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Bulkowski’s Blog Archive: BSC

Blog Posting: March 17, 2008, Dead-cat Bounce in Bear Stearns

The chart shows what happened to Bear Stearns as of Friday’s close. News reports say that JP Morgan has purchased the company for $2 a share. I guess there is a reason the company was called not Bull but Bear Stearns. For the employees with $100,000 in their 401K company stock purchased back in October 2007 for $134 a share, it is now worth less than $1,500. Plus, they will likely be out of a job soon. And all I had to worry about this weekend was an infestation of aphids in my arborvitae.

One wonders who will be next? It is probably a good time to review the dead-cat bounce (DCB) chart pattern. When a stock tumbles like BSC did on Friday, usually there is a gap on the chart because news of troubles are announced when the markets are closed. The decline can span the range from 15% to 70% or more, depending on the severity of the news. A frequency distribution says that 46% of stocks make a lower low the next day (that is, the day after news takes the stock down). In coming days, 17%, 9% and 3% of stocks make lower lows, respectively, but the average decline takes 7 days.

Once the decline ends, the bounce phase begins. The rise in the bounce averages 28% but takes over 3 weeks, so be patient. When you see price cresting, then either get out of a long position or start turning bearish (buy puts, go short, and so on). If there was a gap during the event decline, the bounce closes the gap 22% of the time. I found that the larger the decline, the taller the bounce, just like dropping a ball versus throwing it down.

Once the bounce phase completes, the post bounce decline sets in. This decline is slower, taking price down 30% in 49 days, leaving price below the event low (the lowest low in the stock so far), by 18%. Is that the end of the decline? Maybe or maybe not. If the DCB was caused by an earnings surprise (usually), another dead-cat bounce occurs 26% of the time within 3 months and 38% will DCB again within 6 months.

What does this mean for your stocks? The news certainly is not bullish. More bank bailouts might be coming so remain in cash or tighten those stops. I will likely be stopped out of my small positions shortly. I am 39% in cash and the reason that is so low, is because long term buy and hold positions account for 48% of my holdings. Those are the ones I hold on to during turbulent times (think utility stocks and other defensive issues). They show the most potential but will take years for them to push through the layer of dirt and sprout.

Aftermath

The red line shows that price bounced upward as the dead-cat bounce predicted. What I found surprising was the height of the bounce. Of course, having JP Morgan come out on March 24 and say that they will buy the company for $10 a share helped, revised upward from the earlier offer of $2 a share. Price has been easing lower recently.