What is a bear market rally?
It signals a brief period (ranging between a few days and months) of economic optimism, but is often short-lived and followed by a continuation of declining prices. It can trip individual investors up who believe we hit the market dip and therefore begin to invest in the hope that they’ll make long-term returns. However, those optimistic investors who stack up on assets at discounted prices are left disappointed when their assets plummet to even lower lows.
Bear market rallies are another way in which the market movements can trick us – they last long enough to make us think we’re heading back into a bull market when in reality, investors eventually fall back and lose even more money. That’s why bear market rallies are often referred to as sucker’s rally, bull trap, or dead cat bounce.
KEY TAKEAWAYS
- A bear market rally is a short-term upturn of 5 to 10% in a broader bear market downturn of between 10 to 20%
- It's a brief period of economic optimism of between days and months, followed by a continuation of declining prices
- Bear market rally's trick investors into thinking we're heading into a period of economic expansion, who accumulate assets before they plummet to new lows
- They are therefore caused by optimistic investors who stack up on discounted assets during a bear market
What causes a bear market rally?
When bear markets occur, investors pessimistic about the state of the economy flog off their assets in a panic, leading to declining asset prices. This leads many investors to see these discounted assets as an opportunity to make significant returns in the long-run, leading to a relief rally consisting of risk-averse investors who believe prices have bottomed out. However, since the overall market forces have not changed, the rally will likely see prices suddenly decline after months of inching upwards, causing those bullish investors to lose their money.
Examples of a bear market rally
Bear markets are common occurrences within economic cycles, and every bear market between 1901 and 2015 has experienced a rally of 5% or more. Below are some examples:
- 1929 Stock market crash: The Dow Jones rebounded 48% from mid-November through to mid-April of 1930. However, it proceeded to decline 86% before hitting rock bottom in 1932.
- 2000-2001 Dot.com crash: The Nasdaq entered 8 bear market rallies of at least 18%, all of which proved temporary.
- 2020 Covid-19: The S&P 500 dropped more than 20% between 20 February and 12 March before rising 9% the next day. 10 days later, the markets continued to spiral down further than before.
How long does a bear market rally last?
Historically, bear market rallies have lasted anywhere between a couple of days or months. The S&P 500 has experienced 20 bear market rallies since 1927, all of which have lasted no longer than several months.
How to invest in a bear market rally
Avoid emotional investing: Jumping on the bandwagon of rallying stock market prices because you fear the bottom line and that you’ll miss out on a bull market is a symptom of emotional investing.
Stick to your strategy: Long-term diversified investors should stay focussed on their established investing strategies and not get swept away by the crowd.
Invest consistently: If you’re still keen to invest during a bear market rally, proceed with caution and focus on investing incrementally through dollar-cost averaging, rather than putting down lump sums into assets. Nobody can predict whether this is a sign of a long-term or short-term trend and by putting lump sums down, you run the risk of losing all your money when prices return to new lows.