When Bear Markets End

Today we have answers to key questions you've been too afraid to ask, because they're about... da, da, da dum... (whisper this)... bear markets.

First, why is it called a bear market?
Supposedly, because bears strike things down with their paws -- in a downward sweeping motion. A rising stock market is called a bull market because bulls swing their horns upward to strike.

What is a bear market?
We thought you'd never ask. A bear market is defined as a 20% or greater decline in value for a major stock market index (namely the Dow Jones Industrial Average, S&P 500, or Nasdaq Composite). Once stock indexes fall 20% or more from prior prices, we're said to be in a bear market.

How often do bear markets happen?
Since 1956, a bear market has occurred, on average, once every five years. In the last 50 years, we've seen about 10 bear markets. Prior to this one, 1990 was our last true bear market. So, when this bear market started in 2000, we were statistically overdue.

Why do bear markets happen?
Boom and bust cycles are a natural part of a capitalistic economy. The economy tends to grow for long periods of time and then contract afterwards for, typically, a much shorter period of time, before starting to grow again. The stock market typically moves alongside this growth and contraction in the economy, because stocks typically follow earnings growth at companies.

How does the stock market's decline affect the economy?
Mainly, declining stock prices result in less wealth for both companies and consumers to spend, meaning less money is available to fuel the economy. Declining share prices also make companies cautious to take on new endeavors (thereby stunting growth); make it much harder for new companies to raise capital; and make consumers less likely to spend on big-ticket items.

Didn't scandal cause the stock market to fall this time?
Stocks were falling for about 18 months before the first big scandal, Enron, unfolded. Now several scandals are being uncovered. This typically happens after a large boom cycle. A rising stock market helps a company mask its problems. When the stock market recedes, like a receding waterline, weaknesses are revealed at unstable companies that can no longer depend on high share prices to keep investors and debtors happy. Discoveries of scandal are adding to the market's decline but didn't start it.

When will the bear market end?
Since 1942, the average bear market lasted about 10 months, peak to trough, while about 35% of bear markets have lasted 1.5 to 1.8 years. After a bottom is hit, rebounding is usually a volatile, sporadic process. If we assume this bear market began in spring 2000, it's more than two years old, making it one of the longer bear markets in history. If history is any guide (there's always a chance history will mislead us), we can "expect" stocks to stop sliding in this dramatic fashion soon.

Will there be a big day of capitulation?
People talk about capitulation because most bear markets in history have indeed ended with a large day or two of selling, with the market falling several percentage points on very intense trading volume. From there, the selling finally subsides, and stocks, in theory, can start to rise. The problem is, days of capitulation are easy to see in retrospect, but very difficult to spot as they're happening. And there's no guarantee that one blowout down day will be the last.

What were the worst bear markets?
This one is fairly close to the worst! The Nasdaq is 75% below its March 2000 peak, and the S&P 500 is down 45%. But worse has happened. The big one. The Great Depression. The Dow Jones Industrial equivalent peaked in late 1929 at 452. It hit bottom in July 1932 at 58, for a massive 87% decline. In our current bear market, the Dow Jones Industrial Average is only down 31%. More recently, the S&P 500 fell 48% and the Nasdaq lost 55% in the bear market of 1973-1974.

How much does the average bear market decline?
Over the last 60 years, the average bear market decline was 25%. Today's bear market is an overachiever.

What needs to happen for this bear market to end?
One, earnings at most leading companies need to start growing attractively again. But remember that the stock market anticipates things: Stocks will likely start to recover several months before earnings begin to recover, as long as investors believe that better earnings are ahead. Second, investors must regain confidence in business. We believe this will start to happen as new legislation is passed and criminal businesses are punished.

How much do bull markets rise, and how long do they last?
Excluding our recent bull market, since 1942 the average bull market has gained 90% and lasted more than three years. So, the stock market has still been a winning proposition. On average, investors have gained 90% in good markets and lost 25% in bad markets. And from 1942 to 1994, investors lived through a cumulative 41 years of bull markets and 11 years of bear markets.

Are there better investments than stocks?
Over the last century, stocks have been the best performing liquid (meaning easily sold) investment that you could possibly make. Even after this long slide, stocks have performed far better than bonds, Treasury bills, savings accounts, CDs, commodities -- and far, far better than gold, which has lost investors money -- over the decades. For long-term investors, it's hard to beat owning a stake in leading American companies.

Jeff Fischer owns the Drip Port stocks. The Fool has a disclosure policy. It also has a spankin' new book, The Motley Fool's Investment Guide for Teens. It's a great time to teach your children about investing, so they don't grow up frightened by stocks.

Drip Port's Simple Returns since 7/28/97, as of 7/24/02 Market Close:

Drip Port: -16.6%
S&P 500:   -10.0%
Nasdaq:    -17.4%