On The Potential Elastic Energy of Deceased Cats in Free-fall

Dead Cat

What is the “Dead Cat Bounce”? If you’ve been following the news you’ve probably heard the saying and it has become fairly common among financial professionals to describe the current market in such terms. So what is it?

The phrase has its origins on Wall Street, in that “even a dead cat, dropped from a sufficient height, will bounce.” Charming. But it describes the very real experience of stock markets having a brief but substantial recovery before resuming a fall. The effect is brought on by buyers reentering the market having assumed that a bottom has been reached and encourages others to begin piling in before another sell-off begins. The dead cat bounce is the shadow of hope over an otherwise dire situation that has not yet been fully realized.

As such many have called the current market rally a “dead cat bounce” based on previous experience of other bear markets. The expectation being that this is merely a brief respite before we head into even deeper losses. On March 30th, the website Market Watch asked “Is this a dead-cat bounce or the bottom investors have been waiting for?”. On April 15th Forbes reported “Don’t Be Fooled By The Markets 24% Dead Cat Bounce” and on April 20th the New York Times ran “Can Investors Trust the Stock Market Rally?”.

So what can you do with this new knowledge? Almost nothing.

As that Market Watch article points out, it is hindsight that indicates a “dead-cat” and it is not a predictive asset. Looking at the bear market of the early 2000s there were a number of rallies, some lasting for half a year. Some rallies were indistinguishable from the general volatility of the market and seemed like neither a correction or a rally. Similarly, in 2008 there were a number of rallies before the market finally bottomed and began its long march back (see charts below). Importantly these periods of rebound, while followed by another dip, didn’t hurt investors in the long run. Had you invested in any of the bounces none of the subsequent downturns proved permanent to the long-term investor.

2000 downturn

So if the “dead-cat” isn’t a useful predictor, either of time, recovery or depth of the next fall, why is it so ubiquitous? The answer is because it is a non-position, a place holder until something more tangible can be grasped and a way of saying that you don’t know what’s going to happen framed like you do. Just as most predictions at the beginning of the year were for a moderately positive year in market returns, today people are making a claim that markets that go up may also go down, a decidedly underwhelming statement about the nature of market performance.

If there is a benefit to the proclamations of a dead cat bounce it is to advice caution to investors, waving them off getting too excited about positive market volatility in periods of extreme danger. Would it be wise to rush into a market showing a tentative recovery, buying every highly risky investment on the chance we’d hit bottom? The answer is clearly no. The warning of the bounce provides a mental check on how fast we should proceed and reminds investors to reconsider worst case scenarios.

Lastly, the dead-cat reflects a bias towards how we understand current conditions. This form of bias isn’t isolated to the financial markets. In the business of predicting weather there is something called a “wet bias” by companies like Accuweather and The Weather Network. If there is a 5% chance of rain, weather forecasters are likely to say its 20%, hedging their prediction. If the chance of rain is 50%, they will likely round up to 60% since 50% is considered less accurate by the public. In other words, the accuracy of the prediction is less valuable than how accurate the prediction feels.

This makes sense. If someone goes on TV today to argue that the recovery will be swift, that the economy will be unscathed, and that we will put this whole ordeal behind us with little societal memory this sounds inaccurate, like a prediction completely detached from reality. Arguing that we are in a “dead cat” style rally is plausible, a sensible take on the current situation that gives the illusion that aspects of this unprecedented situation have precedent and can be known.

We can conclude that the dead-cat bounce is a kind of shorthand that serves as both a warning and an explanation. That doesn’t mean it doesn’t have value, but it is a little short on providing guidance. Instead I advise that people who wish to get back into the market consider the following things.

  1. Do you need the money? If you were fortunate to have cash on hand when markets began falling, and can deploy that money today, do you need it? If you are hoping to invest money that is technically ear marked for spending in the near future, think twice about how you would fair without it.
  2. How risky is it? Let’s say you want to buy a blue-chip dividend paying company, a theoretically conservative investment, how well did it perform when markets fell? Did it perform better than the average market return, or was it relatively in line with it? The safety of stocks may be largely illusionary when markets sell off.
  3. Are you building on your financial plan, or abandoning it? Stocks at a discount may represent an opportunity to better round out your portfolio in aid of your financial goals, but if it weren’t for the sudden discount on the value of the company would it have still made sense for your portfolio?
  4. Will you be comfortable with a short-term loss? Just as you would hope that markets continue to recover, its important to consider the possibility that markets will indeed retreat and with it so will the value of your new investments. Can you live with an immediate drop between 10% to 20%? If this is early in the bear market, could you ride out multiple potential drops of up to 20% each time?

The dead-cat bounce is part of the lingua franca of the investing world, but it explains very little and doesn’t really provide advice. Whether you want to get back into the markets, or are fearful of doing so, the same due-diligence and questions about comfort of risk still apply. If you can answer those questions you should be able to benefit from the market volatility of bad markets.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

A Case For the Best Case

A Case for the Best Case

*In an act of hubris I have written this before companies have begun releasing their earnings reports. I can only assume I will be punished by the animal spirits for such reckless predictions!

