Published: November 15, 2023 at 6:18 pm ET
Optimistic stock investors should curb their enthusiasm for the stock market’s explosive rally following this month’s better-than-expected inflation report.
That’s because big rallies are more likely to happen in bear markets than big uptrends.
Consider the Nasdaq Composite COMP since its inception…
Optimistic stock investors should curb their enthusiasm for the stock market’s explosive rally following this month’s better-than-expected inflation report.
That’s because big rallies are more likely to happen in bear markets than big uptrends.
Consider the Nasdaq Composite COMP since its inception in 1971. Since then, just under a quarter of all trading sessions – 24.5% to be exact – have occurred during bear markets, according to a calendar of bull and bear markets maintained by Ned Davis Research. Therefore, if large one-day spikes happened to occur over the course of the calendar, one would expect that only a quarter of them would occur during bear markets.
However, this is not the case, as you can see from the attached table. Take the 25 trading sessions since 1971 in which the Nasdaq Composite recorded its largest daily gains. Of these, 20 – or 80% – occurred during bear markets, more than three times the proportion one would expect assuming randomness. A similar pattern emerges when we expand our focus to the 100 trading sessions with the largest gains: 60% of these occurred during bear markets.
The same general pattern has existed with the S&P 500 SPX since 1928 and with the Dow Jones Industrial Average DJIA since its creation in the late 19th century.
There are three reasons why this otherwise surprising pattern actually makes sense:
- Feeling: Bear markets thrive on the excitement of believing that a new bull market has begun. So if investors are given even a small reason to hope, they will jump back on the bullish bandwagon en masse. Bear markets typically only end when investors throw in the towel and abandon stocks altogether. Investor behavior following this month’s inflation report is typical of the “hope slope” that bear markets like to see fall.
- volatility. Bear markets are more volatile than bull markets. For example, the largest one-day declines are also concentrated in bear markets, as are the largest one-day rallies. For example, of the Nasdaq Composite’s 25 largest daily declines since 1971, 84% occurred during bear markets – much like the 80% of largest one-day spikes that did so. Jon Markman, editor of the newsletter, put it best a few years ago when he compared the psychology of the bull market to the volatility of the bear market: “During a bull market, stocks tend to rise leisurely and thoughtfully, like an 80-year-old couple, walking in Florida.”Sunshine.”
- Risk balancing. This factor is related to the previous one: to compensate investors for the additional volatility of bear markets, the stock market must provide a higher expected return. And to do that, it must first fall to the lower levels that represent the greater upside potential. Therefore, it makes sense that bear markets and periods of high volatility occur simultaneously.
The final result? Don’t get carried away. There’s no big uptrend on any day, even one as impressive as the rally following this month’s inflation report.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that charge a flat fee to review. He can be reached at [email protected]
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