Is This the Biggest “Bull Trap” Ever?

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Three months into 2019, it seems that investors are still intent on celebrating the post-Christmas rally despite signals of an economic slowdown and lingering trade war tensions. Prodded along by a dovish Fed, bulls have had a great year so far, scooping up gains with ease as cheerful headlines push equities further upwards.

But now, after bouncing off early-November highs a few days ago, the market sits in a precarious position. Nervous traders made that clear during Monday’s session, that at its worst saw the Dow drop by more than 300 points before recovering slightly. As of this morning, stocks continue to edge lower as the market holds its breath in anticipation of more trade war news.  

And though the recent disturbance could just be a “blip on the radar” en route to a larger recovery, historical data suggests that something far more sinister could be developing – simply because the recent rally has been so massive.

Big rallies during bear markets (something we still may be caught in) are very common, and the last two surges during market corrections ended up burning overambitious bulls in a major way.

Take the 2000-2002 bear market, for example. Back then, the S&P rallied 21% (close to the current rally’s gains) before eventually dropping again, as stocks plunged over 35%. In total, there were three attempted recoveries in 2000-2002, and all of them eventually fell apart after a few months.

In the 2007-2009 bear market, an even bigger rally occurred as the S&P surged 24%. But after teasing investors with a recovery for several months, again the rally collapsed, skewering bulls in the process.

Big rallies in bear markets often serve as prolonged “bull traps” for investors that stick around too long, and based on what we’ve seen so far this year, 2019’s rally could be the biggest bull trap yet.

With nearly every indicator pointing downwards, a Fed that needs to start raising rates soon, and a trade war truce seeming less likely, stocks keep rising (arguably illogically).

Over time, these stressors could weigh down equities significantly, and once the selling starts, panic could break out among bulls – all of whom would be trying to protect their recently pocketed gains.

As the market falls, the Fed’s hands would largely be tied, since we’re already operating in a low interest-rate environment. Without a safety net in place, stocks would nosedive as investors begin to recognize the dire situation.

That’s a worst case scenario, of course, but it echoes what has happened in the past after big rallies in bear markets. Investors get out too quickly for our institutions to stop the bleeding, and anyone foolish enough to stick around feels the pain.

It’s just that this time, numerous market forces are converging all at once, making this bull trap (if it is one) a uniquely dangerous situation for traders taking long positions.

On the other hand, the “good times” could keep on going if more positive headlines hit the airwaves and sentiment stays optimistic. If they do, though, it could just be priming the market for an even bigger fall down the road, and from what we’ve seen in the past, that’s entirely possible, if not probable.

Three months into 2019, it seems that investors are still intent on celebrating the post-Christmas rally despite signals of an economic slowdown and lingering trade war tensions. Prodded along by a dovish Fed, bulls have had a great year so far, scooping up gains with ease as cheerful headlines push equities further upwards.

But now, after bouncing off early-November highs a few days ago, the market sits in a precarious position. Nervous traders made that clear during Monday’s session, that at its worst saw the Dow drop by more than 300 points before recovering slightly. As of this morning, stocks continue to edge lower as the market holds its breath in anticipation of more trade war news.  

And though the recent disturbance could just be a “blip on the radar” en route to a larger recovery, historical data suggests that something far more sinister could be developing – simply because the recent rally has been so massive.

Big rallies during bear markets (something we still may be caught in) are very common, and the last two surges during market corrections ended up burning overambitious bulls in a major way.

Take the 2000-2002 bear market, for example. Back then, the S&P rallied 21% (close to the current rally’s gains) before eventually dropping again, as stocks plunged over 35%. In total, there were three attempted recoveries in 2000-2002, and all of them eventually fell apart after a few months.

In the 2007-2009 bear market, an even bigger rally occurred as the S&P surged 24%. But after teasing investors with a recovery for several months, again the rally collapsed, skewering bulls in the process.

Big rallies in bear markets often serve as prolonged “bull traps” for investors that stick around too long, and based on what we’ve seen so far this year, 2019’s rally could be the biggest bull trap yet.

With nearly every indicator pointing downwards, a Fed that needs to start raising rates soon, and a trade war truce seeming less likely, stocks keep rising (arguably illogically).

Over time, these stressors could weigh down equities significantly, and once the selling starts, panic could break out among bulls – all of whom would be trying to protect their recently pocketed gains.

As the market falls, the Fed’s hands would largely be tied, since we’re already operating in a low interest-rate environment. Without a safety net in place, stocks would nosedive as investors begin to recognize the dire situation.

That’s a worst case scenario, of course, but it echoes what has happened in the past after big rallies in bear markets. Investors get out too quickly for our institutions to stop the bleeding, and anyone foolish enough to stick around feels the pain.

It’s just that this time, numerous market forces are converging all at once, making this bull trap (if it is one) a uniquely dangerous situation for traders taking long positions.

On the other hand, the “good times” could keep on going if more positive headlines hit the airwaves and sentiment stays optimistic. If they do, though, it could just be priming the market for an even bigger fall down the road, and from what we’ve seen in the past, that’s entirely possible, if not probable.

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