Four Commonsense Clues to a Genuine Market Bottom 52 comments
-
Font Size:
-
Print
- TweetThis
Financial literature and "how to" books about the market are filled with anecdotal advice on catching market bottoms. And who can blame them. Investing at or close to a bottom and realizing maximum returns from a sustainable bull market is the eureka scenario for any investor.
A lot of bottom-catching advice is contrarian in nature and goes something like this: If The New York Times declares that a full fledge bear market is upon us, that means that the bottom has been reached. Or if your aunt Judy has thrown in the towel and liquidated her 401K and mutual funds, it is now time to buy since aunt Judy represents the panic and misunderstanding of the market by the common people.
Other more technical strategies look for certain chart patterns like the reverse head and shoulders, a moving average cross, or the upside-down flounder (I made the last one up.)
The fact is that in this most recent market sell-off, we saw these "buy signals" at Dow 11,000, Dow 10,000 and Dow 9,000, and here we are at Dow 8,000.
I propose a different approach. Instead of reading tea leaves or trying to measure aunt Judy's blood pressure for signs of a market bottom, we use a heuristic approach to try and figure out when the market might be close to bottoming:
1. Energy Prices. We may recall that in the beginning of 2008 one of the reasons for the market's poor performance were the soaring energy prices. When oil crossed the $100 per barrel mark, market indexes became negatively correlated to the price of oil. It is reasonable to assume that as energy prices continue to slide down, a sustainable bottom will be reached, at least for sectors that rely heavily on petroleum products.
2. Stock Prices Start Reaching Book Value. A good indication of a real market bottom is when market prices start to reach book value levels ('assets minus liabilities'). At this point it is likely that we will see buyout firms try to take advantage of the situation and buy companies or take them private. An increase in M&A activity and buyouts would certainly indicate that investors are ready to commit large amounts of money to the market.
3. Unemployment Levels Stabilize. Let's face it, the retail investor will not invest his savings and 401K plan into the market if he feels that his job is not secure and he might need access to quick cash. In order to get the retail investor back into the market, the fear of job loss has to subside. I certainly don't see that happening in the next six months.
4. Composition Changes in the Market Indexes. As I wrote in my book The Stock Market Philosopher, an index that goes down is not the same index that goes up. By looking at the NASDAQ over the past eight years we can clearly see that many of the companies that were part of the index during the bursting internet bubble went bankrupt or got delisted from the NASDAQ following poor performance. When the NASDAQ recovered it was partially due to the inclusion of healthy new companies such as Google (GOOG) and Baidu.com (BIDU). It may seem that a rebalance of the index holdings should have nothing to do with the health of the economy, but it has certainly worked that way in the past and I will look to big changes in the make up of the S&P 500 and the Dow to signify a bottom in the index prices.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 52 comments:
Actually, you did a good job with the heuristic part: since no one can reliably predict a "market bottom", let's give ourselves other puzzles to informally solve that may or may not be indicative of a market bottom.
None of the above points (despite being numbered) come any closer to being "solvable":
1. When do we declare an energy price bottom?
2. Well, okay, maybe this point is closest to being correct, but how many (and which) companies continue below book value, and go bankrupt?
3. After how many drops in employment levels, as in the market, do we consider employment "stabilized"?
4. This is actually a good point, too, but again, which companies will be proven to be "healthy"? Changing the indices still depends on reading the tea leaves to get the "right" companies.
Nice concise little use of webspace, and good thinking-outside-the-b... I don't think anyone, however, will bring us much closer to figuring out when our recession/depression will reverse....
Take a look at Jeff Rubin's (CIBC World Markets) report that attempts to provide hard evidence that each major economic downturn this century was immediately preceded by a spike in oil prices. Note that I'm not saying that *I* believe that this is the case, I'm just pointing out a potential body of evidence that argues the point counter to yours. Make up your own mind. Here's the link to the report:
research.cibcwm.com/ec...
The chart/data that I'm citing is found at the bottom of page 4.
At least, you have put some effort and discipline into your approach!
That said, it is my opinion that we make a mistake when we attempt to view a true bear market bottom as a singular event rather than a PROCESS of price/time.
The so-called bottom of 2002-2003 spanned the better part of 5 months as I recollect!
Are you measuring this by net book value, or net tangible assets?
And, regardless, part of the bottoming process is that there will be companies you could make a lot of money taking private, but that won't happen because of the lack of credit. Eventually the values will build up, the system will delever, and then value vultures will step in and create a bottom.
At least, that's how I see it...
I suspect the market will not begin to make a sustained rally at least until earnings start to rise again.
