The standard definition of a bear market is a decline of 20% or more from a recent high. It is unclear where this definition originates from, but it's a convention that makes it much easier to write headlines and characterize the market action.
Typically, a primary index such as the S&P 500 is deemed the appropriate measuring stick for the stock market's health. When it has dropped 20%, then, and only then, is there a formal bear market.
This may be a helpful definition for journalists and pundits, but it is not very helpful for traders and investors. If you have been waiting for the S&P 500 or Nasdaq to fall 20%, you have likely suffered some damage in individual positions, as a big part of the market is already deep into a bear market. The indices are covering up some of the worst corrective action since last March.
What is particularly interesting about this sneaky bear is that market timers didn't see it coming. Just like the COVID crisis a little over a year ago, no one predicted how things would play out. No one foresaw how quickly new highs would be hit, the resurgence in small individual traders, the outperformance by small-caps, and speculative social media plays.
Over the last two months, no one foresaw the vast gulf built between the indices and many sectors like biotechnology. I don't ever recall a market where the major indices are still so close to highs while sentiment has turned so negative.
The critical issue here is that we are already dealing with bear market action, although the S&P 500 isn't even close to one. We need to take defensive action and not be fooled by the indices. By the time the indices catch up with the reality of the broader market, significant more damage is likely to be done.
The most significant aspect of the current market for us to contemplate is how deeply much of the market has already corrected. The best example is biotechnology and SPACs. Both groups were speculative favorites and have now been under constant pressure for around two months. Many SPACs can't go lower as they are near NAV, and biotechnology is experiencing its worse relative performance in many years.
The big question is whether the rest of the market follows, or will we start seeing rotation into some of the names that have become compelling values? Momentum cuts both ways, and stocks can always go lower than seems reasonable, so bottom fishers have to be cautious.
Right now it's important to recognize that this already is a bear market, to a great extent, regardless of the indices or the definitions. Don't sit around waiting for headlines to confirm that fact. We need to govern ourselves accordingly and view the market through a bear market lens. The good news is that bear markets always eventually lead to bull markets, but we need to make sure we protect capital while we wait.