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Dead Cat Bounce

by rdf Mon Oct 13th, 2008 at 04:27:28 PM EST

This is the term on Wall Street when the market goes up after a sharp drop only to continue downward again.  It is assumed that only suckers will buy into a falling market while it is still on its way down. Unfortunately knowing when a market has hit bottom is impossible to tell, although there are any number of "experts" willing to take your money and tell you when.

Studies have shown that the majority of gains in the stock market occur over a very few days (something like 5%) while the rest of the time prices basically move sideways. This is why conservative, long-term, investment funds try to stay fully invested so that they won't miss these sudden rises. This is the opposite to the philosophy promoted by the daily press and the advice publications which all try to give tips on when to trade. This is called timing the market, and is hardly ever successful. The stories about the trader whose fund has done well because of his secret sauce are mostly reports of people who were lucky. With thousands of mutual funds there are bound to be a few that get things right at any one time. Funds that do better than average in one year tend to do less well the next.  This is called regression to the mean.

If anyone really had a secret formula others would be able to figure it out and do the same thing and then it would stop working.

So what we are seeing in the market today may be a dead cat bounce, or it may be the beginning of the end of the decline. This has implications for everyone, not just those whose pensions have declined in value. Lower values in the stock market lead to less income for some, lower spending, less income by those associated with the financial sector, lower revenues for local governments and then a decline in public services.

Expect to see layoffs of ancillary staff in schools, library closings, cutbacks in food, health and old age local programs and the postponement or cancellation of public works projects. Localities will probably also raise their tax rates, especially real estate taxes, in an attempt to keep revenues up. Unlike the federal government they can't just print money to cover expenses and borrowing has to be based upon the size of the tax base which is used to pay the loans back.

Since the panic started I've been telling people not to do anything. It is the inexperienced investor who ends up selling at the bottom and buying at the top. If your funds are being set aside for retirement or other long-term needs that what the nominal price is at the moment is of no concern.

Having said that I must admit that I shifted a bit of money back into my retirement stock fund for the first time in five years. I'll continue to do this over the next year or so until I've made my total portfolio a bit more risky. If I've guessed right my kids will be a bit richer after I'm gone...


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