Bull Market Rally VS Bear Market Rally

Ever since equity markets have displayed a swift recovery following a rapid fall in 2020, investors are being advised to remain cautious on deploying fresh monies by several stock market experts, who are calling the remarkable recovery as just another bear market rally. So what exactly is a bear market rally and can one distinguish it from a bull market rally? Yogesh Supekar along with the DSIJ Research Team identifies the typical characteristics of bear and bull market rallies and the aspects that differentiate the two.

Figure this out: Over 100,000 Americans have lost their lives and more than 40 million US citizens are unemployed. In fact, these figures are supposed to reflect the worst unemployment status USA has ever witnessed. In this context, guess what happens to the stock market: Dow Jones Industrial Average Index (DJIA) is up by more than 7 per cent in one month while Nasdaq is up by more than 10 per cent in a single month. From its low made on March 23, 2020 the DJIA is up by nearly 36 per cent! Can anyone believe such numbers after considering the dismaying scenario that actually exists in reality? 

In India, the unemployment level is at a historic level, the macro economic situation is deteriorating, virus-infected cases are touching record highs and the NPA situation is expected to get worse. Reality is not pleasing at all with many businesses expected to shut shop permanently, further testing the abilities of the Government of India to revive the economic situation. While this is the stark reality of India, the Sensex is up by nearly 28 per cent from its lows made on March 23, 2020 when the key benchmark index touched 25,981. The Sensex fell almost 38 per cent from its high of 41,952 which it touched in 2020.

Voicing the concern and confusion felt by all investors, Sanjay Agarwal, a retail investor, says, “I am totally bewildered after looking at the Sensex movement. My mind suggests that given the grim situation in real life, the economic and social chaos is bound to increase before we can even reach some semblance of normality but at the same time the Sensex is inching up and easily gaining 1,000 points in a single session as if nothing has happened. Even if I start ignoring the ground realities and make up my mind to invest in these volatile market conditions, I hear experts terming this a ‘bear market rally’ that calls for caution.” 

“I don’t know what exactly does a bear market mean and whether to invest in these market conditions or not. Should I place faith in what the stock prices are telling me and simply go ahead?” he wonders. Indeed, several investors like Sanjay Agarwal are not able to understand the bullishness of the equity market given the ongoing dire situation and many are unable to figure out what a bear market rally is. Most importantly, if indeed it is a bear market rally that we are witnessing right now, what are investors supposed to do then? What if it is not a bear market rally and we may have already entered a bull market territory?

Defining a Bear Market Rally

Before understanding what a ‘bear market rally’ is, it is important we understand what exactly a ‘bear market’ is. The answer to what constitutes a bear market will depend on who you ask; however, conventionally a bear market refers to a sustained decline in stock prices. The most traditional way to define a bear market is when the key benchmark indices and the broader market index witness a decline of 20 per cent or more over a period of at least a couple of months. Different bear markets will last for different lengths but according to investment company Invesco, the average length of a bear market is 363 days while Fidelity estimates that a bear market may occur roughly every six years. Bear markets are usually accompanied by a recessionary phase and or periods when the economy de-grows, which leads to massive surge in unemployment rates.

A bear market rally occurs during a bear market and is characterised by bouncing stock prices before reversing and heading back to fresh lows. Bear market rallies are tricky, and they confuse investors. Such rallies give investors hope that we are coming out of the crisis situation successfully and that ‘now is the time to invest’. Most rallies in bear markets make investors believe that the recovery will take the stock prices to all time highs and recover all the losses recorded so far. In fact, some of the bear market rallies are so strong that they give us a false sense of the beginning of a new bull market.

The upward spikes in stock prices can happen multiple times during a bear market. During an economic crisis when bear market conditions prevail, bear market rallies are normal occurrences. A false sense of market recovery is always there during bear market rallies. Apart from the fact that bull market rallies are longlasting and stay longer, investors also need to pay attention to the participation of foreign institutional investors (FIIs) during all rallies. The table below clearly suggests that the FIIs’ net inflows are typically higher during bull market rallies when compared to volumes in bear market rallies.

Bull or Bear Trap

A bull or bear trap is a trading pattern that occurs quite commonly and is something that most traders dread. As the name suggests, these patterns are traps that are formed in order to capture the weak bullish or bearish positions before the price reverses. A bull trap occurs when there is a quick price increase in a downtrend, which is a false signal. It lures investors and traders who buy or open long on the asset anticipating a breakout. However, the trend soon reverses after a short period of time and the value of the stock or index continues to decline. This results in bullish traders and investors being trapped, who are then forced to close their positions which adds to the selling, thus giving it a more rapid movement.

