls thrust their horns up and Bears swipe their paws down. In terms of price action, when a market falls 10% from recent highs it is typically called a "correction" whereas a 20% decline is considered a Bear Market.
According to research from Ned Davis Research, from 1900 through 2013 we have had approximately 1 correction per year and a bear market every 3 to 4 years. The losses from an average correction have been recovered within approximately 10 months whereas an average Bear Market lasts closer to 15 months.
Closer inspection of the definitions above raise some important questions. For example, how should we define "the market?" Should we look at a particular index like the S&P 500, the Dow Jones Industrial Average, or something broader like the MSCI World Index? Can a single stock be in a bear market? Should the velocity of the decline be taken into account? For example, on October 19, 1987 (Black Monday), the Dow Jones Industrial Average declined by 22% in one day. Should that be considered a Bear Market? A market crash? Something else?
What about the Economy?
While people are asking if we are in a Bear Market, they are probably as concerned with whether our economy is heading for a recession. After all, the stock market is really just one big indicator of the health of our economy. A recession- often defined as two consecutive quarters of negative GDP growth- is characterized by falling wages, rising unemployment, declining retail sales, an increase in bankruptcies, and a generally pessimistic tone.
Based on data from the National Bureau of Economic Research (NBER), the average length of a recession is 15 months. Coincidentally, that is also the average length of a Bear Market. On the surface, 15 months does not sound like a long time but it is painful while we are in it. Behavioral Finance teaches us that negative events tend to have an impact that is twice as large as positive events.
What can we do to protect ourselves?
The absolute best advice we can offer clients is to make sure you are comfortable with both the types and level of risk in your portfolio. Make sure you understand how your portfolio is likely to perform under various market conditions (i.e., if interest rates rise, if inflation picks up, if we do see a recession, etc.). If you find yourself checking your portfolio constantly or you are glued to CNBC, Bloomberg, or Fox Business it might be a sign that your portfolio is too risky. Rebalancing is a simple but often overlooked portfolio management tool that can be particularly crucial at market inflection points.
Emotion is probably the greatest risk when it comes to investing. Try to set objective goals ahead of time so that when volatility strikes you don't have to exercise judgment, you can just execute your plan.
While it is easier said than done, the most widely cited investment aphorism is "Buy low, sell high." In other words, expected future returns are higher the lower prices go. With that in mind, perhaps we should view our next Bear Market as a buying opportunity.