How Bear Rallies Trap Dip Buyers

Jared Blikre |

Download Full Article

Bear market rallies are the stuff of legends. Born through a combination of conditioned dip-buying and FOMO — or a fear of missing out from investors — the bear market rally's purpose is to maximize investor pain. And these events do it well. The market lures in new longs, only to eventually send stocks to new lows. At the beginning of bear market turns, these rallies are flashy and short-lived. As the market grinds lower, these rallies tend to grow bigger, more exciting, and quite deceptive. During the Financial Crisis, the market head-faked investors with three minor rallies from fall '07 through summer '08 — of 8%, 12%, and then 7%, respectively — suckering in new longs near the 2007 record highs. Declines of 45% and 51% from record highs were met with rallies of 18% and 24% in the fall of 2008, moves that came several months before the market's ultimate bottom in March 2009. The S&P 500 dropped 49% from record highs before hitting its ultimate bottom in late 2002. Over the course of 2001 and 2002, the S&P 500 saw no fewer than four rallies of 19% or more. It wouldn't be until the spring of 2007 that the benchmark index would reach another record high. Just in time, of course, for the aforementioned Financial Crisis. At its most recent lows, the S&P 500 was down over 23%, and the rallies so far this year have been shallow and short-lived. The largest was a roughly two-week move at the end of March that produced an 11% bounce for the index. March's move was particularly rough for traders, as this rally took out February highs which weren't too far from the S&P 500's record close seen on January 3, 2022. Anyone who bought that breakout was treated to a 16% loss over the next seven weeks. This bear, it seems, is still young. A less forceful 7% rally in late May and early June was knocked down by inflation rearing its ugly head again, with a four-decade high for the consumer price index tipping the S&P into "official" bear market territory. From here — if history is any guide — this bear market will only get trickier and more frustrating as subsequent rallies likely grow bigger. "If they don't scare you out, they wear you out," says founder Brian Shannon. Something to keep in mind if we're sitting here at the end of June, or July, or August looking at the biggest rally of the year.