- S&P 500 enjoyed its third-biggest daily percentage gain since 1970 on Wednesday
- Investors must now ponder whether this is the start of a recovery or a bear trap
- 2000-02 and 2007-09 saw multiple failed rallies before the bottom was in
“Wednesday’s 9.5% advance in the S&P 500 is the third-biggest daily percentage gain since 1970 and investors will be hoping that such a surge marks the bottom in the benchmark index after a period of great turbulence,” says AJ Bell investment director Russ Mould.
“After all, there is an old market saying that stock market tops are a process, while bottoms are an event. The S&P 500 had been making heavy weather of it even before Donald Trump’s trade and tariff interventions and had already started to roll over in a classic example of that pattern, so the big issue now is whether Wednesday’s spike is a buy signal or simply a cruel bear trap for unwary bulls who are accustomed to ‘buying on the dip.’
Source: LSEG Refinitiv data
“The steady process of peaking out and then sliding lower in late 2024 and early 2025 does look very reminiscent of how the 1998-2000 and 2003-07 bull markets in the S&P 500 finally began to run out of steam.
“After all, no-one wants the money-making party to end, and the grisly truth that valuations and earnings expectations are too high takes some time to sink in before bulls accept the bitter truth.
Source: LSEG Refinitiv data
“Disappointment sets in gradually, as Robert Rhea outlined in his classic 1932 book, Dow Theory, to give a bear market what he saw as a clearly defined shape or pattern:
‘There are three classic phases of a bear market: the first represents the abandonment of hope upon which stocks were purchased at inflated prices; the second reflects selling due to decreased business and earnings, and the third is caused by distress selling of sound securities, regardless of their value, by those who must find a cash market for at least a portion of their assets.’
“It can certainly be argued that we may have seen phase one. The question now is whether the 90-day pause in Trump’s reciprocal tariffs, with the exception of China, and the uncertainty over the which direction the White House’s strategy and social media posts will take next, start to take their toll on corporate and consumer confidence and spending plans.
“If so, then we could see the second phase, namely earnings downgrades, and that is when trouble could really begin, not least as that triggers phase three. A prolonged downturn could easily spark distressed selling, to judge by how much margin debt there is in the US equity market right now. Forced liquidation to meet margin calls is a risk, given how much stock has been purchased with borrowed money in attempt to gear up returns, according to data from US markets regulator FINRA.
Source: NYSE, FINRA, LSEG Refinitiv data
“Equally, a big rally would ease the pressure and substantially reduce the risk of any margin calls, and a 10% one-day movement falls into that category. Such movement will also raise hopes that we are hitting, or past, the bottom.
Source: LSEG Refinitiv data
“Similar upward surges were evident near the market bottoms of autumn 2002, spring 2009 and autumn 2022, while they also helped to call time on the nasty, brutish and short bear market that was inspired by Covid-19 in 2020.
“Equally, however, several big gains in summer 2022 and autumn 2008 simply drew dip-buyers into more trouble and further hefty losses. So nothing can be taken for granted, especially after a massive bull run that took US equity markets to all-time highs on the leading indices and left stocks pricing in strong future earnings growth by dint of the lofty valuation multiples afforded to them.
“Even allowing for the 90-day pause in reciprocal tariffs, challenges such as ongoing tensions between the US and China, the threat posed by DeepSeek to the AI spending narrative, and the way in which America still needs to try and tackle its galloping federal debt in a manner which appeases bond vigilantes without harming growth unduly in the process.”
