A “death rally” refers to a stock market rally that occurs despite poor economic conditions or bad news. It is a phenomenon where stocks rise sharply, even though the overall economic outlook remains bleak. The term “death rally” implies that the rally is not sustainable and will eventually reverse when the grim realities catch up with investor sentiment.
Some key characteristics of a death rally are:
- It occurs during a recession, economic crisis or some other period of turmoil.
- It is often triggered by government intervention, such as stimulus packages or quantitative easing.
- It is driven by speculation and overly optimistic investor sentiment rather than fundamentals.
- Gains are concentrated in a few stocks or sectors, while the overall market remains weak.
- Volume is low, indicating a lack of widespread conviction behind the rally.
The origin of the term “death rally” is unclear, but it appears to have come into broader use during the Great Depression in the 1930s. Back then, the stock market would stage dramatic rallies even as the economy plunged deeper into crisis. These were dubbed “death rallies” because they ultimately led to more losses when the temporary bursts of optimism faded.
Major Historical Examples of Death Rallies
Here are some notable instances of death rallies throughout history:
The 1930s Rallies During the Great Depression
After the 1929 stock market crash, the market staged several forceful multi-week rallies in 1930 and 1931. However, the economy continued deteriorating as unemployment surged and GDP collapsed. By 1932, the stock market had lost nearly 90% of its value from the 1929 peak, reaching its lowest point during the Great Depression. Those 1930-31 rallies are now considered classic death rallies.
The 1938 Recovery Rally
In March 1938, the stock market posted an 18% rally over two weeks, regaining much of the losses from the previous year. Media reports declared that the recovery was finally happening. But the economy plunged into recession again later that year, and stocks relapsed to their lows. This is another death rally that gave false hope during the Depression era.
The 2001-2002 Bear Market Rallies
After the dot-com bubble burst in 2000, the stock market suffered several rallies of over 10% in 2001 and 2002 amid the ongoing bear market. Each time, optimism flared that the worst was over. But the bear market would sink to new lows as the bursting of the housing bubble and financial crisis lay ahead. Those rebounds were head-fakes within a broader downtrend.
The 2020 COVID Crash Rebound
In March 2020, global stock markets crashed as COVID panic set in. But they quickly rebounded, regaining much of their losses by June 2020, even while the pandemic raged on. This led some to claim the sell-off was overdone. But volatility continued in subsequent months as economic challenges persisted. Time will tell if this proves to be a death rally.
Characteristics of Death Rally vs Healthy Rally
How can you distinguish between a death rally versus a rally signaling legitimate improvement? Here are some key differences:
Duration and Magnitude
Death rallies tend to be relatively short-lived, lasting weeks or months before reversing. Typically, they do not recover more than a portion of the preceding losses. In contrast, healthy rallies based on economic fundamentals can run for years and drive markets to new highs.
Economic Context
Death rallies occur amid negative economic conditions like recessions and crises. Healthy rallies align with improving business cycles and growth.
Leadership
In death rallies, gains are concentrated in the most beaten-down stocks. Healthy rallies are led by stocks confirming strengthening fundamentals.
Sentiment
Death rallies are associated with skepticism and disbelief. Healthy rallies align with improving investor sentiment.
Volume
Death rallies occur on relatively low trading volume, reflecting lack of conviction. Healthy rallies are supported by surges in trading activity.
News Catalysts
Death rallies are often triggered by temporary factors like government intervention rather than positive surprises about the economy.
Technical Behavior
Prices during death rallies usually do not break meaningful resistance levels or moving average hurdles. Healthy rallies decisively break through technical levels.
Causes of Death Rallies
Why do death rallies happen in the midst of bearish fundamentals? Here are some key reasons:
Oversold Conditions
After a deep sell-off, stocks become oversold and due for a bounce. Technical traders help generate short-covering rallies and other reflexive rebounds from washed-out levels.
Investor Psychology
During crises, investors tend to extrapolate conditions to extremes. Bearish sentiment becomes so pervasive that any positive news triggers excessive optimism, fueling rallies.
Government Intervention
Death rallies often result from temporary government measures like bailouts, stimuli and liquidity injections. These create hope but do not fix underlying problems.
Short Squeezes
Widespread shorting activity sets the stage for short squeezes if prices rebound even slightly. Short covering feeds on itself and propels death rallies.
