A trend of falling stock prices for an extended period is considered a bear market. Substantial deterioration of at least 20% or more has to be recorded for a market to be classified as bearish. It is typically characterised by a falling speculative demand among residents, thereby reducing the aggregate cash flow of the capital sector in an economy.
A bearish trend depicts slowdown of an economy, with rising investor pessimism and recessionary trends. As the total amount of investments undertaken falls significantly in such events, owing to a slowdown of aggregate demand, businesses often face a monetary crunch, thereby reducing their total output. Therefore, a country often faces high unemployment problems, a downtrend in the overall price level causing deflation. A poor stock market performance is a major indicator of recession.
In this article
How to Recognize a Bear Market?
- Falling stock market indices
A downtrend in the major benchmark indices operating in the country indicate a bear market, wherein investors prefer holding their money or deposit the same with risk less instruments rather than invest in the stock market.
Nonetheless, a bear market can only be declared if the fall in such index values is higher than 20% and prevailing for a period for at least 60 days or more. This differentiates stock market variations owing to external factors or uncertainty prevailing in the economy, which might only have a short-lived impact. Bearish markets, on the other hand, report figures indicating slowdown of a country for at least 2 months or more.
As a stock market bear often creates a negative outlook towards investment, individuals usually prefer hoarding their money in fear of incurring losses. Investors adept with the workings of the stock market often develop a mind-set regarding a further fall in the stock market prices in such bearish circumstances, further aggravating the rate of fall of such stock prices.
Combined with low aggregate demand for general goods and services manufactured, a higher supply caused the general price level to decline sharply, marking a recession. Such economic conditions are characterized with persistently low demands and falling price levels by most functioning sectors of the country, resulting in a fall in the GDP of the country.
A severe case of recession is indicated through negative growth rates of a country, corresponding with high unemployment rates, along with adverse impacts on the stock market prices.
Causes of a Bear Market
- Unexpected fluctuations
Fluctuations can arise due to socio-economic turmoil in a country as well. As political decisions impact the performance of major companies operating in an economy, investments are likely to take a hit as well.
- Global mind-set
With rising interdependence among the countries in the world, any fluctuation in the performance of a sizable major economy is bound to have repercussions in a domestic economy. A recent example can be cited in this respect when tensions between America and China, two of the biggest economies in the world, caused uncertainty among Indian investors as well, leading to a fall in the sensex points.
As relations between the two global superpowers are likely to impact the Indian economy as well through fluctuating imports and export revenues, the profitability of domestic industries is expected to vary accordingly.
- World recession
A global pessimistic mind-set can trigger a worldwide recession, generating a bear market in all major stock markets operating in the world. As companies tend to underperform owing to reduced market demand for their products, the respective share prices tumble on stock exchanges as well.
Such stock market fluctuations affect both large, mid and small-cap companies, wherein a more significant effect is observed in the small and mid-cap businesses, owing to their high degree of volatility.
Types of a Bear Market
- Secular – A secular bear market trend represents long term economic conditions in the stock market, occurring due to domestic policies. Secular trends leading to a bearish outlook can have long-lasting effects in an economy, often discouraging investors from partaking in hefty investment ventures.
High interest on bonds, treasury bills, and other zero risk instruments encourage individuals to undertake investments in these tools, thereby reducing the total speculative demand for stock market instruments, generating a bearish stance in the stock market.
A secular market trend was observed from 1983 to 2002 when the United States of America witnessed the do com bubble.
- Cyclical – Cyclical bear stocks arise due to business cycle fluctuations in an economy, which usually occur every 7-10 years. Markets often adjust after a prolonged period of boom, characterised by extensive growth rates demonstrated by all major sectors of the economy.
A cyclical downtrend in the stock prices is a common occurrence in a country, wherein falling stock prices adjust automatically in a couple of months to regain a positive outlook regarding investments in the stock market.
An example of a bearish market trend was the global economic slowdown of 2008-09, triggered by the subprime mortgage crisis caused due to the overinflated housing asset bubble in America.
