A bear market is something that a lot of traders and investors hate and only a very few love. It is a condition wherein the stock market goes down bringing along it most of the stocks listed in its index. It is a time wherein market sentiment is weak and most of the securities are falling. If a bear market persists, it normally result to either a recession or worse a depression.
A bear market must not be misunderstood with a correction. A correction is a temporary or short term downtrend following a strong market activity. Corrections provide good entry or buying points because the overall trend of the market is going up while a bearish market rarely gives good buying opportunities or if ever they do, it is normally short lived. Corrections are normally caused by profit taking or stock prices go way too overvalued. On the other hand, a bear market is caused by more serious market conditions. Here are some causes that make bearish sentiment on the market.
1.) Overvaluation of stocks. All stocks have face or book values. These are values or prices that dictate whether a certain stock is undervalued or overvalued. A bullish market normally push stocks way too high of their book values causing it to become overvalued. In a bullish market, almost all stocks go up because of the strong market sentiment. Stocks rub off their momentum to other stocks causing everything to go up with the index. As time goes by and stocks continue to go up in a general trend, they reach a point wherein they become too expensive for traders and investors. This is a time wherein they become overvalued. Ideally, stocks trade near or at their book values thus if they go way up, its natural tendency is to go down. If the stock market index goes way above its set value, it has to go down. The duration of stocks going down depend on how high it went or when will the buying sentiment strengthen again.
2.) Political unrest. The state of a certain economy depends on its political stability and reputation thus the leaders of a certain nation play key roles in its economy. The competence of the leaders can dictate market sentiment, if they’re good, the market will do good, and if they aren’t, then the market will go the opposite way. Political unrest can cause bearish market sentiment because it signifies either discontent in a certain administration or simply chaos. Lack of competent leadership means poor economic movement and that drives investors and market sentiment away. If such unrest is solved, good sentiment will return.
3.) Rapid economic growth rate. If a certain economy improves so fast, it prompts the stock market to move fast up as well. The result? It makes most stocks and the index overvalued. Most companies may have a hard time catching up with the economic causing it to become overvalued so fast. A GDP growth of 5% to 10% consistently is considered so fast and could make the market head into bearish sentiment fast.
4.) Natural calamities. One way or another, nature has its way in economics as well. Bad natural conditions are bad for businesses which may weaken market sentiment. The tsunami in Japan is one example that caused major indices all over the world to go down. Though it isn’t as serious as other causes, it is something that must not be taken for granted as well. A series of natural calamities can cause stock markets to crash making the people keep their profits (if there are) or keep what’s left in their portfolios. On the greater scale, natural calamities increase the risk of businesses decreasing the probability of increasing economic growth. Nature always has its way of giving back or getting back.
With all things being considered, non-economic friendly conditions cause bearish markets. That makes stocks overvalued or make traders and investors lose confidence in the market. However, a bearish market isn’t bad and in fact, it is healthy. It is a way to bring the prices lower in order to open better buying opportunities. Many people made great fortune in bearish markets. The adage in the stock market holds true, buy when everybody is fearful and sell when everybody is greedy or in other words, buy when everybody is selling and sell when everybody is buying. That is the best way to make money in the stock market irregardless of market conditions.