The Mirage of Recovery: Why the Recent Market Rally Is a Classic Bear Trap
The recent stock market rally, while impressive on the surface, exhibits all the classic characteristics of a bear market rally rather than the beginning of a sustainable bull market. A concerning divergence has emerged: retail investors are aggressively buying the dip while institutional “smart money” remains cautious or even bearish. This pattern, combined with historical precedents, weak economic fundamentals, and expert analyses, strongly suggests we are witnessing a temporary reprieve within a larger downtrend. Investors should approach this retail-driven rally with extreme caution.
Market Context: From Peak to Present
Since mid-February 2025, markets have experienced significant volatility following President Trump’s tariff announcements. The S&P 500 declined by almost 20% from its peak, placing it on the edge of bear market territory. The NASDAQ Composite fell more than 17%, while the small-cap Russell 2000 plunged over 20%, officially entering a bear market.
This sharp decline was temporarily interrupted by a steep recovery rally over the past two weeks, sparked by Treasury Secretary Scott Bessent’s suggestions that a trade deal with China was “very close” and a 90-day pause on some tariffs. However, this rally is losing steam as tariff negotiations remain uncertain.
Definition and Historical Context of Bear Market Rallies
Bear market rallies are defined as short-lived upward trends in prices amid a longer-term market decline. These countertrend recoveries can last from a few days to several months before the market reverses to new lows. Historically, the deepest bear markets have produced the largest and most deceptive bear market rallies.
Looking at market history, every bear market since 1901 has spawned at least one rally of 5% or more, with two-thirds of the twenty-one bear markets in that period featuring rallies of 10% or more. Perhaps the most notorious example occurred after the 1929 crash, when the Dow rebounded 48% over five months before ultimately declining 86% by 1932.
More recently, during the 2000-2001 Dotcom Crash, the NASDAQ experienced eight separate bear market rallies of at least 18%, including four that gained more than 30%, all of which proved temporary.
Why This Rally Bears the Hallmarks of a Temporary Rebound
Several key factors indicate the current rally is likely a bear market bounce rather than a sustainable recovery.
Retail Investors, Not Smart Money, Driving the Rally
Perhaps the most telling sign that this rally lacks staying power is the clear divergence between retail and institutional investor behavior. While individual investors have been aggressively “buying the dip,” the so-called “smart money” has been notably absent or even positioned against this rally.
According to JPMorgan, retail investors purchased $4.7 billion in stocks on a single day in early April 2025, the highest level of retail buying in over a decade. This historic “buy-the-dip” move included purchases of large tech names and S&P exchange-traded funds, even as institutional investors increased their bets against many of these same sectors.
Bank of America reports that retail investors have been on a record-breaking buying spree, purchasing stocks for twenty-one consecutive weeks—the longest such streak since they began tracking this data in 2008. This persistent retail optimism stands in stark contrast to the caution displayed by professional investors.
The divergence between retail enthusiasm and institutional skepticism is a classic sign of a bear market rally. History shows that when unsophisticated retail money is driving a market recovery while sophisticated investors remain on the sidelines or positioned against the rally, the bounce is typically unsustainable. The “smart money” typically leads sustainable recoveries, not retail investors acting emotionally after steep market declines.
1. Lack of Fundamental Improvement
The underlying catalysts for the market decline—namely, the trade war and tariff concerns—have not been resolved. Despite temporary reprieves and optimistic statements about potential deals, the fundamental economic situation has not improved. Tariffs remain in place, and retaliatory measures from China and other countries continue to threaten global trade.
2. Expert Analysis Points to a Bear Market Rally
Goldman Sachs strategist Peter Oppenheimer recently noted that “the asymmetry for equity investing is poor. Sharp rallies within bear markets are the norm, not the exception.” According to Goldman’s research, since 1980, global markets have experienced numerous bear market rallies averaging 44 days in duration with gains of about 14%—remarkably like our current situation.
3. Rallies Without Resolution Are Common
The pattern we are seeing follows the classic bear market playbook: a sharp decline, followed by a relief rally based on hope rather than fundamental improvement, typically ending in disappointment. As veteran technical strategist Tom DeMark, who accurately called this year’s February top and April low, warns, US stocks are in for another drop that will eventually lead to a bear market in the coming months.
4. Missing Prerequisites for a Sustained Recovery
According to market research, several conditions are typically necessary for a bear market to transition to a sustainable bull market:
- Cheap valuations (current valuations remain historically high).
- Extreme negative investor positioning (sentiment has improved with the rally).
- Significant policy intervention (the Fed has not signaled interest rate cuts).
- Slowing of macroeconomic deterioration (economic indicators continue to show stress).
None of these conditions have been conclusively met, suggesting this rally lacks the foundation for sustained upward momentum.
What Comes Next?
If history is any guide, this bear market rally will likely fizzle out as the fundamental economic concerns reassert themselves. The S&P 500 could resume its downward trajectory, potentially testing and breaking through the 20% decline threshold that officially defines a bear market.
The recent rally’s loss of momentum, coupled with gold rising back above $3,300 per ounce, suggests investors are not fully convinced we are out of the woods. As reported by CNBC, even as Treasury Secretary Scott Bessent reiterated that the trade deal was “very close,” the market response was tepid, indicating waning enthusiasm as the rally ran out of gas.
