What Is a Bear Market? Definition, Causes and How to Invest

A bear market is a sustained decline in asset prices of 20% or more from a recent high. This article covers what bear markets are, what causes them and how they differ from other types of market decline. It also examines some of the strategies employed when prices start declining, from defensive positioning to more active approaches like short selling.

The information in this article is provided for educational purposes only and does not constitute financial advice. Consult a financial advisor before making investment decisions.

What Is a Bear Market?

A bear market is a market condition typically defined as a fall of 20% or more in asset prices from a recent high.  

The 20% threshold is a widely quoted benchmark; however, different organisations define it slightly differently. For example, the US Securities and Exchange Commission (SEC) specifies that the decline should occur over at least a two-month period. 

The term most commonly applies to stock markets, but bear markets can occur across any asset class under the same broad definition. 

Falling asset prices tend to be accompanied by a shift in investor sentiment; confidence and risk appetite both drop, which can lead to increased selling pressure, reinforcing the downward momentum.

Bear Market vs Bull Market: What's the Difference?

Bear markets are characterised by falling prices and declining investor confidence. A bull market is essentially the opposite: a sustained period of rising prices, typically defined as a gain of 20% or more. 

Beyond price direction, the two differ in several important ways:

One important distinction between the two is duration. Bull markets have historically lasted significantly longer than bear markets, which is partly why many long-term investors choose to stay the course during downturns rather than exit and risk missing the recovery. 

It's also worth noting that the two don't always follow each other neatly. A bear market doesn't automatically signal that a bull run is imminent. Short-term rallies can occur within a bear market before prices resume their downward trend. 

What Causes a Bear Market? 

Bear markets don't always have a single cause. They often materialise as the result of a combination of factors which work together to erode investor confidence. Here are some of the most common triggers: 

• Recession or economic slowdown. When economic growth stalls or contracts, corporate earnings typically follow. Investors anticipate weaker profits and may adjust their positions, pushing prices down. 
• Rising interest rates. Higher rates increase borrowing costs for businesses and consumers, which weighs on earnings and spending. They also make bonds and cash more attractive relative to stocks. 
• Geopolitical shocks. Wars, trade conflicts, political instability and the uncertainty they all cause can destabilise the markets. 
• Bursting asset bubbles. When asset prices become detached from underlying value, as happened with technology stocks in 2000, a correction can tip into a bear market as sentiment drops sharply. 
• External shocks. Events with no economic origin can trigger sudden and severe market downturns. The Covid-19 pandemic in 2020 is one such example. 

It's also worth noting that bear markets don't always arrive with obvious warning. Some develop gradually as conditions deteriorate over months whereas others unfold quickly.  

For example, the bear market triggered by the pandemic in 2020 was one of the fastest on record, with the S&P 500 falling more than 30% in under five weeks.

What Are the Different Types of Bear Markets?

Analysts often distinguish between three types of bear market:  

• Cyclical: Occurs as a natural part of the economic cycle, usually following a prolonged bull run as valuations stretch and momentum fades. Rising inflation and interest rates can be precursors. 
• Structural: Triggered by deeper issues, such as the collapse of an asset bubble or a fundamental breakdown in the financial system, such as the global financial crisis in 2008. These tend to be longer and more severe. 
• Event-Driven: Caused by an unexpected external shock, such as a war or a geopolitical crisis. They can cause rapid market declines but tend to recover quicker than other types. 

How Long Does a Bear Market Last?

Since 1929, there have been 27 bear markets in the S&P 500 index, with an average duration of around 10 months and an average peak-to-bottom decline of approximately 34%. By contrast, bull markets over the same period have lasted an average of 2.7 years¹. 

Consequently, although bear markets may feel never-ending whilst you're in one, on average, periods of growth have historically outweighed periods of decline over the long run. 

However, the above figures are just an average. The length of individual bear markets can vary enormously and, unfortunately, there is no reliable method for predicting when they will end. 

For example, the Covid-19 driven sell-off in 2020 was one of the shortest bear markets on record, during which the S&P 500 declined more than 30% in less than five weeks before recovering. Contrast that with the bear market that followed the dotcom bubble in 2000, which lasted approximately two and a half years and saw the S&P 500 drop almost 50%. 

Bear Market vs Market Correction: What's the Difference? 

A market correction is a decline of 10% or more from a recent high, whereas a bear market typically requires a fall of at least 20%.  

Corrections are a common and relatively routine feature of the markets. They occur more frequently than bear markets, tend to resolve more quickly and don't necessarily indicate a widespread deterioration of economic conditions.  

On the other hand, a bear market typically reflects a more meaningful shift in the economic outlook or investor sentiment and is sustained over a longer period. 

How to Invest in a Bear Market 

Falling markets may seem like the wrong time to be thinking about investing strategies. However, for those with a long time horizon, a bear market may present opportunities in the form of lower prices which wouldn’t be available during a bull run. 

The strategies below cover some of the more common approaches investors might consider during a downturn.  

• Dollar-cost averaging 
• Focus on defensive sectors 
• Rotate into safe-haven assets 
• Consider index funds and ETFs 
• Short selling 
• Hedging existing positions 
• Maintain a long-term perspective 

Dollar-Cost Averaging

Dollar-cost averaging involves investing a fixed amount at regular intervals, regardless of what the market is doing. Rather than trying to accurately time the market, investors spread their exposure across different price levels over time. 

