What Happens During Bear Market Bounces

Well, folks. That’s it. We’re officially in another bull market. Don’t believe me? Last Friday, the Dow Jones Industrial Average closed more than 20% above its recent lows, which is the very definition of a “bull market.”

Yeah, I don’t believe it either. In fact, do you know what this does tell me?

That simple definitions are not very useful.

So, instead of celebrating the “end” of the bear market, I think we’re much better off asking whether the uptrend will continue. To answer that, we can look at China.

COVID-19 began in China, which is why many analysts are looking to that country’s trajectory for insights into how the disease could proceed in the United States. The next chart shows the Shanghai Composite Index, a benchmark for Chinese stocks.

There was a sharp selloff when the disease shut down parts of the country. This rapid decline was followed by a rapid rebound. However, as the chart shows, sellers came back into the market and the Shanghai index ended last week at new lows.

The next chart shows an example from the U.S. markets. This is a chart of Invesco QQQ Trust (NASDAQ: QQQ) at the end of the internet bubble in 2000.

There are many other examples of this pattern. Selloffs make prices attractive to bargain hunters. The charts show the logic common among many investors who believe that “if they liked a stock at $100 they should love the stock at $70.” As these investors buy what they think are bargains, prices bounce after a sharp decline.

New Bull Market… Or Bear Market Rally?

Fundamentals determine whether the bounce is the beginning of a bull market or a bear market rally. Right now, the bounce is more likely to be a bear market rally because the global pandemic has changed the fundamentals.

We don’t have much data because the speed of the change has been so rapid. One piece of data we do have is the number of new claims for unemployment insurance. The number of claims increased from 282,000 to 3,283,000 in one week.

Source: Federal Reserve

New claims peaked at 665,000 in March 2009 at the height of the last recession. The latest data points to the depth of the damage to the economy. It’s the first concrete data point — and more bad numbers will follow.

Economists with JPMorgan updated economic forecasts last week. The bank lowered its outlook for the current quarter to reflect GDP contracting by 10%. A week ago, analysts were looking a 4% decline in GDP. For the second quarter, the estimate is now for a 25% decline compared to a 14% decline a week ago.

Fed data indicates the economy contracted by 8.4% at the depth of the last recession.

Source: Federal Reserve

Although experts don’t understand exactly how bad the upcoming recession will be, there is general agreement it will be deeper than the last recession, which pushed unemployment as high as 10% and required years for a full recovery.

Realistically, the stock market should be expected to struggle along with the economy. But now is the time when many financial professionals will say things like “focus on time in the market, not market timing.” Merrill Lynch is one of the firms saying that. Putnam, for example, uses charts like the one below to explain the importance of staying fully invested all the time.

Source: Putnam

This chart is out of date, but the message is similar now even though the stock market delivered two of the 10 best days since the beginning of the year. Two weeks ago, on March 11, the Dow Jones Industrial Average posted its 10th best day in history. That’s now the 11th best day after the index posted its 4th largest one-day percentage gain, last Tuesday (March 24).

The best days like that almost always happen in bear markets. To show you what I mean, I ran a test that gave me a list of days where the Dow gained at least 9%. According to my results, this has happened 17 times since 1900, and 13 of those days (76.5%) occurred while the Dow was below its 200-day moving average (MA). That MA is commonly used to define the direction of the long-term trend, with downtrends defined as periods when the price is below the MA.

Next, I looked at the Dow’s performance over the three years following each of those big “up” days. The chart below summarizes the performance.

Typically, the big day is followed by losses over the next six months, an average loss of more than 7%. Below-average returns continue for three years, with an average annualized gain of 7.3%.

Closing Thoughts

History says we should invest cautiously for the next few months. But don’t forget that things are different this time around… and it could take even longer for the bear market to end.

Even if that’s what plays out, there are still ways you can trade this market. As I explained recently, I’m working with my followers to identify trades we can make that will produce income (what I call “bonus dividends“) with the least amount of risk possible. In fact, we just completed a low-risk trade on an ETF that holds long-term bonds. Thanks to the Fed’s actions, we have the central bank working for us with this trade, rather than against us.

My point is, these are dangerous times for investors and traders. But as I also explained recently, the benefits can outweigh the risks.

If you want to know more about the “bonus dividend” strategy we’re using to earn income in this market, check out this report.