A frequent question asked of many strategists as the stock market rallied on Sept. 19 was: "If this is a market bottom, should I buy into this bounce? If so, how long might it last and how high could it go?"
I don't think anyone knows for sure if the Sept. 17 low for the Standard & Poor's 500-stock index will eventually be the bottom for this bear market. It was accompanied by extreme levels of investor pessimism, which from a contrarian standpoint is a good thing, in our opinion. The two-day rally was sparked by speculation, and then confirmation, of a Treasury Dept.-sponsored Resolution Trust-type bailout in which the federal government would take the troubled loans off the books of beleaguered financial companies. While this action was acknowledged as an injection of calm rather than an overall cure, it served as a catalyst to buoy the markets in general and the financial sector in particular.
So now we are back to the original question. If this is a bear market bottom, how much upside could we see in the initial recovery phase, and then how much might we give back during the anticipated retesting process? Well, if history is any guide—it's never gospel—we may experience a recovery to around the 1290 level on the S&P 500 in the coming 40 days and then bottom around the 1200 level 20 days after the recovery peak.
How Long Might This Recovery Last, and How Far Could It Go?
The accompanying table shows data for market declines, recoveries, and retests. For bear markets, we see when the decline ended, the level of the S&P 500 at the bottom, the number of points lost in the decline, and the overall percentage decline. For recoveries, we see when the peak occurred, the number of days since the bottom, the level at which the S&P 500 topped out, and the percentage of the prior bear market's point loss that was recovered. Finally in retests of the bear market bottoms, we see when the "giveback" concluded, the number of days it took to retest the lows, the level of the S&P 500 at the subsequent low, and the percentage surrendered from the recovery peak.
In the past 50 years the S&P 500 has experienced nine bear markets, excluding the current one. S&P defines a bear market as a peak-to-trough decline of at least 20%. In two other periods, the S&P 500 fell more than 19%, but did not eclipse the 20% threshold. Using these 11 market declines as guides, I found that once a bottom has been put into place, the S&P 500 experiences a fairly swift and sharp surge in prices. Typically, the S&P 500 has recovered about 33% of the point decline experienced in the prior bear market in approximately 40 days following that bottom.
Of course, not all recoveries were the same. Some initial recoveries gained back more yardage than others. Following the 1982 bear market, for instance, the S&P recovered 59% of the points lost in the prior bear market before taking a breather. On the other hand, the S&P 500 retraced only 22% of the ground surrendered in the 2000-02 bear market before getting cold feet.