Dollar-cost averaging isn't a bear market strategy specifically; however, during a bear market, as prices fall, the same fixed investment amount buys more units of an asset than it would at higher prices. 

Over time, this approach can reduce the average cost per unit and it also removes the issues of timing and emotion from the equation. However, it doesn't eliminate the risk of further losses, and there's no guarantee of a recovery. 

Focus on Defensive Sectors

Not all sectors of the stock market respond to economic downturns in the same way. Whilst cyclical sectors are more sensitive to the health of the economy, defensive sectors tend to hold up better during periods of market turbulence. 

Defensive sectors include:

• Consumer staples: Companies producing everyday essentials such as food, beverages and household goods.  
• Healthcare: Spending on healthcare is largely non-discretionary. 
• Utilities: Electricity, gas and water are modern day essentials, meaning suppliers tend to generate predictable revenues. 

Whilst defensive stocks may underperform during a bull market, they tend to hold up relatively well when investor sentiment deteriorates. That relative resilience can help cushion a portfolio during a prolonged downturn. 

It's worth noting that no sector is entirely immune to a market downturn. For example, during the 2008 financial crisis, even traditionally defensive sectors saw significant declines. 

Rotate Into Safe-Haven Assets

Safe-haven assets are investments that tend to maintain or increase in value during periods of market stress. Whilst no investment is risk-free, certain asset classes have historically attracted capital when investor confidence plummets. 

Some of the most commonly cited safe havens include: 

• Gold: Gold has long been considered a store of value by humans and has often held its value during downturns. 
• Government bonds: Particularly those issued by governments with strong credit ratings, such as the US or UK.  
• Safe-haven currencies: The US dollar, Japanese yen and Swiss franc are traditionally considered safe-haven currencies. During periods of global uncertainty, demand for these currencies tends to rise. 

The logic behind rotating into safe havens during a bear market is that they can offset losses elsewhere in a portfolio, acting as a partial hedge against falling equity prices. 

However, like defensive stocks, safe havens are not immune from market downturns. During a severe sell-off, like the one sparked by the pandemic in 2020, safe haven assets can drop sharply as investors look to liquidate anything to raise cash. 

Consider Index Funds and ETFs

For investors who don't want to pick individual stocks during a bear market, index funds and ETFs offer broad market exposure through a single investment. Both track a basket of assets, often following an index such as the S&P 500, spreading exposure across dozens or hundreds of holdings. 

Most major indices have historically recovered from significant downturns, meaning that investors who stayed invested have generally recaptured losses over time. However, recovery periods can vary considerably, in some cases stretching over many years. Furthermore, just because this has been the case historically, it doesn’t mean it always will be.  

Short Selling

Short selling is when a trader or an investor attempts to profit from an asset’s price falling rather than rising. Traditionally, this is done by traders borrowing the asset in question and selling it, in the hope that prices will fall and they will be able to repurchase the asset at a lower price.  

However, retail traders can also short assets using derivatives, such as Contracts for Difference (CFDs), which allow them to take short positions without needing to borrow or own the underlying asset. 

In a bear market, short selling could be a way to generate returns from declining prices. Traders might choose to short individual stocks they expect to underperform, or short an index if they have a bearish view on the wider market. 

However, short selling can be very risky and may not be suitable for beginners. For those considering a short selling strategy during a market downturn, risk management is particularly important. 

Hedging Existing Positions

Hedging involves taking a position that is designed to offset potential losses elsewhere in a portfolio. For example, during a bear market, an investor with significant long exposure might use a short position to attempt to reduce their exposure to falling prices. 

If the market falls and the short position profits, those gains will offset losses on the main positions. However, naturally, if the markets rise, the hedged positions will generate losses that offset gains on the long positions. 

Whilst the logic may be straightforward, putting it into practice may be less so. Hedging is generally considered a more sophisticated strategy, often used by professional investors managing larger or more complex portfolios. 

Maintain a Long-Term Perspective

For many investors, the most difficult aspect of a bear market is staying the course whilst prices are falling and uncertainty is high.  

The urge to sell and wait for conditions to improve is a natural response to sustained losses. But the timing risk that comes with exiting the market can be significant.

According to research from JP Morgan in 2024, over the previous 20 years, seven of the ten best trading days in the S&P 500 occurred within 15 days of the ten worst days. This highlights the difficulty of timing the market correctly; investors who sell during a downturn run the risk of missing sharp recoveries that could potentially follow. 

Bear markets are an uncomfortable but historically recurring feature of investing. For those with a long time horizon and the financial ability to do so, riding out a downturn may be more effective than attempting to accurately time an exit and re-entry.  

Conclusion

Bear markets are defined by a decline of 20% or more from a recent high and can be triggered by a range of factors, including recessions and geopolitical shocks. Whilst they vary considerably in depth and duration, historical data suggests they have, on average, been shorter than bull markets. 

For investors, it's important to keep a clear head. The different options of how to approach a bear market all carry their own risks; the appropriate response depends on individual circumstances, in particular time horizon and risk tolerance. 

It's worth remembering that attempting to time the market is notoriously difficult. Indeed, investors who are able to stay the course may end up faring better than those who try to exit and re-enter at the perfect moment. 

Sources: 

• Kiplinger: How Often Bear Markets Occur and 7 Other Facts About Them 

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