The stock market, sometimes referred to as the equity market, is a trading place for company shares (stocks) and other financial instruments (derivatives). The price of the stocks is measured by an index, in the United States that is the Dow Jones index and in the UK, the FTSE. Each stock exchange uses its own index. As the prices of stocks go up, so does the index and conversely as the prices fall so too does the index.
Over short periods of time, the indexes will fluctuate both up and down as the price of the stocks fluctuate. This is normal and expected. However, underlying these daily fluctuations is a trend. The trend may be generally upwards, that is the price of stocks over time are generally increasing, or it may be generally downwards, that is the price of stocks over time are generally decreasing.
When the underlying trend of the index is increasing over a prolonged period of time and at a significant rate, the market is said to be a bull market. When the underlying trend of the index is decreasing over a prolonged period of time and at a significant rate, the market is said to be a bear market. There is no precise definition of a bear market, but it is generally accepted that a bear market is when the index has fallen by 20% over a two month period.
Origin of the term
The reason that the term bear is used to describe a falling market is lost to history, but there are two reasonable potential explanations. The first of these is that the term bear derives from the sellers of bearskins in America in the eighteenth century. They would often sell the bearskins before they had received their supply in order to achieve a higher price. They would do this when they thought that prices were about to go down. Hence, they were acting like investors on the stock market today.
The second potential explanation is connected to the way that bulls and bears fight. A bull fights by placing its head downwards and sharply raising its head again to hit its opponent with its horns. Hence an upward surge on the stock market is called a bull market. The bear does the opposite, it raises its paw and swipes at its opponent with a strong downward motion, hence a downward surge on the stock markets is called a bear market.
Characteristics of a Bear Market
The prolonged significant fall in share prices which characterises a bear market is a reflection of the wider health of the economy. The reason share prices fall is that investors do not place such a high value on the shares as they had previously. The reason that investors lose this confidence is because the company issuing the shares is not performing well. When this is extrapolated across the whole market, it is because most companies are not performing as well as previously. This usually happens at a time when the economy is in a recession or a depression.
Investors become pessimistic in a bear market as they see the value of their shares, and hence their wealth, go down. This pessimism then feeds on itself as investors are reluctant to buy more shares unless they can buy them at a reduced price. As investors anticipate losses during a bear market, they seek to limit their exposure to further losses. This drives share prices down further and sustains the bear market conditions.
As the share price of companies fall, so does the overall value of their assets. This may affect whether they can obtain finance and at what cost. In order to deal with this situation, companies will often look to cut costs including reducing their staffing levels. Over the whole economy, this results in significant higher unemployment rates. When an economy has high unemployment and is in a recessionary cycle, it is hard for the economy to grow (ie it is difficult for companies to maintain and increase their profits). This is because people have less money to spend, both those who have become unemployed and those in work. Those in work will usually see their wages rise more slowly than prices as companies control costs and try to grow profit. It is even worse if inflation (the measure of increases in prices of goods and services) is at a high level.
There have been some terrible bear market conditions over the last century, such as the Great Depression in the 1930s, the 1973 oil crisis and the dot com crash in 2000. We are currently in the middle of a bad bear market now due to the credit crunch and continued sovereign debt crisis. This is exacerbated by the troubles within continental Europe, which is struggling to reconcile strong and weak economies under one currency. The fear is that recovery from the current bear market may be prolonged if the Euro fails and a new recessionary cycle begins.