A Dead Cat Bounce
Jude Wanniski
July 10, 2002


Memo: To Website Fans and Browsers
From: Jude Wanniski
Re: Bouncing along Wall Street

One of the most colorful terms that has made it into the Wall Street lexicon is "a dead cat bounce," which I've been hearing lately every day on the Bloomberg station on the way to and from work. The Dow Jones Industrials have been falling little by little for two years, Nasdaq by a lot. Just when it seemed the slide would never end, the DJIA seem to have hit bottom at 9000. The rise to around 9300 is not expected to be the start of a new bull market, but is simply the bounce of the dead cat. There is no sign of any energy or enthusiasm for a steady climb in the value of financial equities.

What was this bounce all about? As we advised our institutional and individual clients last Wednesday, the most recent sell off on Wall Street was due to the fears that the political terrorists would be back to do something catastrophic on the July 4 holiday. I wrote: "The market equity slide of recent days almost surely involves investors hedging in advance of the holiday weekend as there have been so many warnings of another incident. I rather doubt there will be any incidents at all in this period. The terrorists who struck at 9-11, I've always believed, did so to get the attention of the United States, which had been ignoring the Middle East except to plan for a war with Iraq -- which also seems more distant now. Once President Bush committed himself to a Palestinian state within three years, there is no reason for Islamic terrorists to disrupt that process, and if they had something cooking for this weekend, they would put it on hold."

Here is more of that July 3 client letter, to give you a sense of the analytical framework we use:

We greeted the President's peace plan for the Middle East with mild enthusiasm on June 25, noting that the price of gold did the same. Gold had climbed to as high as $328 as violence in the Middle East and the subcontinent appeared to be getting completely out of hand. Its decline to $312 cannot be a reflection of good news on the fiscal front, as that news continues to worsen with increased deficits at all levels of government. For the most part, I have to conclude that the chances of increased violence in the Middle East spilling into the United States are steadily lessening as the Israelis and the Palestinians take small, significant steps back to a peace process.

The New York Times this morning reports on its front page that a very important cluster of Palestinian intellectuals and politicians have begun to openly question the use of suicide bombers in the struggle with Israel. Hanan Ashwari, a Palestinian legislator, seems to have taken the lead in getting 54 other opinion leaders to publish an appeal in the June 19 Arab newspaper, Al Qud, urging those behind the bombings targeting Israeli civilians in Israel proper to "stop pushing our youth to carry out these operations." The militants of Hamas denounced the Ashwari appeal as a sell-out, and of course there may be further suicide bombings down the line. But the appeal itself, and the relative quiet in recent days, has giving the Sharon government an opportunity to take small concessionary steps in parallel. By dismantling ten of the newest "settlements" on the West Bank and today lightening the curfews in selected communities on the West Bank, the Israelis are thus "empowering" Ashwari -- who I think would be the best replacement for Arafat if he is kicked upstairs in the January election process. I've watched her over the years being interviewed on our television shows for Palestinian viewpoints and have always marveled at her political skills. It would also be easier for Sharon to negotiate with a woman, I think, as he is innately combative with men.

These movements away from international violence suggest further declines in the dollar/gold price, with a bottom of perhaps $300. We're out of the terrorist frying pan back into the deflationary fire. By our rough-and-ready rules of thumb, the Dow Jones Industrial belong under 9000 at that price. If $350 is equilibrium, we would have to decline to 8600 on that account, although a lower risk of terrorist disruptions to the economy would work in a positive direction.

As you see, in our framework the dollar price of gold is very much a part of the movements of nominal equity values on Wall Street. If you have never thought of the concept before, don't be surprised, because Polyconomics, Inc., which can be found at http://supplysideinvestor.com, is the only firm of its kind that uses the gold signal as one of the key variables. Without it, we could not have foreseen last Friday's bounce.