How Will We Know When the Markets Hit Bottom?

The market is down so much from its October 2007 highs that many analysts and pundits are exploring the question of whether we've hit bottom yet. Statisitics are being trotted out regarding the average length and decline of bear markets in the last 20, 50, or 80 years, or what the lowest P/E ratios, or highest volatility levels, were in previous bear markets, or what other various indicators "say."

There has been a sort of leveling off in the past couple of weeks, since October 10. The lows of that day have not been breached as of session closes. However, if you include intraday activity, there has been so much volatility that even the apparent leveling off looks sketchy. Intraday activity exceeding 5% from top to bottom has not been uncommon.

You know what? We will not know when a bottom has been hit until after it passes. That's the only way anyone ever knows. Until then, any claim that a bottom is at hand is nothing more than a guess. The guess may be educated, and it may be supported by impressive logic, but it is still a guess.

Markets being markets, it does not matter that we have been in a bear market mode for 12 months now, nor that we have dropped over 40% during the decline. Nor does it matter how those numbers compare to other bear markets. Every bear market is sui generis.

Just because we've dropped over 40% (to 877 on the S&P 500 (SPX)) does not mean we could not drop another 40% (to 526). Just because we've been getting crushed for 12 months does not mean that we could not get crushed for another 12 months. Just because logic says we're at or near the bottom does not mean that emotions like fear and panic might not continue to prevail and take us down some more.

It is said by some that because we have dropped so much for so long, we must be closer to a bottom. Well, that's obviously true: You can't drop below zero, and we're closer to zero than we were 12 months ago. But knowing that we are "closer to a bottom" does not tell you much.

The real question is whether the recent leveling off represents early signs of a market recovery or is just a pause before continuing the trip down some more. Only time will tell. And of course, the entire situation is vastly complicated by all of the government intervention taking place. It renders the usual fundamental and technical analysis mostly useless.

For those who like to look for signs of an approaching bottom, look for these:

• A big rally on high volume that is not driven by some sort of unusual government intervention.
• A few days in a row where the market seems to react sensibly to the news of the day. Where there seems to be sanity instead of panic or euphoria. With earnings season in full swing, as well as governments acting around the world, plus the upcoming G20 summit, there will be lots of news to react to in the next few weeks.
• Some persistent reduction in intraday volatility. A few days of 1% to 2% moves would be nice, especially if they seem logically consistent with the news of the day.
• A couple of weeks of generally upward movement, i.e., a trend. Normal noise and zig-zags are OK, but not the kind of intraday whipsaws we've been seeing.

But even if all those events occur, remember that you won't KNOW if the market has bottomed out. But at least it might be safer to peer out from the bushes to see how things look.

I would not purchase any stock or ETF at this time, with the possible exception of a well-valued long term dividend play or a very well-reasoned momentum bet. When the market is behaving this badly, I believe in "waiting for the turn" before risking any money in a stock purchase. There has been nothing that could be called an upward turn recently. The leveling off since October 10 does not count yet, although it could be the beginning of an upward turn. Until a clear turn emerges, I'd wait.

Stock position: None.

Comments

[y3115y:]

The sellers must be exhausted at the bottom.

2008 Oct 26 08:19 AM

[investor88:]

David has taken a wise route ie won't buy anything now and would wait for the turn. This is despite Warren Buffet bull call "cash is trash", Jeremy Grantham turning bull from bear, plus many others.

I respect David's stand, I have come to the same conclusion capital preservation is key in these tumultous times never mind gurus saying "cash is trash". If we pay the price for waiting till after the turn, it is a price worth paying vs being sliced by a falling knife.

2008 Oct 26 10:49 AM

[elliot_mllr:]

I thought that they ring a bell at the bottom.

2008 Oct 26 11:25 AM

[carey_jim:]

We don't but when it does those who guessed right will be called gurus and those who didn't will be called by many other names.

2008 Oct 26 04:02 PM

[Pessimistic...:]

still holding a few good dividend stocks. Price goes down, up goes yield.. then the stock goes up.. you know the rest of the story. A thought, if the bottom hits, I am in.. if not, I am not hurt near as much with thse high flyers.

2008 Oct 26 10:13 PM

[Ahab:]

The best, patented, sure fire test for the bottom is when you don't care any more.

2008 Oct 27 06:47 AM

[alajac:]

Pessimistic Optimist- The yield only goes up for new buys at the lower prices. Your yield (based on your buy price) doesn't change.

We are going to keep going down until the current broken system is replaced. See my HOW TO FIX THE ECONOMY plan in my other comments.

I'll call the bottom just like I called the crash in an email sent out on June 3rd.

2008 Oct 27 09:12 AM

[alajac:]

And like I said in mid-July that oil would see $20 before $200.

2008 Oct 27 09:13 AM