A bear market is a prolonged period of pessimism which results in steady erosion in the value of various asset classes. In such market conditions, it becomes virtually impossible to predict the ‘floor’ (the price at which selling subsides and buyers begin to outnumber sellers). The overriding concern of an investor is: how to overcome this crisis and come out relatively unscathed with minimum losses.
There have been a number of bear market phases in our stock market history, each offering unique lessons on their duration and how stock prices behaved in adverse economic conditions. As the stock markets become more complex with more participants and mind-boggling volumes, some of the classical theories on market cycles like the Dow theory will be severely tested. Recent experiences suggest that both the bull and bear markets are gradually shortening. In other words, the turnaround in market sentiment is happening faster. This is, of course, yet to be logically explained and justified.
History is replete with examples of how markets react to economic and financial crises, scandals and market excesses like insider trading and leveraged trades by greedy individuals and hallowed financial and political institutions.
Among the first few signs that a market has peaked is the behaviour of the so-called smart and savvy investors. These investors include the promoters, founders and their associates (also called the ‘promoter group’) who begin offloading their stakes at valuations which are at stratospheric levels. At the other end of the spectrum you have unsuspecting and gullible investors who are deceived by the lull before the impending storm and are part of a mad rush to buy as if it is the last opportunity available.
The markets traditionally react to expectations and forecast of future company earnings and economic indicators like production, consumption and savings, employment and investments in industry, agriculture and the services sectors. As the economy enters the deceleration phase and production drops, inflation surges ahead and there is less disposable income with consumers, there is a plethora of negative news and a growing community of pessimists.
Corporations hold back expansion plans in the face of shrinking demand for their goods and services. Rising costs, growing inventories and dwindling margins lead invariably to cutbacks in production, slowdown in hiring labour and restructuring of debts. This also results in lower employee morale and decline in productivity.
Experts say that in a bear market, even good news is no news. Bad news is an excuse to hammer down the market as there is general lack of support from individual or institutional buyers as the overall mood is to wait and watch for the markets to stabilise.
As the selling momentum peaks in the last phase of the bear market, smart money resurfaces to pick up shares which are either quoting at a discount to their book values or because company insiders are back in action to mop up shares at bargain prices.
Survival in down market phases calls for patience and conviction to hold on to value investments if there is no urgent need to sell. The problem is that a secular bear market can last from one or two years to as long as 10 years or more.