Beginner’s Guide to Market Volatility

Bear markets are 'the sale of the century' for long-term investors, says financial advisor

Twenty/20

Monday marked 11 years since the start of the bull market in U.S. stocks, and the markets celebrated with an unusual amount of turbulence. And on Wednesday, one of the major benchmarks went into a bear market.

The Dow Jones Industrial Average closed Wednesday more than 20% below its February high. The S&P 500 briefly touched this threshold, based on intraday prices, though most investors don't conclude that a gauge is in a bear market until it's fallen at least this percentage based on closing levels. On this basis, through Wednesday's close, the S&P 500 is down 19% since its February all-time high.

Though atypical, bear markets are not that rare: There have been four in the past 40 years. Whether you're a grizzled veteran or someone newer to investing, you may find it tempting to succumb to fear if stocks enter into one. Many people tend to panic during these types of sell-offs.

Instead, recognize that, if you're a long-term investor, a bear market is "the sale of the century" for stocks, says Jamie Cox, managing director at Harris Financial Group. 

"Selling your stocks may be the most expensive mistake of your investing career," Cox says. "Opportunity cost is where people have to really pay attention during these heightened periods of volatility."

For now, the U.S. stock market remains in a correction, defined as a decline of at least 10% from a recent high, and it's anyone's guess when or if it will cross that 20% threshold to enter a bear market. Still, it's useful to know what happens during these types of declines.

What happens during a bear market

A bear market occurs when an asset's price falls by at least 20% from a recent high. You'll typically hear about bear markets for a broader index, like the S&P 500, but in fact any type of market or individual asset can experience these types of declines. The oil market, for example, fell into a bear market in early 2020 and has already plummeted more than 49% this year.

Since World War II, there have been 12 bear markets in the S&P 500, with average losses of 30%, according to analysis by CNBC and Goldman Sachs. On average, these slumps happened over a period of about 13 months, and the market took another 22 months to recover. That means the total duration of these bear markets was about three years, on average.

While bear markets often coincide with economic recessions, that's not always the case. Of the post-World War II bear markets, four didn't overlap at all. During a recession, there's a significant decline in economic activity — and many economists define a recession as two consecutive quarters of declines in gross domestic product (GDP), or the sum of the value of all goods and services produced in an economy.

In addition, you can expect the following to happen during a bear market, according to Cox:

  • Stress in the banking system, as evidenced by whether banks are willing to lend money
  • Bankruptcies among publicly traded companies
  • Difficulty with cash flow at small businesses
  • Layoffs
VIDEO1:5701:57
The difference between a bear market, a recession, and a correction

Video by Courtney Stith

What leads to a bear market?

There's always a reason why the market tumbles into a bear market, and the novel coronavirus is poised to be the catalyst this time around. Traders are worried that the virus could slow global economic growth. Adding to the market's recent woes was a price war that sent oil prices tumbling more than 20%. 

"Novice traders, and even experienced ones, are scratching their heads with the recent price action," says Edward Moya, a senior market analyst at OANDA. "There's been a consistent avalanche of headwinds that is hitting financial markets."  

The S&P 500 last hit a record high on February 19, just three weeks ago. If it enters a bear market soon, it will mark the index's fastest 20% drop in history, according to data compiled by Bloomberg. Previously, the 1929 market crash — which happened in 42 days — was the swiftest decline into a bear market.

Selling your stocks may be the most expensive mistake of your investing career.
Jamie Cox
managing director at Harris Financial Group

Over a 13-day span through Wednesday, the S&P 500 logged daily moves in excess of 3% up or down on nine different trading days. By comparison, moves of this magnitude have happened about four days a year, on average, since 1980, according to FactSet data analyzed by Grow.

Meanwhile, the yield on the benchmark 10-year Treasury note has also been plummeting: It dropped below 0.5% for the first time ever. This reflects the fear in the markets, as traders rush to invest in assets that historically have been safer, like Treasury bonds.

Moya believes there's likely to be more volatility in the stock market in the weeks ahead. "I don't see it dying down," he says. "U.S. stocks are not going to stabilize until yields stabilize."

How to invest during a bear market

If you're investing in the stock market for long-term goals, like retirement, it's best to stay invested during a bear market. Historically, the market has always recovered. 

Based on his analysis of other past epidemics that have rattled markets, Moya says investors could be due for some relief from the current sell-off in about six months. "By the end of summer, we could see some more optimism priced in [for stock prices]," he says. "And if we have interest rates near or at zero, investors are going to want to run back to equities."

In the meantime, now is a good time to assess opportunities in the market. If you're going to add stocks to your portfolio, prioritize those with the strongest balance sheets, Cox advises. Better yet, invest in index funds to ensure you're well diversified, which is important during all times, but particularly so during bear markets, he says.

To ensure you don't miss out on the market's eventual rebound, experts recommend that you take advantage of a strategy known as dollar-cost averaging. This involves investing money into the market at set intervals, no matter whether the market is up or down. It simplifies the process, allows you to take advantage of normal price fluctuations, and removes any potential emotional bias.

Finally, if you have an investment plan, stick to it. "This is definitely not the time to be trading. This is the time to be accumulating," Cox says. 

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