Market Correction Vs Bear Market
Whilst the best market represents a prevailing fall in stock prices by more than 20% for already two months, market correction is an automated adjustment of the prevailing stock prices followed by a bull market.
The occurrence of market corrections followed by a trend of rising stock prices (bull market) makes way for the prices to soar even further, encouraging vigorous investment patterns. This is a classic indicator of a developing economy, wherein a well-performing stock market generated a positive impact on the GDP of the country as well.
Bear share markets have an opposite impact on an economy, as investors withhold any new stock market deposits in fear of incurring losses. This pessimistic approach reduces the cash flow of the capital market, which, in turn, lowers the total output generated in the respective financial year (GDP).
Cyclical movements in the business cycle are known to cause a recession in an economy, characterised by a downtrend in the overall price level. This includes fall in the average stock prices resulting from reduced demand, which, in turn, lowers the value of benchmark indices in a country.
The first sign of an upcoming recession is a significant value drop of major indices associated with the foremost stock exchanges of a country. For example, in the event of a recession, the first warning sign is a massive fall in the Sensex and Nifty points, associated with Bombay Stock Exchange and National Stock Exchange, respectively.
Looking back at the event causing a recession in India and its corresponding impact on the stock market of India, major bearish markets should be taken into account to develop a clear understanding –
- The great depression of 1929
Reported as the most prolonged depression of the modern world, the great depression was triggered by a bearish market trend and was persistent for about 10 years. As years prior to 1929 saw an immense speculation drive, many individuals purchased overinflated assets at prices higher than their absolute value. Such a rise caused companies to resort to excess production, thereby leading to excess supply in the market. This caused the average price level to fall significantly, causing deflation, the effects of which penetrated to the stock market as well.
The stock market crash of 1929 was first marked the onset of the great depression, when a massive sales volume of approximately 12.9 million shares was recorded on 24th October 1929, which came to be known as Black Thursday marking the beginning of bear in share market.
- 2008 recession
A global financial slowdown was witnessed following the subprime mortgage crisis in America, followed by the collapse of one of the biggest financial institutions in the world, Lehman Brothers Holdings Inc. Owing to globalisation, India also felt effects of this economic slowdown, as witnessed by a fall in Sensex points by 1408 points on 31st January 2008. As the world faced the brunt of this recession, Indian investors undertook a bearish investment pattern and preferred withholding their money and depositing the same in risk-free tools.
What Should Investors Do?
A stock market bear witnesses receding investments from individuals having a lower aptitude for risk initially during initial plummeting prices. Such an investment strategy often leads to significant losses on the part of investors, thereby reducing their speculative investment demand even further. Individuals disregard the importance of long term growth in this regard and sell procured securities in fear of short term losses. A bear market automatically adjusts in a couple of months to reflect the real value of stocks, leading to capital gains of shareholders who purchased respective securities at reduced costs.
The primary point to be noted in this regard is that stock prices don’t remain stable in the market, and fluctuate readily corresponding to changes in the business cycle. As a result, securities purchased at reduced costs can be sold later on when the market recovers from a bearish outlook, helping investors realise substantial capital gains in the process.
Also, immediate sale of securities leads to substantial losses on the part of investors, while withholding the same can be a profitable venture. In the long run, when the prices adjust to a bullish outlook (rising prices), the profitability of major operating companies increase significantly, which, in turn, ensures significant dividend pay-outs in the future. For investors looking to receive a steady periodic cash flow should opt for holding their investments in the future in the prevailing stock market bear for wealth accumulation in the future.
Thus, a persistent fall in the stock market prices (higher than 20%) should not cause investors to panic, as the market is bound to adjust automatically in the long run. Holding funds invested not only allows individuals to escape short term losses, but also lead to long-run profits (through both long term capital gains and dividend pay-outs) when the economy adjusts automatically, and a positive outlook regarding growth is undertaken by investors. A rise in the stock prices drag an economy from recession and pave the way for robust growth through higher output generation and rising GDP.