On similar lines, a bear trap occurs during an uptrend when there is a sudden price drop. This entices traders to quickly close off their positions to avoid further losses. Some might even open short positions hoping to make a profit on the decline in value. However, the trend quickly reverses again and continues to incline. Even though these patterns are common, there are several ways traders can use to minimise the chances of getting trapped in these patterns.

One must constantly be on the lookout for a change in trading volume of the stock because if there is a change in stock movement while the volume remains consistent, then there is a good chance that a trap is occurring. On the other hand, if there is a sudden increase in the average volume of the stock along with a change in price movement, then a chance of a breakout is more likely. But even then, a trader should check the news first before taking any action.

Deepak Jasani Head Retail Research, HDFC Securities 

“India Could Definitely Outperform Global Peers for a Limited Time Period” 

How can one distinguish a bear market rally from a bull market rally?

A bear market rally is sharp as shorts scramble to cover their positions and investors who were on the sidelines jump in to participate. A bull market rally is normally laborious, takes more time and needs a lot of money flow.

What are the bear and bullish case scenarios in the markets?

Nifty could revisit the recent lows of 7,511 in case the developments on the pandemic front in India are not favourable. A breach of this level may happen if India’s macro and micro scenarios see a series of downgrades. However, in case the lockdown is lifted and we do not see much more damage from here, we may make a higher bottom, above 7,511.

What approach should an investor take on the markets in present conditions?

Investors that are already fully invested in equities, as permitted by their asset allocation model, could lighten a bit on rallies and raise cash to deploy again on dips. A review of the portfolio to limit the number of scrips and weeding out scrips that may not withstand disruption is essential. For investors that are not fully invested, a staggered investment in MFs or carefully selected direct stocks is advisable over the next 6-8 months.

What are the key risks for markets in your view?

Sovereign downgrade, insufficient monsoon, the pandemic impact in India getting magnified in terms of lockdowns and health impact, run on the rupee, delay in recovery in economic growth, etc. are some key risks faced by the markets currently.

Will India outperform its global peers?

A lot depends on whether their economic recovery is faster than that of India. Also, if monetary easing in developed countries does not provide the expected boost to their economies, India will be well-placed compared to them as we have been far more prudent so far, At some point in future, India could definitely outperform global peers for a limited time period even on grounds of mean reversion after a prolonged period of underperformance. 

Sectoral rotation from one bull market to recovery year

We can see that while in a recovery phase, stocks of different sectors did well in 2009 when compared to the year 2007 when bull markets were witnessed. The automotive stocks did not do well in 2007 but they led the recovery in 2009. The same can be said about healthcare and IT stocks. Metal stocks were clear leaders in the recovery stage even when the metal stocks did well in the 2007 bull markets. Power and telecom stocks could not recover much after showing leadership in the 2007 bull markets. The table shows how the leaders of 2019 have failed to lead recovery in 2020. For example, banking and financials have not led the recovery. Automotive, telecom and healthcare have instead led the recovery from the recent rapid fall in 2020. 

Key Difference between Bull and Bear Rallies

Bull rallies tend to be of lower volatility and are accompanied by breadth expansion. In other words, more and more stocks and sectors make new highs, along with the major indexes. In bear rallies you tend to see very high volatility. In fact, when you look back at the largest one-day gains or largest one-week gains in the stock market, they all come within very volatile stock market crashes. These are what we call ‘counter-trend’ rallies. We saw many of these throughout the financial crisis in 2008, for example. Towards the end of the bear rallies, fewer and fewer stocks participate. The laggards keep lagging and ultimately lead the overall market to lower levels once again. Bull rallies are boring. The financial media has to work harder to make up stories about why the stocks are moving. Bull rallies tend to last longer than bear rallies. 

J C Parets  CMT, President and Founder, Allstarcharts.com 

Worst Bear Markets

✪ The Great Depression Bear Market : The Dow fell 90 per cent in less than four years, peaking at 381.17 on September 3, 1929 and falling to 41.22 by July 8, 1932. The 1929 stock market crash led to this bear market which followed an asset bubble caused by a financial invention called ‘buying on margin’.

✪ The 2008 Bear Market : The bear market began on October 9, 2007 when the Dow closed at 14,164.53. It fell to close at 6,547.05 on March 9, 2009. The Dow didn’t regain its 2007 high until March 5, 2013, when it closed at 14,253.77. The Sensex made a top of 20,686.89 on January 4, 2008 after which it made a low of 8,756.61 on March 13, 2009. Sensex levels then crossed the top of 2008 on February 21, 2014 on a closing basis.

✪ The 2000 Bear Market : It began on January 14, 2000 when the Dow closed at 11,722.98. The benchmark fell 37.8 per cent until it hit its bottom of 7,286.27 on October, 9, 2002.

