Stocks are officially in a bear market. Let’s look at what causes bear markets, and how they affect older investors who are saving for retirement or have already retired.
A bear market is, by definition, a 20 percent decline from the most recent market high. By that definition, the Standard & Poor’s 500 stock index, the benchmark index that measures the performance of 500 of the largest 500 U.S. companies, peaked Jan. 3, 2022 and entered the bear cave on June 13, 2022. The Nasdaq stock index peaked in November 2021 and bedded down with the bear in March 2022. And finally, the venerable Dow Jones Industrial Average joined the party on Sept. 26, 2022.
The carnage within some stocks in the Nasdaq 100 has been, well, grisly. Netflix shares, for example, have plunged 68 percent from a high on Nov. 17, 2021. Online payment company PayPal is down 70 percent from its high; drugmaker Moderna is down 72 percent.
Bear markets since 1929
|Year||Number of days||Decline amount||Months to break even|
What causes bear markets?
There is no one cause for bear markets, which is why trying to predict them tends to be futile. Here are the general culprits that tend to unleash the bear.
- Rising interest rates. Lenders, whether they are giving you a home mortgage or financing a mega-million-dollar bond offering, like to get their money back. They also want a rate of return that’s higher than inflation. If they think inflation will rise, lenders start raising their interest rates. After all, if you earn 3 percent on an investment and inflation averages 4 percent, you’ve lost a percentage point.
Why is that bad for stocks? Bonds are loans to corporations, municipalities and the U.S. government. If investors can get a relatively good rate (after inflation) on a bond, they will tend to move money out of stocks and into interest-bearing investments, such as government bonds. In addition, higher rates mean that businesses have to pay more for loans, which reduces corporate earnings.
- External factors. The world is an uncertain place, and sometimes events come out of the blue that cause a stock market sell off. In October 1973, for example, OPEC (the Organization of Petroleum Exporting Countries) declared an embargo on oil exports, causing the price of oil to triple in a few months. The price hike affected not only consumers, who had to wait in long lines for gasoline, but also the many companies that relied on oil to make or ship their goods. The bear market that started in January 1973 lasted 69 months and clawed the S&P 500 for a 48.2 percent loss. The short, sharp bear market in 2020 was caused almost entirely by the onset of the coronavirus pandemic.
- Sobriety. The stock market is a place for optimists: You buy stocks because you think corporate profits will increase, the economy will be healthy and prices will rise. Every so often, however, stock investors get too optimistic, making big bets on stocks that don’t deserve all that money. In 2000, for example, investors made huge bets on online companies such as the now-defunct Pets.com. Eventually, investors wised up and realized that those companies were never going to make money, and that started the big bear market of 2000.
It’s entirely possible to have all three factors in play at once. Currently, for example, both long-term and short-term interest rates are rising, albeit from very low levels. The Russian invasion of Ukraine not only made the world a less stable place but also drove up the price of oil. And big moves in dubious stocks, such as video game retailer GameStop, have also been fairly common.
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What to do
Bear markets are almost always discovered in hindsight, and your reaction to them should depend on your current financial position as well as your goals. For example, if you’re 50 years old and plan to retire in 15 years, your best bet may be to keep socking away money in your 401(k) or IRA in the same proportions as you have been. The average bear recovers in three and a half years. In the meantime, if you invest regularly, you hope to be buying stock at progressively lower prices. That’s a good thing: You want to buy low now and sell high later.
If you’re retired, don’t take withdrawals from your stock funds in a bear market unless you have no other choice. You won’t have income to cover your losses. And if your stock fund is down 15 percent and you withdraw 4 percent, your account will be down 19 percent. Withdrawals in a bear market just make things worse.
Instead, most financial planners recommend that you have a “bucket” plan. Consider putting your investments in three buckets: ultrasafe cash investments, such as bank CDs and money market funds; moderate-risk investments, such as bond funds; and high-risk investments, such as stock funds.
Use your cash investments for making withdrawals in volatile markets. Your riskier funds will still get hammered, but you won’t make the situation worse by taking withdrawals that lock in the losses. When your stock funds have recovered, you can replenish your cash and bond buckets — and be prepared for the next bear market.
John Waggoner covers all things financial for AARP, from budgeting and taxes to retirement planning and Social Security. Previously he was a reporter for Kiplinger's Personal Finance and USA Today and has written books on investing and the 2008 financial crisis. Waggoner's USA Today investing column ran in dozens of newspapers for 25 years.