Why do bear markets cause major crashes? To understand that, you’ll need to look at the history of the stock market.
Over the centuries, some of these crashes resulted in major depressions, while other markets were able to bounce back quickly. The stock market is a fickle thing, and it’s extremely difficult to predict when and why these market trends will occur. It’s also incredibly hard to know when they will end if the downward trend continues.
What Is a Bear Market?
A bear market is a term that describes a downward trend in a stock market. If a stock market is in general decline over a certain period of time, one can refer to it as a bear market. The phrase also connotes widespread investor pessimism fueled by fear that the market will crash.
A bear market is the opposite of a bull market. A weak, slowing economy is a sign that a bear market is coming, and that’s important information for investors and non-investors alike to pay attention to. A bear market can affect the entire economy–and they have done just that plenty of times over the years.
In more technical terms, a bear market describes a price decline of 20% that lasts for at least two months. A bear market ends when the stocks in the market recover and reach new highs.
Bear markets are measured in hindsight, as economists analyze the new high prices to the lowest closing price that the stocks reached during the bear market. The “recovery period” from the bear market measures the lowest closing price to the new highs.
If stocks regain 20% of their value from their lowest closing price, that also indicates that a bear market has ended.
From 1926 to 2014, the average bear market lasted 13 months. The cumulative losses in that time averaged about 30%.
The Worst Bear Markets in History
Bear markets have made history several times, as the decline of the stock market can lead to consequences for all of society. These are examples of historic bear markets that changed the lives of the people living through them.
The Financial Crisis of 1791-1792
In autumn of 1791, the First Bank of the United States sold shares that boomed and busted. The next year, the Panic of 1792 occurred. This bear market was exacerbated by prominent bankers who were trying to drive up the prices of bank stocks and debt securities.
Those same bankers ended up defaulting on loans and causing a bank run, which happens when customers begin pulling their money from the bank in fear that it will collapse. Secretary of the Treasury, Alexander Hamilton, was crucial in managing this crisis by providing banks with hundreds of thousands of dollars to stabilize the market.
Although it’s now one of the most cutthroat shopping days of the year, Black Friday initially referred to the terrible day that was September 24, 1869. The collapse of the value of gold on that day was triggered by a conspiracy between Jay Gould and James Fisk, who worked hard to artificially drive up the price of gold.
The panic hit Wall Street immediately, then rippled through the nation for months to come. President Ulysses S. Grant had to do what he could to avoid a national depression.
The Wall Street Crash of 1929
This terrible market downturn is also known as The Great Crash. The crash began in September and lasted through the end of October. This was the most devastating stock market crash in the history of the United States.
The 1920s were a decade of wealth, excess, and post-WWI optimism. Rural citizens flocked to cities, and industrial advancements seemed to promise a great future for the country. But in March, a small crash scared investors into selling stocks. The market began to slide, and a bear market seemed imminent.
Things seemed to get better at first, with stocks gaining back value until September of that year. It was a bull market like no one had ever seen. However, some experts knew that that wasn’t something to be optimistic about.
“A crash is coming, and it may be terrific,” predicted Roger Babson, a financial expert, in September of 1929. Soon after, the market declined, and it wasn’t long until a full-blown crash was in effect.
The Kennedy Slide of 1962
The Kennedy Slide is also referred to as The Flash Crash of 1962. Whatever you call it, this was one of the worst bear markets the country has ever seen. The stock market was in decline from December of 1961 to June of 1962, during the presidency of John F. Kennedy.
The stock market had been in recovery since the Great Crash of 1929, but it reached its peak at the end of 1961. Then, stocks fell drastically in the first half of 1962. The S&P 500 declined by 22.5% at this time.
The Dow Jones Industrial Average also experienced its second-largest point decline ever at this time, when it fell 5.7%. That’s a decrease of 34.95 points.
The Great Crash of 1929 actually caused investors to bet on stock prices to lower–basically, they were betting on a bear market. This then caused stock prices to drop even more. This strategy is known as a bear raid, and it has the potential to be quite lucrative. Wall Street investors who used this strategy made fantastic fortunes through insider trading that was not yet regulated.
A bear raid at the time could involve investors spreading negative rumors about a stock. Traders could also take on huge short positions, selling in large volumes and ultimately manipulating the stock price.
Black Monday was the greatest one-day percentage decline in U.S. stock market history. This event ended in a bear market after the S&P 500 and the Dow Jones Industrial Average plummeted by over 20%.
Black Monday, which occurred on October 19, 1987, was severe and unexpected. All 23 major world markets experienced a major decline. Eight markets declined by 20-29%, three declined by 30-39%, and three declined by more than 40%. The three that declined by more than 40% were Singapore, Australia, and Hong Kong.
People were anticipating a market crash, but they didn’t know it was going to be this bad. When Black Monday began, investors were already feeling pressure to sell their stocks. This led to a major downward trend in stock prices because there was an imbalance between the volume of sell orders and the volume of buy orders.
That day, the Dow Jones Industrial Average fell by 508 points, which is about 22.6%. The futures exchanges market and the options market also crashed. As people sold in large volumes, stock prices continued to drop throughout the day.
People were in fear that another Great Depression was coming. However, the market ended up bouncing back almost right away after the crash. The next day, the market gained 102.27 points back. The Thursday after Black Monday, it gained another 186.64 points. While this was a good thing for investors, it did take two years for the Dow Jones Industrial Average to completely recover.
The Great Crypto Crash
This one was also known as the 2018 Cryptocurrency Crash and the Bitcoin Crash. It all went down when in December of 2017, the price of bitcoin soared to a then-high of $19,783.06. Just a few days later, on December 22, Bitcoin fell 45%. Its value plummeted to below $11,000.
Making matters worse, rumors swirled that South Korea was preparing to ban the practice of trading in cryptocurrency. This triggered another drop in Bitcoin’s price by about 12%.
As all this was happening, the other cryptocurrencies followed a similar trend. Bitcoin’s fall led to drops in all kinds of crypto. By September of 2018, cryptocurrencies had fallen 80% from their January 2018 peak. It’s crazy to see the kind of market volatility that can happen in such a short period of time.
The Phases of a Bear Market
As unpredictable as they can be, there are distinct patterns that tend to define a bear market. They usually go through four phases before the stock market recovers. These are the phases a bear market usually goes through:
- High prices and high investor sentiment abounds. The bear market is unappealing to investors, and they begin to sell off their assets.
- Stock prices fall dramatically. Trading activity slows. Sentiment lowers, and this causes other investors to panic. This can lead to capitulation, which is when an investor gives up any previous gains in a market by selling their positions in a period of decline. This is similar to panic selling, and it’s a common occurrence when bear markets hit.
- Speculators slowly begin to enter the market. This leads to a welcome increase in prices and trading volume.
- Stock prices are still dropping, but it’s not happening as fast. Their seems to be some hope returning as panic leaves. The low stock prices and the promise of a recovery attracts people back to the market, and a bull market is ready to build.
Similar to the way forest fires can be productively destructive, bear markets always end up leading back to a bull market. The problem is, this takes a long time to occur. All we can do is be prepared because bear markets are a fact of the investment world that won’t go away anytime soon.