Simply Put: Bear Market Rally

Two friends catching up in a coffee shop got excited as one of their favourite songs from school days decades earlier, started playing. As they started humming in chorus ‘woah, we’re half way there, woah, livin on a prayer,’ they ended up getting into an interesting conversation.

Ram: The way markets had started rallying from their June lows, I was halfway there in recovering my losses. But now global markets have been tanking over the last week after the US Fed Chair’s speech. Although our markets are holding up better, I am nervous now!

Veena: Haha! In hindsight, what played out in the US and some European markets appears to be a classic bear market rally. Our markets, too, joined the party and had a strong recovery. Technically, we were not yet in a bear market as the Nifty 50 had declined 18 per cent from peak to bottom, and not crossed the 20 per cent threshold.

Ram: What exactly is this classic bear market rally?

Veena: After entering a bear market, when there has just been massive selling, there can be strong and ferocious counter moves on the upside. These rallies can extend for multiple weeks and even months sometimes. In the process, it can make many bears throw in the towel and also make many bulls declare a premature victory. But ultimately, these turn out to be bull traps and markets crash to levels lower than that at which the rebound started.

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Ram:  Oh! Is this common across bear markets?

Veena: Oh yes! The Dow Jones tanked 89 per cent from its peak in 1929 to its trough in 1932. During this period, it rebounded nearly 50 per cent for a few months during end-1929 and early 1930, after initially crashing 48 per cent from its peak. During the dotcom crash, the tech bellwether index — Nasdaq Composite — crashed 78 per cent from its peak in March 2000 to its trough in 2002. When the index was in a downtrend, there were quite a few bear market rallies. Generally, market corrections tend to unwind in waves and not in a linear direction.

Ram: Interesting! Can you give examples of bear market rallies in our markets?

Veena: Sure. During the dotcom crash, the Nifty 50 crashed over 50 per cent from the peak in March 2000 to the trough in September 2001. This down-trending period saw two phases of near 30-per cent rebounds from lows that were thought to be bottom by many market participants. So was the case during the housing bubble crash of 2008-09 when Nifty 50 saw two strong 20-per cent bounces in 2008 between March and May and again in July-August.

Ram: Wow! So how is one to figure out during such strong bounces whether it is bear market rally or the start of a new bull market?

Veena: Haha, well that’s a billion-dollar question. Experts managing billions of dollars fail to identify it correctly. In general, when there is a huge structural shift in fundamentals tilting it more in the direction of pessimism, it would be better not to call victory early on during market rebounds.

Ram: What would you say is the case now?

Veena:  With multi-decade high inflation in developed economies, a slowdown in China, and what one could say are serious geopolitical issues, it does appear we may still be in a longer down-trending market. The correction in some of the developed markets over the last week definitely bears this out. But then in markets you can never say anything with certainty. For example, during the early rebound from Covid crash of March 2020, many thought it was bear market rally, but in hind sight it was not!

Ram: Hmmm… so how should we play the market?

Veena: Invest based on probabilities. Not certainties.

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