Defining “Bear Market”

Correctly Defining “Bear Market”

August 28, 2015

I am starting a personal crusade to expunge the notion of “10% is a correction and 20% is a bear market” from our collective lexicon.  It is among the most meaningless, useless, and untrue statements out there.

The reason I dislike it so much is that it offers no insights about what a trader or investor should do.  If you find the market down some percentage, and conclude that, okay, it is a “correction”, then so what?  What does one do next?

Every 20% decline goes first through 10%.  So if one says, “Oh well, it’s 10%, so it is just a correction,” then that would be similar to the guy who jumped off a 20-story building and was heard to say as he passed the 10^th floor, “So far, so good.”

The chart above shows the stock market decline from the 2007 top to the 2009 bottom.  I am going to assume that we can all agree that this was an example of a “bear market”.  Having lived through it, I also know that early on during that decline, there were a lot of people who were saying that it was “just a correction”.  This decline ended up traveling far beyond the 20% decline threshold.  And it did not become a bear market upon crossing that line; it was a bear market the whole time, whether anyone knew it yet or not.

This helps us understand the point that defining the 10% and 20% thresholds as markers for categorizing types of declines is a functionally meaningless exercise.

Here is another point to consider, along the same lines.  In the summer of 1998, there was a decline of 20% in the SP500 inside the span of 6-1/2 weeks.  So since it was 20%, was it a bear market?

Of course not.  It was a fairly brief (but scary!) pullback within what turned out to be a continuing uptrend, and with many more percentage points of upward movement to go before the final top in the year 2000.  But if someone was using the silly “20% bear market” threshold, then he would have seen that it qualified as a bear market on exactly the bottom day.  That would have been an unproductive conclusion.