Fisher Investments UK understands the two most commonly discussed types of equity market declines are “corrections” and “bear markets”. Investors often have difficulty distinguishing between the two. Whilst they might seem similar, understanding the difference between a correction and a bear market can help you avoid costly mistakes that could potentially prevent you from reaching your long-term investment goals.
What’s the difference between a correction and a bear market?
Corrections are relatively short, sharp equity market drops of -10% to -20%, driven by investor sentiment. They can start for any reason or no reason at all and last for a few days, weeks or months, making them impossible to predict or time correctly. Typically, corrections are sparked by investor fear or a widely circulated media scare story. Corrections occur frequently and are a normal part of bull markets.
Bear markets are different. A bear market is a fundamentally driven market drop of approximately -20% or more that usually unfolds over an extended period of time. Bear markets are much rarer and serve as the natural end to bull markets.
Signs you’re witnessing a correction:
- The drop off a recent relative market high is sudden and sharp.
- The sudden drop is accompanied by widespread scary media narratives like negative economic data releases, recent geopolitical conflicts or natural disasters.
- The economy is fundamentally strong despite negative media headlines.
Signs you’re witnessing a bear market:
- The decline starts slowly. Bear markets often decline by about -2% per month, making the decline more of a rolling top as opposed to a correction’s quick, steep drop.
- Investors and media outlets remain positive about the prospects of the bull market continuing despite souring fundamentals like weak corporate earnings, faltering revenue growth or increasing gaps between rising business inventories and dwindling consumer demand.
- A huge negative surprise with the power to knock several trillion pounds off global gross domestic product (GDP) hits an ongoing bull market – something that wasn’t broadly discussed or feared coming up to that point.
The life cycles of bear markets and corrections
Corrections and bear markets unfold differently. Because corrections are often propelled by unpredictable sentiment swings rather than economic fundamentals, they can start – and end – suddenly. After a swift drop that convinces some investors the worst is yet to come, equities turn around and snap back higher with no warning.
Since they begin and end abruptly, there’s no such thing as a “normal” correction. And no two corrections are exactly alike. During market corrections, market pundits and the financial press invariably search for justifying causes, but by the time they agree, it’s typically all over.
Fisher Investments UK believes bear markets are born on investor euphoria, grow on grinding economics, mature on recession and die on panic. Bear markets often begin softly as euphoric investors prop up prices despite souring fundamentals, with the first few months showing minor declines at most. The true pain of a bear market comes later, once reality sets in. Typically, about two-thirds of a bear market’s percentage drop comes in the final third of its duration.
How investors should react to corrections and bear markets
Corrections’ sudden, unexpected nature can induce panic and lure investors into fear-driven selling. However, investors who try to time corrections face significant risks. First, transaction costs and potential tax consequences can plague investors who sell and buy back into the market frequently. More importantly, investors may unintentionally hamper their returns if they don’t time their market exit and re-entry perfectly, which is nearly impossible to do.
Whilst the uncertainty surrounding corrections can be difficult to endure, a bull market’s upward trajectory can resume swiftly once a correction ends – sometimes surging nearly 10% in the first week alone. Missing out on those returns can be extremely costly and detrimental to reaching your longer-term goals.
To avoid these negatives, Fisher Investments UK believes your best option is often just waiting out the correction. Suffering losses on paper may be uncomfortable in the moment, but remaining invested to capture those positive returns as the bull market reasserts itself goes a long way to helping your investment portfolio recover. Some investors may even use corrections as an opportunity to buy equities at a relative discount.
Investors often don’t need to anticipate bear markets precisely because they typically start gently and generally last longer than corrections. Fisher Investments UK recommends taking at least three months to evaluate whether a market downturn may be a real bear market. This “three-month rule” allows you to assess fundamental data and possible bear market drivers to determine if there are significantly more price declines ahead. It also gives you time to see if the bull market reasserts itself.
Whilst bear markets start slowly, they often end quickly and reverse quickly. So if you’ve determined a bear market is underway and positioned your portfolio defensively, don’t wait too long to get back into the market. Since very few bear markets in modern history have lasted more than two years, Fisher Investments UK believes being bearish for longer than 18 months risks missing out on the rocket-like ride that frequently marks the arrival of the next bull market.
By learning to distinguish between corrections and bear markets, you can give yourself a greater chance of reaching your longer-term investment goals. Whilst any market downturn can be unpleasant for investors, remember that corrections are temporary and a normal part of bull markets. Unless you see definitive signs of a bear market, it’s often best to stick to your investment plan and hold tight.
Disclaimer:
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square (NYSE:SQ), Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
Investing in equity markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.