Doing the ‘Dead cat bounce’

Marketplace Staff Mar 23, 2007

TESS VIGELAND: Our lede this week, yet again: The ongoing meltdown in the subprime mortgage market. Congress held more meetings this week, and 2008 presidential candidate Barack Obama called for a govt conference to help homeowners avoid foreclosure.

But amid all the scary headlines, something really weird happened: subprime stocks rebounded. On one day, New Century stock shot up 101 percent. Wall Street wags call it a “Dead Cat Bounce.” Hopeful investors get back in only to have the stock tank again. Are they crazy? Or maybe, crazy like a fox? Here’s Marketplace’s Bob Moon.

BOB MOON: Sometimes, those numbers can be tempting.

THE NUMBERS: Financial stocks were back in demand. Stock in Accredited Home Lenders managed a big rally, closing up 56 percent. Novastar Financial shares bounced back 23 percent . . .

But before you jump at what sounds like a chance to get rich quick, consider the advice of a successful market professional.

David Dreman is chief investment officer at Dreman Value Management. He says the gyrations in the stocks of subprime lenders have actually created what’s likely to be a sucker’s bet.

DAVID DREMAN: There’s no question some will work out alright, but the probabilities aren’t that high that a lot of investors will make money here. Many of them will lose money.

Sure, the values of some companies did more than double over the course of a few days, but Dreman points out percentages alone can be deceiving.

DREMAN: We’re talking about stocks that have gone from . . . thinking of something like Novastar. Its high must have been 36-40, and it got down as low as 5, maybe 4, and so it’s up 50 percent to 6. But it’s still well below the highs. Even at 6, it’s only a pittance of what it was, say, two or three months ago.

Not to mention the chance that a few big hedge funds can cause a warped view of what’s really happening to particular stock prices.

TV investment guru Jim Cramer has taken some flack lately for being candid about that. He spoke in an online interview on his Web site, TheStreet.com

JIM CRAMER: I think it’s important for people to recognize that the way that the market really works is to . . . is to have that nexus of . . . of hit the brokerage houses with a series of orders that can push it down. Then leak it to the press, and then get it on CNBC, that’s also very important, and then you have a, kind of a vicious cycle down. It’s a pretty good game.

[SOUND: Tennis racket]

MOON: Tennis, anyone?

MEIR STATMAN: People think of trading, very often, as if they’re playing tennis against the wall.

Meir Statman is a professor of business psychology at Santa Clara University. He says if you wouldn’t bet $10,000 on a match with a top-ranked tennis star, think about that when you’re going up against the big guys on Wall Street.

STATMAN: This is a game against an opponent who possibly is very, very skilled . . .

[SOUND: Tennis player grunting, crowd cheers]

STATMAN: . . . and that player might kind of look like he’s going to hit it to the left, and hit it to the right just as you position yourself to the left.

And if tennis isn’t your game, Statman has another way to explain it:

STATMAN: When you trade in the market — when you sell a subprime — somebody is buying it. Are you sure that you are the smart one in the trade? Because you should know that there’s an idiot in every trade. And if you don’t know who that is, it is likely you.

If you just can’t suppress your inner idiot, Statman says at least draw yourself some boundaries.

STATMAN: It really is a good piece of advice to separate your money into sort of serious money, and money you can afford to lose. People have put the percentage at, say, 5 percent or 10 percent money you can afford to lose — if, in fact, you’re inclined to do it. I’ve convinced myself that I cannot tell where the market is going to go next, and I’m quite happy not to do it.

Even though he’s written a book about the benefits of being a “Contrarian Investor,” David Dreman says there’s an important difference between a stock that’s cheap but risky and one that’s truly a bargain.

DREMAN: The most successful investors over time are those that don’t go for the flash, but really buy solid companies and hold on, and continue to buy good opportunities as they’re made available with strong fundamentals.

The experts we spoke to say spreading the risk with a well-diversified portfolio is the best way to invest safely.

In Los Angeles, I’m Bob Moon for Marketplace Money.

As a nonprofit news organization, our future depends on listeners like you who believe in the power of public service journalism.

Your investment in Marketplace helps us remain paywall-free and ensures everyone has access to trustworthy, unbiased news and information, regardless of their ability to pay.

Donate today — in any amount — to become a Marketplace Investor. Now more than ever, your commitment makes a difference.