What is a Dead Cat Bounce in Investing?

January 4, 20236 min read
What is a Dead Cat Bounce in Investing?
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Key Takeaways

• A short, sharp uptick in share prices after an extended period of decline is known as a dead cat bounce. 

• Another term for dead cat bounce is sucker’s rally.

• Difficult to predict, they are usually only recognizable in hindsight.

A temporary rise in the price of an asset after an extended period of declining value is referred to as a “dead cat bounce.” The term is derived from the idea that even a dead cat will bounce if it falls from a great height. However, the key word in that opening sentence is “temporary” — in that those gains are usually not indicative of a rally. In fact, they are almost immediately followed by another price downturn. 

Another term for dead cat bounce is “sucker’s rally.”

Identifying a Dead Cat Bounce

Easiest to identify in hindsight, the textbook definition of a dead cat bounce is the reversal of an extended downward trend in pricing, followed in short order by a continuation of declining value. The trend is officially termed a dead cat bounce when that downward movement surpasses the low at which it stood before the temporary rally began. As a result, the only way to determine whether a dead cat bounce has occurred is after the fact. 

Key to understanding dead cat bounce is the fact that the pricing reversal is unsustainable. Rather than a recovery, a dead count bounce is a temporary turnaround. Moreover, such “bounces” can be quite deceiving. Price increases after a long slide can engender false hope to which even seasoned investors can be vulnerable. 

On the other hand, a dead cat bounce can also represent an opportunity to buy into a security with otherwise sound fundamentals at a discounted price. The key is to have the ability to determine whether the asset’s price is rallying because of some fundamental changes in the business practices of the company, or because it looks like a bargain because the price is so low.

A key sign of a dead cat bounce is a short-lived price rally with minimal volume. This lack of volume can be a strong indicator of the rally’s ephemeral nature. Another thing for which to look is the high price. if it’s less than that of the previous peak, it’s likely that the downtrend is continuing. 

Bull vs Bear Markets

By extension, this raises the question: what are bull and bear markets? A bull market is defined as one in which broad market indices reflect a 20% increase over a two-month period or more. The perception of a bull market tends to invite greater investment, which in turn serves to extend the run. 

Historically, the average bull market lasts approximately 3.8 years. The longest one on record began in 2009, as part of the recovery from the financial crisis that began in 2007. This run lasted for nearly 11 years, until the COVID-19 quarantines brought it to a close. That bull market delivered gains of some 400% between March 9, 2009, and February 19, 2020.

Conversely, a bear market begins when market indices reflect a 20% decline from recent highs. This can result in a hostile environment for certain assets, which leads some investors to sell holdings. This activity then tends to send prices even lower. 

According to U.S. News, the average bear market lasts 289 days. Within that average, some lasted only a few months, while others extended out over approximately two years. While instances such as the COVID-19 pandemic can be a good indicator of an approaching bear market, they can be difficult to predict. 

Another point to consider is that recession and bear markets do not always go hand in hand. The Great Recession triggered economic maladies that went on for quite some time. Meanwhile the market rallied long before the Great Recession was considered over.

Recent Dead Cat Bounce Examples

Shares in Wells Fargo (NYSE:WFC) were trading at approximately $53 each at the beginning of 2020. That share price fell to roughly $26 in April of that year, when the ramifications of the COVID-19 pandemic became widely recognized. 

However, a brief turnaround occurred in which Wells Fargo shares advanced to $33.91, leading some investors to believe the stock was rallying on the heels of the first financial stimulus package. However, the price retreated to $22.50 in mid-May when it became apparent that economic woes were ongoing. That temporary rally was a classic dead cat bounce scenario.

In fact, the same was true for the market as a whole. U.S. markets experienced a decline of approximately 12% over the seven days from February 21 to 28 in 2020 as news of the pandemic quarantines began to circulate. The following week saw a bounce of 2%, leading some investors to believe the initial decline was an anomaly and the worst had passed. However, another decline of approximately 25% followed that uptick. The market eventually recovered during the summer of 2020. 

Dead Cat Bounces and Portfolio Diversification

As mentioned above, predicting a dead cat bounce is very difficult. Because they can generally only be recognized post-occurrence, the best way to protect a portfolio from the phenomenon is diversification.  Attempting to define a stock’s low point, or identify the genesis of a price rally, is to try to time the market. In general, a better strategy is to acquire and hold assets whose fundamentals are sound and supplement them with investments in asset classes that are less likely to move in concert with market swings. 

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

In many cases a dead cat bounce results when investors strive to cast off losing positions, which can trigger temporary price increases. Being drawn in by a dead cat bounce can be injurious to shareholders who react reflexively. While chasing short-term gains can be enticing, it is critically important for investors to keep their long-term goals as well as their time horizons in mind when making trades. 

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