Of sheep and dead cats

By Peter V O'Brien

Friday 1st November 2002

Recent improvement in overseas sharemarkets raise the question whether it is another case of the wonderfully descriptive dead cat bounce. It is unlikely a dead cat bounces after a fall but the term is used for a short-lived lift in a bear market.

An overseas report on last week's trading in the US said investors had "growing hopes" for a lasting turnaround on Wall Street. The optimism was apparently based on the New York market's third week of rising prices after a solid downturn at the end of September and the first week of October.

Much has been made of October being an historically difficult month for sharemarkets, coinciding with the crashes of 1929 and 1987, although the post-1929 fallout did not bottom until the Dow Jones index hit 40.56 on July 8, 1932, and Standard & Poor's (then) 425 industrial index reached 3.5 in the same period.

More than two examples are needed to show an historical trend. The Dow Jones index had substantial falls through 1903, bottoming in November 1907, again bottoming in November 1919-21 the post-World War I depression with a bottom on August 21, 1921, and in 1941-42 when it bottomed on April 28,1942.

The last coincided with the US entry into World War II, the bottom occurring when it was realised the mainland had not, and would not, be attacked and the country was gearing its industry for massive war-generated production.

There were other examples for other months, leading US author Mark Twain to a famous comment worth repeating: "October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February."

His view was valid. Picking a particular month as good or bad for equity investment is as much mumbo-jumbo as the concept of the "rational market." A sharemarket is "rational" only to the extent that participants in it are presumed to be working from the same body of known information and act in the same way, based on that information.

Anyone who has seen seasoned "professionals," let alone enthusiastic amateurs, react to the ups and downs of a sharemarket knows the reactions are fundamentally irrational.

It is also the explanation for the dead cat bounce phenomenon. It is extraordinary, but understandable, how professional fund managers, analysts and observers can use such a cynical term and then act on the basis the phenomenon will not be seen this time.

There is only one fail-safe rule for deciding whether a bull or bear market has started but it unfortunately often has a hindsight application. A bear market is under way when each high is lower than the previous high over a series (the dead cat bounce) and the next low is lower than the previous low. The reverse applies when bulls take control.

Numerous academic and professional analysts' publications about sharemarkets assumed there were "scientific" rules for assessing appropriate prices and market levels. Those people were either trying to create learned reputations of justifying their existence.

I have read reams of the stuff but found they ignored basic facts: investment is money, money involves a gain or a loss, the thought of gain leads to euphoric greed and the thought of loss leads to panic attempts to avoid financial wipeout.

The old established New York-based broking firm Merrill Lynch, Pierce, Fenner & Smith (with a shorter name and severely tarnished reputation after recent scandals) was known as "the thundering herd" in bygone days. It used an apparent stampede of Texas Longhorns as an image projection and, seemingly, to convey the idea bull markets were eternal.

In passing, the "bull" and "bear" concepts seem to derive from ideas that bulls charge (an upward movement) when faced with potential foes. That could be a doubtful division of animal behaviour. Visitors to US and Canadian wilderness areas are warned about unpredictable bear behaviour (charging).

The bovine bull may have had a bad press. They are not all vicious. A flock of sheep would be a more realistic image of sharemarket behaviour than Merrill Lynch's Longhorns.

It would cover market booms, slumps and dead cat bounces. Descriptions of a three-week mild recovery in the US and elsewhere were a ridiculous example of sheep flock behaviour, which is no reflection on sheep, which huddle for group protection.

The Dow was 8443.99 last Friday, Standard & Poor's 500 closed at 897.65 and the technology-weighted Nasdaq was 1331.13. Corresponding numbers on December 31, 2001, were: Dow, 10,021.50; S&P, 1148.08; and Nasdaq 1950.40.

The situation may or may not be a dead cat bounce but apparent joy over weekly gains between 1.5% and 3.4% for the three indices should be tempered with the overall 2002 situation.

Falls of 15.7% for the Dow since the end of last year, 26.2% for the S&P500 and an impressive 31.7% for the Nasdaq were hardly indications of an imminent bull market. The second set of percentages were struck after inclusion of the three week "rally." Only fast-drawing, quick triggers should play markets in November, another peculiarly dangerous month.

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