Bear Market Rally or New Bull Market?
Investors wonder about the current bear market and want to know if we are “out of the woods” or if there is “more pain to come”. The graphic below shows that the stronger the rally, the higher the probability that the bear market will end. After a 17.4% rally from the June S&P 500 lows, there is a low probability (3.6%) that the current rally will fail. However, if it does fail, the historical average decline from these levels to the ultimate bear market low would be 31% and take seven months.
CUMULATIVE DISTRIBUTION DENSITY OF ALL S&P 500 “BEAR MARKET RALLIES” SINCE 1960 (1960 – 2020)
Source: Dow Jones Indices LLC
The chart above groups all 140 S&P 500 index rallies by magnitude that occurred during the nine prior bear markets (defined as a greater than 20% decline from an all-time high) and which failed to push the index up to a new all-time high. The analysis only includes failed rallies that occurred prior to the bear market putting in its ultimate low. Interestingly, once such a rally surpasses the 5% mark, it is already stronger than 70% of the failed rallies. There were only 13 rallies greater than 10% that ultimately failed. The largest and nastiest bear market rally occurred during the bursting of the Tech Bubble. The 24% rally peaked on May 21, 2001 and declined 40.8% to the eventual bear market low 17 months later on October 9, 2002.
Knowing whether or not a bear market bottom has already occurred is nearly impossible to determine in the moment. Fortunately for long-term investors, we don’t have to know. Long-term stock returns average around 10% per year and include all the bear market declines, rallies, and recessions! Putting current events into a longer-term context helps us focus on what we can control and sticking to the plan is often the most effective and least stressful course of action.
From the Behavioral Viewpoint
What is going on?
Recency and Availability Bias - With the 2020 COVID bear market scorched into our recent memory, it is tempting to think this bear market will be just as short lived. But history extending back 60 years shows us that all bear markets have their own unique wrinkles which we ignore at our peril.
Fooled by Randomness and Confirmation Bias - We see information and patterns and believe we have some profound insight. We are particularly subject to information that confirms our own existing ideas. Most of what lies ahead is uncertain and random, an uncomfortable reality. .
Hindsight Bias - We all know a Monday Morning Quarterback who knows what play to call and is sure it would succeed. The same is true with bear markets, everyone believes they would do something different. Very few get it perfectly right on both the down and up sides of a bear market.
What can we do?
Remember your investment time horizon and develop realistic expectations, accepting that both positive and negative returns will inevitably occur. Focus on what you can control with predetermined courses of action.
Build a strategy-diverse equity portfolio that can be resilient in a variety of market conditions and is designed for the long-run. Have a disciplined, data-driven, and rules-based investment process designed to drive out emotional decisions.
Work with an experienced financial advisor, who has been through different market environments and can help you avoid emotional short-term decisions that can impact your long-term success.
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The information provided here is for general informational purposes only and should not be considered an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. It should not be assumed that recommendations of AthenaInvest made herein or in the future will be profitable or will equal the past performance records of any AthenaInvest investment strategy or product. There can be no assurance that future recommendations will achieve comparable results. The author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions. AthenaInvest disclaims any responsibility to update such views. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any AthenaInvest.
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