After a nearly 25% rally off the lows in June, Wall Street strategists have warned that stocks are in line for a pullback – having come too far too fast.
While the recent gains show no signs of being wiped out completely, it is worth looking at previous rallies within historical bear markets.
Bear markets of the early 1980s, early 2000s and 2007-08 have exhibited similar rallies and while it is important to note trends, investors should be wary of reacting in the short-term.
Indeed, Chris Tidmore, senior manager in Vanguard’s Investment Advisory Research Center, said investors should be cautious about trying to time the market.
“Historically, after a rebound such as the one we have seen since June, the market sometimes rebounds quickly and makes a new high, sometimes flutters around and eventually makes a new high or low, and other times heads straight down to new lows,” he said.
‘Several false rallies’
Tidmore referred to bear markets in the late 1970s through the late 1990s, adding that there were minimal pullbacks after a bear market was reached, and all made new highs within a few months.
He explained that this was not the case during the tech bubble bursting and several false rallies occurred before an eventual rebound.
The financial crisis of 2008 did not have many large rallies, but the ones that did carried over an extended period. While more recent bear markets in late 2018 and early 2020 had minimal pullbacks.
Tidmore reiterated that the market starts to price in news and expected news – good and bad.
“When considering if certain things need to happen for the market to recover, the better question is whether the market is already pricing in those events and to what degree, which is usually an unknowable question,” he said.
“Resisting the urge to try to time the market, focusing on strategic asset allocation, and staying the course has typically been a highly effective approach for long-term investment success.”
Necessary to have rallies in bear markets
Raheel Siddiqui, senior investment strategist at Neuberger Berman said rallies are, of course, a common feature of bear markets – especially extended ones such as those that occurred during 1973-74, 1981-82, 2000-03 and 2007-09.
“If markets declined every week or month, the S&P 500 could lose most of its value in 12-18 months and get short sellers to try to discount the trend quickly and ahead of the economic/earnings trend which would then lead to rallies and volatility,” he said.
“In other words, it is almost necessary to have rallies in a bear market.”
Siddiqui added that it is not uncommon for the stock market to retrace 50-60% of the most recent peak to trough decline, before resuming the primary downward trend.
Indeed, there can be as many as four-to-six rallies in a bear market.
“Bear markets tend to bottom within weeks and months of measures of the second derivative of growth ultimately bottoming out, even though the first derivative may still be declining,” he added.
Some of these measures include: 12-month change in expected earnings per share (EPS), 12-month change in leading economic index, and trough in Purchasing Mangers’ Index (PMI).
He added that the current S&P trading pattern seen from January to August is reminiscent those seen in 2007-08, 2000-01 and 1981-82 bear markets.
S&P 500 trading pattern 2022 vs 2007-08
S&P 500 trading pattern 2022 vs 2000-01
