US Market: Tech stocks challenge Wall Street’s traditional bear market definition

Wall Street has long relied on a simple rule to define a bear market: a decline of 20% or more from a recent peak in a major stock index. But the sharp swings in technology and semiconductor stocks are challenging whether that measure still adequately captures market conditions.

The Philadelphia SE Semiconductor Index, a key benchmark for chip stocks, and South Korea's tech-heavy KOSPI both entered bear-market territory in July under the traditional definition. Yet at their respective lows, the indexes were still up about 46% and 25% for the year, following triple-digit gains over the preceding 12 months.

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The unusual performance has prompted investors and strategists to question whether the bear-market label is appropriate for indexes that have experienced extraordinary rallies and remain substantially higher on a year-to-date basis.

Reuters reported that market strategists see the conventional 20% threshold as potentially misleading for highly volatile indexes such as the semiconductor index and KOSPI, where sharp corrections can occur even during powerful long-term uptrends.

The debate matters because market terminology can influence investor perceptions of the severity of a selloff. A bear market has historically represented more than a temporary correction, often signalling a prolonged deterioration in economic or corporate fundamentals.

Since 1928, bear markets in the S&P 500 have lasted an average of 289 days, or about 9.6 months, according to Hartford Funds data cited by Reuters.

Searching for a better measure

The debate over how to define a bear market is not new. Investors and analysts have long questioned whether a fixed percentage decline can adequately capture the complexity of market cycles.

Barry Ritholtz, co-founder and chief investment officer of Ritholtz Wealth Management, argued in a 2008 blog post that investors should not place too much emphasis on imprecise market terminology.

But the distinction can have significant investment consequences. With the artificial-intelligence boom continuing to support technology and semiconductor companies, investors could potentially miss gains if a traditional bear-market designation prompts them to sell during a temporary correction.

The SOX and KOSPI have both rebounded from their July declines, meaning investors who exited at their lows would have missed part of the subsequent recovery.

Corporate earnings expectations also remain supportive. Earnings for the S&P 500 semiconductors and equipment industry group are projected to rise at least 114.7% this year, according to LSEG-compiled data.

Among more than a dozen analysts, there was no clear consensus on what should replace the traditional 20% threshold. Several suggested that any alternative measure should incorporate the duration of a decline, underlying volatility, economic conditions and broader market trends.

David Russell, global head of market strategy at TradeStation, said a genuine bear market should involve a sustained decline over several weeks or months and be accompanied by weakening structural conditions, such as elevated interest rates or an economy approaching a peak.

Other investors suggested using technical indicators such as moving averages and Fibonacci retracement levels to assess whether a decline represents a deeper shift or simply a temporary correction.

Sosnick of Interactive Brokers proposed comparing a market's decline with its historical volatility. Under his approach, the SOX would need to fall more than 44% to qualify as a bear market.

Such a framework could better account for the unusually volatile nature of semiconductor stocks, the KOSPI and technology-heavy Nasdaq 100, but it would also make the definition considerably more complicated.

For now, investors may have to rely on a combination of market experience, economic fundamentals and the broader trend rather than a single percentage threshold when determining whether a selloff represents a true bear market.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of The Economic Times.)