3 Things You Need To Know About Bear Markets

Just the term bear market sends shivers of fear into most investors.  After six years of the super bull in U.S. stocks, investors have become complacent and feel entitled to double-digit yearly gains.

In light of the recent massive swings in the major indexes, the specter of the bear has become front and center in the mind of long-term stock market investors.  Questions are all over financial media about bear markets, how to identify one, and the best way to not only survive but thrive during the inevitable bearish periods in the stock market.

This article will answer these questions and aims to alieve any unfounded fears about bear markets.

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What Has Awakened The Bears From Their Caves?

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March 2015 marked the 6th anniversary of the stock market super bull.  The major stock market barometer known as the S&P 500 has more than tripled in value in just over half a decade.

However, things appear to be changing and changing fast.  The S&P 500 plunged over 6% last week alone representing its worst decline since 2011.  Markets continued to spiral downward this week with the Dow Jones Industrial experiencing its largest three-day price swing in history.

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Technically, the S&P 500 and the Dow have smashed through several critical technical levels over the last several weeks.  The most crucial support level, according to most technical analysts, is the 200-day n simple moving average. The two indexes penetrated on Thursday, helping to fuel selling. Both indexes dropped 2.1 percent that day, before further tumbling on Friday.

Fundamentally, stocks have been hit by a trifecta of bearish pressures. 

  1. Chinese Fears

China is the world’s second largest economy and is slated to move into the number one place in just a few short years.  What happens in China sends shockwaves throughout the global economy.

The recently announced depreciation of the Yuan has exasperated grave fears that the economic situation in China is far worse than the government pundits are letting the world know.

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The additional negative news hit the wire as a gauge of manufacturing revealed the critical Chinese manufacturing sector is continuing to falter.

Another reason China’s has such influence over the U.S. stock market is the fact that plunging Chinese demand has resulted in a steep decline in commodity prices.  Critical infrastructure core ingredients like iron, copper, oil have had their prices slashed, in turn, cutting the profits for U.S. commodity producers.

The Chinese government’s surprise devaluation of the yuan also sparked fears of a global currency war further adding to the bearish sentiment.

  1. Oil Price Plunge

Due to the fact that drillers and energy producers make up a weighty segment of the S&P 500, the bearish oil market has pressured the stock market lower.

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Remember, the peak oil fears?  Well, the opposite actually occurred.  Oil has dipped to below $40.00 per barrel marking its lowest price in many years.

  1. Profit Dip

Corporate earnings have been disappointing recently.  Companies in the S&P 500 earnings have only grown by 0.07% year over year per S&P Capital IQ.  This represents the slowest earnings growth in since the financial crisis ended 6 years ago.

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What is happening is that consumers have pulled back on spending despite the overall improving economy.  Rather than spending extra money, evidence is indicating that consumers have decided to pay off debt.  Perhaps many consumers are gun shy due to the last financial crisis.  Whatever the reason, it is not a positive sign for the economy.

Now that we have an understanding of what is happening in the economy that may result in a bear market,

Just What Is A Bear Market?

Bear markets are officially defined as a drop of 20% or more from the previous highs.  This means that the Dow Jones Industrial Average would have to drop to 14600 in the cash index before an official bear market is underway.  The Dow dipped to a low of approximately 15300, which is just a stone throw away from bear market territory.  A market correction is generally defined as a dip of 10% from the highs.  Under this definition, stocks are in correction or mini-bear territory.

Bear markets and corrections are not as rare as you may first think.  According to Ned Davis research, there have been 123 mini-bears or market corrections from 1900 to 2013.  This is one per year for the 123 year time frame.

Official bear markets have occurred 32 times during this same time frame.  This represents one every 3.5 years.

3 Things You Need To Know About Bear Markets

 

  1. How Long Do Bear Markets Last?

Azzard Asset Management told CNBC that the average 10% correction or mini-bear market lasts about 10 months.

While official bear markets last for an average 15 months, with stocks declining 32 percent.

The bear market from 2007 to 2009 survived for 17 months and knocked the Dow Jones Industrial Average down over 50%.

bear market chart

The good news is that official bear markets are generally shorter than bull markets.  It is important to note that long term stock investing has proven profitable despite the corrections and bear periods.

Looking at the numbers, the S&P 500 has profited an average of 9.9 percent a year, including dividends, from 1900 through 2013, and returned 13.7 percent last year.  Looking at 2015, the S&P is down 6.6 percent before dividends.

 

  1. What Triggers A Bear Market?

History has proven that bear markets can be triggered by a variety of factors.  There is no single cause of a bear market.  Sometimes it is a geo-political event like the Iraqi invasion of Kuwait in 1990 or the 1973-74 bear market caused by the formation of OPEC.

Internal economic factors can also trigger the bear.  In 1982, the Federal Reserve started jacking up interest rates to fight inflation and a bear market in stocks was the result.

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Other times, like we witnessed in the tech crash, simple overvaluation of stock prices can result in massive selling turning into a bear market.

Today, should a bear market be triggered, it will likely be from a combination of the Federal Reserve rate increase, international pressures, and profit taking from the long term bull market.

 

  1. How Can You Profit From The Bear

The good news is that savvy investors can continue to profit despite even a powerful bear market.  In fact, some investors can become extremely wealthy during bear markets in a short period of time.

The most common way to profit when stocks are trending down is to short individual stocks and the indexes themselves via ETF’s and futures.

Using derivatives such as selling calls or buying puts is another time tested way to profit during bear markets.

Interestingly, bull market rallies during bear markets are often very sharp and severe.  This means that investors can actually go long during bear markets and create strong profits.  However, this is only recommended for nimble and experienced investors.

Buying solid stocks at steep discounts is another way long term investors can profit during bear markets.  Sometimes, certain stocks, are simply too cheap to pass up.  This is one way professional traders earn outsized gains.

Always remember that stocks often drop faster than they climb higher therefore the judicious use of stops is critical during bear market periods.