Dead Cat Bounce: Did it Bounce or Not?

When the financial market suffers from a consistent fall, traders will see this as an opportunity for buying stocks hoping to gain profit. If they buy it too soon there will be a small and temporary increase in price. This is what we call a “dead cat bounce”. According to Investopedia, 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. As we can see in the graph below, downtrends are often interrupted by short periods of recovery where prices temporarily rise. The name "dead cat bounce" is based on the idea that even a dead cat will bounce if you drop it from a great height.

The expression “dead cat bounce” was first used in the news media in December 1985 when the Singaporean and Malaysian stock markets bounced back after a hard fall during the recession of that year. Journalists Horace Brag and Wong Sulong from Financial Times quoted that the temporary price increase was "what we call a dead cat bounce". After the statement was published, the economy of Malaysia and Singapore continued to fall. But a few years later both economies were fully recovered.

Spotting a dead cat bounce can be very tricky, so here are three steps to identify them:

  1. Identify a stock that is in a strong bearish trend.

  2. Spot signs of rising prices, which break the slope of the downward trend

  3. The price reverses and breaks its last bottom.

As shown within a graph below, we can see the implementation of those three steps. The red line which was explained in step one represents a strong bearish market. The blue line represents signs of small increasing price and the black line represents price reverse.

Record pace for a stock market decline

Source: Samuel H. Williamson, 'Daily Closing Value of the Dow Jones Average, 1885 to Present,' MeasuringWorth, 2020, and Schroders.

COVID-19 caused the fastest stock market crash on record. US stocks, Dow index has shown a decline over 30% in just 25 days from 6 February. That’s even faster than what happened in the Great Depression, 1929. In that era, it took approximately 46 days to reach a decline of over 30%. The second act showed another drama in this phenomenal rally. Dead cat bounce occured, Dow was up by almost 30% from 23rd March. Did this only happen in America? No, it also happened in the Jakarta Composite Index (JCI). After a decline of 23%, dead cat bounce was also occurred. JCI rebounded by 19% with a similar time as the Dow index, in this case, 24th March. This movement begs the question of whether financial markets have turned the table, even the impact of Covid-19 continues to be deeply troubling.

As said by Robert Shiller, a Nobel laureate in Economics, financial investors have anxiety from two pandemics, one is from the coronavirus pandemic and the other one is pandemic of panic due to the economic consequences of the virus (The Jakarta Post, 2020), two different correlated pandemics but causing a contrast effect. The pandemic is inflicting uncertainty as several businesses shut their doors to curb the unfold of the novel virus. That uncertainty is causing panic within markets across the world. The worry of losing more money is inflicting some investors to sell their stocks, whereas different investors move their cash to safer investments. This investor’s behavior in the market has led to a market crash that has been mentioned earlier. On the other side, positive news can cause optimism in investor behavior. For example, stocks rose on 29th April after a study on an experimental drug from Gilead Sciences showed that it reduced the time it takes patients to recover by 31%. We can conclude that human behavior plays a prominent role in market movement. Although, is it the only thing that causes a volatile stock-market action?

The US Federal Reserve has cut rates near to zero and promised to buy government bonds in unlimited amounts, whereas the Bank of England will pump £200bn into the economy through quantitative easing, and governments around the world will guarantee loans and pay workers’ wages, promising to do whatever it takes to combat the economic disaster. Stimulus pumped by the central banks and governments will also lead to market recovery at a first glance, but such stimulus is unlikely to lead to a sustained economic recovery. The effect of monetary stimulus has its limit, and once it is reached, the markets may decline further. That’s what makes the government and The Fed's stimulus is also contributing to market rebound. With those cause and effect, it is fair to say that human behavior, government, and The Feds are able to shift the market movement, but in the end, everybody in this world depends on this one and only variable, the main culprit, COVID-19 itself.

Therefore, investors shouldn’t cheer too soon about this rebound and should not depend on short-term expectations. Expecting instant results will likely put you on the dissatisfaction since it is difficult to anticipate price movements in the markets precisely and reliably. During irregular circumstances such as this, it is much more difficult. Instead, investors should concentrate on the long-term prospect of their investment portfolio and see how it accommodates their long-term needs. Estimating the long-term returns of good-quality securities is more likely to produce an approximately right outcome than precisely wrong in the case of short-term forecasting.

Written by : Aldino Nabil Makarim, Felicia Rebecca

Illustrated by : Felicia Rebecca



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