Editor’s note: Versions of this article were previously published on March 20, 2020, and June 10, 2020.
As terms like market correction, bear market, and economic recession get tossed around, you may be wondering what it all means. What exactly is a bear market? And how does it differ from an economic recession? Are they related?
We answer some questions you may ask while reading the latest financial news.
How is a bear market different from an economic recession? Although the two often go hand in hand, they are associated with different issues. A recession describes a slowdown in economic output and is generally defined as at least two consecutive quarters of decline in gross domestic product, or GDP, which functions as a measure of economic health.
A bear market describes a stock market decline that may be a result of negative investor sentiment. If investors are concerned about falling returns, they may be more inclined to sell rather than buy stocks. A selloff can then trigger further pessimism about market performance, acting as a negative feedback loop that sends the market into decline.
Generally, a bear market is declared when the market declines at least 20% from the most recent high. In the United States, the S&P 500 is commonly used to measure this decline.
What causes an economic recession? The causes of an economic recession can vary. One potential cause is a loss of business and consumer confidence in investing and the economy. Lower confidence can mean retail sales slow and businesses hire fewer people. This creates a negative feedback loop as businesses cut back in response to lower demand, which in turn reinforces consumers' pessimism.
Other potential causes include:
- High interest rates
- Falling housing prices and sales
- Credit crunches
An economic recession can also be a result of a bear market, which drains businesses’ capital. In this sense, the relationship of cause and effect between a bear market and an economic recession exists in both directions: Just as investor confidence and stock prices can fall in response to a recession, a bear market can also prompt a recession by putting a strain on companies that rely on investor capital.
What causes a bear market? A bear market is essentially a crisis of investor confidence, the causes of which can vary. The most common trigger of a bear market is a weak or slowing economy, or the anticipation of an economic slowdown.
Signs of a slowing economy may include:
- Falling productivity
- Rising unemployment
- Low consumer confidence
- Decreasing corporate profits
- Low disposable income
These signs may cause investors to become pessimistic about the prospect of future returns on investment, prompting them to sell shares. The market declines as a selloff gains momentum and pessimism spreads.