Several days into a binge-watching marathon of The Rockford Files, this writer was informed that quarantine is not a fancy way to say “stay-at-home vacation”. Therefore, if William Shakespeare can write Macbeth and Isaac Newton can discover the law of gravity while sheltered in place, surely some sentiments about stocks can be scribbled in a newsletter during this current period of confinement.
When something as unexpected and disruptive as the coronavirus infects the financial markets, economists describe the phenomenon with words derived from ancient Greek like exogenous, jargon that can be more intimidating than illuminating. On the other hand, animal analogies abound in the world of finance, so the coronavirus is described as a “black swan” and the surge in stocks last week is labeled by many as a “dead cat bounce”.
The idea is that a rapidly declining stock market can experience a brief rebound in price, just like a deceased cat may bounce when dropped from a great height (please don’t test this theory.) These temporary recoveries in value are followed by further declines, dashing the hopes of investors who try to buy back into the market too quickly.
The presence of dead cat bounces has been documented in almost every historical downward-trending market. For example, we’ve illustrated some of the temporary bounce backs in the bear market from 2000 to 2002 in the chart below. Starting on 9/7/2000, the S&P 500 had multiple declines of –25% or more followed by temporary rallies of at least 19% only to decline again before finally bottoming out on 10/9/2002 and then resurging throughout 2003.
It is only in hindsight that one can determine if quick market gains are a dead cat bounce or the start of a new bull market. In 2000 to 2002, the failure of many dot-com businesses, the Enron accounting scandal, and 9/11 helped prevent the market from getting back on firm footing.
Now, there is much uncertainty about the future societal and economic impact of the coronavirus. This has led the S&P 500 to see an absolute daily change of 5.2% in March, its highest daily fluctuation level ever recorded during a month according to the Dow Jones’ data team. Thus the possibility of a such a quick rebound into a stable bull market seems unlikely. In finance, just like in life, it is important to be positive but not Pollyannaish.