The news has been grim. The number of people seeking EI has spiked so much, so quickly that it reduces the previous unemployment numbers to a flat line (this is true in both Canada and the United States, US EI graph below). Countries remain in lockdown and some of the worst hit countries like Italy and Spain are starting to plateau, adding ONLY between 500 to 1000 deaths a day. In Canada the numbers continue to climb and the economy has been largely shut down, with governments rolling out unprecedented quantities of money to stem the worst of this. Talk of a deep economic depression has been making rounds, while the Prime Minister has reluctantly suggested that we may be in a restricted environment until July.

Us Jobless Claims - Q3 2017 - Feb Q1 2020
These two charts show the unemployment rate in the US just before the coronavirus, and after. From Refinitiv
US Jobless Claims Including April 2020
These two charts show the unemployment rate in the US just before the coronavirus, and after. From Refinitiv

And yet.

And yet.

And yet, I suspect we may be too negative in our outlook.

First, just how restricted is the economy? Despite the wide-ranging efforts to restrict the social interaction that daily economic activity produces, much of the economy continues to function. Office and white-collar jobs have quickly adapted to remote working. Few have been laid off in that respect. Industrial production is down, unless they are deemed essential, but the essential label has applied to a lot of businesses. Until the recent additional restrictions applied on Sunday April 5, 2020 in Ontario, Best Buy, Canadian Tire, Home Depot and a number of other stores remained open to the public. Those businesses have had to restrict access to their stores, but remain functioning through curb pick and online delivery.

Even the service economy is still largely functioning. Most restaurants remain open providing take out and delivery. Coffee shops, gas stations, grocery stores, convenience stores are all open, as are local grocery providers like butchers and bakers (and candle stick makers). Its’ true that large retail spaces like Yorkdale or the Eaton Centre are closed but this too tells us something.

The government has helped make it easier to get money since people have been laid off, and many of the people who have been let go will only be out of work for a short time. They are the waiters, union employees and airline pilots who will be rehired when the society begins to reopen. Even in the period I began writing this, Air Canada rehired 16,500 employees, West Jet will be rehiring 6,500 employees, and Canadians applying for the new CERB (Covid-19 Emergency Response Benefit) have reportedly already begun receiving it.

You might be reading this and thinking that I’m being callous or simply ignoring the scope of the problem that we are facing, but I want to stress that I am not. I recognize just how many people have found themselves out of work, how disruptive this has been, how scared people are and how this pandemic and its response has hit the lower income earners disproportionately more. But just as few people correctly saw the scale of the impact of the coronavirus, we should remain cautious about being too certain that we can now anticipate how long the economic malaise may last, or how permanent it will likely be, and what its lasting impacts will look like.

Labour work

The sectors of the economy worst hit will likely be those already suffering a negative trend line. The auto sector, for instance, is one that has been hemorrhaging money for a while, with global car sales in a serious slump. Some retail businesses, already on the ropes from Amazon’s “retail apocalypse” may find they no longer can hold on, though government aid may give them a limited second life. Hotels and travel will likely also suffer for a period as they carry a high overhead and have been entirely shut down through this process (sort of).

Longer term economic problems may come about from mortgage holders who have struggled to fulfill their financial obligations to banks, and it may take several months to see the full economic fallout from the efforts to fight the pandemic, so some of the effects may be staggered over the year.

Economist image

But even if that’s the case, the current thinking is that the market must retest lows for a considerable period, with few people calling for a rapid recovery and many more calling for a “W” shape (initial recovery then a second testing of previous market lows) and in the Economist this week “one pessimistic Wall Street banker talks of a future neither v-shaped, u-shaped or even w-shaped, but ‘more like a bathtub’”.

FT China Cinema

That pessimism is well warranted, and I count myself among those expecting markets to have a second dip. But I admit to having my doubts about the full scale of the impact to the real economy. There will no doubt be some fairly scary charts, like thre were from China, showing the drop off in cinema goers and people eating out. But the more certain, the more gloomy, the more despairing the outlooks get, the more I wonder if this is an over compensation for having overlooked the severity of the virus, or if it is the prevailing mood biasing these predictions? Only time will tell, but I am taking some comfort in knowing that there is still a case for the best possible case.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

Beware the Rally

*At the time that I wrote this markets had just finished several positive sessions, however by the time it was ready markets had once again changed directions!

US-STOCKS-DOW JONES-RECORD

I’m going to potentially embarrass myself and go on the record as saying we shouldn’t place too much trust in the current market rally, though the upturn is welcomed.

Rallies present opportunities for potential short-term gain, and with markets having shed roughly 10% over the month of October, there is certainly money to be made if you’re feeling sufficiently opportunistic and have a plan. For the rest of us, the rally is a welcome break the punishment the market has been delivering, and an opportunity to see portfolios stabilize and regain some ground.

S&P 500 Rally

The long-term viability of a rally, its ability to transition from opportunistic buying to sustained growth, very much depends on the fundamentals of that rally. Are markets sound, but oversold? Or are fundamentals deteriorating and represents more hopefulness than anything else?

