Congratulations on surviving the first big bear market rally of 2022! Investing during a bear market is like riding a bucking bronco. That bronco will do everything it can to throw the cowboy off. Likewise, bear markets go to similar extremes to pummel as many investors as possible.

We’ve been through a first-hand example of that over the past couple of months. As we’ve pointed out a number of times, big rallies within the context of broader bear markets are common. Nonetheless, living through them in real time is a lot harder than simply acknowledging them on a historical chart. Staying true to your process when the market is moving against your portfolio’s positioning is tough emotionally — and potentially financially as well. (SMI’s cash positions don’t lose money during bear market rallies, as opposed to those who “short” stocks and actually lose money as prices go up.)

The reason bear market rallies are so difficult emotionally is investors can never be 100% sure that it is a bear market rally rather than the start of a new bull market — until the bear market rally ends. Bear market rallies are notoriously sharp and powerful...but so are new bull markets. And there’s always a plausible explanation as to why the rally could mark the end of the bear market and the beginning of the new bull. If there weren’t, the rally would fail to lure many investors back in.

The chart below, showing the path of the average bear market since 1970, illustrates this clearly. Note the typical pattern of a significant down move (-25%), followed by a sharp rally (+10%), before the bear market resumes (-17%). Of particular interest is the trajectory of the bear market rally before the bottom and the recovery after the bottom. They’re very similar, which lures investors back in because they fear missing out on the rebound rally at the beginning of the new bull market.

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