The financial press will be quick to report on a market rally. Feel good news, especially one which involves people getting richer, is an attractive headline which sells newspapers. It also has the effect of drawing in more investors – driving a rally ever upwards! Although many will have heard of a market rally, how many will know that their are different types of market rallies?
Types of market rally
How they are created
How to use them for the benefit of your portfolio
It is an upward move by a large number of hot stocks, which causes the stock market to increase in value. The trigger can be a number of factors, such as a well received political outcome, some positive economic data, the latest shot of quantative easing morphine from the New York Fed or investors having identified some undervalued stocks.
There are different types of market rallies. The most common is the broad based rally, where every sector and virtually every stock will be in the green. This occurs when investors receive a piece of news which will benefit the worldwide economy.
Another form of market rally is the bear market bounce, which is also known as a dead cat bounce. In this situation the stock market will rise rapidly, often after a violent sell off. The initial sell off draws in bargain hunting investors whose buying causes the market to recover.
Do not ignore the irrationality of retail investors.
Eventually common sense and the fundamentals prevail and the stock market returns to its downwards spiral. Usually this will occur before an impending recession as the stock market prices in the reduction in company profits.
In the 2000s, the use of quantative easing by the New York Federal Reserve has led to a buy-the-dip-mentality. Every time there is a major economic shock, the Fed increases its quantative easing program. This has led to a comical situation, where bad news is good, because it means more Fed (QE) support!
Sometimes a rally in stocks is driven by a sector. This sector will then give confidence to investors who pour into other sectors. The March 2020 market rally was started and driven by the recovery in share prices of the big tech firms. As the rally progressed, it became noticeable that the shares in utility companies, not typically associated with investor exuberance, started to rally upwards too due to momentum trading.
The current appreciation of the S&P500 can best be described as a rally. After one the fastest crashes in March, the S&P500 has recovered nearly all its losses 3 months later. This rally was started by the combination of The Federal Reserve pledging massive support programs and numerous retail investors bargain hunting. There is some suggestion that portfolio managers missed the rally initially and joined in later, so quick did the rally take hold.
Some commentators, who are best not listened to, will try and time the market. Few can realistically predict when the ‘low’ has been reached, and a market rally is about to start. There are techniques to use which mean you can benefit from buying before and during a market rally.
Firstly using cost averaging will mean you will never fail to buy at the bottom. Although you may end up buying at the top also, over time and through compounding you will benefit from a market rally.
Discipline is key.
Investing across a wide variety of sectors and markets will mean you will limit your downside risk if a particular area does poorly. You will also do well if a market rally is led by a particular sector (hello big tech) or megatrend!
It is always an investor’s dilemma of whether to back a rally or not. Ensuring you give yourself a margin of safety when investing, will ensure you are not left with your pants down when the tide goes out. This can also ensure you have not piled in to overvalued stocks.
A market rally is exciting and will make every investor happy due to the increase in capital it brings. Spotting one is hard, but investing for the long-term through discipline will ensure you do not miss one. Remember over the long-term leaving your money in the market, will give you a superior return than timing a market rally!