What a Bear Market Means for the Economy

If you invested pandemic-era gains into the stock market, or own a 401(k) plan, get ready for an anxiety-inducing ride. For the first time in nearly two years, the stock market crossed into bear market territory this week as inflationary concerns have sent the S&P 500 spiraling down more than 20% from its record high in early January.

The grim milestone marks yet another low point for Wall Street, which has been rocked by a sharp selloff of stocks in recent months. On Monday, the S&P 500 tumbled nearly 4% as all but five of its components ended the day with losses. Stocks continued to fall on Tuesday but turned upward following Wednesday’s Federal Reserve meeting, where policymakers raised interest rates by three quarters in a continued effort to fight inflation.

It’s unknown how long the bear market will last, but historical examples can shed some light on what to expect. Here’s what you need to know.

What a Bear Market Means for the Economy

What is a bear market?

Wall Street uses the “bear market” term to describe a sustained period when the equity markets are down at least 20% from their recent peaks. Passing the 20% threshold—which occurred on Monday for the S&P 500 index—typically indicates widespread pessimism about the health of the U.S. economy and negative investor sentiment.

Such steep downturns are relatively rare, only occurring 14 times since World War II, including this one. Once previous bear markets had begun, it took an average of 19 months for stock prices to stop falling, according to an LPL Research analysis. But some take less time. The last bear market carried on for only 33 days, from mid-February to late March of 2020, at the start of the Covid-19 pandemic—the shortest bear market since World War II.

The most recent sustained bear market lasted 17 months, beginning in 2007 at the start of the financial crisis, and resulted in the S&P 500 dropping by 51.9%. Another sustained bear market emerged in late 2000 when the dot-com bubble burst, causing many tech companies to go under. It lasted around two years.

But in order for a bear market to end in relative quick fashion–like it did in 2020–there needs to be some sort of catalyst to get investors excited about stocks again, says Emily Bowersock Hill, chief executive of Bowersock Capital Partners, a financial management firm. During the last bear market, investors had the cryptocurrency market, meme stocks and new technology companies to rally around. This time, it’s a little less clear. “To turn this sentiment around and have a real recovery in this bear market,” Hill says, “we’re either going to need to see some surprisingly good earnings, which I think is quite unlikely, or would need some kind of improvement in the conflict between Russia and Ukraine, which I would consider equally unlikely.”

How did we get here?

After producing double-digit returns during the pandemic, the stock market took a sharp turn in early 2022 as the economy reckoned with supply chain breakdowns, a war in Ukraine, record inflation, rising interest rates and a recovery from the pandemic. All of these factors reinforced investor angst and contributed to the bear market.

With inflation at its highest levels in 40 years, fueled by rising food and energy prices and the war, the Federal Reserve raised interest rates for the first time since 2018 in an attempt to get prices under control. Such aggressive moves from the Fed tend to make investors anxious, because it makes borrowing more expensive for corporations and households, which can thereby stifle economic growth and potentially lead to a recession. A higher-than-expected inflation report on Friday also helped trigger the bear market, as it raised fears the Fed would need to bump up interest rates even more aggressively this year.

But Wall Street had been expecting this moment for some time, so it came as no surprise to market watchers and analysts that the S&P 500 dropped more than 20% on Monday since its peak.

Is the U.S. headed for a recession?

Bear markets don’t always lead to recession, but they can be an indicator that one is coming. They can also be used to help predict other kinds of economic signals, like treasury bond yields or stagflation (when prices rise while economic growth slumps).

But it’s complicated. Market watchers have different opinions on whether the economy is headed for recession. Some say it would be unlikely for recession to start when unemployment is near its all-time low and consumers continue to spend. Others think a recession is inevitable, especially as Russia’s invasion of Ukraine wages on and inflation continues to rise.

“The only way to stop inflation is to reduce demand and make the labor market less tight,” says Victoria Greene, chief investment officer at G Squared Private Wealth. But even if that happens, and consumers cut back on their spending habits, it could have a trickle down effect on the economy and result in employee layoffs—all signs of recession. “Consumers are already buying less electronics and home goods and buying more staple goods,” Greene adds. “The U.S. economy lives and dies with the consumer, so if spending slows, that could lead to a recession.”

What should investors do?

Investors may want to pull their money from the stock market to avoid further losses, but for some, that might be the wrong strategy, Hill says. Bear markets have historically been an opportune time for investors to accumulate wealth over the long-term, as stock prices are lower.

“You could sell now and probably save yourself some short term pain,” Greene says, “but you risk missing out when the market turns around and you’re buying back at a higher price.”

Hill concurs. “If you’ve got a lot of cash, start gradually putting that money to work while stock prices are low,” she says. “You could be in an even better position a few years from now.”

But that may not work for everyone. Investors need to be aware of what their needs are when facing a volatile bear market. For instance, if they are retired and have spending needs or need money for rent, it’s imperative to have some sort of savings set aside for 12 to 18 months of cash flow, Greene says. Stock markets do tend to improve over the long term, with the S&P 500’s returns over the past five years still around 70% when including dividends, but it may take three years or longer coming out of a bear market.

It’s also important for investors to look closely at the kinds of companies they are investing in since some will be higher risk, such as small caps which have no earnings, because of the volatility and possibility of a recession.

“I’m advising clients to hunker down and be prepared,” Hill says. “Don’t overreact, but this could well be one of the longer bear markets that we’ve experienced since 2000.”

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