The Black-Art of Predicting Stock Market Dead Cat Bounces: One More for S&P 500?

On March 14th 2008 Nouriel Roubini’s made a prognosis about bouncing dead cats "Reflections on the latest dead cat bounce or bear market sucker's rally". I was so inspired that I conducted a very scientific experiment throwing dead cats off buildings to check how high they bounce; based on my findings I built a carefully constructed “algorithm” to prove beyond all scientific doubt that he was wrong. Regardless, Roubini has become quite famous for his timing on stock markets; so much so that some disrespectful wags recommend that whenever he says stocks are going down 20%, it’s time to buy. The question a few people are asking these days is whether the recent run up in the S&P 500 to 1,200 will end in tears, particularly since the “support” just got broken? Or more specifically a dead cat, where the low following a rally ends up lower than the previous low (my definition of a dead cat bounce).

Looking at history, there is an intriguing number (7) for dead cat bounces following the burst of a bubble (which is what happens when what the Austrians call the “malinvestments” of the past (usually debt fuelled), get washed out of the system. The “reality-check” often lasts for some time, five years is “normal” in USA, but in Japan it can take twenty (something to do with the hardness of the water and the quality of the detergent).

It’s a minority view, although that logic did predict the S&P 500 would turn at 675  (which it did if you don’t count intraday), and then it would go up until 1,200 or thereabouts, at which point it would turn down.Other models are much more in line with conventional economic dogma (trailing P/E ratios,  Tobin’s q, Elliot Waves, and Fibonacci), but the evidence of the recent past is that in spite of that (and inflation targeting, “velocity of money”, etc), they don’t seem to produce the right answer vey often. Although that might be a bit unfair; after all Bob Prechter DID say “hold onto your shorts” in February 2008. I guess that might have had something to do with Warren Buffet’s quip “when the tide goes out you get to see who’s been swimming naked).

So I’d be surprised to see a drop from the pinnacle of 1,200 to less than 950 at any point in the future, although I still don’t foresee a big bounce upwards for some time; from here on in it’s a “picker’s” market to “buy and to hold”.

By Andrew Butter
Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2010 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.