Investopedia defines a bear market as when a market experiences prolonged price declines with security prices falling 20% or more from recent highs amid widespread pessimism and negative investor sentiment.
We’re there. We are experiencing declines in growth stocks, like technology and biotech, which are typically found in the NASDAQ index, and many digital currencies are trading down greater than 50% from all-time highs. As we write this article in late May 2022, the Nasdaq index is down 27% and Bitcoin is down 58% from their all-time highs.
While these sorts of corrections can be unnerving, it helps to remember that bear markets are part of the normal market cycle and are needed to maintain healthy markets. They wipe out excesses and restore market efficiency.
Instead of making decisions that you will regret in the future, you can actually create investment wins you will brag about long into the future.
What Brings Out the Bear in the Market?
It’s part personal emotion but also factors outside our control. While bear markets are marked by investors reducing their expectations for future growth, those feelings are typically brought on by macroeconomic events. Currently, high inflation is causing Central Banks, including the Federal Reserve (the Fed), to increase interest rates.
Rising interest rates slow economic growth. The Fed is pumping the brakes in an attempt to tame inflation, while trying not to to completely stop, or even worse, reverse economic growth. Yet, many economists and market strategists do believe that the Fed’s actions will lead to a recession. When this negative sentiment tempers investors’ expectations for future growth it further reduces security prices. The more “risky” the security the bigger the reduction in price.
How Should You Manage the Bear?
One of the biggest mistakes investors make is becoming fearful during bear markets and selling their risky assets. That’s what led Warren Buffett, arguably the greatest investor of all-time, to say in his 1986 Berkshire Hathaway annual letter, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
You can be like Warren and use bear markets to buy great companies that have been put up for sale by fearful investors. Imagine the opportunity to buy the next Amazon, which traded down 90% to $11/share during the bear market of 2000/2001; if you had invested $1,000 in Amazon in March 2001, it would be worth $200,000 today.
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