Dead Cat Bounce or Real Recovery? Lessons from 1930

In financial markets, a dead cat bounce refers to a short-lived recovery during a prolonged decline, a fleeting rebound that can mislead investors by giving the impression of a market turnaround but often precedes further losses.

• The S&P 500 lost 19% of its value between February 2025 and April 8, six days after the “Liberation Day” tariff announcements.
• As of May 16, it gained back 20% in value, despite no formal trade deals being signed between the U.S. and any other country. 

A Familiar Pattern Playing Out Again

 Understanding these historical patterns helps us develop resilient strategies for today’s investors. In the 1932 U.S. election, Franklin Roosevelt defeated the incumbent Herbert Hoover by a wide margin (18% more in the popular vote and 472 to 59 in the electoral college). His campaign song was “Happy Days Are Here Again,” a choice that in hindsight feels remarkably fitting given his four terms. The irony is that the song was written in 1929, during the final stretch of the Roaring Twenties and just months before the crash that marked the start of the Great Depression.

There are some striking parallels between that period and today’s U.S. equity markets. A brief chronology:

• The Roaring Twenties were an explosive decade for stocks. The S&P 500 equivalent rose 72% from January 1928 to October 1929.
• When the crash came, the S&P 500 peaked at 30.55 and quickly dropped 38% to 19.9 by late November 1929.
• What followed is less well known. Markets recovered, and by April 1930 were up 29% to 25.86. That was the dead cat bounce of the Great Depression.
• Two months later, Hoover signed the Smoot-Hawley tariff legislation into law. (Starting to sound familiar?)
• The real damage came over the next two years. By June 1932, U.S. stocks had dropped 83%, bringing the S&P 500 to 4.4.
• Markets then rallied, rising 308% by spring 1937, but that only brought the index back to 18.1.
• A second low came in April 1942, five months after Pearl Harbor and just before the pivotal naval victory at Midway.
• It took nine years after WWII for the S&P 500 to finally return to its 1929 level, nearly 25 years later.

Fast-forward to May 2025

As of May 18, 2025, U.S. markets have retraced almost all their losses since Liberation Day (April 2, 2025). The TSX even hit a record high last week. 

At the risk of sounding like a contrarian, I feel it’s worth bringing a measured perspective to the current euphoria taking hold in equity markets. That said, I also agree with John Maynard Keynes’s observation: markets can remain irrational longer than you can remain solvent.

Cautionary Signals from the U.S. Market

For Canadian investors with U.S. exposure, these signals highlight the importance of regularly reviewing portfolio risk. Let’s start with U.S. markets, the economy, and debt. Here are a few of the signals I’m watching:

• The S&P 500 is close to record highs and now trades at a PE ratio of about 28. The long-term median is closer to 18.
• The more conservative CAPE Shiller index, which uses 10-year smoothed earnings, is at 36. This is higher than in 1929 and exceeded only during unusual periods like the dot-com bubble.
• The S&P 500 dividend yield has dropped from 2% to 1.24% over the past five years. This reflects earnings not keeping pace with rising prices. Today, the earnings yield is 3.57% (gurufocus.com), which is one standard deviation below the 20-year median of 4.62%. The only times it has been lower were post-COVID and during the Global Financial Crisis.
• U.S. GDP declined at an annualized rate of -0.3% in Q1 2025. While modest, it’s a sharp drop from 2.5% growth in 2024. Much of this is due to front-loading of imports before tariffs kicked in. Not a strong foundation for future profit growth.
• According to Trading Economics, corporate profits in many major economies are expected to fall in 2025. The U.S. is projected to see a 12% decline. With historically high PE and CAPE ratios, it’s difficult to see how stock prices can continue to rise as profits fall.

I’ve focused on numbers because, as Damon Runyon said, they may not tell the whole story, but they improve your odds when placing your bets.

Tariffs and Inflationary Pressures

 Trump and his administration backed down quickly and significantly after their Liberation Day announcements about tariff rates for many foreign countries. However, tariffs did not fall to zero.

 According to the Yale Budget Lab, average tariff levels are expected to reach 17.8% in 2025, up from just 2.5% in 2024. That is essentially a 15% tax added to most imported goods in the U.S. Either importing companies absorb that cost and see their margins fall, or they pass it on to other businesses and consumers. In either case, prices rise and the resulting inflation creates additional pressure on interest rates. None of that bodes well for corporate profits, employment, or economic growth. 

