2005 Innovative Quant Solutions, LLC

IQS Research Brief

Can a Dead Cat Bounce Make Money?

February 11, 2005


It is a generally accepted belief in finance that stocks that significantly under-perform will bounce back in the
short run and outperform. From value to momentum players, investors acknowledge that short term reversals
occur, but what about after a deep loss? Is it a profitable strategy to short the stocks that go down with or
without waiting for the reversal to occur?

In this research brief, we look at the subsequent returns to stocks that significantly under-perform our IQS 3000
stock universe for one month. Without taking into account transaction costs, or the added expenses to shorting
stocks, we create a nave trading strategy to determine if it is profitable to short these stocks.

According to wordspy.com, a dead cat bounce is a temporary recovery from a major drop in a stocks price.
What exactly is a major drop or a temporary recovery? Each month, we take the stocks with the steepest relative
losses, defined as any return more than 2 standard deviations below the mean return for that month. See Exhibit
I. We then track the returns for this group of stocks over the subsequent 3 months. We analyzed this event
from 1990 through 2004, and share the results below.

Over the entire period, on average, these stocks out-performed the universe in 10 out of 15 years, and by more
than 1.1% per month in the first month after the large losses. In the second month, these stocks under-
performed in 11 out of 15 years, and by .5% per month. And, in the third month these stocks under-performed
in 12 out of 15 years, and by 1.4% per month! See Chart I.

Based on these results, the dead cat bounce pattern seems alive, and potentially profitable if you wait one month
to short these stocks. Exhibits II, III and IV graph the returns by year, and for the entire period, for month 1,
month 2 and month 3. However, lets take a closer look at the more recent data. See the chart below for 2004.

Summary Chart Average Monthly Return for 2004

Month 1 Month 2 Month 3
Average Excess Return -.6% -1.6% -.4%

Which pattern might we see in 2005 - the dead cat bounce in the first month and then further declines, or just
continuing stock losses without the bounce? As with most strategies discovered by looking at past patterns, they
have a tendency to end just after implementation!


IQS Research Brief Can a Dead Cat Bounce Make Money? - February 11, 2005
Chart I Summary Chart


Average Monthly Returns, 1990-2004

Month 1 Month 2 Month 3
Average Excess Return 1.1% -.5% -1.4%
Years Out-Performed 10 4 3
Years Under-Performed 5 11 12


IQS Research Brief Can a Dead Cat Bounce Make Money? - February 11, 2005
Exhibit I Under-Performing Group of Stocks

Average Loss by Year for the
Under-Performing Stocks
-60%
-50%
-40%
-30%
-20%
-10%
0%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
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On average, from 1990-2004, the under-performing stocks were down 33% in the month of determination. The
worst year was 2000, where the average monthly return was -53%, while in 2004, these stocks were down 25%
per month.
IQS Research Brief Can a Dead Cat Bounce Make Money? - February 11, 2005
Exhibit II Dead Cat Bounce in Action!

Average Monthly Excess Return
Versus the Equal-Weight Universe
First Month
1990-2004
Subsequent First Month Returns
After Steep One-Month Losses
-10
-8
-6
-4
-2
0
2
4
6
8
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 ALL
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This graph shows that in most years, the one month dead cat bounce return is significant. In 10 out of the 15
years, these stocks out-performed the rest of the universe one month after their big negative losses. In 1990,
1996, 2000 and 2004 these stocks did not have a noticeable bounce - they continued to under-perform.








IQS Research Brief Can a Dead Cat Bounce Make Money? - February 11, 2005

Exhibit III Second Month is Mixed!

Average Monthly Excess Return
Versus the Equal-Weight Universe
Second Month
1990-2004
Subsequent Second Month Returns
After Steep One-Month Losses
-10
-8
-6
-4
-2
0
2
4
6
8
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 ALL
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This graph shows that after a one month bounce back, these stocks with big losses continue to under-perform.
However, in 2001 and 2003, these stocks out-performed in both the first month and the second month.


IQS Research Brief Can a Dead Cat Bounce Make Money? - February 11, 2005
Exhibit IV Third Month is Down Again!

Average Monthly Excess Return
Versus the Equal-Weight Universe
Third Month
1990-2004
Subsequent Third Month Returns
After Steep One-Month Losses
-10
-8
-6
-4
-2
0
2
4
6
8
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 ALL
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This graph shows the return in the third month for stocks with large relative losses. Note that with the
exception of the unusual 1999 bubble year, until recently there were no occurrences in which the big losing
stocks out-performed in the third month.