There is often confusion around the definition of a bear market, and if it will lead to a recession. Let’s break this down and address some of the most commonly asked questions around bear markets.
Should I be worried about a recession?
Let’s start by first pointing out that there will always be a recession in the future; it’s a natural part of the business cycle.
Knowing if we are entering one or already in one is only certain in hindsight. The reality is that by the time we know we are in a recession, the stock market has typically already priced in a large part of the move, and you can usually expect it to do the same on the way up. This means the market almost always starts rebounding well before the skies clear, so timing the market is a fool’s errand. You may get lucky and sell stock before a larger down move, but you now take the risk of not getting back in, a risk that is very real in times of extreme market volatility. Even if you do get back in on time, you probably only end up saving yourself a few percent, which is probably not worth the risk you are taking and the stress of making two very hard calls.
Bear markets are often accompanied by recessions, but not always, since the stock market and the economy (although related) are different. The market is forward looking and tends to overshoot both to the upside and the downside.
It’s fair to assume the odds of a recession are higher during a bear market because they often coincide, but that assumption won’t give you any insight that will help you time the market.
So it’s best to focus on what matters most and what gives you the best chance of success rather than worrying about what you can’t control. Focus on your long-term goals and what’s needed to get you there, though that can be easier said than done.
As it relates to your portfolio, this means making sure you are in the appropriate allocation that aligns with your time horizon, risk tolerance, and financial goals so that you can stick with your long-term plan. That way, you can ride out volatility and not react emotionally during extreme events, which tends to lead to poor financial outcomes.
Correction vs. bear market vs. recession
A bear market is a decline of 20% or more in stock prices usually over a sustained period of time, typically two months or more, but there is no hard number.
A correction, on the other hand, is a shorter-term market downturn, usually over a timeframe of less than two months. It is a drop of less than 20% in major stock indices.
Although U.S. stocks are in bear market territory, this is not the same as an economic recession. To clarify, an economic recession is typically defined as two consecutive quarters of declines in quarterly real (inflation adjusted) gross domestic product (GDP).
Can a bear market happen without a recession?
Contrary to what some people believe, a bear market can occur without an economic recession — they are not synonymous. A bear market without a recession tends to be shallower in nature compared to a bear with a recession, which tends to be more severe.
Per LPL Research and FactSet, the average drop in all bear markets going back to 1946 was 31%, bears with a recession were 37% and bears without a recession were 24%. And interestingly, according to their data, there was a 50/50 split in bear market instances since 1946 — seven bears without a recession and seven with a recession, out of the fourteen defined bear markets over this period.
5 ways to stay in control of your finances during a bear market
Both bear markets and economic recessions are natural parts of market cycles and are very hard to predict, so the best thing to do as an investor is focus on what you can control and not get caught up in the sensationalism.
Here are actions you can take to stay in control of your finances during both up and down periods in the market.
1. Check your asset allocation and risk tolerance.
Are they appropriate for you? Have market downturns made you rethink your level of risk?
Personal Capital’s free Investment Checkup tool allows you to assess your asset allocation. The tool will suggest a target allocation for you based on your financial goals. It’s extremely important to understand your true risk tolerance; people often conflate risk tolerance with their feelings about current market conditions.
Risk tolerance is stable over time and shouldn’t fluctuate based on what the market does. For new investors, sometimes it does take a bear market to realize the amount of risk they can endure for a potential gain.
2. Diversify and rebalance if necessary and at the right time.
Rebalancing your strategic asset allocation during volatility can help you systematically buy low and sell high. Bear markets are where diversification shows its true value. Often, the benefits of diversification can be forgotten when markets are going straight up.
If you’re not properly diversified, talk to your financial advisor about the best way to get there. Diversification is a key principle in Personal Capital’s investment portfolios — not just on the asset class level but also within asset classes.
Learn more about SmartWeighting methodology here.
3. Get a fiduciary partner.
During emotional times when we’re seeing red in our portfolios, it can be valuable to have a financial advisor who can guide you through the unstable times and provide you with objective financial advice. Ensuring that your advisor is a fiduciary means that they are obligated to act in your best interest.
4. If you are able to and have decades before you retire, consider using this as an opportunity to increase your 401K contributions.
Of course we don’t know if markets will rise or fall in the near term. But taking advantage of market downturns gives you the opportunity to buy stocks at much lower prices than previous highs.
5. Try not to panic. Keep things in perspective.
Ups and downs are a natural part of market cycles, as are bear markets. But over the long run, investing in the stock market will richly reward investors.