When Does a Bear Market Rally Become a Bull Market?

Back in June, we talked about how a rally can happen in the middle of a bear market. Even though the overall trend of the market is downward, there are naturally periods in which it comes back up. Then in August we warned about the signs for when such a rally would end. And all through September markets trended lower and found a new bottom at the end of the month.

But, since the start of October, US indices have been generally trading higher. It hasn’t been an equal rally, with the DJIA having much better performance than the Nasdaq, for example (and the S&P sort of splitting the difference). But after the Dow poked above the summer highs, it starts raising the question of how long the current trend will last. Particularly as we get into the end of the year.

Where are we going from here?

Usually, the last couple of weeks of the year give extra buoyancy to the markets in what is known as the “Santa Clause Rally”. Typically, after the Fed’s final interest rate decision for the year in the middle of the month, most major traders take a break. The constricted liquidity contributes to higher volatility, but also smaller traders tend to be more optimistic.

Since December is about to start, we’re sort of running out of time for there to be another bear market ahead of the holidays. So, does that mean markets are likely to keep going up from now on? Or, at least to the end of the year? And does that mean the bear market is over? How closely do we need to stick to the definition?

Drawing conclusions from the ups and downs

“Bear” and “bull” markets are more about directionality. But the market fluctuates a lot, so some kind of separation is needed between the market going down temporarily, or has entered a longer-term trend. Typically a 20% marker is used, but it’s more of a guideline than a strict rule. If the market is down 20% from its last high, it’s safe to say it’s in a bear market. By contrast, if it moves up 20% from its most recent low, generally it’s considered a bull market.

Since hitting its lowest point on October 13, the DJIA has rallied 19.5% to date. Which, if it continues to rise, puts it technically in range of being a bull market. The problem is, of course, that the generalized trend has been downward. And with most economists forecasting a recession next year, there is every reason to expect the index to resume its downward trajectory. In other words, don’t set up trading based on a technicality of a definition.

The bigger the rise, the bigger the fall?

The Dow has been outperforming compared to other indices, particularly the Nasdaq, which gives us some insight into the dynamics. Since the Fed started hiking, there has been a generalized move towards value stocks, and away from tech stocks that are seen as riskier. Meaning that even when the market is moving higher, it’s because those who are daring to buy are doing so in defensive, relatively “safe” assets.

Since the Nasdaq hasn’t rallied much at all over the last couple of months, it doesn’t have much of a “correction” to make. But if the Fed were to disappoint, or another risk event were to come up before then, traders might be very quick to pull back that tentative toe they’ve dipped into the safest part of the stock market.

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