Is It Possible to Predict a Bear Market?
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"If you’re focused on a long-term strategy with a well-diversified portfolio, you don’t need to do much else but hang on for the ride."

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Unless you have a flux capacitor, it’s nearly impossible to predict the future. But there are some signs you can watch to get an idea of when a bear market might come out of hibernation.

Wait, remind me again what a bear market is?

Technically, it’s when a major index like the Dow Jones industrial average (which tracks 30 of the largest U.S. stocks) and Standard & Poor’s 500-stock index, drops 20 percent below its 52-week high. That’s twice as big as a market correction, defined as a 10 percent decline.

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Good news: While corrections might occur every year or two, bears don’t come around often. In fact, since 1926, we’ve only seen eight bear markets, according to First Trust Advisors. On average, they involved a drop of about 41 percent and lasted 1.4 years before stocks recovered. The last one hung around from October 2007 through March 2009 with the S&P 500 shedding 50.9 percent total (which it’s long since fully recovered).

What are the signs one’s coming?

Some indicators can be found in the market itself. For example, if prices are running up too quickly, we might be in bubble territory and nearing an inevitable pop. You can analyze whether stocks are too expensive by looking at the market’s price-earnings ratio. (Over the last 15 years, median P/E for the S&P 500 has been 14.8.)

That issue can be exacerbated by overly optimistic investors who pile in on high-priced stocks, making them more expensive than they should be based on the company’s revenues and other criteria, which is why investor confidence is another indicator to watch. The Investor Sentiment survey gauges how investors are feeling each week.

Other indicators are tied to economic conditions, such as unemployment, inflation, interest rates and GDP growth. If any or all factors point to a weakening economy, a recession or bear market could be lurking.

How do I prepare?

Give yourself a gut check. The early February 2018 correction might’ve been a good opportunity to better understand your risk tolerance. If you held steady, you’ll probably be just fine, even through worse times. Otherwise, you might want to fine-tune your portfolio and invest a little more heavily in bonds, which tend to provide lower returns but are viewed as less risky.

Beyond that, if you’re focused on a long-term strategy with a well-diversified portfolio, you don’t need to do much else but hang on for the ride.

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