The stock market fluctuates along a trend line. When the overall trend is up for an extended period of time, it's a bull market. A bear market begins when the trend turns down and continues down. While the bear market is in effect, some market sectors and some companies nevertheless fare quite well, even posting new highs in their stock prices. Switching the emphasis of your stock purchases can bring you through a bear market successfully.
Bear Market Defined
An extended decline of 15 to 20 percent or more in the major stock market averages, such as the Dow Jones Industrial Average, the S&P; 500 and the NASDAQ, qualifies as a bear market. It might last for a few months to several years. A rapid decline of 20 percent, lasting a few days to a few weeks, is called a correction; this is just one of the normal fluctuations in a trend. A bear market might kick off with a steep correction, climb back up and then continue a down trend, but the key determinant of a bear market is the direction and length of the trend.
Cyclicals vs. Counter-Cyclicals
A bear market is more likely to start as the economy begins to weaken after hitting a high in the business cycle, and the bear continues until the economy starts to improve. Since the stock market is made up of many types of companies, the counter-cyclicals tend to do better in an economic downturn. A cyclical stock represents a company that does well during good economies, such as an automobile company or a company that produces luxury goods. A counter-cyclical is a company that produces what people need to buy every day, regardless of the economy. Examples are utilities, oil companies, food companies, pharmaceuticals, household products and the so-called sin stocks like tobacco and alcohol companies. Counter-cyclicals perform in any market, but are often outpaced by cyclical stocks during periods of economic prosperity.
Value Investing Pays Off
While counter-cyclicals are defensive stocks, each bear market can present different challenges. For example, electronics are commonly considered cyclicals, but in a bad economy, when companies are replacing workers with computers, electronics stocks can perform well. When looking for a good counter-cyclical stock to buy, consider how social trends might affect its performance. Also look for a stock that has a history of earnings stability, good management, low debt relative to other companies in its sector and no foreseeable challenges to its performance, such as expiring patents or products that are declining in popularity.
Dividends Are Defensive
Companies that have a history of paying stable dividends are another place to invest during a bear market. Utilities normally pay dividends and are a service the consumer can't do without even during a deep recession. Dividends protect your stock from a major decline in value because, as the stock price drops, the dividend yield rises and this attracts buyers to the stock, helping to support its price. Buying a defensive or counter-cyclical stock doesn't guarantee that you'll dodge a decline in price during a severe bear market, but it is likely to decline less than the cyclicals.
- Incademy: 15. Bear-Proofing - Sectors That Historically Do Well in Bear Markets
- Peter Dag: Timing Your Investment Strategies Using Business Cycles and Stock Sectors
- Federal Reserve Bank of San Francisco: When Were the Most Prolific Bull and Bear Market Periods in the United States?
- Kiplinger: Make Money in a Bear Market
- Stock Markets: Differentiating Between Cyclical and Non-Cyclical Stocks
- Hemera Technologies/Photos.com/Getty Images