How to Tell the Difference Between A Market Pullback and a Bear Market

History repeats itself. Those that do not learn the lessons of the past are doomed to repeat past mistakes. A land war in Russia during winter for example was a bad idea for Napoleon and even worse for Hitler. Investing is no different—and learning from past experiences of bear markets (vs. a market pullback) can help you foretell the next bear or invest with more confidence.

The current bull market has been running since 2009 – and people clearly worry what the next catalyst for a bear market will be. The Tech Wreck, the latest market correction, and some of the mild dips that have occurred along the way of this bull market have spooked investors and pros.  However, each of these market pullbacks have proven to be excellent buying opportunities where you can get into stocks at a discount. Then, when the market continues to go up, you are in for the ride and can enjoy the improved return.

The problem is that this strategy works until ultimately the real bear market hits. One of these days, a market pullback will become a correction and ultimately a bear market. The key is to distinguish between a momentary hiccup and a full blown correction. This takes intuition and guts, and it takes knowing a little about the causes of prior bear markets.

Market Pullback Vs. Bear Market: What are some of the triggers for a bear market?

Sadly, our financial institutions have been responsible for several of the last few bears. For example, the mortgage crisis was the main culprit in instigating the last bear market in 2008. Banks with overleveraged balance sheets, ridiculously loose mortgages that were put into even more leveraged structured products was a huge bubble that was a perfect recipe for a bear market. Other financial-triggered bear markets were the emerging market loan crisis and the savings and loan crisis.

Before that, the tech industry drove the 2001 bear market. People will remember that there was the “internet bubble.” No one today would invest in an entire industry that had little to no earnings, and almost no prospect to generate earnings in the foreseeable future. Well, they did back in 2000. Stock analysts had to create new metrics to assess these internet companies. Valuations were based on “eyeballs” rather than traditional financial metrics like Earnings, and P/E. When people woke up, the bubble popped and the bear market was upon us.

Another industry that can trigger a recession and a bear market is the energy industry. If you are old enough to remember the gas crisis in the early 70’s and the mid 80’s, you know that an energy crisis can raise prices so quickly it craters any industry that relies on oil.

Any warning lights from these causes?

As you look around, there really are not many places that could drive a bear market. A very bad recession would hit earnings and ultimately stock prices. Energy prices are low, and the U.S. produces enough to not be held hostage. Banks have rebuilt their capital cushion and are extremely healthy right now, and there are no extreme valuations. Valuations may be high, but in an economy that features low rates, and strong employment, that is appropriate. While it is entirely appropriate to scan the horizon and look for warning signs from the past, it is hard to say that there is a trigger event ahead.