Bear Market Rallies: A Structural Feature of Volatility

The financial markets of 2025 are navigating a landscape defined by uncertainty, where bear market rallies—those elusive bursts of optimism—have become both a psychological crutch and a tactical opportunity. Goldman Sachs’ recent analysis underscores a critical truth: such rallies are not anomalies but inherent features of prolonged downturns. Yet their persistence in this cycle hinges on resolving a precarious balance between cyclical risks and structural headwinds.

The Anatomy of a Bear Market Rally

Bear markets, as categorized by Goldman, fall into three archetypes: structural, driven by long-term economic decay; cyclical, tied to business cycle contractions; and event-driven, sparked by sudden shocks like geopolitical strife or policy shifts. The current downturn, triggered by the "liberation day" tariff hikes and geopolitical tensions, is classified as event-driven. However, with the U.S. GDP growth forecast slashed to just 0.5% for 2025 and recession odds at 45%, the risk of it evolving into a cyclical bear market—with deeper, longer-lasting declines—is mounting.

Historical patterns reveal that bear market rallies since the 1980s have averaged 44 days and delivered 10–15% returns for the MSCI AC World Index. These rallies are not random but follow predictable dynamics: cyclical sectors (energy, industrials, materials) outperform defensives 83% of the time, while emerging markets (EM) beat developed markets (DM) in 67% of cases. The 2022 rally, for instance, mirrored these traits, suggesting the current environment could replay this script.

The Four Pillars of Recovery

For a rally to evolve into a sustained rebound, four conditions must align:

1. Valuation Adjustments: The U.S. equity market’s forward P/E ratio of 19.4x—near the 80th percentile over 25 years—suggests further de-rating is inevitable. Goldman’s analysis of S&P 500 scenarios shows that even a modest 15x–16x P/E multiple could push the index to 3,000–3,500, depending on recession severity.

2. Investor Sentiment: Goldman’s Risk Appetite Indicator (RAI) has plunged to -1.4, near but not yet at the -2.0 troughs historically signaling buying opportunities. Extreme pessimism may still be required to clear the overhang of bearish positioning.

3. Policy Support: The Federal Reserve’s delayed response to easing is a critical wildcard. In a non-recession scenario, three 25bp rate cuts starting in mid-2025 could lower rates to 3.5–3.75%. A recession, however, could force a 200bp cut over 12 months, a stark contrast to current expectations.

4. Growth Momentum: The "second derivative" of growth—the rate at which economic improvements accelerate—is critical. While near-term earnings disappointments loom, stabilization in metrics like the ISM manufacturing index could reignite confidence.

Structural Headwinds: The Post-Modern Cycle

Even if a cyclical rebound materializes, long-term returns are likely to be constrained by secular shifts:

• Interest Rates: After decades of decline, government debt and defense spending are pushing term premia higher, locking rates into an elevated trajectory.
• Trade Dynamics: Globalization’s retreat has slowed merchandise trade growth relative to GDP, reducing a key engine of corporate profitability.
• Profit Margins: At record highs, corporate profit shares of GDP face pressure from labor cost inflation and trade barriers, limiting future expansion.

Goldman’s "Post-Modern Cycle" framework suggests that post-2025, equity returns may average 4–6% annually, down from the 8–10% seen in prior decades.

Investment Implications

The path forward is fraught with duality. Near-term, bear market rallies offer entry points for tactical bets on cyclical sectors and EM equities, provided valuations align. However, investors must temper enthusiasm: the 30% decline typical of both event-driven and cyclical bear markets means further downside is probable unless policy and growth surprises improve.

Longer term, portfolios should prioritize quality growth firms with durable earnings and dividend-paying stocks in defensive sectors. The S&P 500’s potential 3,000–3,500 range underscores the need for patience, while the 45% recession risk demands hedging strategies like Treasuries or gold.

Conclusion: Rallies Are Normal—But the Game Has Changed

Bear market rallies are not aberrations but natural reactions to oversold conditions. Goldman’s data affirms their historical prevalence, yet today’s structural challenges—elevated valuations, geopolitical fragmentation, and fading trade dynamism—ensure that recovery will be neither swift nor straightforward.

Investors who recognize this duality can navigate the volatility: seize tactical opportunities during rallies while anchoring portfolios to long-term resilience. The market’s current -1.4 RAI and 19.4x P/E signal that the bottom is still distant, but the ingredients for a sustained rebound—valuation corrections, policy support, and growth stabilization—are within reach. The question is no longer whether bear market rallies occur, but whether they can evolve into a lasting upswing amid a shifting economic paradigm.

In a world where 45% recession odds and $30 trillion in global government debt redefine risk, the answer may hinge on patience—and the courage to act when others despair.