✪ The 1970 Bear Market : The 1970 bear market began on December, 31, 1968, when the Dow closed at 943.75. It dropped more than 30 per cent before bottoming out at 631.16 on May 26, 1970. 

Jyoti Vaswani,

Chief Investment Officer, Future Generali India Life Insurance Company Ltd 

“It Will Take At Least Two Quarters to Return to Normalcy” 

How are bull market rallies different from bear market rallies? Generally, in a bull market, corrections are short-lived and every rally leads to the formation of higher top whereas in a bear market, though the rallies are ferocious, each rally fades below the top of the previous rally. To illustrate this, we have shown the major corrections or rallies from the previous bull and bear markets (2003-08). Also, short-term bear market rallies are much more powerful than shorter-term bull rallies. It is important to recognise cyclical versus secular trends.

Bear market rallies are essentially cyclical and technical in nature wherein they try to retrace back to the technical levels (Fibonacci retracements, reversion to moving averages, etc.) as the falls are quite fast and the market swings to extremes and then tries to mean revert. Volatility is higher during bear market rallies. Leadership isn’t clear during a bear market rally. And, if leaders are defensive stocks such as utilities or FMCG, it usually indicates a countertrend rally, which is a shorter-term rally in the opposite direction of the larger trend.

What is your outlook on Indian economy?

While the near-term outlook for the economy is tough as we battle the virus and the resultant disruptions to economic activity, the medium-term and the long-term outlook remains quite encouraging. All the four pillars of economic activity face uncertainty. Consumption is expected to slow down due to uncertainty over jobs, pay hikes, etc. Capital expansion or investment will be pushed back by a few more quarters; government expenditure will be constrained by the weak state of government finances due to revenue shortfall while exports will be hit by the weak global demand. But though the current situation regarding the economy is tough, it’s on expected lines. It’s an inevitable consequence of the necessary extreme step of a long lockdown.

Shutting down the economy for 15 per cent of the year (almost two months) makes it a tad difficult to show growth in this financial year. But, unfortunately, everyone seems to be putting insane amount of effort and coverage trying to find the negative number, which is already past. FY 2020-21 full-year GDP is meaningless as we have already have lost 15 per cent of time in a lockdown situation. What is certain is that the worst is most likely behind us, not ahead. We should focus on numbers that matter i.e. Q3 onwards. Since that’s unknown and unknowable, we might have to wait how this pans out but we are hopeful that most of the pain will start easing from Q2 itself.

We are gradually changing course, away from this extreme. Like all other countries, we are also doing our best in responding to an evolving situation and we can only hope that the worst is behind us. Once we win the battle against the virus, we believe the government will pay undeterred attention to fixing the economy. The global backdrop is conducive to economic recovery in India. Liquidity is sloshing in the global economy with central banks across the globe printing trillions of dollars which will keep the interest rates low for a long time.

Commodity prices are expected to remain subdued which makes us very comfortable on the inflation and external account front. These two factors provide significant headroom for the RBI to continue with monetary easing. The tougher part is to provide short-term fiscal push as government finances are under stress. We are of the opinion that the government will overlook the near-term fiscal concerns and go for fiscal easing to bring back growth.

Where do India stand compared to its global peers?

The global stock markets have seen incredible volatility over the last six months. The turbulence in the stock market is at levels last seen during the Great Depression. While India’s response to the pandemic on the healthcare front has been the best globally, this has come at a cost i.e. significant disruption to economic activity. In addition to this, globally, the fiscal actions have been far more aggressive and we have had some sort of disappointment on that front in India. These factors have led to India’s underperformance versus most other markets in CY20.

Going forward, we believe that till the time we do not see resumption of economic activity on a large scale, we are likely to keep gyrating in a trading range. Market moves also will be contingent on government’s action. We are of the opinion that government has tried to preserve the firepower and we are likely to see some sort of fiscal stimulus once we have clarity on resumption of economic activity and the damage caused by the lockdown.

Also, any action taken by the government to open India’s doors as the new global outsourcing hub as against China will be watched very carefully. That is when we believe Indian markets will start outperforming the global markets. The performance of the Indian markets will also depend on the FII flows. FIIs have been relentless sellers on the back of risk-off sentiments globally. Once we see the sentiments turning, FIIs will come back, which, along with sticky domestic inflows, augers well for the domestic equity markets.

How does one know if we are out of the bear market?

Bull and bear markets often coincide with the economic cycle, which consists of four phases: expansion, peak, contraction and trough. The onset of a bull market is often a leading indicator of economic expansion. Because public sentiment about future economic conditions drives stock prices, the market frequently rises even before broader economic measures such as gross domestic product (GDP) growth begin to tick up. The average bear market time from peak to trough has been 14 months, and the current record is three months, set by the 1987 bear market which wasn’t associated with a recession. This bear market could be different. It has already set a record for the fastest bear market to ever develop, and it could set a record for the drawdown phase as well, but caution is warranted.

