Advertisement
Markets

Watch Out for Bear Market Rallies

Thanks to strong gains recently, the stock market has erased all of its early-2016 losses. But that doesn’t mean investors are out of the woods yet.

Stocks have been on a tear since February 11, gaining 11.9% through March 17 and erasing much of the 12.6% downturn since May 2015, when Standard & Poor's 500-stock index notched an all-time high. And with its 0.4% gain on March 18, the S&P 500 is now positive for the year.

What should investors make of the rally? Correction over, bear market averted and onward for the indefatigable bull market, charging into its eighth year, right?

Advertisement - Article continues below

Not so fast. It turns out that bear markets are routinely marked by rallies that seem diabolically designed to fool the largest number of investors into letting down their guard and jumping back into the market, only to be clobbered again when the bear reasserts dominance.

Since the start of the 20th century, every single bear market has spawned at least one rally during which stock prices rose 5% or more, according to data from InvesTech Research, a newsletter. Investors were treated to rallies of 10% or greater during 14 of the 21 bear markets since 1901—and often several such rallies within the same bear market. For instance, in the bear market that began in 2007, stocks staged 12 rallies of 5% or more, with four of the 12 logging gains of more than 10%. The 30-month-long bear market that began in March 2000 staged nine rallies of 5% or more; four of those surpassed 10%. Looking at bear market rallies since World War II, the Leuthold Group, an investment research firm, found that the average bear market rally produces stock gains of nearly 11% over a six-week period, recovering nearly 60% of the preceding decline.

Advertisement
Advertisement - Article continues below
Advertisement - Article continues below

Assuming that a bear market began in May 2015, the number of bear market rallies so far is below average. We've only seen two: a 13.4% gain between August 25 and November 3 of 2015, and the 11.9% rally since February 11. (Technically speaking, the market is in a state of limbo today. A bear market would be confirmed if the S&P 500 dropped to 1,708, representing a 20% decline from the index’s May high of 2,134.72. Confirmation of the continued existence of the bull market requires the S&P to surpass its previous high.)

For now, investors are left with the same—still largely unanswered—questions about the direction of the stock market. But even if the bull market is intact, says InvesTech publisher Jim Stack, risk remains elevated. For one thing, stocks aren't cheap. Despite recent setbacks that wrung some excesses out of the market, stocks still look expensive on the basis of price to earnings, cash flow and book value (assets minus liabilities), according to Leuthold. If stocks were to reverse course and take valuations down to typical bear market lows, we could see price declines from recent levels approaching 30%, Leuthold says.

Advertisement - Article continues below

On the positive side, the recent upswing has been surprisingly broad-based, with the number of advancing shares far outpacing decliners. Oil prices have rebounded, with crude up nearly 40% from February lows. Another round of economic stimulus bodes well for Europe. Worries about China have abated somewhat. In the U.S., economic indicators are mostly positive. Manufacturing activity has been contracting for five months, but the service sector—which accounts for two-thirds of the economy—is expanding (although, it, too, has shown some recent volatility). Corporate earnings this year could see some relief as the drag from falling oil prices on the energy sector and the strong dollar lessens.

All things considered, the chances of a rare, eighth bull market birthday don't seem unreasonable, says Burt White, chief investment officer for investment advisory firm LPL Financial. “Bull markets don't die of old age. They die of excesses,” he says. But that doesn't mean the market hasn't gotten ahead of itself for now, says Russ Koesterich, chief global strategist at BlackRock. “Against a backdrop of continued uncertainty in the global economy, the recent rally is beginning to look a bit excessive,” he says. “March may have come in like a lamb, but the lion may be lurking.” Or maybe the bear.

Advertisement

Most Popular

What Are the Income Tax Brackets for 2020 vs. 2019?
tax brackets

What Are the Income Tax Brackets for 2020 vs. 2019?

The IRS unveiled the 2020 tax brackets, and it's never too early to start planning to minimize your future tax bill.
June 20, 2020
HSAs Get Even Better
Financial Planning

HSAs Get Even Better

Workers have more options with flexible spending accounts, too.
July 2, 2020
17 States That Will Gain or Lose Electoral-College Votes After the 2020 Census
Politics

17 States That Will Gain or Lose Electoral-College Votes After the 2020 Census

Every 10 years, the 435 seats in the House of Representatives are reassigned based on the results of the U.S.
July 2, 2020

Recommended

Closing Bell 7/6/20: U.S. Stocks Grab the Baton From China
Markets

Closing Bell 7/6/20: U.S. Stocks Grab the Baton From China

A surge in Chinese equities, as well as a massive improvement in services-sector data, lifted U.S. stocks and sent the Nasdaq to new highs Monday.
July 6, 2020
When Online Investing Turns Deadly: Lessons from a Robinhood Trader’s Suicide
investing

When Online Investing Turns Deadly: Lessons from a Robinhood Trader’s Suicide

Gamification of financial apps can make investing fun, but unsophisticated investors can get in over their heads if they aren’t careful.
July 6, 2020
21 Dividend Increases During the COVID Crisis
dividend stocks

21 Dividend Increases During the COVID Crisis

These 21 stocks were doling out dividend increases as the coronavirus crisis accelerated – and as many stocks were cutting or outright suspending thei…
July 3, 2020
The Awkward Relationship Between Markets and the Economy
investing

The Awkward Relationship Between Markets and the Economy

Why is the stock market doing so well during such a rough time? Well, it’s because the stock market and the economy are not the same thing.
July 3, 2020