## Thursday, March 4, 2010

### Cat Bounce Fever

Noted author and financial analyst Robert Kiyosaki recently predicted that the Dow could sink to 5,000 (the S&P 500 equivalent is 540) in 2010. Kiyosaki is probably using a sophisticated formula using strange mathematics sometimes referred to as “calculus” to get his number. I use a much simpler model and a spreadsheet, often referred to as “Excel”, to get the Model “T” number, which remains at 580.

Kiyosaki describes the recent jump in the market as just a “dead cat bounce”. “The term "dead cat bounce" is derived from the idea that "even a dead cat will bounce if it falls from a great height"(Wikipedia). In investing, it means even a bad stock will increase some after it hits bottom.

What I want to know is who goes around dropping dead cats from the top of buildings. It is not hygienic to be handling dead cats and to drop them off of buildings is just sick. Interestingly, it is one of the few things that PETA and Larry the Cable Guy would agree on. One would call it “a heinous abuse of a corpse”; the other would say “that ain’t right”.

But I think the 3,800 point jump in the Dow is more than a dead cat. If you coated the dead cat in latex and heaved it off of a skyscraper, it wouldn’t even bounce that high. While PETA would still object to this, Larry would say, “Hey, that looks like fun. Can I chuck the next one?”

At the beginning of the year, I wrote about how wide the forecasts were for the stock market in 2010. After more than two months, this has not changed. Some very prominent experts are predicting the Dow could reach 12,000 or more, while Kiyosaki and others are forecasting something near or below the previous low of 6,547.

Checking The Model “T”

I have a dual axis graph of the Model “T” value and the S&P 500 index for the past 20 years. Even in periods when the Model “T” was not as accurate, the two lines were still relatively close together on the graph. The gap between the lines is currently more than double than the previous maximum. The divergence began in March 2009 when the current stock market rally started, but the Model T continued to fall.

When examining the graph, you would conclude that some major, positive, factor that is outside the Model “T” occurred in March 2009 that spurred the stock market jump. What was it? I have no clue. Something is wrong.

If the current gap between the two lines on the graph is too wide, you would expect something to happen soon to bring the lines back into their historic relationship. Of course this can happen in one of two ways:

Scenario One: The commercial transportation market takes off faster than a rocket with freight demand and equipment usage increasing at a tremendous rate. At this point the people still fortunate to have jobs in commercial transportation are laughing because this is so far from reality. The two expert firms in the field, ACT Research and FTR Associates, are both forecasting a very dismal 2010. The industry will improve over 2009, but remain at historically bleak levels.

Scenario Two: The stock market plunges to below the previous S&P 500 bottom of 666 (was God sending us a message?).

Which one of these would you bet on?

A Live Cat Bubble

Instead of a dead cat bounce, I think we have a “live cat bubble” (my new term). The cat is still alive and has been lifted high in the air on a new stock market bubble. I will let the experts explain the causes of this bubble. And if you believe we are just too darn smart to create another bubble so soon after the last one, I have some Greek bonds that I need to unload. Financial historians will probably label the last 15 years the Lawrence Welk Era because you can never have too many bubbles.

So the cat is still floating high, contently sitting on the bubble. Everything goes well as long as the cat is calm. If the cat becomes frightened, its claws instinctively come out, the bubble bursts, and the cat comes crashing down. Then you get your dead cat bounce.

#### 1 comment:

1. As always Don another great post. Congratulations on the job. Re: this post. During my career, after grad school, an acquaintance in CA convinced me to go into industrial/commercial real estate. It wasn't my passion but I learned from the best. As I was taking my broker requirements for finance at UCLA-a discussion broke out over 15 year mortgages and 30 year mortgages. For the average home owner, who plans to stay a few years in the home, buy a home you can afford with a 15 year mortgage. It may be a smaller home but it will be yours in your lifetime. If your job requires moving every 3-5 years a 30 year mortgage offers interest rate write offs. And if the cycle is right maybe a profit on on the sale. Any variable loans or loans on a home that exceeds 3 to 4 times net income require a risk taking astute investor. My friends in the hospitality business move regularly and have done very well with each move. Secondly, (especially in California) real estate is cyclical. My uncle would buy a small office building, wait a year, sell it at a profit, wait a couple years when prices went down, buy the same building and sell it again at a profit. A little homework on real estate cycles will go a long way. I have seven friends who had to short sell their homes in the last year.