by Bryce Coward, CFA, Knowledge Leaders Capital
Several weeks ago we did some research to find out what a typical rally looks like after a big waterfall-like decline takes place. The takeaway was that the rallies after those waterfall declines have lasted anywhere from 1 to 74 days and have retraced 20-90+% of the initial decline. That’s quite a wide range in both duration and magnitude of the move, but a universal similarity was that in 19 of 19 post-war instances of a 15% uninterrupted decline (excluding the current one), the stock market ended up testing the waterfall low in some fashion. That is a pretty compelling statistic that flies in the face of what we are currently witnessing.
That said, the big rally we’re living through is not completely unprecedented after a waterfall decline. Indeed, there were three cases of rallies lasting longer (those highlighted in green in the table below) and three instances of the rally retracing at least 75% of the waterfall decline (those highlighted in orange).
So readers can get a visual depiction of what a waterfall decline followed by a large counter-trend looks like, I’ve pasted below two examples of such action. The first took place throughout 2001. In that case the stock market sold off in waterfall fashion from February through early April. Then, a counter-trend rally took the mark up 19% through most of May. Stocks then topped out at resistance and proceeded to make a new low into the Fall of 2001.
The second instance depicts the bottoming of stocks in the 2002-2003 period. The market declined by about 20% from August through October 2002. They then rallied by 21% over six weeks into late November before turning down again in to the Spring of 2003 to ultimately test and hold that 2002 low. In this instance, we can clearly see how the bottoming sequence in 2002-2003 was a process in which the 800 level on the S&P 500 was touched on three occasions with intermediate rallies in between.
Will the current market go back and revisit those Christmas Eve lows? It would be an outlier, but outliers are common in this business. Either way, it’s useful to put the action we’ve seen recently into historical context, a context that shows rallies lasting longer than the current one and retracing large amounts of the previous waterfall decline.
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