Bulls and bears are powerful animals. A bull tends to charge ahead, pitching its horns upwards. Bears tend to pummel downward and eviscerate their prey.
In the financial landscape, the prey is your portfolio. Fortunately, bulls and bears trade off their dominance of the markets. Bull runs are relatively easy to ride. But bear markets? They can be tough to manage. Do you sell off everything and hide until it’s over? Or is that just panic that will backfire when the market turns?
One thing is certain: it’s helpful to understand the forces at work in a bear market.
When Does a Bear Market Happen?
Here is the definition of a bear market:
“A time when stock prices are declining and market sentiment is pessimistic. Generally, a bear market occurs when a broad market index falls by 20% or more over at least a two-month period.”
While that’s the description set out by the U.S. Securities and Exchange Commission, there is room for interpretation. The important part is the sentiment, which is typically an indicator with more staying power.
For instance, the crypto Fear & Greed Index tracks multiple sources to determine the bear market in crypto:
- Volatility: asset price swings that are not typical, often dipping into double-digit negative numbers.
- Market momentum: measured by trading volume. Typically, when there is high trading volume, it indicates buying pressures, which means the market is bullish, not bearish.
- Social media: checking for the prevalence of negative keywords and hashtags on social media platforms, usually related to the largest coins — Bitcoin or Ethereum.
- Bitcoin dominance: perhaps the most interesting part of sentiment metrics, whenever there is a bearish sentiment, investors tend to withdraw from riskier assets, thus increasing Bitcoin’s percentage of the total crypto market cap.
- Trends: typically taken from Google trends, collecting search volume and queries.
Taken on their own, these data points could signal a bear market. Together, they make a sentiment chart, ranging from 0 to 100, with the highest range, dubbed Extreme Greed, denoting a bull market. Needless to say, much of 2022 has been in a steep bear market, under 30. This is the range for Fear, and below that is Extreme Fear.
This mapping of the metrics matches up with a severe, double-digit decline across the board. From the stock market to cryptocurrencies, 2022 has been dominated by bears. Although a major decline was felt early in the year, the bear market started in earnest in May.
True to its bear market definition by the SEC, just looking at the crypto market, a two-month, double-digit dip transpired. The question is, why do such long-term market downturns happen?
What Contributes to a Bear Market?
Even in major downturns, assets with the largest market caps resist selling pressures the most. For this reason, the S&P 500 Index, representing the biggest listed companies in the U.S., fare the best. Using this index as a reference point for the whole market, there have been 26 bear cycles since 1928, according to data compiled by Hartford Funds.
Bulls are represented in equal measure, which means that the mean average goes up, as new high lows are established. As far as frequency goes, bears appear every 3.6 years, and last on average about 9.6 months, which is significantly shorter than bulls, which last 2.7 years.
What causes bear markets is hard to specify. The Federal Reserve plays a major role because it sets interest rates and manages the money supply.
Specifically, the Fed can increase the money supply to stimulate the economy. This happened following the outbreak of the Covid-19 pandemic in March 2020, with around $5 trillion in extra cash flooding the economy. Simultaneously, the Fed kept benchmark interest rates near zero, making capital cheap.
The stimulated economy and cheap capital overheated the system, triggering inflation that has increased four times higher than the Fed’s original 2% target. In an attempt to cool down the economy and tame inflation, the Fed has started raising interest rates; the federal funds rate is 2.25 to 2.5%%. This raised the cost of capital, which motivates businesses to borrow less and slows down economic expansion. Investors tend to shift from stocks to bonds when rates rise and remove risk from their portfolios. This causes market selloffs.
As risk-on assets with comparatively low market caps, cryptocurrencies performed the worst in these harsh macro conditions. Yes, even Bitcoin, which was hailed as a hedge against inflation. It turns out that Bitcoin thrives during currency debasement, not inflation.
And as it happened, the Dollar Strength Index (DXY) has grown in strength compared to euro and yen because their economies are even worse. This is the privilege enjoyed by the global reserve currency status.
Typically, when the Fed makes such corrections and increases the cost of capital, a recession is very likely. This is especially true in 2022, with exacerbated supply chain issues, backfired sanctions against Russia, and random lockdowns in the manufacturing powerhouse — China.
All of these factors tend to spook investors, thus creating the perfect bear market storm.
What To Do in a Bear Market?
Corporations have a well-oiled strategy to deal with recessions. They tend to increase cash flows because operational money is necessary to deal with uncertainty, debt obligations, and unforeseen expenditures.
Indeed, this has already happened. According to a Bank of America survey, fund managers have increased their cash holdings to the highest level in 21 years.
This is why Tesla recently sold 75% of its Bitcoin holdings, despite Elon Musk vowing to not sell BTC.
Cash is king in a recession. With that said, many investors look for bargains in a bear market. Yet every bear cycle is different, with changing economic conditions and geopolitical crises affecting sentiment.
While “buy low, sell high” remains the No. 1 cliche for market behavior, many investors struggle to follow through on the idea. The one comfort investors may take during bear markets is that they are invariably followed by a bull run. It’s just a matter of timing.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.
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