Your Bear Market Primer

What is a bear market? How should you approach one as an investor? What should you expect in the months ahead? Let’s discuss those issues today.

A bear market is defined as a 20% correction of a major index from a recent high. The technology-heavy NASDAQ Composite Index has been in a bear market since last month. On Friday, the S&P 500 touched that mark for the first time (on an intraday basis) since the pandemic-induced meltdown of 2020.

This sell-off is different than the 2020 bear market. At that time, energy stocks led all sectors lower. This time, the energy sector is still in a roaring bull market, while the technology, communication services, and consumer discretionary sectors are leading stocks down.

Bear markets are more common than many investors think. Since 1945, we have averaged one about every five years. The average bear market lasts about 10 months, and stocks lose about 36% on average. Of course, it can be better or worse than this, but knowing these facts can help you steel yourself against what may be to come.

Missing the target…

There are many factors that lead to a bear market. Presently, rising inflation, driven by high energy prices, is hitting the profitability of many retailers. Target (NYSE: TGT) reported poor earnings and a disappointing outlook last week, and the share price declined by an astounding 25% in one trading session. It just goes to show that no company is immune to a large sell-off if it fails to meet expectations.

Other retailers followed Target last week by reporting a disappointing outlook. That sparked fears in an already nervous market, and that helped push the S&P 500 into bear market territory on Friday.

Technology stocks are often the first to be hit, and the hardest to be hit in a bear market. Depending on the cause of the bear market, energy stocks can do quite well, and are an effective hedge during a bear market. Defensive sectors such as utilities and consumer staples also tend to outperform the market, but during a significant bear market no sector is immune from declining.

As an investor, you have to take a long-term view. Sure, bear markets are bad, but bull markets are longer (~3 years on average) and the gains are larger than the bear market losses (~114% gains during the bull market versus 36% losses during the bear market).

What about timing the market? Ideally you would like to sit out the bear market, and only come back in during the bull market. Sure, that’s ideal. Just like you can quickly become rich in Vegas if you only pick the right numbers on the roulette wheel. It’s nice in theory, but practically impossible to achieve.

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Here is why. Nobody knows when a bear market will start, or when it will end. You only know a bear market is happening (or threatening) after stocks begin to decline. So, if you anticipate a bear market and sell your shares, you have already sold them after an initial decline. You have clipped your gains in fear of further losses.

On the flip side, bear markets can end rapidly, and have a huge bounce as they transition back to a bull market. Studies have shown that if you miss that initial bounce, you will significantly underperform the market. But how can you anticipate such a bounce? You can’t do it accurately and consistently. Thus, you will only enter the market after the rise begins, once more clipping your gains.

The only answer is to stay invested in quality stocks, and just keep deploying money. It’s psychologically tough to do when the market is declining. It’s easier if you don’t check your account on a daily basis, and you have automatic investments that are dollar cost averaging for you.

In the long run, building wealth is really as simple as that. Ignore the noise about bull and bear markets. Just invest consistently across all cycles, and let time and long-term growth build your wealth.

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