Characteristics of Bear Market Rallies
We started to cover the topic of “Bear Market Rallies” in Mondays’s piece, “Mr. Market’s Bear Market Rallies” (https://markonomics101.com/2018/10/14/mr-markets-bear-market-rallies/). Their behavior differs so much from the type of trading in Bull Markets, that they have their own signature. This is quite valuable because of its informational content, but also provides investors, who haven’t done so, great opportunities to reduce risk in the vein discussed in (https://markonomics101.com/2018/10/09/how-to-survive-prosper-and-thrive-in-the-coming-bear-market-part-1/).
Tuesday was a whopper of a Bear Market Rally but not all that uncommon. The major indexes rose about 2 % on average. Keep in mind that larger moves are often the result of evaporating liquidity which yields an imbalance between buyers and sellers. In a BEAR Market, short sellers who seek to gain by SELLING HIGH first, and BUYING LOW second, are often very quick on the draw and act in what appears to be unison. In a market so horrendously overvalued, being in sync with the trend requires short selling. If they’re caught by a rally, they are very quick to BUY or what is called “covering”.
The Gains In the Major Equity Indexes Are Big But Temporary
The major stock indexes all peaked between late September and early October, 2018. The highest levels for each are as follows:
Index High Low Loss Retracement of Loss
Dow Jones 26,900 24,900 7.5% 50%
Nasdaq 100 7,700 6,900 10.5% 50%
S & P 500 2,940 2,710 7.9% 44%
NY Comp 13,250 12,300 5.0% 32%
Russell 2000 1,740 1,530 12.0% 29%
Wilshire 5000 30,900 28,000 9.5% 38%
Value Line Geo 592 537 9.3% 35%
Use Sharp Bear Market Rallies as Opportunities to Reduce Risk.
Before the process of looking for opportunity begins (“going on offense”), one needs to have reduced, hedged, or eliminated major sources of risk. This includes trimming some or all positions that are highly volatile or tend to experience large moves. Bear Market rallies are usually pretty short in duration (a day or two) but very high in percentage moves as the table above shows. It’s obviously best to have begun the risk reduction process before the big drops begin, but the next best thing is to use this type of rally to trim positions.
Obviously, the assumption being made here is that we are indeed in a BEAR market. So, here’s how to look at it. Is the upside conceivably worth the downside? If you’re a buyer, your goal should be to seek gains via BUYING LOW and SELLING at a HIGHER price. How likely are “higher prices” in a Bear market? The higher the price at which you bought, the greater the chances you will lose money (https://markonomics101.com/2018/09/22/mr-market-and-ultra-high-risk-for-equities/). Valuations remain at very inflated levels (https://markonomics101.com/2018/07/12/inflection-point-part-1-the-long-term-equity-valuation-cycle/). A 10 to 15% drop is not enough to make an impact.
Most BEAR market rallies will retrace roughly 30-50% of the loss. This percent can vary widely, but the chance to sell into a rising market is much easier than into to a declining one. However, the psychology of doing so is the biggest hurdle. Many see the rally as a RESUMPTION of the former BULL market and therefore fail to use the opportunity to get a sale assomplished at better prices. They’ve been trained that every drop is followed by new highs. That mindset is constantly reinforced by the media and brokerage houses who perpetuate this concept to keep their clients generating income and fees.
According to Wikipedia, the 20 largest “percentage” gains in the DOW occurred subsequent to the 1929 Crash and Depression, the 1987 Crash, or the 2008-9 Waterfall. See their lists of the TOP 20 changes for the DOW of all time! (https://en.wikipedia.org/wiki/List_of_largest_daily_changes_in_the_Dow_Jones_Industrial_Average).
The conditions for a BEAR Market Rally have been largely met. One should expect a resumption of the decline shortly, assuming that this is the early stage of the BEAR. Additional rally cannot be ruled out at all, but the most probable scenario is a continued downward move no later than Monday. In any event, this is still only a good time to unload risk rather than attempt to take advantage and be caught by one of these moves.
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