The aunt judy contrarian signals i really agree with - and we aren't close to being there yet. All the expert (ie dumb) financial planners on TV are telling boomers to wait it out. The market still has a world of pain to inflict on this aging herd who are still confident they have a 10-20 year outlook. When the S&P hits 650 they may start puking en masse, it will be time to start paying attention. Once they have said "uncle" i'm in.
The one thing you have to think about - is that this economic situation will be a drawing line between the haves and have nots - and i'm speaking of debt. So in a sense there will be two "equity markets" to think about going forward. We have not seen debt like this - personal, corporate, government - and it is possible the bottom may not look like what we are used to seeing. I've dealt with LBO financing a lot and the one thing i will say is that it takes a long time once you are full on debt and start to have stuff blowing up around you, to get that down takes a long time and your competitors start leaving you in the dust if not smelling blood and starting an all out assault. A list of the nonbank S&P 500 who have debt to cash flow under and over 3.0 or so and no near term refinancing issues -now that would be a good index to track.
We haven't even started with stories about potential problems with China funding our gov't bailout sprees, war debt and trade deficits. No one is even thinking about inflation yet - but are printing money like its free.
Seems to me we still have a lot of mental baggage to work through and haven't even booked an appointment with the shrink yet. If I would corrolate to the Kubler Ross scale en.wikipedia.org/wiki/..., i'd have to say john q public is nearing def con 3.
Yes, it is possible for the market to decline 50% from today’s level but interestingly, I cannot find a Vegas or elsewhere book willing to take the bet! “You betcha!”
"There was a climax selling in October, the US markets were down 18% in a week. In history when you buy into a selling climax you always make money. Let`s see in 2, 3 years." Jim Rogers
jimrogers-investments..../
i think a general market bottom is near now, simply because i hear more and more 'experts' saying that we will be in a deflationary phase for a long time and oil could go to 5 (yes, FIVE) dollars....
i am buying dips on oil etfs these days... (and commodities)... will double my money or more within 2 years the latest...
ah, but this time wall street was one of the causes of this economic crisis so we have an economic linking this time. but the dow will now do whatever the dow will do.
for me, i see the real problem as less buyers. and for a multitude of reasons - i do not see these buyers coming back in their former quantities. even with good economic news, i doubt we will see a strong bull market anytime soon.
Till I don't hear that investors from Dubai bought a few billions homes in USA I will not remain confident of anything.
Rest of the article is more of the same...but still worthwhile..
3 Cramers - not bad! - congrats. You would have earned an extra Cramer if you had included some reference to "Moving averages" , "Stochastics", or other magic.
Employment is a lagging not a leading indicator. Once employment rises you will be +20% from bottom. Thanks for coming.
Oil is an very indirect inficator of economic activity and mostly in emerging - energy intensive markets - has little to do with market bottoms or top.
Market indexes - huh? That's a good one. As in "funny" good, not "good" good.
Book value - you are kidding right
This is really drivel even by the standards of web schlock - it is in the Cramer category.
Stock prices are driven by earnings and value relative to other risk-free assets. Once the Earnings yield vs. US treasuries reaches the right spread threshold - stocks rise. We are probably close. Right now 2009 is nicely discounted. Maybe it will be worse - could be - if you think that - short the market - if not buy.
Take care.
Although, if a really long and deep depression hits, they (PE guys) might eventually be forced to sell their portfolio companies just to liquidate their funds, creating an uptick in that very M&A activity... But lets not think of that scenario...
An interviewer back in the '60's once asked Mick if he thought the Stones had "progressed," (as in progressed forward as a band.) Without missing a beat, he answered, "I don't think a "progression" really exists, because at any given time, you never know whether you are going forwards, backwards, or sideways."
Think about it. Isn't that true?
Today, we could ask ourselves if the market is going up, down, or sideways. The truth is no one knows where the market will be tomorrow, or the next day, or next week, or next month, etc. If we really thought we knew, we would bet everything we had on it. But, we don't make that bet because we aren't sure.
So, has the market bottomed yet? We don't know. How can we tell? Well, the only way to really know is to look back in time and see. We can see a bottom in 1932 for the 1929 crash, and we can see bottoms in the '87 and dot com busts clear enough because we are far enough in time away from them. Those are obvious. But for this meltdown, we won't be able to see the bottom, and know it is truly the real bottom, until long after it is past. And for this mess, it will take a very long time after its past to really know.
Don't forget, there were many "bottoms" between '29 and '32 that actually looked like the "real bottom," where the market went up 20 to 50% each time, but it wasn't until the market was down 89% from the peak, did we hit the "real bottom." We have yet to recover even once since the top last year, anywhere near 50%, yet people are wondering if we have bottomed yet. Its probably much too early, folks.
