It is important for investors to understand the concept of a bear market rally, which refers to a phenomenon that can occur following a plunge into a bear market. To help investors make smart decisions, here is essential information about bear market rallies.
Occurring amid a more protracted bear market decline, a bear market rally is an acute, short-term resurgence in share prices.
For investors, such rallies can be fraught since they can be mistaken for the end of a long-term market fall. Once the bearish environment is again manifest, the dismay of investors who bought during the bear market rally help to push prices down to new lows.
While there is no official definition of a bear market rally, many say it is a recovery of at least 5%, ultimately followed by a reversal.
Bear market rallies occur during almost every period of decline. During the bear market – often defined as a decline of at least 20% – panic selling at some point ensues, and bargain hunters begin to believe capitulation is nigh, and that the market has bottomed out.
As these investors buy stocks at new lows, a rally follows that lasts anywhere from several days to many months.
While such rallies are often mistaken for bull market recoveries, the markets do differ. A bull market is a sustained upward movement in stocks, one which usually results in new highs.
By contrast, a bear market rally is an increase in stock prices, also known as a dead cat bounce, following the fall into a bear market. However, the rise in prices is temporary and the stocks will drop again.
Bear markets do eventually end, and any reversals across markets could signal the start of a misleading bear market rally. The prevailing rub is that it is hard to know for sure – except in hindsight.
Afterall, every bear market between 1901 and 2015 produced one or more 5% rallies. Over that period, rallies of at least 10% disrupted two-thirds of the 21 bear markets.
Between Nov. 19, 2021, and May 11, 2022, the Nasdaq Composite dropped 29%. In the middle of March, with the Nasdaq already down 22% from the previous year’s high, a two-week bear market gained 16%
With the rally nearly peaking, market analysts cautioned that such gains were not aligned with worsening investing fundamentals including increasing interest rates. Four weeks later, the Nasdaq set new lows.
Earlier this year, the S&P 500 Index increased more than 13% since last year’s mid-October low, rising to about 6%. The rally mirrored optimism that inflation would soften, and interest rates would drop.
However, some analysts are less sanguine, pointing out that inflation and monetary tightening remains unsettled. They speculate that the rally may be more related to swiftly easing financial conditions such as cheaper oil and more consumer spending.
There is concern, for example, about a marked decline in oil prices, a drop in longer-term Treasury Yields, the U.S. Treasury spending down its general account, and consumers depleting excess savings. There is also significant volatility in the bond market, resurging interest rates, and a resilient U.S. dollar.
To date, the longest recorded bear market was during the Great Depression. Between Sept. 3, 1929, and June 1932, stocks fell 84%. A full market recovery did not occur until January of 1945.
The deepest bear market took place in 2008 and 2009, which led to the worst recession since the conclusion of World War II. That was followed by a bailout that helped lead to a decade-long bull market.
Common bear-market rally triggers include investor sentiment and economic data. In general, when investor sentiment is rosier and market liquidity is rising commensurate with looser conditions, asset prices usually increase.
A key function of the cycle of bull-bear stock markets is to alter investor sentiment, to persuade them that a further decline is not to be. This period of optimism injects capital into the market, causing stock prices to rise, and a flurry of selling, resulting in further decline.
Before participating in a bear market rally, some insights recommend that investors focus on these factors: the state of the economy’s reopening, how corporate profits will look for the year, and the state of consumer spending.
Some actions to take during a bear market rally can include making certain one’s time horizon and risk profile matches their asset allocation. In other words, it could be a good time to hew to longer-term strategies to rebuild risk exposure.
Another move could be to start or maintain, at regular intervals, dollar-cost averaging, which is the kind practiced by investment participants in 401(k) and 403(b) accounts. This would permit investors to skirt the risks involved with investing a lot of capital into the market shortly before a likely dip.
An additional action could be investing in alternatives, which are increasingly popular in general due to their low correlation to public markets, rendering them – and investment portfolios – less volatile. Private markets also have outperformed stocks in every economic downturn of the last 15 years.
In addition to potentially providing consistent secondary income, investing in alternative asset classes such as art, real estate, structured notes, private credit, and legal finance serves the very important purpose of diversifying investment holdings. Building a portfolio of various types of assets can reduce overall volatility, thus protecting against total losses.
Alternative investments can be a good way to help accomplish this.
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
It is important for investors to recognize a bear market rally for what it is – a short-lived rally – so that they can make informed decisions without mistaking the event for a full-market recovery.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.