Last Thursday Was the Bottom - It's Time to Get Back in

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Includes: BAC, DIA, DRYS, HERO, QQQ, SPY
by: Tacitus

Last Thursday, November 20, was the lowest finish for the market since the bear began last October. Since then we have had four consecutive double-digit gains, something that has happened only 45 times in the history of the market, dating back to 1896.

So was last Thursday the bottom? I think it was.

Much has been written over the last few months about how to tell when this market would hit bottom. Several well-done pieces noted the five (or six, or ten) signs that the market has bottomed out and noted that nearly all were in place a month or more ago. For instance, more than one essayist argued that when a "Perma-bear," such as Jeremy Grantham, begins talking bullishly about the market, that is a surefire sign of a bottom. Gratham has indeed argued the current market is more favorable for the equity investor than any he has seen since 1982. Other essayists focused on technical indicators, capitulation, mutual fund outflows, and other factors, most of which seem to have been present for some time.

However, the one historically consistent sign of a market bottom that has not been in place heretofore has been the market's discounting of bad news. That missing element finally appeared on Wednesday, November 26, when a stream of bad news came over the wire before the opening about weak durable goods orders and other negative factors.

But for the first time in months, negative news did not take the markets lower. Though stock futures pointed lower Wednesday morning, and though the market started down more than 100 points following the opening bell, the market quickly began a surge northward and finished more than 250 points above its Tuesday close. There was no positive news to account for this determined show of optimism, unless you want to count the official announcement of Paul Volcker's appointment to head a new committee of economists advising Barack Obama-- an appointment that has been hinted at for weeks, and it therefore appears that this bear market has finally gotten tired of dropping and intends to rise regardless of the news. Together with the various factors discussed above and elsewhere, that is the unmistakable sign of a market bottom. Another is the breadth of the bounce, which has affected nearly all sectors-- including, notably, the financials. Bank of America (NYSE:BAC) is up more than 25% from its low, and even poor old Citigroup (NYSE:C) has bounced back.

But doesn't the continued weakness in the economy mean that this cannot be a true bottom and is instead a dead-cat bounce? Not at all. The market always starts its upwards move months before a bad economy has even bottomed. In his book Stocks for the Long Run, Jeremy Siegel documents how the bottom of the market always precedes the trough in the economy as a whole, typically by 4 to 6 months, and on average by 5.1 months. Looking at the current downturn, it makes sense that we would be at or near the bottom at this point in the cycle. We have been in a recession for two quarters, and it is likely that we will continue to be for two more quarters. A one year recession would be one of the longest in the postwar period. But if the trough in the economy occurs late next spring or early next summer, as most economists believe, that would mean we should expect a market bottom around here.

In short, it's time to get back in. I am buying good companies that have been unfairly beaten down over the last few months and now sell at substantial discounts to book value-- companies like shallow-water driller Hercules Offshore (NASDAQ:HERO), dry bulk shipper Dryships (NASDAQ:DRYS), and solid financials like Bank of America (BAC) that look like they will not only survive but thrive after the shakeout.

One word of caution, however; I suspect the coming bull-- whether you consider it secular or cyclical-- will be short-lived. The feds have force-fed the economy with three-plus trillion dollars in the last few months, and as soon as the crisis is over and the economy seems stable, expect the Fed to begin tightening to keep inflation from running wild-- with correspondingly negative effects for the market as a whole. In short, buy aggressively here, but keep trailing stops on your big buys and be ready to move into gold and TIPS when the bill for the bailout begins to come due next year or in 2010.

Disclosure: Author holds long positions in BAC, C, HERO and DRYS