I think its good to look at the macro view and see how everything is looking economically all over the world. The way I see it right now, it looks HORRIBLE everywhere. It also looks like things are just getting started in their melting process. Don't forget, some of the underlying causes of our problems now, have been decades in the making.
I am all in cash except for 7% in double inverse index ETFs. My entire perception says we are going down big time from here over the next 3 to 6 mo short term, to about 2 yr long term. A lot of leverage has to unwind, and it may take awhile as governments try to create a smooth drop into a soft bottom.
So, because we can't find the bottom until long after its taken place, mathematically speaking, the optimum way to get back into the market is to begin to buy in spurts before the bottom gets here. Probably about the time you don't think things could go any lower would be a good time to edge in maybe 10%. Then wait for that feeling again and go in another 10%, all the while keeping on top of the world wide macro conditions. Of course, there is no set way to do this, because its your EMOTIONS that will dictate how you proceed, and we all know what wonderful leading indicators they are.
And that's the real problem, because logic, technical indicators, etc., etc., don't work in predicating the future. It may look like they worked yesterday, but that was a coincidence. Nobody can drive a car by looking in the rear view mirror. So all we have are our emotions. But that's as good as it gets, so best of luck and try to have some fun in the process.
What was Nasdaq 5000 'looking forward' to? What was the Dow forecasting when its PE was 8?
The idea that markets turn in advance of the economy is baloney which stems in part from bad research methods, matching the final, revised historical GDP data from a given period with the stock index prices at the time... with no regard for the TIMING of each piece of information: the final edition of GDP data is often not available until YEARS after the date in question. At a MINUMUM it's not available until at least a month after the fact. In five years, if you compared current S&P with current GDP you would be making a grave error, because we only 'know' PAST GDP at present.
Cheers
GT
What was Nasdaq 5000 'looking forward' to? What was the Dow forecasting when its PE was 8?
The idea that markets turn in advance of the economy is baloney which stems in part from bad research methods, matching the final, revised historical GDP data from a given period with the stock index prices at the time... with no regard for the TIMING of each piece of information: the final edition of GDP data is often not available until YEARS after the date in question. At a MINUMUM it's not available until at least a month after the fact. In five years, if you compared current S&P with current GDP you would be making a grave error, because we only 'know' PAST GDP at present.
Cheers
GT
What we see in corporate filings is basically about as plausible as the 'pro forma' balance sheets that are found in IPO prospectuses: the SEC doesn't give a rat's patootie unless a company actually falls over.
I can't believe that folks who have just lived through Fannie and Freddie (remember their accounting frauds started being discovered almost FIVE YEARS AGO) would advocate price to book (or price to NTA, or pretty much any Balance Sheet ratio).
Just use price to trailing PEAK earnings, and you'll find the relationship is actually pretty interesting.
Cheers
GT
> So many people think this is the low...so, this is almost certain
> to be the low. How could so many be wrong?
Indeed! We should take a vote! That will tell us if we are at the bottom! :-)
Momentum trading, technical analysis - those are day trading techniques, with very high risk. All gamblers eventually lose. The only thing more risky is letting some media guru like the Cramer tell you what to do.
Never invest in anything that you wouldn't be willing to commit to for 10 years. If you can't do that, you have no business in the stock market (older retirees included). If you buy a future stream of earnings that your careful analysis tells you should yield a 20% long term ROI, you shouldn't care if it gets even cheaper. You got a great deal!
> Cramer is the gold standard of investment advice schlock. 5 Cramers
> is the ultimate schlock advice. You get a 3 Cramer rating.
Have you noticed that in the last week or two Cramer has reversed course? He formerly was "Stocks are cheap! Buy, buy buy!" But lately he's been saying, "Keep your powder dry," and "Techs are nowhere near the bottom yet." Can we use him as a contrarian indicator now and proclaim a bottom?
Unfortunately, I believe that Cramer just wants to get on the "me, too" bandwagon before he makes (an even bigger) fool of himself, and he doesn't really have a clue (as usual). We are nowhere near a bottom, yet.
A couple of remarks I heard today, both replete with scholarly and compelling arguments: "Stocks will fall 15-20% more" and "The DJIA will be at 6400 by the first week in December."
Check your own tea leaves, charts, and economic intuition and act accordingly.
On Nov 19 02:44 PM GeoffreyT wrote:
> Whooper - stock prices don't lead a damned thing: they are about
> as forward-looking as a day-old meatloaf. You're repeating what I
> refer to as a Kudlowism (something that sounds high-falutin' but
> is not borne out by the evidence). The belief that stock prices incorporate
> an unbiased expectation of the present value of future income streams,
> is based on a very flawed understanding of the Rational Expectations
> Hypothesis.
