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The Most Important Signs Of A Bear Market

All of the last bearish market had the same preliminary signs. Here are the most important signs of a bear market you have to detect on time
Author: Jack Wickens
Jack Wickens

Writer, Contributor

Experience

Jack is a personal finance writer who has been writing for more than a decade. His passion for educating consumers and helping everyday families earn more and live better. He is most knowledgeable with years of experience covering topics such as savings, budgeting, and responsible credit use and always happy to share his expertise with readers.

Review & Fact Check: Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Financial Expert, The Smart Investor CEO

Experience

Baruch Mann (Silvermann) is a financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.
Author: Jack Wickens
Jack Wickens

Writer, Contributor

Experience

Jack is a personal finance writer who has been writing for more than a decade. His passion for educating consumers and helping everyday families earn more and live better. He is most knowledgeable with years of experience covering topics such as savings, budgeting, and responsible credit use and always happy to share his expertise with readers.

Review & Fact Check: Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Financial Expert, The Smart Investor CEO

Experience

Baruch Mann (Silvermann) is a financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.

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Table Of Content

After hitting record after record, should we afraid the bears are coming?

A lot of Wall Street veterans say “bullish” markets won’t die from growing old. However, after almost an entire decade of these bullish markets and rising trends, we may need to consider the idea of a peak, and then perhaps a “bearish”, down-falling market.

A bull can’t go on for eternity. “What goes up must come down”, and after the thrills and excitement of these bulls, the bears come in inevitably. Take, for example, the Standard and Poor’s 500 stock index: since the 1930’s, twelve ups were followed by downs (these were downturns of 20% or more).

Even so, the average bear market is about 40%. If more evidence for this is needed, we can look at the 2007-2009 riddle in which the S&P 500 considerably dropped down 57%, as well as the almost 50% landslide post-internet stock bubble exploded in 2000.

Is the term “bearish” even useful here? Or do we need another one to describe these plunging markets?

What Causes a Bear Market?

A bear market develops when the economy is weakening and the majority of equities are losing value. This is a period of low economic activity, which has spilled over into the stock markets as a result of companies' poor financial performance.

When the stock market drops by 20% or more from recent highs, this is usually regarded as a “bear” market. The drop in share prices reinforces pessimism and fear among investors, forcing them to sell their stocks because it is assumed that the downward trend would continue.

This further perpetuates the the downward cycle. A bear market can be caused by a variety of events, such as poor economy growth, bursting market bubbles, pandemics, wars, geopolitical crises, and significant paradigm shifts in the economy.

Bear Markets vs. Corrections

Bear markets and corrections both indicate a decline in indexes, however, they are differentiated in terms of the magnitude of the decline. A correction occurs when stocks or indexes decline by 10% from the recent highs, a bear market on the other hand represents a 20% decline from recent highs.

Also, corrections are short-lived and could last for days or weeks, unlike bear markets that may last several months or even years. This is because while corrections may reflect price levels and market sentiments, bear markets reflect a wider economic reality such as a recession. However, a correction may morph into a bear market if the decline continues.

6 Ways To Detect The End Of A Bullish Market

We are actually living in the second-largest bull run, which is impressive because it has produced a fourth-best gain of nearly 254%. However, the bulls have to tire out at some point. Then, like waves in the ocean, it will reach its’ highest level, the peak, and start to crash like all of the bulls before it.

So whether you are a solid investor that prefer blue-chip stocks, semi trader investor who deals mainly with penny stocks trading or an adventurous investor deals with alternative investments such as Fintech and even a bitcoin – in all cases you should have detected the bullish signs beforehand and make the necessary adjustments.

To prepare for these “doomsday” predictions, we need to know what they are. Here are seven notable clues to look out for:

1. Extreme Optimism

Unfortunately, it seems when people get “happier” about the market, the better the chances of it crashing. This is a great example of the metaphor previously stated: “what goes up, must come down”.

How can you tell when investors and others are very optimistic?

