Though over the longer term the stock market has tended to move higher, we still experience down markets lasting for various periods of time on a fairly regular basis. Sometimes this is a short blip, other times it is more protracted. In some cases, these downturns are called bear markets.
What is a bear market?
A bear market is one where a broad market index declines by at least 20% from their recent highs. A correction, on the other hand, is when the market drops anywhere from 10% to 19.9%.
Bear markets are not unusual as there have been 28 bear markets since 1928. Bear markets tend to be shorter than bull markets on average at less than a year in duration compared to over 3.5 years for the average bull market.
What causes a bear market?
In many cases, a bear market occurs just prior to or just after the economy moves into a recession. The prospect of reduced earnings growth in companies, combined with lower wage growth, higher interest rates and higher inflation.
Bear markets can also be event driven, such as the steep, sudden and short bear market we saw in 2020 sparked by the onset of the COVID pandemic.
What should investors do during a bear market?
One of the key things for investors to do is similar to what they should do in a bull market, invest with a long-term focus. A diversified portfolio that is tied to their investment time horizon and their risk tolerance is an appropriate strategy in any type of market cycle.
In this long-term investing context, here are a few things for investors to consider during a bear market.
- Focus on quality. A bear market, especially one fueled by a downturn in the economy and/or an increase in interest rates will often expose weaknesses in companies. Quality companies, built for the long-term with strong business models and healthy balance sheets stand a better chance of weathering the bear market environment than a company whose business fundamentals are weak. These types of stocks are often referred to as defensive stocks.
- Assume you won’t catch the bottom. This can be a good time to buy stocks of solid businesses that have declined in price. Even if the price drops a bit more after your purchase, this may well turn out to have been a sound purchase over the long term.
- Along these lines, consider building positions in depressed stocks gradually. If the price declines after your initial purchase you will be buying additional shares at a lower price. If it goes up a bit, you are likely still purchasing shares at a historically low price.
- Be sure to rebalance your portfolio to maintain your target asset allocation. This includes putting new money to work to shore up those asset classes that are below your target allocation.
- Invest over time and on a regular basis. If you are contributing to a workplace retirement plan like a 401(k), continue to make your regular contributions. You are buying more shares of the plan investments while the market is lower, this can pay off over time for long-term investors.
Are we entering a bear market?
Many experts think the crisis in Ukraine is the event that may push us into a bear market. At one point in mid-March of this year the S&P 500 had declined just over 13.0% on a year-to-date basis, not in official bear market territory. The index had regained much of this ground during the latter half of March.
The crisis in Ukraine has certainly contributed to the market declines so far in 2022. This situation plus the Fed indicating an increase in the Fed Funds rate and an unwinding of their balance sheet could contribute to a further decline in the market at some point. Whether these or other factors will lead to a full bear market remains to be seen. Experts are very mixed in their opinions of whether or not we are heading for a bear market in 2022.
The reality is that while we may or may not be headed for a bear market this year, the market could remain choppy. This is a good time to review your investment strategy with your Wedbush advisor to see if any adjustments may be needed.
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