How to spot Dead Cats, Falling Knives and False Charges across the plains of Africa and stock markets
Me (to an African guide): "When an elephant charges you, how do you know it's a false charge?"
Guide: "When the elephant stops."
In 2013, I had the brilliant idea to ride horses among galloping herds of wild animals across the Mara plains in Africa. My (then) husband refused to join me, as he pointed out this fact: lions are faster than horses.
We were charged at by lions, elephants, buffalo, and worst hippos.
Guides talk about false charges, as if they know the difference ahead of time. They don't. Talk to an experienced guide, and they'll share with you that the only time they really know is after the fact, i.e. the elephant stops or it tramples you.
The markets are the same.
How do you know the bear market is over? After the fact.
In the meantime, you have to deal with dead cat bounces, falling knives and false charges. Like Africa's Big 5, these are the treacherous three of bear markets.
The smartest investors I know run their portfolios with the shortest leashes.
This isn't day trading. They have a thesis for the future. AND they test that thesis every day based on data points coming in.
Africa data points like:
Is that elephant still running or has it stopped?
Would that pissed off buffalo charge us for sport?
Would those breeding lions expend effort to charge us?
Market equivalents include:
Is the market technically overextended to the upside or downside?
How healthy is the stock market (lots of conviction, broad buying, or only buying a few safe names)?
Are investors reacting positively to negative news (bad news is good news) or negatively to negative news (bad news is bad news)?
When I started as an investor, confidence poured out of me. I had no fear of dead cats, falling knives and false charges. But the market will train the overconfident to respect it. How? Through losses.
Here's what I've learned in the 30 years since.
Dead cats
Dead cat bounces are both opportunities and hazards, depending on how you play them. A dead cat bounce refers to a stock that is "dead" or left for dead, and all of a sudden it catches a bid and goes up 20-40% in short order. The trick is not to believe the "new narrative" and be able to evaluate any new data with plenty of analytical rigor, aka suspicion.
Motorola was one of my memorable dead cat bounces. And did it ever bounce.
The market had left MOT for dead. Nokia (yes, the later Nokia became a dead cat) had ushered in the era of digital cell phones and MOT was still playing the analog game. MOT's earnings were HALF of expectations.
Then they released the RAZR which took off like wildfire.
They stock rallied for close to a year. But there was no follow-on. The trick was to ride the rally but see the long-term writing on the wall. Dead cats can be lucrative, but they are dangerous because you start to believe in them again right before they die for real.
Then you're catching a falling knife...
Falling knives
Yes, catching a falling knife is exactly what it sounds like. Bloody. Painful. Nothing good comes from it.
In a previous newsletter, I mentioned that the mathematical difference between down 80% and down 90% is not 10%, it's down an additional 50%! 100 to 20 is down 80%. 100 to 10 is down 90%.
The move from 20 to 10 is down 50%.
That's why buying something that is down 80% only to have it go down an additional 50% is called catching a falling knife. Down 80% seems like a great deal until you lose half your money in short order.
What to do about falling knives?
Wait. A. Little. Longer.
Wait to see if the animal stops charging. This is why seasoned investors don't need to buy at the very bottom. They are happy to miss a 10% upside by getting in 10% later, but with more certainty that they won't get 50% of their capital wiped out in short order.
Wait till the knife stops falling.
Wait for the stock to start working again. Then come in slowly, 1/3 of your investment at a time.
So now it starts working. One stock at a time. Then the market, which is made up of these individual stocks, starts working.
False charge?
How do we know it's a new bull market, and not a false charge?
We don't.
Just like a Bear. The Bull can only be confirmed after the fact. After the fact you can see if the charge was false or real.
In the meantime, you keep it close to the vest, pay attention, and look for signs of false charges, like the market getting overextended in the near term.
Then when the market pulls back, you look for signs that the knives have stopped falling and the market has found new footing.
There will be those that encourage you to just stick to the facts.
People pulling up charts showing earnings are coming down while stocks have rallied. And what will they do when stocks keep rallying? They'll fight it the whole way, because it "doesn't make sense".
Like Africa, the numbers are aggregates over the long term, but your survival relies on your own individual animal instincts.
Naysayers build bull markets. They create a "Wall of Worry" for new bulls to climb. When the market starts regularly trading UP on bad news, this is a signal that a bull has begun, and day by day, person by person is convinced that this worry is overblown and they buy into the market. Investors buy into the market because the main fact is stock prices are going up.
Yes, the mere fact that people buy just because prices are going up is what gets us into these overvalued messes in the first place!
But we're human and prone to excess. Bulls and bears included.
Why are there so many weird names like dead cats, falling knives, and walls of worry?
These are signposts to remind investors:
We've seen this movie before
Don't let emotions run you
And be open to new facts
Many, like my (former) husband, will chose to opt out of galloping with wild animals or buying individual stocks, in favor of the "safety" of suburbia and buying the index in the markets. These safer strategies often lead to greater wealth (less chance of extinction allows for compounding to continue). Even indexes experience bulls and bears, and some ETFs may become dead cats!
Note: no actual cats were harmed in the writing of this