What Causes a Bear Market? 

It is difficult, if not impossible, to predict just what will precipitate 
a market plunge. It is an equally daunting task to foresee how investors 
will react to an initial decline in stock or bond prices and what impact 
such reactions will have on the financial markets. Some professional and
individual investors may view a temporary price drop as an opportunity to 
buy securities "at a discount," while others may see the same decline as 
the start of a deeper downturn. 

Using history as a guide, however, one can discern some of the underlying
causes of past bear markets. Iraq's invasion of Kuwait in 1990 touched off 
the most recent bear market in the U.S. stock market. The Persian Gulf crisis 
led to an escalation of oil prices, renewed fears of inflation, and a rise 
in interest rates, all of which, among other factors, sent stock prices 
reeling. Such a confluence of economic and political factors also accompanied 
the 1973-1974 stock market collapse. The country remained mired in economic 
"stagflation," which stemmed primarily from the energy price increases 
resulting from the Arab oil embargo. The downturn was exacerbated by political 
upheavals associated with the Watergate saga and the winding down of the 
country's involvement in Vietnam. 

The stock market, however, does not always mirror the state of the economy.
The downturn in 1987 occurred during a period of economic advance, although
the sharp rise in interest rates certainly contributed to the crash in stock 
prices. Conversely, the current leg of the prolonged bull market in stocks 
started in the early 1990s in the midst of a recession. 

Nonetheless, the relative strength of the stock market is tied to the general 
health of the economy as well as to political forces. Obviously, when the 
economic outlook or political landscape appears bright, investors tend to be 
optimistic about the prospects of corporate profits and are more willing to 
invest their money in stocks. When conditions sour, investors often forgo 
investing additional assets in stocks or sell their shares outright. Beyond 
fundamental economic factors, then, the sentiment of investors also exerts 
tremendous influence on the direction of the securities markets, both up and 
down.