Bear Markets Explained

by Andy Boyd on 26 September 2011 1 comment

Residents of the financial world have a way of creating terms for particular market trends that sound relatively inconspicuous to the average layman, even though in reality those trends signify a time for concern. A good example of this is the bear market. This is not a place where you would go to get a good discount on a few Theodore Roosevelts ("teddies"). In fact, a bear market actually has more in common with an angry grizzly you might encounter in the forest: it is shocking, can instill considerable panic, and can leave you without a leg to stand on.

So what exactly is a bear market? It's the opposite of a bull market (which is why the bear market is sometimes known as a "heifer market"). A bull market is when traders are making a killing on the stock exchange, prices and indexes are rising, people are making money, and optimism fills the offices of the NASDAQ and NYSE. Unfortunately, this means that a bear market is when share prices are falling, traders are panicking, and the economy looks perilously close to tail-spinning out of control. It is not a good thing, as the poverty and average living conditions of the Great Depression demonstrated. (See also: Survive the Bear Market: 10 Steps to Ride the Downturn)

A bear market does not have a strict definition, but it can be classified as an overall price decline of 20% or more that lasts over two months. Among the myriad problems related to a bear market is the period of time it can last. Just as a bull market can last for months or even years, so can a bear market. The oil crisis of 1973 and the energy crisis of 1979 were constituent components of a long bear market occurring at that time, which lasted from 1973 until 1982.

Bear markets can also shatter the stock exchanges. The Wall Street Crash of 1929 led to the Dow Jones Industrial Average falling from 381.17 in 1929 to just 41.22 by 1932. Billions of dollars were lost ($14 billion on Black Tuesday alone), and it took years for the USA, and the rest of the world, to recover.

Investors and non-investors should pay attention to a bear market's universal effects. Having an "it only affects the fat cats of Wall Street" mentality would be seriously misjudged, as a bear market can infiltrate our everyday lives. Here are some ways a bear market can make things more difficult for everyone.

Fear Becomes a Cycle

Traders can be like sheep in moments of financial turmoil, which only exacerbates the problem. Everyone starts selling to get out of a plummeting price drop. Companies lose money and value because of the mass offloading of shares, so in the long run they try and save money by not investing or hiring. Jobs become harder to find. As a consequence of there being fewer people in employment, less money is spent, and companies are forced to save more money by cutting back on staff and investments.

Years of Saving Can Come to Nothing

All that money invested in a safe pension fund will not be making the same kind of interest you initially hoped for. Savings in 401(k) plans can be decimated by bear markets, and since a bear market can happen at any time, it may hit just before you are due to retire.

People Become More Polarized

In times of bull markets, people are generally content, and the majority follow centrist politics, thinking, "Well, I have money and food, so this government can stay." However, because bear markets make people poor, they start to look for who is culpable, and the mindset becomes, "Well, I have no money and no food, so this government has to go." This is a great time for radicals to slip in and get into power with promises of economic resurgence and food on the table. This is one of the many reasons that a certain Herr Hitler came to power in Depression-devastated 1930s Germany.

People Become More Egocentric

They will fight over a job, over food, over a place to live. They are less likely to help others in need, as the individual's focus becomes smaller and smaller. Conversely, in a bull market, people are more likely to share.

Charities and Non-Essential Spending Programs Suffer

Why give $50 to a charity like the Salvation Army when you are not sure if there will be enough money left to feed your own family? And many smaller, less-supported charities fail.

Nationalism Rears Its Ugly Head

Immigrants and people on welfare will suffer various problems from prejudice to soul-destroying cuts in benefit provisions. In times of monetary strife, people will look for any scapegoat to vent their frustration upon, and it's often the new guy on the block who's to blame in mainstream opinion.

Paper Isn't Worth Anything

Bear markets are the times when those people who kept pennies in jars or bills jammed under their mattress are not seen as slightly eccentric, but as wise savers. Hard currency becomes key as share certificates and investment reports become worthless pieces of paper.

Physical Assets Are Liquidated

Smart investors might lose money in a bear market, but being smart means they have savings or invested in physical assets that can be liquidated, such as gold coins or silver bullion.

Personal Relationships Can Change

Bear markets can also affect the sexual dynamic of the working population.

It would be prudent to keep an eye on the Dow's average. The Dow Jones Industrial Average is based on the daily trading peaks and troughs of 30 of the largest U.S. based companies (such as ExxonMobil, Walmart, and Microsoft). It has been calculated that a bear market occurs when the Dow's average is 9,378 or below. This happened recently, when the average closed at 6,547 at one point in March 2009.

Perhaps the best way to sum up a bear market is to quote Charles Jones, who is Professor of Finance and Economics and chair of the finance and economics division at the Ivy League Columbia Business School, "Definition of a bear market: when it hurts to look at the stock tables in the newspapers in the morning."

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"Smart investors might lose money in a bear market, but being smart means they have savings or invested in physical assets that can be liquidated, such as gold coins or silver bullion."

Smart investors don't put themselves in a situation where they need to liquidate all there investments when a bear market presents itself. Smart investors make money from bear markets.