Did I Just See a Dead Cat Bounce?

Sorry to be a party pooper, but I don't buy the sustainability of the recent market rally. 500+ points in two days? Give me a break. Market prognostication is not one of my specialties but I simply have to speak.

It doesn't take a rocket scientist or the Amazing Kreskin to see that things suck out there. In the real economy. Being excited about lower rates is only part of the equation. Sure, you are discounting back future cash flows at lower rates and therefore increasing the present value, but what exactly are you present valuing?

I'll tell you what - lower future cash flows. So many market participants get all excited about the prospect of the Fed dropping rates, but I think a few questions need to be asked:

1. Why are they dropping rates, and what are they seeing that we aren't?
2. Does the Fed really have the power to stimulate growth simply by monkeying with the short end of the yield curve?
3. What are the knock-on effects of the Fed lowering rates that could work against a rosy outcome, i.e., a weaker dollar that chokes off domestic demand and causes long-term rates to rise?

I personally don't like the answer to any of these questions right now. The Fed is scared, that's for sure. They see the dislocation in the credit market persisting, and perhaps getting worse. All we need is the failure of a single monoline insurer or (another) 10-figure write-down by a major bank to toss the financial markets into a complete panic, which would be good for precisely nobody (except perhaps Bill Ackman, Jim Chanos and a few others).

So in light of these risks, they may well tilt towards an accommodative stance. However, if they do this, will this really stimulate growth in the real economy and meaningfully loosen up tight credit markets? Debatable.

There are likely more direct steps they could take to provide banks and other financial intermediaries with the liquidity to bridge the gap and to address the tightness in the mortgage markets, steps that maybe wouldn't have such an adverse effect upon the dollar. And what if they continue to push down short term rates, and the real economy doesn't react as hoped?

In the absence of real growth and in light of lower rates, the dollar will fall further, only exacerbating an already difficult situation. This could have the effect of causing foreign capital to flee and long rates to rise, making it more costly for firms to raise stable, long-term capital (not to mention the US Government).

So market rallies are great, and I am an optimistic person in general, but the trading action of the last few days doesn't fool me. I just saw a dead cat bounce. And it will soon fall back to earth.

Comments

[firboy4]

I agree, and I like the way this guy writes.

[EricPeterson]

The Dead Cat is still bouncing! Higher and Higher!

[Bob K.]

It stopped bouncing today

[EricPeterson]

Well, 11 points up in the SP500 is not a bad day. That's way above the daily average in the bull market the past 4 years. So far, the bounce from Monday's close is 74 points, more than 5%. That's a pretty nice bounce.

[zippier]

i like cats the term"dead cat bounce" is insulting to cat lovers. i realize there are cat haters out ther and folks who just don't care about the origin of th eterm, but i cringe when i read or hear it.

kinda like the term dead bambi bounce would have on some i guess.

or dead baby bounce...

maybe you should be a trendsetter and start a name that is less patently offensive to many in our society- if you want them to read your verbage.

how about something technical like oscillating bouncing ball with negative dampening coefficient.....

[EricPeterson]

The more people I see say this is just a small bounce in a new bear market, the more I buy. The majority opinion is usually wrong.

[dancing diva]

Mr Ehrenberg - congratulations on spouting conventional wisdom. How about a little deeper thought?

No one denies there is a problem in either the credit market or the economy. In fact, the market had been voting with its pocketbook all month, with the downside accelerating after the Fed's statement "the risks are balanced". Well, you and I and everyone else except the Fed realized the risks were definitely not balanced. However, this weeks realization that the Rip Van Winkle Fed had finally woke up gave the market a reason to rally for the first time in a while. Like an alcoholic can't be cured until he acknowledges his dependency, neither can the economy be cured until the Fed realizes there is a problem.

Will the economy be cured by a 1/4 or 1/2 point rate cut? No. Will I short this market? No way! The reason is that most stocks are not overpriced and with the Fed working with rather than against the economy there is more hope for the future. Sentiment is far more important than the short term gdp level for the direction of the stock market.