  • The News – Recently on Barron’s, a headline read “Next Stop: Dow 30,000”, which shows a great amount of hope in the market.
  • Expected IPOs – Be sure to look out for IPOs like Snap, which had a 44% hop due to its’ debut. These investors are measured by what is called a “fear gauge” which is nicknamed “Vix”. The Vix is flirting very closely to its’ all-time low, which means the level of scared investors is quickly lowering.
  • Escalating Consumer Confidence – The Conference Board ran a survey in February wanting to know the confidence level of investors. The results? They received the highest measurement in almost 15 years! Also, the Industrial Averages for Dow Jones shows us an example of this with 12 record highs, and more chasing after it!
  • Rising stock valuations are another red flag – The average, in history, of trading the market is well below what we are trading at. In fact, we are trading at nearly double what we were in March of 2009, which is about 20x the earnings.

In stocks, it is extremely hard to think for your own and now “buy-in” to the hype of these bulls. Think on your own. It takes a complete change of mind, but it pays off in the long run. Don’t try to base your knowledge off of trend emails or what “everybody else is doing”.

2. Profitability of Companies Filing IPOs

When investors are afraid to buy at the lows of a downtrend, companies who sell IPOs will nearly fall to their knees for the buyers to get the word out about what they have. Often times, they do this by displaying they have strong signals, and also offer larger portions of the company.

In 2002 and 2009, the percentage of idle companies that went public was less than 2%. At the near peak of these bull markets, there are a lot of companies who invited other investors to partake in the fruit and invest in the risk, handing over the small parts of the company, but they were still documenting weak financials.

Since a decade high of 81 percent in 2009, the share of U.S. companies that were profitable after their IPO has been declining. By 2020, this figure had dropped to only 22%, which could spell doom for this method of capital raising. 

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3. When Borrowing Costs Are Distinctly Different

This bull is almost an entire decade old and has been fed 0% interest rates for around the same time. Why is this strange?

Because now, due to the high inflation,  the FED expect to raise the interest rates in 2022. These high rates impede the overall economy and impedes the profitability of the prices of stock.

High interest rates make it astronomically more difficult for the borrowers to keep track of their debts, which makes incisions on the consumer spending and cripple the well-being of businesses with high debt loans.

4. The Risk Of Increased Recession

When looking at RBC Capital Markets data, 7 out of 8 of bulls were dismantled by economic reduction. These reductions can cause the consumer spending to go down, cause the unemployment rate to go up, and can also lead to small corporate gains.

When the data from the economy is crippled, even more, crippled than what we thought, this raises a good red flag for trouble. Also, when our economic growth is starting to slow down, you should take caution of this as well.

5. Consumer Confidence Dying

It’s a simple concept in economics that shopping and spending money causes economic growth. Holidays and special times of the year cause our country, state, county, cities, and even more detailed parts of your demographic to flourish.

How important is this?

Americans shopping claim a 66% of the economic activity of the United States. If we spend less than this, it should absolutely ring a bell to be cautious. In 2008, for example, our Consumer Confidence Index hit a low, below 30, on the scale, but in February it was at 114.8. If you remember back to 2008, the economy wasn’t in full-health.

Don't forget: You should also be cautious when sensitive stocks start to degrade after a profitable session, as this is a good sign buyers are getting scared. If you need examples of these stocks, just look at the stocks who are at their peak when everything is “good” like businesses that sell products not needed for survival, banks, and stocks that involve transportation in them.

 

6. Fewer Stocks Are The Leaders/A Mess of Stocks Drop

When a market is rising, and the force of that rise is a few stocks and getting smaller, this is a sign of bad times ahead. You can check if a lot of stocks are now hitting their new 52 week lows and that they are more consistently dropping than rising in price, as these are extremely good indicators. Usually, after these two happen, and the lows keep increasing while the prices keep dropping, this means the veteran investors are quickly exiting the market.

So should we sell now?

According to these signs, we shouldn’t be drop-dead ready to sell, but after considering the fact that some of these signs have slightly started to happen causes the need of selling to be in our minds. Alternatively, we can look for defensive stocks for investment.

This bull has been running for a long time and keeps going. This should make us all cautious for the tired bull to end.