Readers of this blog will not be surprised to find out I have no set answer to this question. As always, “it depends”. But as I look over the news that has supposedly rekindled the fire in the markets much of it seems at best temporary, perhaps even fanciful. Up against the wall of risk that investors are currently starring down, the best news currently available is that Trump had a phone call with Xi Jinping and has asked for a draft to be prepared to settle the trade disputes between the two countries.

FGIS_fig_2

I’m of the opinion that a recession isn’t imminent, but it should be obvious that recessions happen and the longer we go without one, the more likely one becomes. That seems especially true in a world that is undergoing a seminal shift when it comes to international trade and multilateral deals. To take one example, in the last year U.S. soybean exports to China have dropped by 97%, with no exports for the last quarter. This is a trade war still in its infancy. Other market data is mixed. Even as job growth exceeds expectations it will also keep the Fed raising rates. Housing starts have dropped significantly below expectations, driven in part by rising costs.

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All this is to say that market rallies like the one we’ve just seen should be treated with trepidation. Investors should be cautious that a bottom has been reached and that this is a good time to rush into the market looking for deals, and we should keep an eye on the fundamentals. Rallies falter precisely because they can be based more on hope than on reality.

So what should investors do if they want to invest but are unsure about when to get into the markets? Come talk to us! Give us a call and help get a plan together that makes sense for your needs! Check out our new website: www.walkerwealthmgmt.com or give us a call at 416-960-5995!

The Market is Rallying – Why Again?

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Markets have begun to rally around the globe, perhaps signalling an end to the volatile beginning of the year. The mood has definitely lightened and there seems to be some broad support for a return of some positive numbers across the board.

But if we stop to ask ourselves why, we may be left scratching our heads at the answer. The current list of issues affecting the global economy is pretty long. China’s slowdown, the demand destruction for oil, problems across multiple oil and commodity producing nations, financial instability and an almost unbelievable amount of debt. In fact the the market turmoil has a lot of justification, far more than some of the previous sudden corrections over the last two years.

So what’s changed? Three things. First, central bankers have recommitted themselves to doing whatever it takes to put the economy back on a path to growth. Second, a deal has been announced with Russia and Saudi Arabia to cap oil production. Third, a growing concern about the financial assets of Deutsche Bank have been “put to rest” as it were by the German government.

As a list of reasons to be excited, I’m left somewhat underwhelmed. Take the deal between Russia and Saudi Arabia. The larger promise of this deal is that is spells out potential future moves to get oil prices back to a level of sustainability. For right now it simply outlines capping oil production at January levels, but will be largely meaningless if Iraq and Iran can’t be brought into the deal. Iraq and Iran for their part aren’t really interested. Iran, who isn’t exactly friendly with Saudi Arabia, has just got back into the global oil market and is looking to ramp up production. Iraq is also increasing it’s oil production, helping bring much needed funds to a country that is still looking to stabiles and legitimize itself. Neither are particularly interested in following Saudi Arabia’s lead.

Screen Shot 2016-02-17 at 5.21.55 PM

It would at least mean more however if the January production numbers reflected some kind of wide ranging reduction in oil output, but among OPEC nations, as well as the United States and even Canada, oil production has continued to increase despite the price drop.

What about the central bankers promising to use all their muscle (and some that we didn’t know they had) to save the economies of the planet and return economic growth? Having spent the last eight years with emergency level key interest rates and very little to show for it the only solution is to go to a negative interest rate. Earlier in 2015, Stephen Poloz suggested that negative interest rates were a possibility for Canada. Much of Europe already has negative interest rates. Japan surprised markets a few weeks ago by making their key interest rate negative. Last week Janet Yellen, head of the Federal Reserve, also said that negative rates were not “off the table.” Disturbingly, having interest rates as close to zero as possible hasn’t encouraged wide ranging inflation across developed economies. Obviously the only solution is more of the same but SAID LOUDER AND MORE CLEARLY.

Here is Christian Bale yelling at you to spend some of your money!

But possibly the least exciting of the exciting news is surrounding Deutsche Bank. Last week Deutsche Bank seemed to be cruising towards the unenviable title of “the next Lehman Brothers”, before the German government “encouraged” the the market with some supportive words around the stability of the bank; a coded signal that Deutsche Bank is both “too big to fail” and that the German taxpayer would be on the hook.

Deutsche Bank’s problems have been extensively catalogued. Between massive fines, massive losses, massive layoffs, and a massive derivative position currently in excess of $50 Trillion (yes, with a “t”) the potential for the world’s fourth biggest bank to implode and set of some kind of financial (and given it’s position within Europe, political) cascade effect is very real, even if they do get a bailout.

On top of all that is the regular bad news that we haven’t addressed. China’s liability is still unknown, and as it hemorrhages foreign currency reserves threatens yet another line of attack against markets. Venezuela may, or may not, default on it’s debt. Here at home provinces like Ontario would have at least been hoped that a combined falling dollar and oil price would start bringing new manufacturing within our borders, instead they must brace for the disappointing news that of three new auto plants for North America, we will get none.

Some people may be excited about the most recent rally, but I’m afraid I’m not one of them.