Dead Cat Bounce: Intra-day swing of 700 Dow points, ending down 200

Though yesterday’s numbers were eye-popping, today is arguably going to create more jitters. Big intra-day swings that end on lows scare traders. Though China and Japan were down, most of Europe and Asia was up. So the stage was set for an uptick in the US. Which reminds me of the senior equities trader who once told me “Europe does nothing at all till 1pm when the Americans come in to set the tune”. The negative close means the three largest markets, China, Japan and the US closed down today.

There’s the inevitable talk of painting the close. And there is the competing view that the morning session was just a dead cat bounce.

The real story is that Chinese over-investment in infrastructure and capital goods is grinding to a halt (they’ve built more roads, rails and apartments than they need). It’s all fueled by large increases in borrowing which is what causes most bubbles. Given the size of the Chinese economy, this has had an impact on resource prices (who is going to use all that oil and iron). At the margins, this will impact US businesses, especially the global behemoths. There are some parallels to the US situation in 1928, also coming at the end of a period of extensive capital investment (also in railroads) and when the US was emerging as a major economic powerhouse.

The backdrop is that US stocks are at cyclically high valuations, at least as measured by longer-term ratios like CAPE. This coupled with a 7 year long rally means a lot of people are rightfully wondering whether stocks can go higher.

As an aside, over 80% of stocks on the Shanghai exchange were untradable yesterday. Many of them because they hit the daily limit of a 10% fall in prices, the rest are suspended at the request of company management.