Not quite. An economy that shrinks for two consecutive quarters of the year is said to be in recession. It’s possible for an economy to experience a recession without its stocks being in a bear market – but a recession can often follow a bear market, which is perhaps why people sometimes confuse the two.

What causes a bear market?

It all comes down to supply and demand: if investors are selling more stocks than they’re buying, then prices will fall until they’re low enough to attract enough buyers. What might cause investors to begin selling in the first place is perhaps more interesting.

Stock prices reflect the average value investors attribute to companies today, based on those companies’ future earnings potential. If expectations for future earnings fall, then so too might stock prices.

One major reason earnings forecasts fall (and, indeed, rise) for several companies at once is the economic growth outlook. If an economy’s growth looks set to slow down – or shrink altogether – spending by consumers and companies is likely to head in the same direction, leading to company profits also growing more slowly or declining.

If investors then slash growth forecasts for several companies at once, it could cause a change of market sentiment – investors may fall out of love with riskier stocks in favor of the comparative shelter of government bonds, for example.

The keen sensitivity of stock prices to changing future expectations means they can sometimes reflect economic slowdowns or recessions before the wider economy actually experiences them. That’s happened before – as we’ll see...