A particularly concerning indicator is the “funding spread,” a measure of demand for long exposure through equity derivatives such as swaps, options, and futures, which has decoupled from the latest leg higher in stocks. According to Goldman Sachs managing director John Marshall, “This suggests macro investors trimmed their equity exposure on the recent strength,” another sign that professional investors are stepping back while retail money continues to flow in.
The phrase “bear market rally” will likely remain in the financial lexicon until concrete progress appears on the trade front, and institutions, not just retail investors, join the buying.
Current State of Credit Spreads (May 2025)
- Investment-Grade Credit Spreads: According to data from April/May 2025, investment-grade credit spreads have increased by approximately forty basis points since the tariff announcements in early April but remain relatively modest by historical standards.
- High-Yield Credit Spreads: High-yield spreads have seen a more significant increase, recently measuring around 468 basis points over Treasuries. This represents an increase from earlier in the year but remains close to historical averages.
- Trend Analysis: Credit spreads have been moving wider since the tariff announcements, but have not yet reached levels typically associated with recession or severe market stress. This suggests growing caution but not panic among fixed-income investors.
Relationship with Bear Market Rallies
Credit spreads can provide important context for equity market behavior:
- Warning Signal: A significant widening of credit spreads while equities rally can be a warning sign that the equity rally lacks a solid foundation, as bond markets are often seen as more forward-looking.
- Confirmation of Risk: When credit spreads remain tight or continue to tighten during an equity rally, it generally confirms that the rally has broader support across financial markets.
- Current Situation: The modest widening of credit spreads we are seeing now, combined with decoupling funding spreads, suggests growing caution in the bond market that contradicts the optimism shown by retail equity investors, supporting your bear market rally thesis.
While credit spreads have not yet spiked to crisis levels, their gradual widening provides additional evidence that institutional investors across both equity and fixed income markets are growing more cautious, even as retail investors continue to buy stocks.
Funding Spreads
Looking at the most recent data from May 2025, funding spreads for equities are currently showing negative signals, which supports my bear market rally thesis. According to the Goldman Sachs analysis mentioned in the article, the funding spread (the measure of demand for leveraged exposure through derivatives like swaps, options, and futures) has “decoupled from the latest leg higher in stocks.”
This decoupling is significant because it indicates that while stock prices have been rising (driven by retail investor enthusiasm), institutional investors have been reducing their leveraged exposure rather than increasing it. In a healthy bull market, we would typically see funding spreads widening alongside rising equity prices, showing institutional conviction in the rally.
The current situation, where retail investors are buying while funding spreads indicate that institutional investors are pulling back, is a classic warning sign of a bear market rally rather than a sustainable recovery. JPMorgan’s data further supports this, showing that while retail flows have been strong, institutional positioning remains cautious, particularly in certain sectors where retail has been most aggressive.
Investment Implications
For investors, the current environment requires caution and strategic thinking:
- Maintain perspective: Bear markets are normal parts of the investment cycle. Since 1928, there have been twenty-seven bear markets and twenty-eight bull markets, with stocks rising significantly over the long term.
- Cash is king: Until uncertainty dissipates, cash earnings over 4% are king.
- Do not follow the retail crowd: The current market environment presents a clear case where following retail investors’ enthusiasm may lead to poor outcomes. History suggests that when retail money floods in while institutional investors remain cautious, the rally is often unsustainable.
- Watch institutional positioning: Rather than joining the retail buying spree, monitor what the “smart money” is doing. When institutional investors begin deploying significant capital into equities, it may signal a more sustainable recovery.
- Prepare for opportunities: Bear markets eventually create compelling valuation opportunities. Patient investors who maintain dry powder may find attractive entry points as the market fully prices in economic concerns. When valuations reach truly attractive levels, institutional money will likely return in force.
TLDR
While it is tempting to view the recent market recovery as the beginning of a new bull market, the weight of evidence suggests we are experiencing a classic bear market rally driven primarily by retail investor enthusiasm rather than institutional conviction. The fundamental issues driving the market decline, especially trade tensions and tariff concerns, remain unresolved.
The divergence between retail and institutional behavior is particularly telling. When unsophisticated money leads the charge while sophisticated investors remain skeptical, history suggests the rally is built on shaky ground. As veteran traders know, market recoveries that evolve into genuine bull markets typically see institutional investors leading the way, not following behind retail enthusiasm. (smart money)
Investors would be wise to maintain discipline, avoid being seduced by short-term market strength that is driven by retail FOMO (fear of missing out), and prepare for continued volatility as economic realities catch up with market prices. History tells us that bear markets end eventually, but rarely without testing investor resolve through multiple false dawns—and this retail-led rally has all the characteristics of being exactly such a false dawn.
Pigs get fat, hogs get slaughtered.
There is an old Wall Street saying that it still rings true: pigs get fat, hogs get slaughtered. The message is simple: greed can cost you everything. I have chosen to be the pig that survives, not the one hauled off to slaughter. In this market, cash and patience aren’t just virtues—they are power.
This article represents the opinion of the author and does not constitute investment advice. All investments involve risk, including the possible loss of principal.