Monday, 13 October 2014

Vigorous short-lived bear market bounces

There is nothing as vigorous as a bear market rally. After a severe swoon, the market gets oversold. Earlier sellers see an opportunity to get back in much cheaper, while cautious shorts may want to cover and lock in decent gains. When this mindset gets root among investors and speculators, a bear market rally is born. However, there is nothing as short-lived as a bear market rally. That's why I called them “bear market bounces” in the blog title.
The below table shows an excerpt of the most remarkable rallies the Dow Jones Industrial has seen. The DJ goes back to the end of the 19th century; the public Yahoo data series used here starts in Oct 1928. Not surprisingly, most of the bear market bounces were recorded during the 1930's financial crisis, started on black Monday in Oct 1929. No less than 7 of the 10 largest rallies relate to those hectic days. Further down the list, I've selected only the rallies since 1980. Remarkably the list drawn from the top-50 rallies only contains seven more observations not relating to the 1930's.

Ranking Date DJ-close D/D-1
1 Mar 15, 1933 62.10 15.34%
2 Oct 6, 1931 99.34 14.87%
3 Oct 30, 1929 258.47 12.34%
4 Jun 22, 1931 145.82 11.90%
5 Sep 21, 1932 75,16 11.36%
6 Oct 13, 2008 9387.61 11.08%
7 Oct 28, 2008 9065.12 10.88%
8 Oct 21, 1987 2027.85 10,15%
9 Aug 3, 1932 58.22 9.52%
10 Sep 5, 1939 148.12 9.52%
22 Mar 23, 2009 7775.86 6.84%
24 Nov 13, 2008 8835.25 6.67%
25 Nov 21, 2008 8046.42 6.54%
27 Jul 24, 2002 8191.29 6.35%
35 Oct 20, 1987 1841.01 5.88%
38 Mar 10, 2009 6926.49 5.80%
44 Jul 29, 2002 8711.88 5.41%

Only few years turn up however and all of them ring a bell. Seasoned investors will still recall the 22.6% crash of the DJ on Oct 19 of 1987. It was followed by a two day rally, with the market recovering early losses on Oct 20 and rallying to a 10.15% gain on Oct 21.

The dotcom crisis slashed the Nasdaq index, but caused less havoc on the DJ. The 2002 bear market rallies are far down the list with a 6,35% rally on July 24 and a 5,41% rally on July 29 of 2002.

That leaves us with two top-10 rallies and four more rallies (not surprisingly) from the 2008-2009 financial crisis. No less than two manic bear market bounces occur amidst a number of exasperating swoons in Oct 2008. November 2008 adds two more rallies to the list, with the DJ closing lower than after the October bounces. The rallies after the March 2009 double bottom even end up lower.

And what about bull markets ?

You may ask where the rallies are occurring during the vastly longer periods of prospering stock markets. Bull markets usually last for several years, occasionally interrupted by a pull back (down between 5% and 10%) or a correction (usually defined as a down-turn between 10% and 20%).
Yet, we don't find one single bull market rally with a daily gain of more than a few percentage, such as to make it into the top-50 of DJ market rallies. Short vigorous rallies are exclusively found during bear markets, when volatility is very high.
Bull markets generally progress through minor daily gains outnumbering minor daily declines. This also implies a low volatility environment, typical for bull markets.

Decent entry levels?

Do bear market rallies provide decent entry levels for investors? Hardly ever: with hindsight we find plenty of occurrences of lower DJ levels further down a financial and/or stock market crisis than those before the first few bear rallies. Preceded by breath taking swoons, it also is impossible to pre-position for a bear market rally. During these rallies, selling pressure rapidly increases as many investors want to take advantage of higher stock market prices to cut their losses. Gains because of bear market rallies are the fruit of technical analysis and tactics rather than of strategic considerations.

Often, but not always, seeing a new market bottom and/or top higher than the previous one, suggests a profitable entry level. An examples is the March 23, 2009 rally ending higher than the previous March 10 rally and signalling the end of the 2008-09 financial crisis bear market.
It works out less well with the July 29, 2002 secondary top. Though further gains followed, the market was to slide back to a double bottom in March 2003. It would take to May 2003 before the level of the July 29 market top was more permanently left behind.

A bear market rally doesn't bail you out

Back to the present now and to the precious metal miners, which have been in a bear market for longer than most investors can stand.

Against the background of a world-wide stock market correction, we witnessed the usual volatility on precious metal markets. On Monday Oct 6, Platinum set the tune, with an intra-day $35 plunge to below $1190, followed by a $55 rally to close at $1241, up $20 from Friday Oct 3. It would trigger a short-lived recovery for all precious metals. Platinum continued its recovery rally till Wednesday ($1274) to correct down to $1251 by the Friday close. Over the week, gold adds 2.7% to $1223, while silver adds 3.2% to (a still dismal) $17.40.

Miners watched the the precious metal recovery from the side-lines in disbelief. The HUI index managed to sell-off more than its timid previous gain on Tuesday, only to come roaring back on Wednesday, Oct 8. The bear market rally doesn't bail us out however: two more dismal sessions made miners sympathize south, along with the broad stock market. HUI/Gold now set a fresh low, beneath the December 2013 bottom. In six weeks time the ratio plunged from its 2014 high to where we end up now.  You find fresh graphs on the GoldMinerPulse page.

Further reading on volatility and long term stock market analysis:
Risk mispricing (May 13, 2012)
Volatility persists (Nov 16, 2010)

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