What Is a Bear Market Rally?
Bear market rally refers to a sharp, short-term rebound in share prices amid a longer-term bear market decline. Bear market rallies are treacherous for investors who mistakenly come to believe they mark the end of an extended downturn. As the primary bearish trend reasserts itself, the disappointment of those who bought during a bear market rally helps to drive prices to new lows.
- Bear market rallies are significant counter-trend recoveries in stock prices that can last as little as a few days or as long as months before the market reverses to new lows.
- The deepest bear markets have tended to produce the largest and longest bear market rallies.
- There is no sure way to identify a bear market rally as such until it unwinds.
- Investors focused on the market's fundamentals and familiar with the history of bear market rallies stand the best chance of avoiding these traps.
Understanding a Bear Market Rally
A bear market is commonly defined as a stock market decline of 20% or more. At some point during the downturn, an orderly retreat typically turns into high-volume panic selling. Bargain hunters grow convinced capitulation is at hand, signifying at least a short-term market bottom.
As these risk-tolerant buyers acquire stocks from the risk-averse sellers getting out at new lows, a relief rally often follows, lasting from a few days to several months.
As with a bear market, there is no official definition for a bear market rally. One benchmark pegs it as a recovery of 5% or more, followed eventually by a reversal to new lows.
Every bear market between 1901 and 2015, spawned at least one 5% rally. Rallies of 10% or more interrupted two-thirds of the 21 bear markets over that span.
The deepest bear markets have in the past produced the biggest bear market rallies. In the aftermath of the Stock Market Crash of 1929, the Dow Jones Industrial Average went on to rebound 48% from mid-November through mid-April of 1930. From there, the Dow declined 86% by the time the bear market hit rock bottom in 1932.
The Dotcom Crash in 2000-2001 saw the Nasdaq mount eight bear-market rallies of at least 18%, including four gains of at least 30%, and one 56% advance, all of which ultimately proved temporary.
Example of a Bear Market Rally
The Nasdaq Composite declined 29% between Nov. 19, 2021 and May 11, 2022. In mid-March, with the Nasdaq already down 22% from the prior year's high, it staged a two-week bear-market rally, gaining 16% over that span.
Near the bear-market rally's peak, market analysts including Bank of America equity strategists warned the relief gains were not in line with deteriorating investing fundamentals such as rising interest rates. The Nasdaq set new lows four weeks later.
The Bottom Line
Declines large enough to qualify as bear markets often take place as a result of deteriorating fundamentals, whether the ultimate cause is a housing market crash, a pandemic, or merely a recession.
Because bear markets tend to be prolonged, they can generate multiple selling exhaustions that temporarily improve the market's fortunes without altering the fundamental factors causing the downturn.
Investors who keep focus on the fundamentals can expect, and even profit from, bear-market rallies without assuming the next bull market is at hand and paying a heavy price when the bear returns instead.