‘Bear market’ and ‘recession’ are two terms, which are thrown around a lot. But many don’t actually know what exactly they mean, how they are defined and how they can be distinguished.

So let’s take a look on what these terms really mean and how they are different.

Definition of a Bear Market

Here is Investopedia’s definition:

A bear market is when a market experiences prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment.

Other assets, such as commodities, individual securities or real estate can also be considered to be in bear markets when they decline a certain amount. However, the 20% is a very arbitrary and loose number. Assets with high volatility might experience such movements quite frequently. Therefore, it does not really make sense to call it a bear market every time.

For instance, in my master thesis I analyzed Bitcoin cycle periods. Since 20% price drops in Bitcoin are quite frequent, I used 40% as the criterion to define the bear market territory. In the same way, it would be erroneous, to call bear markets for particular technology companies, or other volatile stocks, every time when they decline by 20%.

Thus, the 20% benchmark is generally applied to broad indices, such as the S&P 500, to determine whether the stock market is in a bear market.

Definition of a Recession

A recession is a more severe phenomenon than a bear market, because it describes not only the decline in assets, but it is a prolonged downturn of the whole economy.

There are different definitions on what criteria to judge whether we are in a recession. In the US, the National Bureau of Economic Research “NBER” determines, when an official recession has occurred. Their traditional definition is:

“A significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

To determine whether a period should be called a recession, a committee evaluates several indicators with regards to three criteria: depth, diffusion, and duration. However, many of the indicators that they look at, are lagging datasets that are adjusted over time and only confirmed after some time has passed. That means that the NBER always declares a recession in hindsight, after it already occurred.

The general understanding is, that two consecutive quarters of negative real GDP growth determine a recession. This is the ‘technical’ (as compared to the ‘official’) definition of a recession.

Are We in a Recession Right Now?

So far, the first quarter of 2022 saw a negative GDP growth of -1.6%. (It fist came out at -1.4% but has since then been adjusted to -1.6%).

If we look at the forecast for the second quarter, the outlook is dire:

The Atlanta Fed currently sees Quarter 2 GDP down 2.1%. If that is true, that would mean that according to the 2-quarter negative GDP growth definition, we are likely in a recession.

Another way to look at it, is not to look at past economic numbers, but instead focus on current sentiments that people and businesses have about the economy.

Nik Bhatia and Joe Consorti at the Bitcoin Layer, argue that there are three main indicators to look at, when it comes to determining the Likelihood of entering into a recession:

1. Purchasing Managers’ Index (PMI): This is a survey conducted by asking managers from 300 manufacturing companies about the state of their business.
   PMI → Broad manufacturing supply chain health
2. Consumer Sentiment Index (UNMich): This index is conducted by the University of Michigan through household phone calls and it tries to gauge the consumer confidence in the current state of the economy.
   UMich → Consumer health
3. National Federation of Independent Business’ small business optimism survey (NFIB): This is a survey focused on gauging the economic outlook of small businesses.
   NFIB→Small business health

The chart shows that these three indicators are quite correlated, which makes sense. While they look at it from different angles, all of them capture the sentiments of individuals who experience and need to operate in the same economy.

Moreover, what sticks out of the chart is that the consumer confidence is at an all-time low (the above chart starts at 1988, but the UMich is also at its all-time low since its inception in 1952). This means that the general consumer feels worse about the state of the economy than ever in the past 70 years. That’s quite bad!

The grey areas in the chart show the recessions and it is obvious that all three indicators tend to have substantial downwards swings, before and during the recession periods.

Putting these three indicators together, they come out with the following chart, which they call the “Economic Cycle Wayfinder”:

They use the red line (set at 57) as the benchmark to determine whether we are in an economic expansion, or an economic contraction. According to this indicator, it seems quite likely that the economy is contracting and has entered into a recession.

Are Bear Markets and Recessions Related?

The short answer is yes.

While they are not exactly the same thing, a huge downturn in stock markets is usually a sign of troubles in the economy.

The following chart shows how intertwined they are:

As can be seen, bear markets and recession tend to occur in tandems. In many instances, the bear market occurs first.

In general it can be said, that the stock market is a good indicator to gauge what is happening in the economy. However, it does not necessarily predict economic activity. For instance, the Black Monday in 1987 saw stock markets tumble more than 20% within just one day. It happened in an environment of high inflation, rising interest rates and fear of tensions in the Middle East. Nevertheless, the American economy was fine and continued to grow.

Since world war ll, the S&P 500 has had drops of more than 20% from its peak 13 times (including right now). And we also have had 13 recessions during that time (the short recession of 2020 is not shown in the chart).

Even though recessions pose a difficult time , they are also the time in which things tend to get improved, malinvestments get exposed and more prudent businesses prevail. Investments based on stable fundamentals and a coherent value proposition will survive and strive once the market gets back on track.

Lastly, for investors — at least those who are not exposed swimming naked during the recession — it offers many opportunities to scoop up valuable assets at a cheap price.