November 28, 2022

September was bad for stocks. But an October rebound made everyone think all is well and it’s time to jump back in the market. That might be premature.

While history isn’t guaranteed to repeat, there are certainly lessons to be learned from looking back. In reviewing past bear markets, it became clear (in two eras at least) that bear market rallies took place in advance of a true bull run.

Research firm Piper Sandler examined the “dot com” bust from 2000-02 and the 2007-09 financial crisis and found each era endured multiple bear market rallies that grew before we truly hit a bottom:

The reason for the small early rallies is that investors in those markets were used to “buying the dip” and had an ultra-bullish stance most times. When markets began to drop, they stepped in to buy it back up. Of course, the market punished them repeatedly by dropping even more.

As such, it took bigger rallies to bring the bulls back. The market obliged, rallying more than 20% at times. But again, bulls were walloped with losses.

This causes investors to quit. We then see market movements punctuated by larger extremes at either end of the gain/loss spectrum.

And that’s when markets finally bottom out.

Looking at today, it resembles the past. Markets have been trending lower but have seen rallies. We saw one of 11% in March and a 17% gain beginning in June. This tricks investors. They think the bottom is in, but then markets fall more.

If today’s bear market behaves like ones in the past, we’ll see more rallies and fallbacks. The two eras above indicate investors who won big while markets roared basically sold when bullish trends turned bearish. That may happen again. After all, bugs continue flying into “bug zappers,” don’t they?

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