How the bear behaves

Excluding the latest grizzly attack, there have been eight bear markets since 1969 in the Datastream UK Total Market index, which is similar to the FTSE All-Share index. However, only during four of these was there at least one bear market rally. Those bear markets in which they occurred were the longer sell-offs lasting at least 138 trading days.

They don't last long

By their very nature bear market rallies are short-lived affairs. The average UK bear market rally since 1965 has lasted 40 trading days or 56 calendar days. There have been quite a few bounces that have gone on for more than this, though. The savage bear markets of the early 1970s and early 2000s both saw significant bear market rallies of 54 trading days.

To put it in context, the present rally – which began on 3 March – has so far lasted 56 trading days.

Really big rallies are a rarity

Gains of more than 20 per cent during UK bear markets aren't common. Before this bear market, there has been only one major downtrend where a 20 per cent rally occurred. That was in 2001, following the savage sell-off that occurred after the 9/11 terrorist attacks.

During the most recent bear market, a '20 per cent-er' took place between October 2008 and January 2009. Assuming that the bear market is not yet over, as we do, at 29.8 per cent, the explosive move that began in March qualifies as the biggest relief rally to occur in the UK during the last 40 years or so.

Mega-bear market rallies

Comparing rallies within the current bear market to those in previous sell-offs in the UK over the past few decades may not be appropriate, however. That's because the present meltdown in equities is part of something much bigger than a normal UK bear market. Pessimists have frequently argued that the situation today is more like the Great Depression of the 1930s.

Between 1929 and 1932, the Dow Jones index in the US collapsed by an unprecedented – and hitherto unrepeated – 89 per cent. However, on the way down the market experienced no less than six powerful rallies. One of these – in 1930 – took the Dow up by 52.2 per cent in just 105 trading days.

The average bear market rally during the worst of the Great Depression registered gains of 35 per cent and lasted 40 days. So, while the typical rally during that episode was greater in size than our biggest recent bear market correction, it lasted almost exactly the same amount of time.

Land of the falling market

The experience of Japan over the past two decades could be another relevant guide to the next few years for the UK market. After hitting an all-time high in 1989, the Japanese market has fallen persistently, shedding four-fifths of its peak value by October last year. Along the way, however, it has enjoyed some massive turnarounds as can be seen in the Nikkei 225 chart below.

Despite the very severe bear markets that we have suffered in the west since 2000, there is still a widespread belief among investors that shares are still a good long-term investment. But the lesson from Japan is that equities can head sideways and downwards for many years, and that a buy-and-hold investment style is an ineffective strategy in such a market.

Bear rallies on the charts

Bear rallies tend to begin when the market has become oversold and often end when it has become overbought. A simple way of diagnosing this condition is to measure the distance of the market from its 20-day moving average. So, if the average closing price of the last 20 days is 100 and the market today stands at 105, the market is 5 per cent above its moving average as can been seen on the momentum chart below.

On average, bear market rallies have tended to start when the market is around 7 per cent below its recent average. Sometimes, though, daily prices have closed as far as 13 per cent below the 20-day average before the rally begins. After these more extreme sell-offs, the subsequent rally tends to be that much stronger.

Rallies typically see the price close by around 5 per cent above the 20-day average. However, this momentum high usually comes before the actual rally high. The highest close of a bear market rally tends to occur when the price is about 4 per cent above the moving average. In other words, momentum begins to roll over negatively in advance of the rally high, giving advance warning of an impending change.

The present rally in the UK market saw it close 13.3 per cent below its 20-day average on 3 March, before rallying to 7.2 per cent above this level on 8 May.

UK bear markets since 1969