After a strong rally in the first two trading days of the year, the market has faced significant volatility, eroding positive sentiment and casting doubts over a stable year ahead. This follows the market correction of 2024, which had left investors hoping for economic boosters such as tax cuts in the upcoming budget.
However, those hopes are now overshadowed by fears surrounding the fast-spreading HMPV (Human Metapneumovirus), with a few cases detected in India.
Uncertainty—something financial markets dislike—has taken hold of investors and traders. Coupled with persistent foreign investor selling, the Indian stock market has turned risk-averse, making life difficult for the bulls. While this doesn’t mean a bear market is imminent, it’s evident that positivity is scarce.
In such an environment, fear and speculation about worst-case scenarios, including the possibility of a bear market, naturally emerge. Let’s explore this possibility.
What causes a bear market?
At its core, a bear market stems from a decisive shift in sentiment from optimism to pessimism.
When investors collectively believe that stock prices will decline, fear takes over. Concerned about potential losses in their portfolios, they decide to sell their stocks pre-emptively, anticipating further price drops. This fear-driven selling pushes prices down, which only amplifies anxiety and triggers more selling.
This cycle of fear and selling becomes a self-fulfilling prophecy, culminating in a market crash. If the decline exceeds 20% from the peak, the market officially enters bear territory.
Bear markets can be brief, lasting a few months as seen during the Covid-19-driven downturn in 2020, or drawn out over years, like the post-dotcom crash of the late 1990s. Their duration depends on how quickly sentiment shifts back to optimism, allowing the bulls to regain control.
But what drives these shifts in sentiment—both from positive to negative and vice versa? Let’s explore.
Reasons for changes in sentiment
Investing is as much an art as it is a science, and changes in market sentiment are a testament to this complexity.
There is no single factor that drives a shift in sentiment. The triggers can vary widely—weakening GDP growth, a sudden spike in crude oil prices, geopolitical tensions, pandemics, significant policy changes, or a crash in a major industry like housing, technology, or finance. Sometimes, it’s a combination of these factors acting simultaneously.
Often, the market remains unaware of the underlying causes behind a trigger. Events like the outbreak of a war or a pandemic, known as “Black Swans,” catch everyone by surprise. The Covid-19 pandemic is a prime example of such an unpredictable and far-reaching event.
The same unpredictability applies in reverse—no one can pinpoint when a bear market will end. Over the past two decades, however, central banks have played a pivotal role in turning sentiment positive through aggressive measures like interest rate cuts and liquidity injections into the financial system. These tools have proven effective in restoring confidence and reviving markets.
Bear market in 2025
Is a bear market possible in 2025?
The short answer is yes, but that’s true for most years. A more pertinent question is: What could trigger a bear market in 2025?
Here are some potential scenarios:
Wars: Escalation in ongoing conflicts like Ukraine or West Asia, or the outbreak of new ones involving Taiwan or Iran, could create significant geopolitical instability.
US economic recession: While the current strength of the US economy makes this unlikely, a misstep in trade policy—such as a trade war initiated by the Trump administration—could spark retaliatory measures from other nations, potentially triggering a US recession.
New pandemic: The emergence of another fast-spreading virus could lead to lockdowns and widespread economic disruption.
Black Swan event: The most unpredictable and potentially devastating scenario, a Black Swan event—like Covid-19 in 2020—could catch markets completely off guard, leading to panic and steep declines.
Each of these triggers could individually or collectively lead to a decisive shift in market sentiment, setting the stage for a bear market.
Conclusion
Long-term investors should not be overly concerned about a bear market, provided they do not need to liquidate their investments in the near term. This is particularly true for portfolios consisting of high-quality stocks with strong fundamentals.
However, investors with a shorter outlook of 1–3 years may face greater risks. A bear market could lead to losses in certain stocks, potentially undermining the overall health of their portfolios. For these investors, caution is paramount.
Here are some prudent steps to consider:
Review your portfolio: Weed out stocks with poor fundamentals, such as low growth, high debt, weak return ratios, or consistent losses.
Reassess valuations: Identify stocks with average fundamentals but high valuations (e.g., elevated P/E or P/B ratios). If these companies fail to meet their growth promises, consider selling.
Avoid governance risks: Stocks with questionable corporate governance are especially vulnerable during a bear market and should not be treated as serious investments. Keep speculative bets separate from your core portfolio.
Be wary of narratives: Companies relying on a “future growth” story but lacking strong fundamentals are often the hardest hit in a bear market, as investors lose patience with promises that lack substance.
Also read | Value vs momentum strategy: Which works better in bull and bear markets?
By taking these measures, investors can mitigate risks and better position themselves to weather potential market volatility.
Happy investing.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com
