There is a bear market

Setback, correction or bear market?

When stock prices fall rapidly, many investors get nervous. But not every course diver on the stock exchange is a crash.

When do you talk about a setback, a correction or the beginning of a bear market or a bear market on the stock market? Many retail investors find it difficult to distinguish between these financial terms. To make matters worse, there is no scientific definition for it. But in the financial world these different market phases are clearly differentiated. The boundaries have a lot to do with market psychology and the extent of a price slump and its consequences for the overall market and the economy.

Setback

If a stock index such as the Swiss Performance Index (SPI) falls back by 5 to 10 percent, one speaks of a setback on the stock exchange. As a rule, such setbacks are more short-term in nature. They occur comparatively frequently, often from a previously recorded high. They are inherently healthy and normal movements in the market cycle. They take place in a bullish market environment where the upside momentum remains intact. Such setbacks do not affect investor sentiment any further, as they are part of everyday life on the stock market. Market participants therefore remain confident about the outlook for the stock market and economic growth.

correction

We speak of a correction when a stock index falls by 10 to 20 percent. Corrections can be very severe in the course of the "herd mentality" and drag on over two to four months. The intensity of the price fluctuations is significantly higher here than in the case of a setback, because investors' fear increases and these market phases are often accompanied by unfavorable market conditions. Panic selling can now also be partially observed on the stock market. A good example of this would be the final quarter of 2018. At that time, the stock markets fell sharply due to the trade dispute and the clouding economic outlook in China, especially since the international trade in goods was heavily impacted by the uncertainties.

Corrections are often seen as the ideal time to buy shares in companies that have first-class credit ratings, high profitability, a solid financial structure and a sustainable and attractive dividend policy. In a correction phase, such quality stocks can sometimes be bought at attractive prices or valuations. However, this only applies provided that the company's fundamentals and growth prospects have not changed significantly. If the market situation or the company is misjudged, this can quickly lead to price losses.

Bear markets or bear markets

If a stock index falls by at least 20 percent from its last high, this is usually considered the start of a bear market. The confidence of market participants was badly shaken in this market phase, and many investors are selling their shares for fear of further losses. This often takes several months and can take a year or two in pronounced bear markets, which is why one speaks of a bear market. The price fluctuations are most extreme now, with panic selling occurring frequently. The fear of investors can be read from so-called volatility barometers such as the VIX.

The fear of losses and the loss of confidence can lead to a downright vicious circle, because investors use every recovery move to sell their shares in the temporary market strength. Bear markets therefore tend to drop in stages from one low to the next. At the bottom of a bear market, real bargain purchases can be made on the stock markets. When an index overcomes the lows and sustained new highs in the subsequent recovery, a bear market gradually turns into a new bull market or a new bull market.

Historically, bear markets and recessions often go hand in hand. However, they are triggered for different reasons. It can be absurdly high valuations for tech and internet companies like in the times of the dotcom boom or junk paper-fueled speculation in the US real estate market that led to the financial and economic crisis of 2008/09. The phase before the crash was mostly characterized by carelessness on the part of investors.

Thomas Pentsy

Thomas Pentsy is a market analyst at Migros Bank. He gives tips on finances on the blog and analyzes current business developments.