Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 351

Four stages of a typical bear market - but is this typical?

Typically, bear markets have four stages.

Stage one is recognition. Almost everybody shrugs off a bear market’s initial slide as being an ordinary event. The markets rise, and they fall. Treating every bad week as the bear’s arrival would not only shred one’s nerves, but would cause poor performance, should the investor act upon that instinct. Nine times of out 10, realising a quick 5% or 10% loss would result in a permanent 5% or 10% loss, as stocks quickly return to their previous level.

This coronavirus-driven market achieved stage one during its third week. Stocks were up slightly for the year, before suddenly dropping 11% in the last week of February 2020. In response, advisory firms issued reassuring notes about how these things happen, and market volatility is natural. The stock market surged the following Monday, failed to hold its gains, and then collapsed in week three. The bear was on.

Stage two is panic. This occurs when shareholders realise that the standard advice failed. Buying on the dip wasn’t easy money, as it is nine times in 10. Rather, it led to greater damage. Along with the pain (and regret) of unexpected losses comes the surprise that the conventional wisdom was wrong. Investors’ faith is tested, and some are found wanting. They sell first, then ask questions later.

We are currently in stage two, maybe testing stage three. Along with the 1987 bust, the current stock market crash - it fully deserves that name, with the Dow down 34% from its peak at one stage but recovering some of the loss since - was the fastest stock-market descent since The Great Depression. It is difficult to apply rational analysis when so much happens, so quickly.

View from the bottom

Stage three is stabilisation. Stocks halt their decline, thereby ending the impression that they will do nothing but fall. The panic subsides but the situation remains grim. Investors believed during the first stage that stock prices slide on a whim. Now they realise that equities stumble for good reason, and that until that reason is eliminated, they will continue to struggle, despite some good days. Shareholders’ losses will not soon be recouped.

This period is marked by turbulence. Stocks rally, sometimes furiously, only to be knocked back down. Investor sentiment varies between guarded optimism that the end is at least remotely in sight, and despair that the hope was false. This is typically the bear market’s longest period, extending for several months. (Several years for The Great Depression, but we do not wish to emulate that example.)

Stage four is anticipation. This is when stocks start their recovery. As with the bear market’s beginning, almost nobody recognises its end until after the fact. The news at the time tends to be almost unrelievedly grim, accompanied by articles about how stocks’ golden days have passed. However, some investors perceive economic improvement distantly in the future. They make their bids, and stocks begin to rise.

A classic case occurred in March 2009. The recession was in its terrifying midst. Real US gross domestic product declined that quarter, and the next quarter, and the quarter after that. The Morningstar Ibbotson Conference was held that month to empty seats, with the keynote speaker predicting several more months of equity losses. The rally began the next day.

Example #1: Black Monday

This is how the four stages played out 33 years ago in US markets:

Example #2: Financial crisis

And this is how they operated more recently, from late 2008 through early 2009:

Looking forward

This scheme applies to bear markets that are primarily caused by recession fears. In addition to the two historic bears charted above, the scheme can be used to map the much smaller slump of 1990, and 1981’s decline, and 1970’s sell-off. Of course, the details for each of those markets vary, sometimes substantially but the pattern is roughly similar.

However, the blueprint does not work for bear markets that arise from other causes. For example, the stock market’s grinding decline from 1973 through 1974 doesn’t map well to the four stages, because it was caused by steadily increasing inflation fears. The 2000-02 technology-stock implosion also fails the test, because the major concern as the New Era concluded was that equity prices had risen too high, not - aside from some of the internet stocks - that earnings would disappear.

The question then becomes, does the current bear market fall into the first category or the second?

The former would be greatly preferable. With that scenario, the enormous uncertainty about the spread of the coronavirus, and the economic damage that the containment efforts will wreak, disappears over the next few months. The problems will remain large, but they will at least be known quantities, and the financial markets are adept at planning for what is known.

Should the picture become clearer, the four-stage scheme figures to be relevant. Fairly soon, I should think, stocks will more firmly enter the third stage, that of stabilisation. That doesn’t mean that they won’t decline further, but the struggle will at least be bounded. Within months, not years, the stock market recovery should begin.

On the other hand, should uncertainties remain high and unresolved, perhaps because the virus’s behaviour confounds the scientists, or because the financial stimulus efforts prove ineffective, then all bets are off. I do not know how to analyse such a situation. I hope that I never shall.

Big hat, no cattle

I have written about buying market puts, giving the right to sell at an index level, as protection on institutional portfolios. But you know what? It was easy for me to talk bravely as a columnist, with no public numbers on the line. It would have been much more difficult to follow through and make the trade as a professional manager, knowing that if stocks didn’t quickly tumble that I would have squandered previous performance in protecting against an emergency that did not arrive. I might not in fact have made that trade, and either way, it doesn’t count if you don’t do it. 

 

John Rekenthaler is Vice President of Research for Morningstar, a columnist for Morningstar.com and a member of Morningstar's Investment Research Department. This article is general information and does not consider the circumstances of any investor.


Try Morningstar Premium for free


 

1 Comments
Rachel
April 01, 2020

Very interesting analysis! Thank you.

 

Leave a Comment:

RELATED ARTICLES

5 insights that put market volatility in perspective

The ASX's 16-year drought: a rebuttal

Bear markets don't go paw-in-paw with recessions

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Latest Updates

Taxation

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

7 key charts on the state of the Australian property market

The Australian property market stirs fierce debate - often bullish optimism versus crash predictions. But beyond the noise, seven charts reveal what's really driving prices and the outlook for residential real estate.

A simple alternative to the $3 million super tax

Division 296 aims to introduce improved fairness into the superannuation system, yet is overly complex. This scours the world for better ideas and suggests a simpler alternative which can achieve the same goals.

CBA and the index conundrum for super funds

After the hyperbolic rise in CBA shares, super funds are floating the idea of carving out the weightings of ASX bank securities and indexing them within their portfolios. This looks at why that might be a big error.

Strategy

10 policies to drive Australian productivity higher

Here's a comprehensive list of proposed reforms to fix Australia's stagnating economy, including introducing a flat income tax rate, reducing migration, and making childcare tax-deductible.

Interviews

Where to find big winners in Asia

As more money looks for a home outside the US, Asia may soon get some love. Fidelity's Anthony Srom outlines the best places in Asia to invest, including in Chinese consumer names, Indian financials, and Thailand.

Investment strategies

We have trouble understanding the time value of money

We overvalue the present and underestimate the future - it’s a cognitive glitch called hyperbolic discounting. It affects savings, spending, and loans, and it's more common - and costly - than we think. 

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.