Bear Market

The conventional threshold is arithmetic and mechanical: take the highest closing level of the index, take the current level, and express the fall as a percentage of that peak. A decline of one fifth or more marks the transition from correction territory into a bear market. Two conventions matter. First, most published dating uses closing prices rather than intraday extremes, so headline figures can differ by a percentage point or two across data providers. Second, the standard measure is price return, not total return, so dividends are excluded and the economic loss to a reinvesting holder is somewhat smaller than the quoted drawdown.

Recovery arithmetic is asymmetric. A 20% fall requires a 25% subsequent gain to restore the original level; a 50% fall requires a doubling. This convexity is why drawdown control, rather than average return alone, dominates practical risk discussion.

Practitioners commonly distinguish three archetypes. Event-driven declines are triggered by an identifiable shock such as a policy error, a geopolitical rupture or a liquidity seizure; they tend to be sharp and comparatively short, and they can occur without any economic contraction. Cyclical bears track the business cycle, driven by rising rates, peaking margins and falling forward earnings expectations; they are the most common variety and typically span several quarters. Structural bears follow the unwinding of an asset bubble or a balance-sheet imbalance, frequently involving the banking system, and they are the deepest and slowest to repair.

Decomposition is analytically useful: index levels equal earnings times a multiple. Early declines are usually multiple contraction as discount rates rise and risk premia widen; later phases reflect actual earnings downgrades. Distinguishing which component is moving indicates how much of the news is already priced.

Bear markets alter the statistical properties investors rely on. Cross-asset and cross-sector correlations rise toward one, so diversification delivers least protection when it is most needed; volatility clusters, with the largest single-day gains often occurring inside the decline rather than after it. Style leadership rotates: defensive sectors such as consumer staples, utilities and health care typically outperform in relative terms, quality and low-volatility factors hold up better, and high-beta, long-duration growth names fall hardest when discount rates are the driver.

For portfolio construction this shows up in downside risk measures such as maximum drawdown, downside deviation, semivariance and value at risk, and in the sequence-of-returns problem facing investors drawing income from a portfolio. Disciplined rebalancing mechanically buys equities as weights fall below target, which is why policy statements specify rebalancing rules in advance rather than in the moment.

Compute a drawdown from peak and current index levels, and compute the gain required to recover it. Classify a decline correctly: a fall of roughly ten to twenty percent is a correction, and a negative calendar year is neither if no twenty percent peak-to-trough move occurred. Explain why equity markets lead the economy, since prices embed expectations of future cash flows discounted at a required return that itself rises with perceived risk.

Connect the concept to behavioural finance: loss aversion, herding, overreaction and the disposition effect all sharpen selling pressure, and market-efficiency questions frequently ask whether such episodes contradict informational efficiency. They generally do not, because revisions to expected cash flows and required returns can justify large price changes. Finally, be able to describe why realised risk measures estimated in calm periods understate exposure to these episodes.