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In the Market - April 2009
Apr 15, 2009
Sustained Rally or Reprieve
The sudden 20+% surge in the equity markets has been a welcome relief to investors who have experienced negative returns for the last 18 months, but the question on investors' minds is whether this move is the beginning of a sustained rally or a just a temporary bear market reprieve.
To answer this question we identified periods over the last century where the DJIA rallied by at least 20%. Over 80% of those rallies occurred during bear markets which, while initially surprising, is consistent with higher volatility during bear markets than in bull markets. We then broke out the 20% rallies into two time horizon groups of fast rallies or slow rallies. The fast burst rallies almost always occur in bear markets and periods of high volatility. While the long steady rallies occur in periods of calm and market prosperity. The current rally would be considered a fast rally since it only took 20 trading days for the Dow to climb over 20%.
The fast bursts historically have not been sustainable. Within six months the market gave back at least 50% of the rally in over 90% of the fast bursts whereas the slow rallies proved to be much more sustainable and retraced 50% of their gains less than half as frequently.
The two charts below identify the periods when we have seen the majority of the rallies in the Dow as defined by 20% gain without a 5% retracement and identified by the green line. The dashed green line represents the slow rallies and the solid green line the fast rallies. If we look at the first chart, 1930's, we can see the majority of the fast rallies were in a down market. For almost all of these jumps, the Dow retested the previous lows. If we look at the slow rallies, they tend to hold their gains for a longer period of time, giving investors a chance to lock in gains. The recent time frame paints a similar picture. Since the 30's there have been three fast rallies in the Dow and all have had selloffs either right after the rally or within 6 months of the rally. Whereas the slower rallies in this period held their gains until market conditions changed in 2008. This does not bode well for the current rally. There have been quite a few sustained rallies since the 30's but very few fast rallies that did not revisit the lows or at least give back much of the gains.