With the markets having been on a tear since the S$P 500 made a new 12-year low on March 9, the question remains whether this move up is the beginning of a new major trend or simple another bear market hiccup.
Dr. Housing Bubble featured the table on the left showing the magnitude of bear market rallies during the Great Depression. He elaborated as follows:
Some people think that stock market rallies only happen in full on bull markets. That is not the case. In fact, some of the fiercest short term jumps happen when the economy is in utter disarray.
From November of 1929 to September of 1932, the Dow saw 5 rallies over 20+%. One hit 72% and one hit 48%! In fact, the 72 percent rally happened right after the market hit the abyss. Yet as we all know, the Great Depression caused fundamental problems in the economy that lasted the entire 1930s. So only looking at the stock market as an indicator is problematic. And keep in mind the rally occurred right on the heels of thousands of bank failures in the 1930s and unemployment spiking to 25%.
We also have the problem of interpreting math results. For example, everyone was cheering the 40 percent rise of Citigroup this week but forgot to mention that this amounted to 40 cents. You gained 1 quarter, 1 dime, and 1 nickel for each share you owned. The rally we are currently seeing is strictly a technical rally. Don’t fool yourself into thinking otherwise. It is the same as the Great Depression bear market rallies. We will test lows again soon. Maybe once those stress tests are released or when the 1st quarter results are announced starting in April of 2009. For the mean time, enjoy the bear market rally.
The investment community has always been and still is fascinated with trying to pick a bottom, and then ride the gravy train all the way to the top whether it is a bear market rally or not. Of course, getting in at the bottom is nothing but sheer luck as is selling at the exact top.
If you are a buy and hold victim, you are pretty desperate in trying to make up huge losses as fast as you can, which usually leads to bad decisions and even more losses. There is nothing wrong for an aggressive investor to take a chance and jump in early. However, without acknowledgement that an incorrect decision could have been made as well as a plan in place to get out again, before major portfolio damage occurs, is something that most ignore.
The above table shows that bear market rallies can be incredibly powerful and long in duration. They may even generate a buy signal for our domestic Trend Tracking Index (TTI) and get us back in an invested position. Since you can never be sure about the duration of an uptrend, especially given current economic times and circumstances, it is imperative that you have a clear plan in place as to how to deal with market adversity the moment you establish new investment positions.
Neglecting to do so will enhance your odds of seeing your portfolio getting pummeled when the rally runs out of steam, the bear resumes its trend and new lows are being made. These treacherous times are far from being over and if you decide to engage some outside help for portfolio management, be sure to ask the most important question: “What is your exit strategy?”