How to Protect Your Portfolio in a Bear Market

There are various ways investors can protect their portfolio in a bear market

  • Diversify: Portfolio diversification reduces risk and the effects of drawdown on your portfolio. By investing in different sectors and asset classes, the investor spreads his risks which reduces their average impact on his portfolio.
  • Dividend stocks: Investing in dividend stocks in a way of protecting your portfolio. The dividends bring extra cash flow. If reinvested, they can be used to dollar cost average thereby reducing the losses on the overall portfolio.
  • Portfolio restructuring: In a bear market, some sectors or companies would be hit harder than others. Restructuring your portfolio is a good way of protecting your investments. By increasing your position in quality stocks, and trimming your holdings in sectors or companies that would be severely hit, you reduce the proportion of drawdown on your portfolio.

How to Trade in a Bear Market?

Traders can profit from every cycle in the stock market, bear markets inclusive. Here are two ways to trade in a bear market

  • Take a short-selling position – Ac popular mantra among stock market investors is: The trend is your friend. Short-selling is the most obvious way to trade in a bear market.  Since the prices of stocks are on the decline, shorting stocks during a bear market allows the trade to follow the trend and profit from it. However, just because it is a bear market does not mean that prices cannot rally. As such, before shorting as tock make sure you conduct your technical and fundamental analysis.
  • Buy inverse ETFs – Traders can use Inverse ETFs to trade profitably during a bear market. An inverse ETF delivers inverse (opposite) returns of underlying indexes or assets it is tracking. For example, if the price of the underlying index declines, the value of an inverse ETF appreciates and vice versa. During a bear market when indexes and stocks decline, inverse ETFs appreciate.

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FAQs

The common way of ascertaining the end of a bear market is when prices have risen by 20% from their most recent lows.

However, the most viable way of establishing the end of a bear market is by looking at chart trends. if the chart shows higher lows and higher highs tend this could be an indication that a bullish momentum is building and the bear market has ended.

To be sure, you have to identify key support and resistance levels. Once there is an upside that breaks a resistance level, this may also be another indication of the end of a bear market.

Index funds generally do not do well during bear markets, but compared to individual stocks, the drops are less steep. Index funds track the performance of indexes. Since stocks decline by over 20% in a bear market, the drawdown effect would spill over to indexes.

However, because index funds are diversified and spread their holdings across different stocks in a particular index, the effect is less severe than when investing in individual stocks.

For example, while the price of  Apple stock may decline by over 25% in the bear market, the value of the S&P 500 may decline by 5% because of other stocks that may not decline by the same level as the Apple stock. An index fund tracking the S&P 500 would decline by 5% and not by the level of individual stocks.

A bear market presents a great opportunity to buy more stocks at cheaper prices. As legendary investor Warren Buffett says, “Be fearful when others are greedy, and be greedy when others are fearful”. As an investor, it is sometimes important to have a contrarian view, as this is one of the best ways to increase your gains exponentially. Buying stocks during bear market is an opportunity to increase your gains as you would have entered positions of utility stocks at cheap valuations.

However, there are also dangers with this approach. Firstly, you do not know when a bear market would end. As such, when you take a position, the price of the stock my continue to decline leading to losses.

Also, liquidity is low during bear markets, which impacts on the bid-ask spread. This makes it difficult to exit your position at your preferred price target.

Bear markets are well-known for their short lifespan. On average, a bear market lasts 289 days (i.e. 9.6 months). That's far shorter than the average bull market, which lasts 973 days (2.7 years).

The average time between bear markets over the long run is three and a half years. Since 1928, the S&P 500 Index has seen 26 bear markets. Bear markets have only accounted for around 20.6 percent of the previous 91 years of market history.

Despite the fact that bear markets indicate a drop in price if stocks and a downward market trend, it is still very possible to make money in a bear market.

The ways an investor can profit from a bear market include opening short positions, put options, and investing in inverse ETFs. For example, an ETF that performs inversely to the S&P 500 will rise by 10% if that index falls by 10%. A trader can also buy leveraged ETFs which amplify the gains of the underlying assets.

The market operates in cycles. At the end of one cycle, another begins. As such, when a bear market ends, this signifies the start of a bull market. A bear market is said to have ended when the stock market has gained 20% from its all-time lows.