>
> What was Nasdaq 5000 'looking forward' to? What was the Dow forecasting
> when its PE was 8?
>
> The idea that markets turn in advance of the economy is baloney which
> stems in part from bad research methods, matching the final, revised
> historical GDP data from a given period with the stock index prices
> at the time... with no regard for the TIMING of each piece of information:
> the final edition of GDP data is often not available until YEARS
> after the date in question. At a MINUMUM it's not available until
> at least a month after the fact. In five years, if you compared current
> S&P with current GDP you would be making a grave error, because
> we only 'know' PAST GDP at present.
>
> Cheers
>
>
> GT
GT:
Of all the components of the government's index of leading economic indicators, stock prices have the best record of predicting future economic activity. By far. Check it out.
Whooper
2-Stoick prices are reaching book value because future earning expectations are horrendouse, the consumer is broke. Who is gonna buy out a company, with what money?
3- Rise in unemployment has only just begun, where it stops is anybodies guess
4-Market Index changes- well yea, Im sure that will happen but who know when and then what like moving the chairs on the Titanic
He said " use a heuristic approach to try and figure out when the market might be close to bottoming:" Why, nobody is or has been able to do that in this market, better to just wait to hear the "SPLAT" see the stain adn then you will know we hit bottom.
We are very nearly there..or are infact there
The recovery,however, will be slowed by the USA car industry mess.
Would you please tell us what Stock Prices were "predicting" during the months of July, August, and September of 2007 ??. We should find your comments most interestng.
A more pertinent question for truth seekers would be what was the stock market predicting during the months of October, November and December of 2007and the months of January, February, March, April, May, June, July, August, September, and October of 2008.
Whooper
On Nov 20 12:45 PM SeekingTruth wrote:
> To Whooper1:
> Would you please tell us what Stock Prices were "predicting" during
> the months of July, August, and September of 2007 ??. We should find
> your comments most interestng.
Did you see the Star Trek with Spock dying? He went through genesis. He came back but he came back a changed Vulcan! You, I, or anybody else cannot predict what the next moves the markets will act on. We have all seen it.. at the drop of a hat lemmings bail out ,shorters act quickly with the precision of a surgeon's scalpel and bam.. everything goes to *#^@. Unfortunately, the vast majority, if not all of us have felt that cut.
I agree that those companies which can cling to whatever lifeblood remains until the dust clears will be stronger but they will be different than they were before this cluster%^$# happened. They will have metamorphisized into a much more efficiently run company.
This is my take on what we're going to witness.. after the all indices bubbles burst, I also believe it will be a process not an event. If you have the moxie.. dig in and hold your ground. If not, get out. One last thought, even if you miss the true bottom, stocks are so damn cheap right now that at100 points off, you will still prosper.
The LEI doesn't predict anything - it is created by curve-fitting, and the parameters are not stable (it is re-estimated periodically). Any regression with more than five explanatory variables - some of which are not of the same order of integration as the dependent variable - is worthless... which is what anyone should expect from a statistic generated by a pack of bureaucrats.
The market looks SIDEWAYS. At best. Participants may be forward-looking - that is, they attempt to form expectations about the future - BUT... their expectations are formed in an ADAPTIVE way, and their information set - even the historical bit like recent economic statistics - is subject to a large degree of uncertainty.
I've done plenty of work on expectations formation, including being asked by the Australian government to provide them with a paper detailing the treatment of expectations in THEIR OWN macro model. All of the research underlying our work was clear - market behaviour at a given point in time is explained better by BACKWARD-looking expectations-formation... than it is if you assume rationality (forward-looking behaviour that results in an unbiased estimator of the future).
There was a good paper in the 90s by two researchers at the Reserve Bank of Australia (Gruen and Gyziski) which canvassed the idea of 'anchored' expectations - that is also an interesting bit of work.
Financial market participants love to promulgate the idea of the REH because it makes them feel smart, and they love feeling smart (that's why they spend so much on suits and shoes and hair product). But forward-looking? Nope. They make the same mistakes - systematic, predictable mistakes as nuffnuff tech investors - and they do it with HUGE amounts of money (I was a Mutual Fund researcher - I was HORRIFIED at what I saw).
Cheerio
GT
The stock market was going UP in March. April, May of 2008. Was it "predicting" a recovery? The Stock Market is a lagging indicator in many, but not all situations. The 1930's is perhaps one of the better illustrations of this. Better to watch a selection of other indicators as this very good article points out. I have many more indicators than the article listed and they have served me much better than mere stock prices alone. But if you like it --- wear it.