What is a bear market and how can you survive one?

Falling markets represent one of the biggest challenges you face as an investor, but these testing periods are an inevitable part of investing.

| 4 min read

The Nasdaq, the US technology-heavy market is in a ‘bear market’, down around 27% since December 2021. This decline is not quite matched by the broader US market, the S&P 500, which is 18% lower. That too could easily tip into a bear market – generally considered to be a fall of over 20% from the most recent high.

The origin of the term ‘bear’ in the context of markets is unclear. It is thought to come from 18th-century hunters selling bear skins before catching their prey in the anticipation that prices for them might fall. Whatever the starting point, it has come to be associated with those that believe markets are going to go down, or with the price action itself.

This particular bear phase has been caused by central banks’ efforts to reduce inflation by restricting economic growth. Inflation is running several times higher than the generally accepted target of 2%, and authorities are likely to continue on a path of raising interest rates until they see it start to come down towards target.

Inflation appears to be peaking, but how quickly it falls back will be critical to the end of the bear market. Persistent inflation will mean central banks won’t be able to ease off on tightening monetary conditions and allow economic growth to recover. We may not be out of the woods this bear inhabits just yet.

Bear markets are normal

It’s important to remember, though, that bear markets are a normal part of investing. They happen from time to time, but it’s hard to predict when and why. They are only obvious in hindsight when the warning signs suddenly look clear as day. Yet in the long term, they can also present good opportunities to acquire assets as others despondently sell.

It’s not easy to do that of course. In fact, it’s one of the biggest challenges you face as an investor. In a bull, or rising, market, investing feels fun. Seeing investments rise is rewarding and offers proof you were ‘right’. It seems appropriate to invest some more. A bear market turns the feel-good factor around. Confidence gives way to doubt. Committing money to invest is beneficial in the long term, but is mentally taxing when prices grind lower. Investing feels uncomfortable and it’s easy to lose interest or give up.

That tends to be the wrong reaction though. Decisions made in a bear market can be really important in the longer term. Those that threw in the towel during the Dotcom crash (which lasted 18 months, during which the S&P 500 fell 57%) or the Global Financial Crisis (which lasted 2 years, during which the S&P fell 49%) will have regretted that decision when things turned around. In the 14 years following the crisis the broad US market rose sixfold and the Nasdaq over twice that.

Nature is healing

Another way to think about bear markets is that they blow excess froth and complacency away. Highly-priced assets with overly optimistic projections built in come back down to earth. Those using inappropriate levels of debt or an overconcentration of investments to juice return are exposed. More resilient, diversified portfolios do inevitably take a hit, but they live to fight another day – and harness the next bull market.

On encountering an actual bear in the wild, the general advice is to not panic and to stand your ground – contrary to our natural instinct to run. Similarly, the flight response is not helpful when investing. It generally involves two decisions, selling and then rebuying, and it is fiendishly difficult to get these right. Plus you’ll stop the flow of income from dividends and interest from your investments.

It’s therefore generally best to resist the urge to trade the choppy and volatile markets or make hasty changes that undermine the longer-term objectives of your investment portfolio. However, if the bear market is a wake-up call that it wasn’t sufficiently diversified then consider taking measured action to ensure you have a better balance going forward.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

What is a bear market and how can you survive one?

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