Modules for Beginners
Navigating Bear Markets
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Glossary: 10 terms you should know about bear markets
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1. Business cycle
A business cycle is essentially the cyclical movement of businesses that make up the economy, as well as the economy as a whole, through periods of upswings and downswings. It consists of four phases, namely expansion, peak, recession and depression.
During the expansion phase of a business cycle, an economy’s GDP witnesses a rise. Depending on the prevailing circumstances, the increase in GDP can either be slow, moderate or rapid. Also, in the expansion phase, people are generally left with more disposable income. This is then used to purchase more goods and services.
The peak is the phase in a business cycle where the GDP of an economy is at a high point. Everything from economic activity and consumer demand to employment and production are at their highest levels. Although peak is a favourable phase, if it lasts for a long enough time, there’s a risk of inflation.
When the Gross Domestic Product (GDP) of an economy declines for two quarters of a year simultaneously, the economy is officially considered to be in recession. Recession has a multi-fold effect on the economy. The lack of economic activity during a recession essentially prompts people to save up rather than spend, which lowers consumer demand.
Recession, if left unchecked, can end up turning into a depression. In this phase, the economy bottoms out and touches its lowest point. Here, consumer spending and income levels are at their lowest, unemployment is at its peak, and the supply of goods and services reach levels of overproduction.
6. Bear market
A bear market is a phase in the stock markets that is marked by prolonged and consistent declines in the prices of the stocks listed on the exchanges. Typically, the prices of stocks decline by 20% or more for a sustained period of time. Negative investor sentiment fuels shareholders to sell their holdings, thereby making it a seller’s market, characteristically. In other words, investors flee the market.
Capitulation essentially refers to investors selling out and migrating out of the markets massively. It is at this point that stock prices start to fall noticeably. Trading activity dips on the buying end of the spectrum and, depending on the economic conditions, corporate profits also begin to decrease. Panic sets in among investors, leading to peak bear market conditions.
8. The financial crisis of 2008
The 2007-2008 crisis was brought about by the U.S. financial institutions and the excessive amounts of risks taken by them. A few years prior to the crisis, the U.S. housing market had been witnessing a meteoric rise. This led to these financial institutions giving out too many loans. A huge number of these loans went to subpar borrowers with low credit scores and inadequate repayment abilities. In a bid to insure these less-than-favorable loans, these financial institutions also bought and sold credit default swaps between each other.
When these loans ultimately went into default, the financial institutions were not able to honor the commitments of the credit default swaps. Such a situation culminated in the failure of several huge financial institutions, the biggest of which was Lehman Brothers.
9. The dot-com bubble
Spurred on by the popularization of the internet and growing access to the World Wide Web, many internet companies came into the market in the early 1990s. Investors were keen on putting their money in these companies, backed by a firm belief in technology and its future growth potential. As an increasing amount of capital flowed in, the valuations of these internet companies, many of which were online shopping businesses, shot through the roof, starting from 1995. By the start of the year 2000, these companies were found to be significantly overvalued.
As a result, the Nasdaq Composite stock market index swelled by as much as 400% in response to this manic buying. However, all of that came crashing down at around March, 2000. Both the primary broad market indexes of the U.S. started to fall consistently by several percentage points all throughout 2000, 2001, and 2002. Several internet and communication companies such as Pets.com, Boo.com, Webvan, NorthPoint Communications, and Worldcom, among others had to shut shop.
10. Sell and hold strategy
The sell and hold strategy is a two-part technique where you’re first required to sell out all of your investments. And instead of investing it right away, like in the capitulation strategy, you hold on to the cash. Then, when a market correction happens, instead of exiting from your position like in the previous strategy, you buy stocks using the cash that you already hold instead.
Once you’ve executed this strategy, you hold onto these newly invested stocks and ride out the bear market. And when the tide turns in your favor and a bullish reversal happens, you could choose to sell your investments for a handsome profit.
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