The stock market’s slippage this year has brought the S&P 500 closer to what is known as a bear market.
Rising interest rates, high inflation, war in Ukraine and a slowing Chinese economy have caused investors to reconsider the prices they are willing to pay for a wide range of stocks, from tech companies high-flying to traditional automakers.
The last bear market happened just two years ago, but it would still be a first for investors who started trading on their phones during the pandemic.
For years, thanks in large part to the extraordinary actions of the Federal Reserve, stocks often seemed to go in one direction: up. Now the familiar rallying cry to “buy the dip” after every market swing gives way to the fear that the dip will turn into a crater.
Here are some frequently asked questions about bear markets:
WHY IS IT CALLED A BEAR MARKET?
A bear market is a term used by Wall Street when an index like the S&P 500, Dow Jones Industrial Average, or even an individual stock has fallen 20% or more from a recent high for an extended period.
Why use a bear to represent a market crash? Bears are hibernating, so bears represent a pullback market, said Sam Stovall, chief investment strategist at CFRA. By contrast, Wall Street’s nickname for a booming stock market is a bull market, as the bulls charge, Stovall said.
The S&P 500 index slid 165.17 points on Wednesday to 3,923.68. It is now down 18.2% from its high of 4,796.56 on January 3. The Nasdaq is already in a bear market, down 29% from its high of 16,057.44 on November 19. The Dow Jones Industrial Average is 14.4% below its most recent high.
The most recent bear market for the S&P 500 was from February 19, 2020 to March 23, 2020. The index fell 34% during this one-month period. This is the shortest bear market ever.
WHAT ANNOYS INVESTORS?
The number one enemy of the market is interest rates, which are rising rapidly due to high inflation hitting the economy. Low rates are acting like steroids for stocks and other investments, and Wall Street is pulling back.
The Federal Reserve has aggressively turned away from supporting financial markets and the economy with record rates and is focusing on fighting inflation. The central bank has already raised its main short-term interest rate from its all-time high near zero, which had encouraged investors to shift their money to riskier assets like stocks or cryptocurrencies to get better returns. yields.
Last week, the Fed signaled additional rate hikes of double the usual amount likely in the coming months. Consumer prices are at their highest level in four decades and rose 8.3% in April from a year ago.
Deliberate measures will slow the economy by making borrowing more expensive. The risk is that the Fed could cause a recession if it raises rates too high or too quickly.
Russia’s war in Ukraine has also put upward pressure on inflation by driving up commodity prices. And worries about China’s economy, the world’s second-largest, added to the gloom.
SO WE JUST NEED TO AVOID A RECESSION?
While the Fed can do the tricky job of taming inflation without triggering a downturn, rising interest rates still put downward pressure on equities.
If customers pay more to borrow money, they can’t buy as much stuff, so less revenue goes to a company’s bottom line. Stocks tend to follow earnings over time. Higher rates also make investors less willing to pay high prices for stocks, which are riskier than bonds, as bonds suddenly pay more interest thanks to the Fed.
Critics said the global stock market entered the year looking expensive relative to history. Big tech stocks and other pandemic winners were seen as the most expensive, and those stocks took the most punishment as rates rose.
Stocks have fallen nearly 35% on average when a bear market coincides with a recession, compared with a decline of nearly 24% when the economy avoids a recession, according to Ryan Detrick, chief market strategist at LPL Financial.
SO I SHOULD SELL EVERYTHING NOW, RIGHT?
If you need money now or want to lock in losses, yes. Otherwise, many advisers suggest riding through the ups and downs while remembering that swings are the price of entry for the stronger returns stocks have provided over the long term.
While dumping stocks would stop the bleeding, it would also prevent any potential gain. Many of Wall Street’s best days have occurred either during a bear market or right after a market has ended. This includes two separate days in the middle of the 2007-2009 bear market when the S&P 500 jumped around 11%, as well as jumps over 9% during and shortly after the roughly month-long bear market in 2020.
Advisors suggest putting money into stocks only if it won’t be needed for several years. The S&P 500 has come back from each of its previous bear markets to finally hit another all-time high. The decade of stock market declines following the bursting of the dot-com bubble in 2000 were notoriously brutal, but stocks were often able to return to their highs within a few years.
HOW LONG DO BEAR MARKETS LAST AND HOW DEEP DO THEY GO?
On average, bear markets have taken 13 months to peak to trough and 27 months to break even since World War II. The S&P 500 index fell an average of 33% during the bear markets of this period. The biggest decline since 1945 occurred in the 2007-2009 bear market when the S&P 500 fell 57%.
History shows that the faster an index enters a bear market, the lower it tends to be. Historically, stocks have taken 251 days (8.3 months) to fall into a bear market. When the S&P 500 fell 20% at a faster rate, the index recorded an average loss of 28%.
The longest bear market lasted 61 months and ended in March 1942 and reduced the index by 60%.
HOW DO YOU KNOW WHEN A BEAR MARKET HAS ENDED?
Typically, investors are looking for a 20% gain from a low point as well as sustained gains over at least a six-month period. It took less than three weeks for stocks to rise 20% from their March 2020 low.