On December 26th, just a couple of days ago, I was getting concerned phone calls about whether or not the world was collapsing. This seemed probable to some, as the apparently infallible S&P 500 had entered into a Bear Market (commonly defined as a decline of 20% from a previous peak) just one trading day earlier.
Here we are, less than two full trading days later, and all seems to be well again. As of market close on December 27th, the S&P 500 had rallied more than 6% from its dreadful low the day before. As of the time of my writing this, that rally extended to almost 7%. So, is all well?
It is my opinion that all is not well, and that this return to the market’s raging bull ways is actually a cat disguised as a bull.
Yet another terrible expression from the world of finance is “dead cat bounce.” It essentially describes a sharp reversal to the upside in a security or index after a previous period of heavy declines. As awful as it is, to fully understand the descriptive nature of the expression, it is helpful to know that the phrase in its entirety is “even a dead cat will bounce if dropped from high enough.” Again, awful, but a cat bounce might be exactly what we’re experiencing here. I will provide some historical precedence.
During the market routs that began in both 2000 and 2007, after indexes reached or very closely approached intra-day Bear Markets, they reversed sharply. Cat bounces.
October 11, 2007 marked the intra-day high of 1,576.09 for the S&P 500. On March 17, 2008 the S&P 500 reached an intra-day low of 1,256.98, exceeding the 20% bear market threshold. From that low, the market rallied 9% by April 1, 2008, 10.32% by April 7, 2008, and 14.58% by May 19, 2008. The index then turned and dropped 16.65% from its May high by July 15th of that year. I don’t think many need a reminder about what happened over the next eight or so months.
And in 2000? Pretty similar, really.
March 24, 2000 marked the intra-day high of 1,553.11 for the S&P 500. On December 21, 2000 the S&P 500 tickled Bear Market territory by reaching 1,254.07, a decline of 19.25%. From that low to January 4, 2001, the S&P 500 rallied by 7.66%. By January 31, 2001 the index rallied 10.31%. From that January high, the S&P 500 declined by another 21.84% by March 22, 2001. The index eventually found its bottom at negative 50.51% from its peak.
Of course, back then, the Nasdaq Composite was where all eyes were glued. It reached its peak on March 10, 2000, at 5,132.52. By April 4, 2000, the same day the index slipped into Bear Market territory, it reached a low of 3,649.11; a decline of 28.9% from the peak. From this low, the Nasdaq Composite cat bounced 22.64% by April 10, 2000. The index then went on to extend its peak to trough decline to negative 78.4%. A drop almost unthinkable today.
For whatever reason, reaching certain levels in an index has triggered a fairly predictable reaction over the years. Being down 20% from a peak happens to be one of those levels. It is as if investors collectively earmark a drop of 20% as a buying opportunity – understandably. Even if this market were to eventually continue down to much lower lows, it would have been expected that there would be a rather fantastic reprieve at or around the Bear Market line in the sand.
So, am I saying that you should panic-sell everything in your portfolio to take advantage of this cat bounce? No. What I am saying is that, without an historical perspective, there is an increased risk that investors who have gotten used to reaping the rewards of buying any dip in equity prices over the last decade might end up holding the proverbial bag, as they did during the last two major bear markets.
Why I am saying this is not to fear-monger, but merely to remind. There are many people who could currently meet their financial objectives with the assets that they have today, yet they continue to push the envelope by assuming risks in excess of their actual tolerance for risk. In hindsight, if we really have seen the peak for this market cycle – and the current rally is, therefore, just a cat bounce –these investors will kick themselves for getting greedy. They won’t be wrong in this assessment.
A rational investor, even with the longest-term investment horizon, does not assume more risk than they need to achieve their goals; and definitely does not assume more risk than they can tolerate. Risk tolerance has not meant much over the last few years, due to very low volatility, but I suspect that one’s actual tolerance for investment risk is going to become very apparent over the next several months.
Assess the risks you’re taking, and make sure that they are congruent with your objectives and risk tolerance.