Bear markets – the name given to periods of declining stock markets – can scare investors, but possible losses can provide opportunities.

History is littered with “bear markets” and it’s important to know that. the best way to invest when they occur.

Here, Telegraph Money explains what a bear market is and what it means for your investments. This guide will cover:

A bear market describes a prolonged decline in stock markets.

This is a term generally invoked when there is a decline of around 20% or more over a period of at least two months.

Susannah Streeter, head of money and markets at stockbroking firm Hargreaves Lansdown, said: “Bear markets can start with a decline in the stock market, and a mini-correction or period of volatility before a decline occurs. settles down. »

Bear markets typically follow a large or unexpected shock to the global economy or financial system – and sometimes both.

Richard Hunter, head of markets at stockbroking firm Interactive Investor, said: “Uncertainty – the archenemy of investing – then invades as sellers rush towards the same exit. Then, investors scramble to assess the full impact of the event.

This can lead to a downward spiral that, historically, can take several years to reverse.

A number of different events can trigger a bear market. These could include:

• Geopolitical shocks: These can include terrorist attacks, high-profile assassinations, unexpected political changes.
• Wars
• Public health crises – such as the Covid-19 pandemic
• Market bubbles
• Major economic changes.

Steps

The start of a bear market is actually the bull market that precedes it. Russ Mould, investment director at broker AJ Bell, said: “More pertinently, it is the final boom of the explosion that takes valuations to levels that cannot be sustained, and expectations for of profit growth and cash flow that ultimately cannot be met.

During the boom, insiders (such as management, founders, entrepreneurs) will start selling their shares to take advantage of the high prices. Mr Mold said: “Eventually, sellers will start to overwhelm potential buyers, who keep the faith and continue to buy on dips, because that’s what worked for so long during the bull market. »

In what is becoming a bear market, each rally fades. The high fails to reach the previous highs and the lows before the next rally decline. Mr Mold said: “Faith is starting to decline. Potential buyers become forced sellers if they have borrowed to finance their investment, and rather than buying during downturns, investors begin selling during upturns.

Confidence falters further and pessimism spreads. At this point, the race to exit is well and truly underway. The spread of pessimism about market performance can act as a “negative feedback loop,” exacerbating stock market declines as selloffs gain momentum.

Only then does the feeling fade enough for pessimism to prevail and the cycle begins again.

Examples

Global financial crisis

The global financial crisis of 2007-2009 was perhaps the most acute bear market in recent times.

Mr Hunter said: “A US recession was of little consequence given what followed, with the subprime mortgage market descending into chaos. The repercussions ran through the entire global financial system.
This has led to widespread risk of insolvency for many major financial institutions.

Mr Hunter added: “Unprecedented interventions by global central banks have helped steady the ship, including large swathes of ‘quantitative easing’. »

Quantitative easing (QE) injected liquidity into the system and forced interest rates to fall to historic lows.

This situation was followed by a number of regulatory measures aimed at strengthening banks’ balance sheets in order to avoid a repeat of this situation.