Please help us continue to provide you with free, quality journalism by turning off your ad blocker on our site.

For instructions on how to disable your ad blocker, click here.

I’ve Turned Off My Ad Blocker
This is a BETA experience. You may opt-out by clicking here
Edit Story
Editors' Pick|

Beware Of A Dead Cat Bounce

Chuck Jones

Thursday’s decline of 2,353 points or 9.99% is the largest percentage decrease since Black Monday in October 1987. As of Thursday’s close the Dow (and other Indexes) are on track to have their worst week since the Great Recession as the three largest point drops in history for the Dow occurred on Monday, Wednesday and Thursday.

In just the first four days this week the Dow has fallen 4,664 points or 18%. Depending on what happens today, this should be the worst week in percentage terms since 2008’s Great Recession and may vie for the worst week ever. The overall trend is pointing to further losses in the equity markets due to the uncertainty surrounding the coronavirus and the Trump’s Administration response, but the Indexes have become very oversold.

During the last month’s declines, there have been a number of days when the market has risen but came under pressure and eventually fell. This is a situation of portfolio managers wanting to sell some of their positions and when they see some strength in the market, decided to unload. This is the classic dead cat bounce.

During Thursday evening and early Friday morning the Dow’s futures were initially down over 500 points. It rebounded to a positive 600 and is trading around 400 as of 3:00 am ET. The S&P 500’s futures have also shown the same swing in value.

The Dow has gotten shellacked 

The Dow has cratered 8,351 points or 28% to 21,201 over the past month. Out of 20 trading days since it peaked at 29,551 on February 12, the Dow has fallen on 16 of them. As shown in the chart below it is very oversold.

The top portion of the graph is the Dow’s Relative Strength Index, or RSI. When it gets below 30 it is showing the Dow to be oversold and likely to move higher in the next few days or weeks.

Another indication that the Dow is oversold is in the bottom portion of the graph. This is the MACD or Moving Average Convergence Divergence. As the blue circle shows it is significantly lower than other times when the Dow has subsequently moved higher.

Also included in the chart is a line that traces back to the late May/early June 2017 timeframe when the Dow was at a similar value. As of Thursday, all the gains over almost three years have been wiped out.

The S&P 500 has been taken to the woodshed

The S&P 500 has fallen 906 points or 27% to 2,481 in just over three weeks. Out of the 16 trading days since it peaked at 3,386 on February 19, the S&P 500 has fallen on 13 of them. The chart below also shows very oversold positions via the RSI and MACD.

Also included are various support levels that the S&P 500 has fallen through. Technicians, or investors who use charts and their patterns to invest in the markets, use support levels to help determine at what price or point a stock or Index could fall to and then stop. As seen in the chart below, these have not been helpful in determining where the markets could find some support and stabilize.

The One Chart to watch

Jim Cramer on CNBC sometimes highlights a chart from the Fibonacci Queen, Carolyn Boroden. She uses the 5-day (blue line) and 13-day (red line) exponential moving averages to show upward and downward trends in the markets. When the 5-day is above the 13-day the market is moving higher and tends to stay in that trend until the lines cross.

The same goes for the downside. When the 5-day is below the 13-day the market tends to decline. Below is the S&P 500 over the past year with highlights for the previous three and current downdrafts.

When the lines cross it tends to show that the market has bottomed or topped and could reverse direction. Included in the chart is a vertical green line to highlight the gap between the 5-day and the 13-day moving averages. It should take at least a few days, and probably longer, for the blue line to cross above the red line even if the markets were to flatten out to indicate a bottom in the Index.

Note that while this chart shows a discernable pattern, no chart is perfect for investing.

The VIX is at its highest since the Great Recession

The VIX, or the Volatility Index, is back to where it was in late 2008, a few months before the markets hit bottom in February 2009. The VIX can be a good contrary indicator meaning that when it is high and investors are very nervous, the markets are near a bottom. Again note that while this chart shows a discernable pattern, no chart is perfect for investing.

I provide independent research of technology companies and was previously one of two analysts that determined the technology holdings for Atlantic Trust (Invesco's high

I provide independent research of technology companies and was previously one of two analysts that determined the technology holdings for Atlantic Trust (Invesco's high net worth group), a firm with $15 billion under management. Before joining Atlantic Trust I was the Internet Security Software analyst for Smith Barney (where I authored the most comprehensive industry report “Internet Security Software: The Ultimate Internet Infrastructure”) and an Enterprise Server Hardware analyst at Salomon Brothers. Prior to becoming an equity analyst, I spent 16 years at IBM in a variety of sales and manufacturing positions. I have a B.S. in Industrial Engineering from Stanford University and a Postgraduate Diploma in Economics from the University of Sussex, England.