Out of the way you Scorpios and Capricorns. When it comes to the stock market, there are two signs of significance: the bull and the bear.
In stock market parlance, a bear market means stocks have fallen 20 percent or more. Figuratively speaking: The bear is driving its paw from the top to the bottom.
The bull indicates that the market has risen significantly. He moves his head with horns from the bottom to the top.
Both markets are part of the life cycle of the stock market: investors are likely to experience both phases at some point. But knowing what’s coming can help guide investment decisions.
What is a bear market?
A bear market is when the share prices of the most important market indices, such as the German Dax40 share index or the U.S. S&P 500, fall by at least 20 percent compared to their last peak.
Otherwise, it is more commonly referred to as a market correction. In this case, prices collapse by at least 10 percent, and the decline is usually of much shorter duration.
In general, corrections do not result in full bear markets. But if they do, the bear market results in an average decline of 32.5 percent from the market’s last peak.
A bear market is often caused by a weakening economy and rising unemployment rates. During these times, the majority of investors are pessimistic about the outlook for the stock market. The changes in the stock market may be accompanied by a recession.
However, a bear market does not always indicate an impending recession. In the recent past, a bear market has been followed by a recession about 70 percent of the time.
During a bear market, many investors want to sell their investments, either to protect their capital, preserve cash, or shift their holdings into more conservative securities. This creates the unintended side effect of a sell-off that causes stock prices to fall even further.
In addition, investors may sell their investments at a lower price than they originally paid and walk away with a loss.
Although bear markets have become less frequent overall since World War II, they still occur about every 5.4 years. So as an investor, you can expect to witness about 14 bear markets.
How long does a bear market last?
From a historical perspective, bear markets are usually shorter than bull markets. The average period of a bear market is only 289 days, or less than 10 months.
Some bear markets lasted for years, while others lasted only a few months. The longest bear market occurred from March 1937 to April 1942 – the Great Depression in the U.S. – and lasted 61 months. During the last decades, however, bear markets have generally become shorter. In 1990, for example, the duration of a bear market was only about three months.
Since World War II, it has taken an average of about two years for the stock market to recover or reach its previous high. However, this is not always the case.
The last bear market, which began in March 2020, was unusually short and ended in August, when prices closed at a record high. In contrast, the previous bear market, the Great Recession, lasted about four years before a recovery occurred.
It may be that the stock market can make big gains even during bear markets. For example, over the past two decades, more than half of the S&P 500’s strongest days occurred during bear markets.
What is a bull market?
A bull market is when a major stock market index rises at least 20 percent from its most recent low. During a bull market, stock prices rise steadily and investors are optimistic and confident about the future results of the stock market.
Bull markets indicate a strong economy and, more generally, low unemployment rates. This further boosts investor confidence and people have more income to invest. This can result in massive growth: Stock prices rise by an average of 112 percent during bull markets.
How long does a bull market last?
Bull markets can last from a few months to several years, but they tend to be longer than bear markets. They also occur more frequently: Over the past 90 years, we have experienced bull markets 78 percent of the time.
The average bull market spans 973 days, or 2.7 years. The longest bull market lasted from 2009 to 2020 and gave stocks growth of more than 400 percent.
What should you do in a bull or bear market?
While bull markets don’t usually cause too much stress, bear markets are often accompanied by fear and uncertainty. However, how you should handle a bear market depends on your long-term investment goals.
If you’re decades away from your savings goal
If you’re in your 20s, 30s or even 40s and heading for a distant goal like retirement, you should hold on to your stocks and just keep investing during any market.
If you invest in a diversified portfolio, your investment will withstand bull as well as bear markets. You may be tempted to sell your investments to avoid losing more money during a bear market.
However, by doing so, you only solidify the losses you have already suffered. You also face the difficult problem of finding the right time to re-enter the stock market.
Market timing is notoriously difficult because you never know when the market will bottom. A study by Charles Schwab found that someone who shifts their stock holdings into cash on a short-term basis and waits for the right time to re-enter is giving away about a 30 percent return.
Instead, look at bear markets as opportunities: if you’re young, you can profit from lower stock prices. For example, if you invest monthly in a savings plan and buy additional shares or ETF shares at a lower price.
A bear market can also be good from a psychological point of view. You may find that your risk appetite is lower than you initially thought and rebalance your portfolio in the medium term.
When you are approaching your savings goal
As you approach the end of your investment period (i.e. you have only a few years left until retirement), you have less time to recover from price drops. Even though we know that the market has recovered from every bear market in the past, you may not have the two years that a recovery takes (on average).
For this reason, it’s a good idea to review your securities portfolio several times over the course of your life and make adjustments if necessary, i.e., reallocate safe versus more volatile investments accordingly.
Specifically, this means buying or selling different securities to arrive at the mix of stocks, bonds and cash that suits your investment goals and risk tolerance.
If you’re already retired
Those who are no longer drawing active income often shift their investment strategy to capital preservation. Growth, on the other hand, is often less important. In general, this means that you should be more conservative in your investments, i.e. you should focus more on cash, bonds and fixed-income securities than was previously the case.
If you live on savings, this in turn carries a risk: In bad times or in times of high inflation, you may withdraw more money than you actually have available. So you may end up running out of funds too quickly. It is better to stick to a proven withdrawal rule, the so-called 4 percent rule.
The 4 percent rule states that you can safely withdraw 4 percent from your investment portfolio in the first year of your retirement. After that, you can withdraw the same amount each year, adjusted for inflation, without running out of money for at least 30 years. It’s worth noting that the study that established the 4 percent rule found that this statement applies to both bull and bear markets.
However, if you’re particularly concerned about stock market returns in retirement, you might as well just take out 3 percent of your portfolio.
Here’s what you can take away from the text
Although bear markets can be scary at first glance, they are part of a normal economic cycle and often lead to even higher market returns. A diversified portfolio that reflects your long-term investment strategy allows you to confidently stay the course and withstand any market.