NEW YORK — Investors on Wall Street need a place to hide.
The last bear market happened two years ago, but it’s still a first for investors who started using their phones to trade during the pandemic. Over the years, thanks in large part to the extraordinary actions of the Federal Reserve, the stock market has often seemed to move in only one direction: up. Now, the familiar mantra of “buy the dip” after every market swing is giving way to fears of dips turning into craters.
Here are some frequently asked questions about bear markets:
Why is it called a bear market?
A bear market is a term used by Wall Street when indices such as the S&P 500, the Dow Jones Industrial Average, or even individual stocks have fallen 20% or more for a sustained period of time from their recent highs.
Why bears are used to represent market slumps? Bear markets hibernate, so bear markets represent a retreating market, said Sam Stovall, chief investment strategist at CFRA. By contrast, Wall Street’s nickname for the surging stock market is bull as bulls charge, Stovall said.
The S&P 500 fell 1.9% in Friday afternoon trade and was 20.3% below its Jan. 3 high. For many investors, if the S&P 500, Wall Street’s main health gauge, ends the day down at least 20% from its peak.
The Nasdaq has entered a bear market, down 31% from its Nov. 19 peak of 16,057.44. The Dow Jones Industrial Average is more than 16% below its most recent peak.
The most recent bear market for the S&P 500 lasted from February 19, 2020 to March 23, 2020. The index fell 34% during that month. This is the shortest bear market ever.
What’s bothering investors?
The market’s number one enemy is interest rates, which are rising rapidly as high inflation hits the economy. Low interest rates are like steroids for stocks and other investments, and Wall Street is exiting right now.
The Fed has shifted from propping up financial markets and the economy with record-low interest rates to being aggressive and focused on fighting inflation. The central bank has raised its key short-term interest rate from record lows near zero, encouraging investors to move money into riskier assets such as stocks or cryptocurrencies for better returns.
Earlier this month, the U.S. Federal Reserve signaled that it could triple interest rates in the coming months. Consumer prices are at their highest level in four decades, rising 8.3% in April compared with a year earlier.
These deliberate moves will slow the economy by raising borrowing costs. The risk is that if the Fed raises rates too high or too quickly, it could lead to a recession.
Russia’s war in Ukraine has also pushed up commodity prices, putting upward pressure on inflation. Worries about China’s economy, the world’s second-largest economy, have added to the gloom.
So, do we just need to avoid a recession?
Even if the Fed can accomplish the delicate task of containing inflation without triggering a recession, higher interest rates will still put downward pressure on stocks.
If customers pay more to borrow money, they can’t buy as much, so less revenue flows into the company’s bottom line. Stocks tend to track profits over time. Higher interest rates also make investors reluctant to pay more for riskier stocks than bonds, which suddenly pay more in interest thanks to the Fed.
Critics say the overall stock market looks expensive this year compared to history. Large tech stocks and other pandemic winners are considered the most expensive and have been punished the most as interest rates rise. But the pain is spreading widely, with shares of Target and other retailers tumbling this week after reporting weaker-than-expected profits.
When a bear market coincides with a recession, stocks lose an average of nearly 35%, and when the economy avoids a recession, stocks lose an average of nearly 24%, said Ryan Detrick, chief market strategist at LPL Financial.
So I should sell everything now, right?
If you need money now or want to lock in losses, yes. Otherwise, many advisors recommend ups and downs while keeping in mind that volatility is the entry price for the higher returns that stocks provide over the long term.
While selling the stock can stop the bleeding, it will also prevent any potential gains. Many of Wall Street’s best days happen during or after a bear market. These included two separate days in the middle of the 2007-2009 bear market, when the S&P 500 surged about 11%, and a more than 9% jump during and shortly after the 2020 bear market in about a month.
Advisers recommend putting money into stocks only if you don’t need it for a few years. The S&P 500 has bounced back from every previous bear market, finally rising to another all-time high.
The decade after the dot-com bubble burst in 2000 was a notoriously brutal period, but stocks were usually able to return to their highs within a few years.
How long will the bear market last and how far will it go?
On average, since World War II, bear markets have taken 13 months from peak to trough and 27 months to return to breakeven. During the bear market during that time, the S&P 500 lost an average of 33%. The biggest drop since 1945 occurred during the 2007-2009 bear market, when the S&P 500 fell 57%.
History shows that the sooner an index enters a bear market, the shallower they tend to be. Historically, it takes 251 days (8.3 months) for a stock to enter a bear market. When the S&P 500 fell 20% at an even faster pace, the index lost an average of 28%.
The longest bear market lasted 61 months and ended in March 1942, cutting the index by 60%.
How do we know when a bear market is over?
Generally, investors want a 20% gain from the lows and a consistent return for at least six months. The stock market has risen 20% from its March 2020 lows in less than three weeks.
Vega reported from Los Angeles. — Follow more AP business coverage at https://apnews.com/hub/business.