Beware the ‘dead cat bounce!’ Again!

A dead cat bounce is a temporary recovery of asset prices from a prolonged decline or a bear market that is followed by the continuation of the downtrend.

Another less morbid expression we’re hearing on occasion is ‘relief rally.’ Despite what the consensus believes – that the FED is trying to allay fears related to coronavirus – the reality may be far worse. The surprise cut of 50 basis points is unsettling.  The FED sees much more data that the rest of us, and to me they’ve just confirmed what I’ve been saying – a recession is well underway (I call it an ‘inflession’ to account for the fact inflation is rising and economic growth is declining.  Despite evidence of a possible recession, prices for various goods in the PPI have jumped concernedly year-over-year:  Vegetables +21.4%, Pork +14.9%, Gasoline +23.1% and Home Heating +12% for example.

Their action  suggests the data is looking so sour that they couldn’t even wait a couple of weeks for their scheduled meeting.

US Mftg Prod Mar 2020

rate cut picThe cut will be devastating for banks (already wrestling with skinny margins) who’s balance sheets are unprepared.  The FED would have know this and acted anyway.

There’s plenty of discussion about the market’s valuation. Valuations needed to be settled down, and the adjustment in the market P/E is pretty much done.  Balderdash!

First of all, research confirms that the Price/Earnings ratio on its own does not correlated at all with future moves in the market.  What it doesn’t say, is the the interpretation of the ratio contains a great deal of information.  Below is a long term picture of the market’s P/E ratio.
<a href="http://S&P 500 PE Ratio – 90 Year Historical Chart“>long term chart of the S&P 500 Index P/E ratio.

sp-500-pe -2020-03-02-macrotrends

The ratio (it’s simple arithmetic) goes up and goes down.  But is it trending in a direction because prices are trending up or down?  What about earnings?  The ratio clearly changes as earnings go up and down.  In 2008 – 2009 the P/E skyrocketed not because prices were rising – but because earnings were falling faster than prices were declining. This period was the subject of my A Maverick Investor’s Guidebook published in 2011.  C

The market for most of this cycle enjoyed prices rising faster than earnings, which took the P/E ratio up to more than 20X.  Currently, prices may be falling faster than earnings…but earnings will also fall. Given the downward guidance from corporations, and shutdowns of various varieties (companies telling employees to stay home, travel bans, border closures and so on) it is self-evident that earnings will fall rapidly this quarter and perhaps next.  Surprises drive markets (always have) – NOT what is expected.  What is expected is already in prices.  Opportunities are created when expectations are wrong.  Adjustments to expectations are sticky.  Analysts are especially slow to revise down (or up) their targets.  In the meantime sentiment takes over.

denialThe problem is that sentiment is unreliable.  What usually occurs prior to a bear market is the 1st stage of the Kubler-Ross seven stages of grief:  Shock and Denial.  Everyone simply refused to change their outlook until they’ve suffered some serious cognitive dissonance.   What investors believe (this is just a blip) is being crushed, and as humans we are loathe to change our minds.  The surprises will keep coming as analysts follow up with the companies they report on for the next several months.  And they will not be positive surprises.

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About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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