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Have we just seen a dead-cat bounce in the stock market and will shares plunge again?

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After such a strong uplift from the coronavirus lows of the spring, many believe the buoyancy in the stock markets could be a dead-cat bounce.

It’s a horrible expression, I know. But, in finance, brief recoveries in markets and share prices have become known as dead-cat bounces because ‘even a dead cat will bounce if it falls from a great height’.

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But unfortunate, lifeless creatures don’t move much after that. And the implication is the market may plunge again, perhaps even dropping lower than before.

False dawns in the stock market

And the history of stock markets has many examples of such false dawns. However, as with trying to predict all movements in shares, nothing’s certain. It’s also possible for the market to continue rising. We may, indeed, have already seen the bottom of the 2020 crash.

As investors, we should be prepared for both outcomes. And, in either case, I think the best way to handle the situation is the same – keep investing. After all, if we select shares backed by good-quality businesses and invest with a long time frame in mind, we could do well.

The coronavirus crisis caused governments to shut down economic activity around the world. And we’ve never seen anything like that before. The way stocks usually react to unknowns is by trying to adjust valuations to accommodate them. But because the effects of the pandemic were unquantifiable to start with, it’s not surprising if share prices overshot to the downside.

So it’s rational that, as recovery begins to gather pace in businesses and economies, shares will rise to re-adjust to the new information. If shares continue to rise from where they are now, I reckon it’ll be driven by the emerging strong and rapid recoveries we’re seeing everywhere.

If the improvement continues, why shouldn’t shares continue to move back towards prior levels? And if that’s the case, it makes sense to keep buying selective stocks and share-backed investments, such as managed funds and trackers.

Why I’d keep investing if markets fall

But if markets do plunge again (that is, more than the falls seen in recent days), I reckon it still makes sense to keep buying. My guess is the world has enough experience to keep Covid-19 under control and avoid another peak in infections. So I’d expect ongoing recovery from the effects of the pandemic.

However, if shares do fall again, it’ll likely be because the markets are trying to adjust for the recession the pandemic is leaving behind. But recessions come and go. Stocks fall and rise. So, if we pick great stocks with strong underlying businesses, or index tracker funds, it makes sense to me to buy them when they’re lower.

In cases like that, we’ll get more for our money and benefit as stocks and their underlying businesses recover when the recession fades. So I’m not allowing fear of a second plunge in the markets to keep me away from investing in great stocks today.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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