Introduction to the bear market
While we all want the good times to last forever, the economic reality is that financial markets go up and down on a daily basis.
Investors must contend with a degree of volatility as market conditions change. They can fluctuate at macroeconomic, company, market and global levels. But the good news in Australia is that a down market always recovers over time.
A bear market is a period of falling share prices. The technical definition is a 20% or more decline in share prices over at least two months.
In a bear market, investor confidence falls to low levels. Many investors opt to sell their shares to avoid further losses, thus fuelling a vicious cycle of negativity.
The term relates to the manner in which a bear attacks.
A bear will usually swipe its paws in a downward motion upon its prey. For this reason, a market downturn with continually falling share prices is called a bear market.
What are the bear market phases?
Bear markets typically begin when investor confidence wanes following a more robust trading period and rising share prices.
As investor sentiment grows increasingly pessimistic about the state of the market, investors tend to sell off their investments in anticipation of falling share prices.
This behaviour can cause widespread panic selling, and share prices can plummet when it does. Trading activity tends to decrease, as do dividend yields when this happens.
At some point during a bear market, investors will typically try to capitalise on the lower stock prices by reinvesting in the market.
As trading activity increases and investor confidence begins to grow, the bear market will eventually transition to a bull market.
Bear vs bull market
A bull market is marked by strong investor confidence, economic growth and optimism. In a bull market, share prices go up.
The term derives from how a bull attacks. Bulls tend to charge with their horns thrusting upwards into the air, so trading periods dominated by continually rising share prices are called bull markets.
Unfortunately for investors, bull market periods don't last forever and can give way to bear markets.
Bear market vs market correction
A market correction is like a bear market but less severe. The technical definition is about a 10% decline in share prices in less than two months.
The idea behind a correction is that falling prices serve to 'correct' the situation because prices have risen higher than they should have.
One significant difference between a bear market and a market correction is how much prices fall. Bear markets occur when share prices drop by 20% or more, whereas corrections typically involve price drops of about 10%.
Furthermore, market corrections typically last less than two months, whereas the average bear market lasts two months or longer.
Examples of bear markets in Australia
There are several real-world examples of bear markets here in Australia.
Most recently, the All Ordinaries Index (ASX: XAO) plummeted from an all-time high of 7,926.80 on 4 January 2022 to 6,663.30 by June 2022 as rising interest rates began to bite.
Before this, the ASX shed 37% in the space of a month between February and March 2020 as global markets reacted to the coronavirus pandemic.
But these aren't the only (or the sharpest) sell-offs the Australian share market has experienced.
The bear market with the steepest fall occurred in 1987, sparked by the infamous Black Monday. This was the name given to the day the Dow Jones Industrial Average Index (DJX: DJI) in the United States lost almost 22% and marked the beginning of a global stock market decline.
Black Monday hit Australian shores on Tuesday, 20 October, resulting in the ASX losing 26% in a single day. The All Ords fell by 50% between the start of October 1987 and 13 November 1987.
The global financial crisis (GFC), sparked by a cratering housing market and credit crunch in US financial markets, saw the All Ords fall by 55% over 14 months, from its peak in November 2007 to its market bottom in early March 2009.
Other examples include the Wall Street Crash of 1929, which sparked the Great Depression, and the bear market that followed the dot-com bubble collapse in the 2000s, which saw the All Ords lose 21% of its value between March 2002 and March 2003.
How to invest during a bear market
Investing during a bear market requires a different strategy than in a bull market. The key lies in recognising that a bear market, while challenging, can also present unique investment opportunities.
During a bear market, it's essential to focus on high-quality assets. Look for companies with strong balance sheets, good cash flow, and solid business models likely to withstand economic downturns. These companies are often undervalued during bear markets, offering the potential for significant returns once the market recovers.
Bear markets can also be an ideal time to practice dollar-cost averaging – investing a fixed amount of money at regular intervals, regardless of the market's ups and downs. This approach may allow you to buy more shares when prices are low, potentially reducing the average cost per share over time.
Importantly, it's essential to maintain a long-term perspective. Bear markets can be unsettling, but history shows that markets have always recovered over time.
Patience and a long-term view can help investors avoid making impulsive decisions based on short-term market fluctuations. Remember, a bear market doesn't last forever, and for the astute investor, it can be a time to lay the groundwork for future gains.
Investing during a bear market, when stock prices are falling, might feel risky. But bear markets can present unique opportunities for savvy investors. They often lead to undervalued shares as prices drop, potentially offering a lower entry point. This can be an opportune moment for those who have done their research and have a long-term investment strategy. Buying in a bear market can be similar to shopping during a sale, where you find valuable items at discounted prices.
However, it's crucial to tread with caution. Not all cheap stocks during a bear market are good buys; some might be low-priced for fundamental reasons related to the company's performance or industry challenges. It's important to conduct thorough research to identify stocks likely to recover and grow in the long term. Bear markets require investors to focus on potential future growth rather than immediate gains. Patience and a carefully considered investment strategy are vital to making the most of these market conditions.
A range of economic, financial, and geopolitical factors influences the duration of bear markets. Historically, bear markets have lasted from a few months to several years, with their length and severity often dictated by the underlying causes of the market downturn. In Australia, the bear markets have varied in length, with some relatively brief and others, like during the Global Financial Crisis, lasting longer.
However, it's important to note that each bear market is unique. Factors such as shifts in monetary policy, changes in consumer confidence, and market speculation can all influence the duration and depth of a bear market. Given the unpredictability of markets, it's challenging to pinpoint the exact duration of a bear market. Investors should focus more on understanding the characteristics of bear markets and adapting their investment strategies accordingly rather than trying to predict their course.
The first half of FY24 has been challenging for the Australian share market, with indices drifting lower. Investor sentiment took a turn for the worse over the prospect of interest rates remaining higher for longer than anticipated, plus gold and oil prices fell.
Reporting season saw falls in the profits of mining companies, which impacted the overall level of corporate earnings. Guidance for FY24 has been cautious, with profits expected to moderate as higher interest rates and operating costs put pressure on margins.