Rotation
In grim times, money rotates between weak sectors rather than leaving the market altogether. This rotational effect helps Wall Street while Main Street still suffers.
Examples of Death Rallies vs Healthy Rallies
To illustrate the differences, let’s compare death rallies to healthy rallies across some major historical cases:
2001-02 Bear Market Rallies vs 2009 Bull Market
In 2001-2002, stocks bounced over 10% several times during the post-dotcom bear market on hopes the worst was over. But the gains were fleeting. In contrast, the 2009 bottom marked the birth of a new bull market. The recovery was initially met with doubts but persisted for a decade on improving fundamentals.
1938 Depression Rally vs 1950s Postwar Boom
The 1938 stock rebound during the Depression gave way to a new low later that year. But after WWII ended, the 1950s saw a prolonged economic expansion and bull market driven by pent-up consumer demand and growth industries like autos and housing.
1930s Rallies vs 1980s Recoveries
The death rallies of the 1930s Depression constantly disappointed as the economy weakened Further. But in the 1980s, rebounds were justified by declining inflation and interest rates, productivity growth, and resurgent business investment.
2020 COVID Rally vs 2021 Ongoing Rally
The initial 2020 rebound after the COVID crash lost steam within months amid economic uncertainty. In contrast, the rally since late 2020 has been much more persistent based on progress on vaccines, reopening, and positive growth.
Predicting Death Rallies
No one can consistently predict death rallies with perfect accuracy – the market always has surprises up its sleeve. However, examining the context around a rebound can provide clues as to its likelihood of sustainability.
Here are some ways to gauge the health of a rally:
- Analyze the economic fundamentals – are leading indicators pointing to recovery or further deterioration?
- Assess sentiment – is investor psychology still fearful or has optimism taken hold?
- Evaluate momentum – have key resistance levels and moving averages been broken decisively?
- Compare volume patterns – is trading activity broad-based or concentrated?
- Consider the drivers – is the rally based on temporary factors or lasting improvements?
- Review leadership – are new leaders emerging or laggards from the downtrend still dominating?
No single factor confirms a death rally, but synthesizing these clues can determine the probability of sustaining positive trends versus a head-fake rebound.
Trading Death Rallies
For traders, death rallies present opportunities but also risks. On the one hand, large counter-trend moves allow nimble traders to profit from the volatility. On the other hand, death rallies tempt investors to buy prematurely before a downtrend has fully run its course.
Here are some strategies for trading death rallies while managing the risks:
- Use technical analysis and identify key resistance levels where rallies could falter. Take profits as prices approach those levels.
- Deploy trailing stop orders to lock in gains as the rally progresses.
- Buy inverse ETFs or invest in volatility instruments like the VIX to benefit from the eventual reversion.
- Look for divergences such as the market moving higher while key indicators like small-cap stocks or transportation companies lag.
- Play sector rotations by moving from weak groups into temporary strength then back again.
- Wait for confirmation – if a resistance level is reclaimed, wait for it to become support before assuming a trend change.
With disciplined risk management, nimble traders can generate profits during death rallies. But most investors should avoid getting sucked into what could become bull traps.
Famous Investor Quotes on Death Rallies
Here are some insightful perspectives from famous investors on how to interpret death rallies:
“Bear markets actually begin with hope and optimism. They end after the abandonment of hope, in total despair.” – James Stack, InvesTech Research
“The big money is not in the buying or the selling… but in the waiting.” – Jesse Livermore
“The most money lost in a bear market is by those who don’t know it’s a bear market.” – Victor Sperandeo
“Don’t confuse a bull market with genius.” – Barton Biggs
“The ability to detach yourself from the crowd is an essential quality for an investor.” – Jesse Livermore
“The phase of widespread liquidation and despair is the right time for the investor to purchase securities.” – Sir John Templeton
These veteran investors caution against getting caught up in death rallies and advocate patience until markets align with fundamentals.
Conclusion
In summary, a “death rally” describes stock market gains amid adverse business conditions that are unlikely to be sustained. These head-fake rallies are born out of overly pessimistic sentiment and require disciplined analysis to navigate. While providing trading opportunities, death rallies also carry risks of encouraging premature bullishness. By studying past examples and utilizing prudent strategies, investors can aim to avoid the pitfalls and profit from the volatility they bring.
