Bear markets are periods in which stock markets drop for an extended amount of time. These pullbacks typically run to twenty percent or even greater amounts of the underlying stock values. Bear markets are the direct opposites of bull markets, when prices rise for extended amounts of time.
Bear markets and their accompanying drastic drops in stock share prices are commonly caused by declining corporate profits. They can also result from the correction of a too highly valued stock market, where stock prices prove to be overextended and decline to more historically fair values. Bear markets commonly begin when investors become frightened by lower earnings or too high values for their stocks and begin selling them. When many investors sell their holdings at a single time, the prices drop, sometimes substantially. Declining prices lead still other investors to fear that their money that they have invested in the stock market will be lost too. This motivates them to sell out through fear. In this way, the vicious cycle down progresses.
There have been many instances of bear markets in the United States since the country began over two hundred years ago. Perhaps the greatest example of an extended bear market is that found in the 1970’s. During these years, stocks traded down and then sideways for more than a full decade. These kinds of encounters keep potential buyers out of the markets. This only fuels the fire of the bear market and keeps it going, since only a few buyers are purchasing stocks. In this way, the selling continues, as sellers consistently outnumber buyers in the stock exchanges.
For long term investors, bear markets present terrific opportunities. A person who is buying stocks with the plan to keep them for tens of years will find in a bear market the optimal sale price point and time to purchase stocks. Though many individual investors become frenzied and sell their stocks continuously during a bear market, this is exactly the wrong time to sell them.
Bear markets provide savvy investors with the chance to seek out solid companies and fundamentals that should still be strong ten to twenty years in the future. Good companies will still do well in the coming years, even if their share prices fall twenty or forty percent with the overall market. A company like Gillette that makes razors will still have a viable and dependable market going years down the road, even if the stock is unfairly punished by a bear market. Making money in a bear market requires investors to understand that a company’s underlying core business has to be distinguished from its short term share price. In the near term, a company’s fundamentals and stock prices do not always have much in common.
This means that a discounted price on a good company in a bear market is much like a periodic clearance sale at a person’s favorite store. The time to buy the products heavily is while they are greatly discounted. The stock market is much the same. History has demonstrated on a number of different occasions that the stock prices of good companies will rebound to more realistic and fair valuations given some time.