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The Physics of bouncing Dead Cats: Will DJIA pierce 6547 this time?

Stock-Markets / Stocks Bull Market Mar 30, 2009 - 07:13 PM GMT

By: Andrew_Butter

Stock-Markets Diamond Rated - Best Financial Markets Analysis ArticleMarch 14, 2009 Professor Nouriel Roubini wrote a piece: Reflections on the latest dead cat bounce or bear market sucker's rally. Well he could be right, certainly the rally looked busted on Friday and grim on Monday,. plus Tom Dryden pointed out yesterday that those bank profits were thanks to a scam; someone called it a "fraud bounce" http://seekingalpha.com/article/128390-exclusive-big-banks-recent-profitab (but aren't bank profits always thanks to some sort of scam).


On top of that where we are with Secretary Geither's plan which supposedly created a surge of optimism based on the idea that there WAS a plan, well it's starting to look less good now that people get around to reading it (and working out how long it will take to implement).

And still no one can agree the value of the toxic assets, and more important the CDS "problem" still didn't go away (not much different from last September (http://www.marketoracle.co.uk/Article6495.html), although the good news is that the CDS at Lehman got cleaned up quite painlessly (that's one good argument for liquidation rather than the miss-mash of semi public-semi-private).

All this unfinished business! And Oh I forgot, The President said something - that's 2% off equities, guaranteed.

Two arguments against the thesis that that was a dead cat (there are others);

(1) The stock market is now valued exactly the inverse of how much it was over-valued in 2000 (but that's old news http://www.marketoracle.co.uk/Article9658.html).

(2) I did a bit of investigation about dead cats bouncing.

CLASS SCIENCE PROJECT

INVESTIGATING THE PHYSICS OF BOUNCING DEAD CATS .

Definitions: A dead-cat-bounce (for the sake of this analysis) is when the next low after a rally is lower than the preceding low (note mini-rallies less than 25% of the previous drop that then drop more than 10% are not considered dead cat bounces, those are defined as dead mouse bounces).

Just so we are clear - from the greatest time series of dead cat bounces in the history of mankind:

Thesis to be investigated:

(1) Can the height that a dead cat bounces be reliably predicted from the height you drop it from?

(2) Can you work out if a cat is dead from how high it bounces as a function of the height you dropped it from?

Materials used for experiment:

Seven dead cats (representing the most elastic dead cats observed in the period 1909 to 2009 on the DJIA (from one hundred years and 26,234 points of data).


Results:

Analysis:


"Bounce" was compared to the previous drop:

Remarks:

1: On average 91.35% of the "bounce" could be explained by the height from which the cat was dropped.

2: This is consistent with Newton 's Laws of Physics (and the General Theory of Relativity...I fink

3: The purple dot on the picture representing the "bounce" from 9th March is 4.2 Standard Deviations away from the best-fit line.

4: In other words the probability that the cat that was observed bouncing being a dead cat is One in 16,966. That is a much lower probability than a AAA bond rated in 2006 by either Moody's, Fitch or S&P, will default; in fact about 3,000 times less likely.

5: Unless of course it's a "Black Swan" (there have been a lot of those flying around these days, and if you can claim to have seen one of them well you can say black is white). That's extremely unlikely given the number of Black Swans that have allegedly been sighted (a Black Swan is the explanation used by the rating agencies to explain their little faux pas "not my fault 'Gov, it were a Black Swan" - last time I tried that line the Policeman breathalysed me).

Conclusion:

The rally was not caused by either the janitor or the chimpanzee who are all that's left at AIG selling plutonium and anything else not screwed down out the back door, as was so graphically explained in http://seekingalpha.com/article/126444-aig-employees-not-too-happy-with-persistent-death-threats (My money is on the chimp).

So I'm sticking to 6,547 DJIA or thereabouts as THE bottom, which is more or less what I said in January (then I was branded a pessimist now I'm supposedly part of the "chorus of optimists" - can't win). http://www.marketoracle.co.uk/Article8293.html

Not that I have any hope that there will be a "Raging Bull" for quite some time. One way to know when that's imminent is that I won't be whiling away my time writing silly articles about dead cats.

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Andrew Butter Archive

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