What is the ‘bear market’ and why is it happening now?

In the last six months, the main stock markets have plunged on fears that a rise in interest rates would trigger a recession in Europe and the United States. This Monday, after the main Wall Street index, the S&P 500, lost 3.88%, the headlines of the main media officially announced it: investors are in bear territory, the so-called bear market.

The bear market (bear market, in English) is an animal analogy that relates the stock market to the hibernation of the bear, that is, that investors have started to withdraw their money from the markets waiting for the storm to weather.

Technically, the bear market begins when the stock loses 20% of its value in a certain period of time. In this case, the S&P 500 has lost close to 22% between January 3 and June 13.

The S&P 500 is an index that includes the evolution of the price of the shares of the 500 largest companies in the United States, such as Apple, Google, Tesla, Coca-Cola or Visa. So when it crashes in just six months, the market is said to have gone into hibernation mode.

However, the rest of the indices and stock markets have not suffered so abruptly from inflation and the war in Ukraine. For example, the Ibex 35 has lost 5.3% this year, while the Paris and Frankfurt stock markets have fallen close to 15%.

As an antithesis to the bear market, we speak of the bull market, the one in which the stock market shoots up more than 20% after a period of contraction. The correction market is also known, which occurs when an index falls 10% or more in a short period of time because analysts calculate that the companies that comprise it were overvalued on the stock market.

Why does the bear market occur?

The value of a stock index, for example, the S&P 500, represents the expectations that shareholders have about the companies that comprise it. If these firms are expected to close the year with good results, more investors will bet on them, but at the moment the opposite is true.

The very strong inflation, the war in Ukraine and the worsening of the Chinese economy predict a fall in consumption by 2022. At the same time, the central banks have already announced – and will continue to announce – drastic increases in interest rates, which will reduce the access to credit for companies and will make it difficult for them to invest in expanding their business. This scenario causes investors to take their money out of large companies to move it to safer markets. That is to say: they have put their money to hibernate.

James Chen, an editor at Investopedia, explains that when fear of a recession grips the market, investors flee the stock market in droves and it can be a long period of time before they return. Herd behavior, fear, and the rush to protect losses can lead to prolonged periods of depressed asset prices.

The expert explains that the most common triggers for a bear market period are the slowdown in the economy, a war, a pandemic or the bursting of a financial bubble or the rise in interest rates. In fact, it is not necessary for any of these situations to occur, the mere expectation that they will occur can be enough to cause investors to be scared.

In Europe, for example, the European Central Bank did not confirm the rise in interest rates until last week, but listed companies on the continent have been losing value for months while waiting for the ECB to finally decide to take measures to stop the inflation.

And what is the bull market?

When the situation is reversed, it is said that the market is in bull mode (bull market). This analogy represents the charge of the animal, and is related to rapid and strong rises in the value of stocks. Specifically, it is a 20% increase in a stock index after two consecutive falls of 20%.

Adam Hayes, also an editor at Investopedia, stresses that the bull market is extremely difficult to predict, and often goes undetected until it’s already happening.

From a macroeconomic point of view, bull markets are usually accompanied by large GDP growth, as well as falls in the number of unemployed. They also coincide with periods of great consumption by citizens and a reduced offer, which causes the increase in prices and the increase in margins and business profits.