What Does a Typical Counter-Trend Rally Look Like After a Big Drop in Stocks?

So here we are, having added 10% to the value of stocks from their Christmas Eve low when we listed a baker’s dozen reasons why stocks could tactically rally from there. We wrote further about the statistical merit to a rally after such an emotional selling panic. Now the question is, after such a fast and furious rally that has retraced 65% of the waterfall decline from the December 2nd high in just 14 trading days, how much longer does this thing have to run before we experience some sort of pullback of at least 5%? Furthermore, under what kinds of conditions do uninterrupted 15% waterfall declines occur in the first place, and what does that portend for our current situation?

To answer those questions, we’ve cataloged all 20 uninterrupted 15% declines in the post-war period and documented what has happened afterward, as well as the type of market environment in which those declines have taken place. By uninterrupted decline, we mean a waterfall decline of at least 15% without an intermediate counter-trend rally of at least 5%. Some bullet points describing the rallies following those declines are below:

  • The average counter-trend rally following a 15% waterfall decline is 11.9% (11% median) and it takes place over 21 trading days on average (median 11 days).
  • The rallies end up retracing 57% of the decline on average (median 52%).
  • Waterfall declines of at least 15% have only taken place in bear markets.
    • The average of those bear markets have a peak-to-trough decline of 33% (median 29%)
    • The duration of those bear markets is 284 trading days on average (median 139 days)
    • In 16 of 19 instances (excluding the decline we just witnessed), a recession was associated with the bear market
  • 100% of the time the low resulting from the waterfall decline was retested, and in 15 of 19 cases a new lower lower was made.