We will know if we are out of the bear market or not only with the benefit of hindsight. Bear market rallies and the start of new bull markets look the same. While markets will have sharp rallies based on various news flows like developments around the corona virus vaccine, pace of increase in virus cases, government or monetary response, etc., the sustainability of the rally will depend on two questions – whether there is resumption of economic activity and whether there is a second wave of the virus when we open up. Only when we have the answer to these two questions will we have an answer to whether we are out of the bear market or not. However, volatility will likely persist as we digest information about the economic damage incurred during the lockdown period.

We anticipate that it will take at least two quarters to return to normalcy. Markets are a forward looking animal and will make an up move as soon as we have some visibility on the above two questions. Also, when the bond yield and earning yield converge, it is usually followed by a bull rally. Currently, we are witnessing a convergence of the bond yield and earning yield. But regardless of whether we have hit the bottom yet or whether there are further declines to come, setting up an investing strategy to put money into equity in such bear markets in a systematic manner is likely to pay off in the long run as has been evidenced by history time and again. 

"The Worse a situation becomes, the less it takes to turn it around, the bigger the upside."

George Soros Hungarian-American Billionaire Investor

Conclusion

Whether the current market rally is a bear market rally or a bull market rally only time will tell, but the fact that the Sensex is up by almost 28 per cent from the bottom made on March 23, 2020 gives us confidence that we may come out of the bear market territory sooner than later. In case the Sensex does not breach the highs made in 2020, we will technically be in a bear market zone. Investors need to tread cautiously and avoid getting caught in a bull trap as we are definitely not out of the woods yet. However, any bear market is caused by a loss of investors, business and consumer confidence.

If we take stock of the current situation, investors, business houses and consumer sentiment do not indicate loss of confidence while recognising the fact that the challenges posed by the current crisis are unique and hence uncertainty will remain longer than expected. The disconnection between the weak macros and rising stock prices may be unsettling for several investors. However, if one carefully studies how the equity market discounting mechanism works, there is always a chance of markets moving ahead of fundamentals. The current global rally is liquidity-driven. The amount of liquidity flushed in the financial system is unprecedented as almost all of the major economies pressed the panic button and opened the gates of liquidity to support businesses.

The quick response through the route of monetary policies by the central banks worldwide and the fiscal policies adopted by several governments have unleashed a monster-sized cumulative stimulus which is feeding the current bull rally. Ample liquidity, slow and steady opening of the economies, stabilising of credit markets in developed nations supported by various governmental initiatives, historical low rates in the interest environment and under-ownership of equity as an asset class are all indications that the rally in stock prices may have some steam left.

Surprisingly, amidst all the chaos with the ratings being downgraded for India, the volatility index (VIX) is in sub 32 levels, which is comforting for the bulls. There is healthy broader market participation in the current market rally and the prices are increasing with rising volumes, which suggests a change in the sentiment of investors. FIIs have turned net buyers and retail participation always increases with rising stock prices. A survey conducted by Bank of America indicates that two-thirds of the money managers believe we are witnessing a bear market rally and only about 10 per cent of the participants believe we will witness a V-shaped recovery.

So while we must respect the views of the professional money managers, we cannot ignore the fact that the ‘unlocking of the economy’ is going to act as the biggest stimulus for the economy and the expected pent-up demand will further enthuse investors once more as an increasing number of economic activities begin afresh. From the look of it, the current market rally has all the makings of a very strong bear market rally if not the beginning of a bull market. Without getting carried away, investors can remain invested in this rally as there is no indication of the current rally halting any time sooner. Historical evidence suggests that bear market rallies can continue for months together.

For those who practise technical analysis – applying Fibonacci retracement levels to understand whether the rally is a bear market rally or a bull market rally can be very useful. Also, using Fibonacci retracement levels one can anticipate the timing and the extent of bear market swings. Distinguishing rallies between being bullish or bearish is important as determining the nature of an ongoing rally can influence the overall portfolio stance. One can be defensive when a bear market rally is in progress while one can take an aggressive portfolio stance when it is otherwise.

Also, the most important aspect that investors need to remember is that leadership almost always changes post heavy corrections. If banks lead a bull rally prior to the correction period, the rally post bear markets which helps market recover may have stocks from different sectors lead the rally. Investors tend to bet on same sector stocks in all the rallies which may not help beat the markets. During such uncertain times what investors need is to be independent thinkers, being contrarian at times and having a long-term investment horizon to be well-positioned in the market on a consistent basis.