A few weeks ago, I wrote about U.S. federal debt and deficits being at record levels. In early April, shortly after Liberation Day, the U.S. government bond market reacted poorly to a Treasury auction that drew little demand. Investors seemed preoccupied with the flood of new tariffs and the risk of further political disruption. That moment was enough to make Trump pause and begin walking back some of the more aggressive tariff plans. But we should be clear: reduced tariffs are not trade deals. They can be changed again before anything is signed. And why would any country trust the U.S. to honour new deals after tearing up the ones already in place? Meanwhile, none of this does anything to address the core issue: U.S. fiscal imbalances.

Congress is about to receive the 2025/2026 budget proposal. Predictably, it faces resistance from Democrats, but also from Republican fiscal hawks who are beginning to acknowledge a more urgent risk. The U.S. is approaching a point where foreign buyers may no longer be willing to automatically purchase or roll over its government debt. At the same time, Trump wants to maintain and even cut taxes for high-income earners, while potentially reducing programs like Medicaid or Social Security. That sets the stage for a political battle that could bring further volatility to both equity and bond markets. Over the past 25 years, U.S. debt-to-GDP has climbed from 55% to 124%. There are countries with higher ratios, but few rely as heavily on outside capital as the United States.

As of May 22, the U.S. Congress narrowly passed a budget that now moves to the Senate. This budget approves a deficit of over $3 trillion, or over 7% of U.S. GDP, significantly higher than most other G7 countries. If the full budget is passed, the debt ratio referenced above will increase by trillions of dollars over the next decade.

These macro shifts reinforce why adaptive planning, not prediction, is essential, and something we build into every client strategy.

Playing Defense

Rereading this, I realize I may come off as a bit of a downer. But I’m usually a glass-half-full kind of investor. This environment, however, seems extraordinary, and at times, extreme. We’ve long believed at Nicola Wealth that playing defense isn’t about retreat, it’s about positioning portfolios to weather volatility while staying aligned with long-term goals.

I recently rewatched Remember the Titans, which I highly recommend for football fans. At the end of the movie, the team is down 10 to 3 with only minutes to play in the state championship. Of course they won, or they wouldn’t have made the movie. The key to the comeback was an incredible defensive stand that gave them the chance they needed. 

This is one of those times. Playing defense is not about standing still. It is about being thoughtful, strategic, and prepared.

1. Revisit your asset mix. Make sure it’s truly diversified, not just across sectors but across asset classes. Fixed income, private equity, income-producing real estate, and infrastructure all bring different qualities to a portfolio. Broad diversification isn’t just a principle, it’s part of how Nicola Wealth has sought to help clients weather volatility for decades while aiming to generate meaningful returns.
2. Aim to generate a cash yield of 4% or better across your portfolio. Rents, dividends, and interest income are less volatile than the price of the assets that produce them. Reliable cash flow gives you breathing room when markets are moving fast.
3. Within equities, focus on dividend yield, but more importantly, on companies with a strong record of increasing those dividends over time.
4. Consider reducing exposure to U.S. public equities. The chart below shows the PE ratio for the TSX alongside its 20-year average. The TSX is not cheap, currently trading around 20 times earnings, but that is still roughly 30% lower than the S&P 500. It’s also worth noting that the TSX dividend yield sits at 2.76%, more than double that of the S&P 500. The Dividend Yield on the Nicola Canadian Equity Income Fund, for instance, is at 4.5% (as of April 2025), and this kind of yield potential is one of the ways we’re positioning portfolios defensively.

We are not trying to predict the next move in the market. We are focused on preparing portfolios that can hold up through a range of scenarios. Successful investing, especially in uncertain times, is about consistency, liquidity, and protecting capital while still pursuing long-term growth.

Looking Ahead Means Preparing, Not Predicting 

We’re about two months away from the end of the current tariff pause. Will meaningful trade agreements be in place by then? Probably not. These things typically take years to negotiate, not weeks. 

Tariffs will remain in some form. Likely not enough to solve the deficit problem, but enough for Trump to declare victory. We’re entering a phase of market uncertainty not unlike hurricane season: the timing may be unclear, but the risk is real, and preparation is everything. We can’t prevent the storm, but we can make sure we’re as prepared as possible for whatever damage it brings.

If uncertainty is the only certainty, then preparation is your best strategy. For investors, this begins with a conversation about what your portfolio is built to withstand. At Nicola Wealth, we continue to focus on what we can control: sound planning, broad diversification, and building portfolios that generate consistent cash flow and are positioned to hold up across different market environments.

As with COVID, the financial crisis, and the cycles that came before them, this too shall pass. The real question isn’t whether we’ll make it through, but how well we position ourselves along the way. That’s where our focus remains, not reacting to headlines, but staying grounded in strategy.