Bear market could be on the horizon — what that means

Investors on Wall Street need a place to hide. The stock market’s skid this year has pulled the S&P 500 close to what’s known as a bear market.

Rising interest rates, high inflation, the war in Ukraine and a slowdown in China’s economy have caused investors to reconsider the prices they’re willing to pay for a wide range of stocks, from high-flying tech companies to traditional automakers.

The last bear market happened just two years ago, but this would still be a first for those investors that got their start trading on their phones during the coronavirus pandemic.

For years, thanks in large measure to extraordinary actions by the Federal Reserve, stocks often seemed to go only in one direction: up. Now, the familiar rallying cry to “buy the dip” after every market wobble is giving way to fear that the dip is turning into a crater.

WHY IS IT CALLED A BEAR MARKET?

A bear market is a term used on Wall Street when an index like the S&P 500, the Dow Jones Industrial Average or even an individual stock has fallen by 20% or more from a recent high for a sustained period of time.

Why use a bear to represent a market slump? Bears hibernate, so bears represent a market that’s retreating, said Sam Stovall, chief investment strategist for the investment research firm CFRA.

In contrast, Wall Street’s nickname for a surging stock market is a bull market because bulls charge, Stovall said.

The most recent bear market for the S&P 500 ran from Feb. 19, 2020, through March 23, 2020. The index fell 34% in that one-month period, which was the shortest bear market ever.

WHAT’S BOTHERING INVESTORS?

Market enemy No. 1 is interest rates, which are rising quickly as a result of the high inflation battering the economy. Low rates act like steroids for stocks and other investments, and Wall Street is now going through withdrawal.

The Federal Reserve has made an aggressive pivot away from propping up financial markets and the economy with record-low rates and is focused on fighting inflation. The central bank already raised its key short-term interest rate from its record low near zero, which had encouraged investors to move their money into riskier assets, like stocks or cryptocurrencies, aiming to get better returns.

Consumer prices are at the highest level in four decades, up 8.3% in April over a year ago.

The Fed has signaled that more rate increases of double the usual amount are likely in the coming months.

By design, the moves will slow the economy by making it more expensive to borrow money. The risk is that the Fed could cause a recession if it raises rates too high or too quickly.

Russia’s war on Ukraine also has added to inflation by pushing up commodities prices. And worries about China’s economy, the world’s second-largest, have added to the gloom.

SO WE JUST NEED TO AVOID A RECESSION?

Even if the Fed can pull off the delicate task of tamping down inflation without triggering a downturn, higher interest rates still put downward pressure on stocks.

If people are paying more to borrow money, they can’t buy as much stuff, which hurts businesses.

And, over time, stocks tend to track profits.

Higher rates also make investors less willing to pay higher prices for stocks, which are riskier than bonds, when bonds suddenly are paying more in interest thanks to the Fed.

Critics said the overall stock market came into the year looking pricey versus history. Big technology stocks and other winners of the pandemic were seen as the most expensive, and those stocks have been punished the most as rates have risen.

Stocks have declined almost 35%, on average, when a bear market coincides with a recession, compared with a nearly 24% drop when the economy avoids a recession, according to Ryan Detrick, chief market strategist for LPL Financial.

SO I SHOULD SELL EVERYTHING NOW, RIGHT?

If you need the money now or want to lock in the losses, yes.

Otherwise, many advisers suggest riding through the ups and downs and remembering the swings are the price of admission for the stronger returns that stocks have provided over the long term.

Dumping stocks would stop the bleeding. But it also would prevent any potential gains.

Many of the best days for Wall Street have occurred either during a bear market or just after the end of one. That includes two separate days in the middle of the 2007-2009 bear market during which the S&P 500 surged by roughly 11%, as well as leaps of better than 9% during and shortly after the roughly month-long 2020 bear market.

Advisers suggest putting money into stocks only if it won’t be needed for several years. The S&P 500 has come back from every one of its prior bear markets to eventually rise to another all-time high.

The down decade for the stock market following the 2000 bursting of the dot-com bubble was a notoriously brutal stretch, but stocks have often been able to regain their highs within a few years.

HOW LONG DO BEAR MARKETS LAST?

On average, since World War II, bear markets have taken 13 months to go from peak to trough and 27 months to get back to breakeven.

The S&P 500 index has fallen an average of 33% during bear markets in that time. 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 into a bear market, the shallower they tend to be. Historically, stocks have taken 251 days to fall into a bear market. When the S&P 500 has fallen 20% at a faster clip, the index has averaged a loss of 28%.

The longest bear market lasted 61 months, ending in March 1942, and cut the index by 60%.

HOW DO WE KNOW WHEN ONE IS OVER?

Generally, investors look for a 20% gain from a low point and sustained gains over at least a six-month period.

It took less than three weeks for stocks to rise 20% from their low in March 2020.