A bear market is generally defined as a drop of 20% or more from market highs. The term can be used to describe a specific security or the market in general. When a certain stock drops 20% in a short time, for example, it can be said that the stock has entered a bear market.
A bear market during a general market downturn means that multiple broad market indexes such as the Standard & Poors 500 Index (S&P 500) or Dow Jones Industrial Average (DJIA) fall by 20% or more in two months or less.
Bear stock markets are usually associated with economic recessions, although this isn’t always the case. As economic activity dries up, people lose jobs, consumer spending falls and business earnings decline across the board. As a result, many companies see their share prices tumble.
Image Credit: coffeekai / iStock.
Potential investing strategies in a bear market
Rather than avoiding a bear market altogether, there are some investing strategies investors may want to consider.
The term “hedging” is investment lingo for insurance. A hedge against something is an action taken that provides a kind of insurance policy against a specific outcome.
Owning gold is often referred to as an inflation hedge, for example, because it’s thought that the price of gold performs well during times of high inflation. Investors sometimes buy gold as insurance against inflation.
Likewise, while most investors remain hopeful that their investments will rise in price, the reality is that sometimes financial assets decline in value.
To protect against the potential of that happening, investors can employ bear market trading strategies. To hedge against the effects of a bear market, investors generally employ a bear market strategy falling under one of three broad categories:
- Buying investments that should go up during a market downturn.
- Using various strategies to short the market, like put options or inverse Exchange Traded Funds (ETFs).
- Holding on tight and waiting things out.
Image Credit: monsitj / iStock.
Researching bear market assets
The first of these bear market investing strategies involves buying assets that will increase in price when the market takes a dive. There are many factors that influence which investments perform well during a bear stock market.
In general, investors tend to be risk-averse during downturns and seek safe-haven assets rather than risky ones. That means things like gold and silver, stocks relating to the mining and production of gold, dividend-yielding stocks or large and mature companies and stocks of companies that work in sectors that have constant demand, like utilities and food. Buying assets like these at the beginning of a downturn, or just before, can be beneficial.
There also tend to be parts of the market that do well according to the particular circumstances surrounding a market downturn or economic recession.
During the 1970s, for example, there was a shortage of oil. While this led to high prices for gasoline, it also wound up being bullish for oil and related investments like the stocks of large petroleum companies.
More recently, many economists believe that the United States is currently in a recession. The recession of 2020 has, so far, seen at least three types of stocks outperform others. These include companies in:
- Cybersecurity and work-from-home tech.
- Pharmaceuticals working on disease cures.
- Gold and silver mining.
Thinking about the context in which the current recession is happening, it’s not too hard to see why these investments have done well.
More people are working from home than ever before, so companies that deal with cybersecurity, video conferencing, or workspace communication have generally outperformed.
Because a pharmaceutical cure for the COVID-19 virus might bring economies out of shutdown, companies that have put out press releases showing progress toward a cure or vaccine have seen their share prices increase rapidly.
And last but not least, gold and silver have increased in value because people have become worried about the future. With a lot of uncertainty in the air, many people have sought the safety of gold.
So much so, in fact, that there were times when physical silver and gold were temporarily unavailable at any price from most dealers. The rising price of the precious metals has, in turn, led to increased profits for mining companies that are the world’s only source of new supply.
Image Credit: Sergii Zyskо / iStock.
Using short strategies to hedge losses
One of the more sophisticated bear market trading strategies involves placing bets that will rise in value when other investments lose value.
This might involve, for example, placing long-term put options contracts on some of the securities in a portfolio. Alternatively, investors can purchase shares of an inverse ETF as the overall market starts declining.
The topic of using put options and other various short strategies has many nuances that go beyond the scope of this article. Interested investors ought to conduct additional research before considering this strategy.
Image Credit: Sitthiphong / iStock.
Holding for the long haul
During a bear stock market, it’s not always necessary to do anything special.
Investors who have a long-term time horizon in mind sometimes choose to simply hold on and stay the course. The reason behind this is simple.
Bear markets happen in ways that tend to be abrupt, volatile and short-lived. The 2007 to 2009 bear market began in December 2007, and was over by March 2009, lasting only about a year and a half, for example.
But the bull market that followed lasted almost eleven years – the bottom for stocks was seen in March 2009, whereas the next big crash didn’t happen until February 2020.
Taking a long-term perspective can pay off well over the course of many years, as the market as a whole trends upwards over time. Investments in an S&P 500 index fund during the summer of 2008, for example, saw steep losses over the following year. But that fund, ten years later, in 2019, has still appreciated by a wide margin.
There’s one caveat for long-term holding, though, and that’s a well-diversified portfolio. Being diversified typically ensures that all of an investor’s eggs are not in one basket, thereby spreading risk around and reducing it overall. One easy way to accomplish this might be to buy structured securities like ETFs or index funds.
One way to hold assets for the long-term and not be too concerned about short-term market fluctuations is to make regular investments regardless of what’s happening.
Some employers offer 401(k) retirement plans and will match an employee’s contribution up to a certain point. This type of long-term investing on a regular basis has the potential to be financially advantageous.
It’s also possible to set up automatic contributions to different investment accounts including brokerage accounts, individual retirement accounts (IRAs), or robo-advisor accounts. Robo-advisors make investment decisions for you based on your personal needs and goals.
Image Credit: gopixa / iStock.
Bear market investing vs. bull market investing
For those investing for the long term, the only real difference between a bear market and a bull market will be a temporary dip in the value of their portfolio. The main goal will be to stay the course. As mentioned, long-term investors often make regular, recurring purchases of financial assets.
Some investors choose to increase the amount of money they put into their investments during market downturns. Their overall strategy remains the same, but buying more assets at cheaper prices lets them acquire a larger number of assets overall.
For those with a higher risk tolerance looking to make short-term gains (often referred to as speculators), a mix of strategies might be employed. Speculators may look to short the market using puts or inverse ETFs, or research assets likely to increase in value due to current bear market trends.
During bear markets, there may be short-lived, rapid rises in asset prices, which are often referred to as “bear market rallies,” “bull traps,” or “sucker’s rallies.” Some investors choose to sell during these rallies, and either save the cash or use it to speculate elsewhere.
During bull markets, a common investment strategy is simply to buy and hold. This tends to work because bull markets are characterized by most asset classes rising in unison.
Markets don’t go up or down in a straight line. Conventional wisdom states that during bull markets, it’s wise to “buy the dips,” meaning investors buy whenever prices decline significantly. During bear markets, some investors “sell the rips,” meaning investors sell during the large rallies that tend to occur.
Image Credit: peterschreiber.media / iStock.
Choosing a strategy
Bear market investing strategies don’t have to involve anything fancy. Sometimes it just means making additional investments or finding new ones. A simple to use online investing account is one tool that offers multiple strategies.
Choosing the right bear market strategy is a personal choice, but that doesn’t mean an investor has to have all the answers.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA/SIPC. The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER, CFP (with plaque design), and CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Image Credit: DepositPhotos.com.AlertMe