Are You Ready for the Bear Rally?

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Investors are looking long and hard at Citigroup CEO Vikram Pandit’s comments about the company’s profits for the first two months of the year. Word of his comments spread quickly, and investors reacted accordingly, if not over-reacted, and sent the major market indices up more than 7% in one day. Better than expected retail numbers caused investors late last week to further push the market above its 12 year lows.  Now the outlook for the market has completely switched, with many analysts covering their shorts and calling this the bear market rally everyone is hoping for.

Bear market rallies

There are historically huge bull market runs even in the worst bear markets. Looking back through history to the Great Depression and the 1987 stock market fallout, there were some huge rallies that propelled the market upwards, only to move lower shortly thereafter. The 1980s double dip recession is the most notorious for a bull market move in a bear market, as is the Great Depression, when the stock markets double dipped to find new lows before moving higher.

Should you bet on the bear market rally?

Betting on a bear market rally includes plenty of timing, as you’re betting on a short term burst in a long term downturn. Predicting bottoms in the market is difficult, and picking tops in a bear market is equally as strenuous. For many of us with retirement accounts, we’re already invested in a bull run in the market and have already seen much of our retirement balance eroded by the fall.

How to jump into the bear market

Bull market runs in the stock market generally happen with virtually every stock rising. Remember, the bull run is the result of the market moving higher because it is “oversold” – not because the companies are good or bad, have positive earnings, or are growing rapidly. A positive blip on the radar is an effect of the market and not the effect of individual businesses in the stock market. Though this is a result of oversold territory, this does not mean that the market will keep its newfound highs for long, if at all.

The Elliot Wave Theory

For technicians, the Elliot Wave Theory certainly gains some traction in market climates such as these. Elliot’s belief that the market does not find new highs and new lows in one fell swoop is only proven truer in volatile markets. Looking at the general market indices, it looks like the market is now making its third wave down, with the credit crunch dip in late 2008 being the first and the last occurring at the present level of 6700 on the Dow. With only three waves made thus far in the market fall, Elliot would contest that there should be two more, not to the upside, but to the downside. The bear market rally that everyone is waiting for will be an extension of the upward movement in the third leg of the waves down. In the last few months, we’ve seen huge drops with very minimal surges back to the upside, and the Citi-generated bounce was exaggerated to include more ground than we’ve seen in any other leg.

Lower volatility is a plus

Lower volatility in the stock market is the first good sign that the markets are calming and could turn around into a bull run. Low volatility to both the upside and is indicative of a bottoming formation due to the fact that the market is content at one level and in one area.

ETFs are an easy bet

Lower option spreads on general market ETFs make trading the bull run a possibility. It would be best to start first with an index like the S&P 500 and the ETF SPY to profit off the move. A broad-based index may not have the leading market performance that investors are looking for, but it will move in a way that does not merit dangerous volatility. Plus, with option spreads this low, all the leverage you could ever need is already at the disposal of the investor without the high costs.

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