Data Brief - Is This a Typical Bear Market Rally?

Is This a Typical Bear Market Rally?

Monday, May 19, 2008

"Is this just a bear market rally?" has got to be the most-asked question I get.

There's no way to know that for sure, of course, but when we look at our current juncture in terms of sentiment, it does seem as though we should be entering a period where prices at least flatten out and being to swing more widely than we've seen, perhaps ultimately leading to a lower low sometime this summer or fall.

But instead of looking at sentiment, let's just look at the current rally in terms of other bear-market rallies in the history of the S&P 500 to see how it stacks up. Maybe we can glean something from the data if what we've seen so far is out of the ordinary.

The definition of "bear market rally" is certainly open to interpretation. So to take all subjectivity out of it, let's clearly define what we're looking at:

1. The 200-day average of the S&P 500 must be sloping down (a bear market).

2. The S&P must make a low that is the lowest low of at least two months before and after that date.

3. After the low, it must make a high that is the highest price for at least two months going forward.

4. The low must ultimately fail, leading to a lower low sometime within the next six months.

Based on those definitions, what we're going to measure is the average duration and magnitude of intermediate-term rallies in ongoing bear markets.

The scatter plot below shows all 26 rallies that I could find going back to 1928. The horizontal scale shows the length of each rally in calendar days, while the vertical scale shows how much the S&P rallied in that time.

The solid black line in the chart shows that there was a slight positive correlation between the two, which makes sense - the longer the rally, the bigger the rally.

The red diamond highlights our current juncture, with the S&P up about 12% over 70 calendar days. It looks pretty average to me in terms of magnitude, but it's getting long in the tooth as far as number of days. Only three other rallies went on longer than the current one.

The table below shows the start and end date of each rally, along with the duration and magnitude.

The average length of the rallies was 47 calendar days, so as mentioned above we're well above average there. The average magnitude was just over 13%, so we're right on the button there as far as our current situation goes. However, since the 1940's, only three rallies went on to bigger gains than our current one, and only two lasted longer.

On average, the rallies retraced about 50% of the decline from the prior intermediate-term high (the definition or use of "prior intermediate-term high" could be argued, but we have to use something, and feel that this is most appropriate as a guide). Our current scenario is about exactly there, as the S&P has regained just over 50% of the decline since last October.

There are any number of ways to define a "bear market rally", and any one of them could be a good way to look at it. By no means is the criteria we used the only right way to do it, and using different parameters may give a different picture of what "average" is, but I think this definition is fair and gives us a good idea of prior failed rallies.

According to the averages, if this is just another bear market rally and we're doomed to see a lower low sometime this year, then the S&P should be putting in a high very soon, and it shouldn't see that much more upside. If it substantially violates the average length and/or duration, we'll have to question the idea that we're still in a bear market.