Does a bear market mean a recession?

By Morningstar |  04-04-20 | 
 

Shankar Sharma of First Global recently stated that a bull market may happen because of many reasons: fraud, central bank manipulation, irrational euphoria, sometimes fundamentals. But a bear market is always based on only one reason: Fundamentals.

He believes that now we are witnessing a significant fundamental-driven bear market, which is exactly what 2008 (Global Financial Crisis) and 1997-98 (Asian Financial Crisis) was.

Michael Schramm and Margaret Giles, both data journalists for Morningstar, explain the basics of a bear market and a recession.

What is a bear market?

A bear market is generally when a market segment declines by at least 20%, usually over two months or longer.

Bear markets often arise from negative investor sentiment because the economy is slowing or because people anticipate that it will. Indications of a slowing economy can include rising unemployment, decreased corporate profits, and low disposable income.

(By the way, an entire stock market can reach bear-market territory, but it's also possible that only a specific market segment enters one.)

Though this is the technical definition of "bear market," it is often used in a more general way, sometimes interchangeably with these other investing terms that describe the market or economy faring poorly:

  • A recession is generally when gross domestic product, a measure of economic output, declines for two consecutive quarters.
  • A pullback is a short-term price decline within a grander scheme of price increases.
  • A correction is when an asset's price falls at least 10%.
  • A market crash is a drastic market decline over a few days.
  • A depression is a long-term recession that can last multiple years.

You might also hear the term bearish. If someone has a "bearish" view, they have a pessimistic outlook for something.

What causes a bear market? 

A bear market is essentially a crisis of investor confidence, the causes of which can vary. The most common trigger of a bear market is a weak or slowing economy, or the anticipation of an economic slowdown.

Signs of a slowing economy may include:

  • Falling productivity
  • Rising unemployment
  • Low consumer confidence
  • Decreasing corporate profits
  • Low disposable income

These signs may cause investors to become pessimistic about the prospect of future returns on investment, prompting them to sell shares. The market declines as a sell-off gains momentum and pessimism spreads.

In this case, investor confidence first wavered during the initial outbreak of the novel coronavirus in China. The spread of the virus, and the comprehensive countermeasures the Chinese government took to combat it, disrupted global supply chains and slowed the country’s productivity. Investor confidence continued to fall as the virus spread internationally and governments implemented measures to slow that spread. The combination of government policy and public-health concerns have stifled consumption and adversely affected a wide range of industries.

How is a bear market different from an economic recession?

Although the two often go hand in hand, they are associated with different issues.

A bear market describes a stock market decline as a result of negative investor sentiment.

A recession describes a slowdown in economic output and is generally defined as at least two consecutive quarters of decline in Gross Domestic Product (GDP), which functions as a measure of economic health.

The causes of an economic recession can vary. One potential cause is a loss of business and consumer confidence in investing and the economy. Lower confidence can mean retail sales slow and businesses hire fewer people. This creates a negative feedback loop as businesses cut back in response to lower demand, which in turn reinforces consumers’ pessimism.

Other potential causes include:

  • High interest rates
  • Falling housing prices and sales
  • Credit crunches

An economic recession can also be a result of a bear market, which drains businesses’ capital. In this sense, the relationship of cause and effect between a bear market and an economic recession exists in both directions: Just as investor confidence and stock prices can fall in response to a recession, a bear market can also prompt a recession by putting a strain on companies that rely on investor capital.

While COVID-19 has certainly put a drag on the global economy, it remains to be seen whether it will have lasting effects on economic output. Since a recession is defined as two consecutive quarters of GDP decline, its beginning can only be identified retroactively.

How does a bear market play out?

John Rekenthaler, Morningstar’s vice president of research, explains this in great detail in How will the market play out?

Bear markets can be frightening when you see your savings on the verge of getting wiped out. There is no need to sugar-coat the severity of the stock market’s decline. But a perspective would help. And Rekenthaler does give one.

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