The stock market is recovering, but investors shouldn’t be happy just yet.
The S&P 500, an index commonly used to measure overall stock performance, jumped 2.8% on Tuesday, while the Dow Jones Industrial Average and Nasdaq Composite closed up 2.4% and 3.1% , respectively. Tuesday marked the largest one-day percentage gains since June 24 for all three indices, and a welcome relief for investors. The S&P 500 also rose about 0.9% midday Wednesday.
While financial markets have been buoyed for much of the past two years by government stimulus funds and near-zero interest rates, equities have struggled after peaking in January amid a downturn. skyrocketing inflation and rising interest rates.
The S&P 500 fell into a bear market in June and was still down about 18% for the year as of Tuesday’s close.
The truth is that rallies like Tuesday’s during a general downturn are common, and they certainly don’t mean stocks have bottomed or are going to recoup all their losses in a hurry.
“Bear markets are generally thought of as periods of relentless market decline where stocks only go down,” Bespoke Investment Group analysts wrote in a note to clients on Tuesday. “The reality of bear markets, however, is that they often include periods of extreme countertrend rallies, luring investors along the way.”
What past stock market declines tell us
If history repeats itself, rallies as large as 5% or more do not necessarily mean that the bear market has bottomed out.
Look at the dot-com bust. Between the S&P 500’s peak in March 2000 and its trough in October 2002, the index lost 49% – but along the way it has seen 11 different rallies of 5% or more, according to Bespoke.
It’s a similar story around the 2008 financial crisis: the S&P 500 had 12 different rallies of at least 5% between October 2007 and March 2009, when it lost 57% of its value.
Bespoke even points to early 2020 when COVID-19 first hit the US and stocks crashed. There were three rallies of at least 5% between mid-February and the end of March, during which the overall index lost more than a third of its value, the investment firm found.
“Just when an investor thinks the market is starting to turn, new positions quickly turn into losers,” the analysts write. “The last three periods of sharp declines in the stock market since 2000 illustrate this trend.”
What’s the takeaway for investors? Financial advisors tend to recommend that investors do not attempt to time the market, as it is difficult enough for professional traders to do so successfully.
Instead, if you’re looking to benefit from a possible stock market rally, consider cost averaging, which involves investing a set amount of money at varying intervals. For example, if you’ve saved $10,000 that you want to put on the market, you can invest $1,000 every two weeks until it’s all invested.
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