Are We There Yet? Has a Market Bottom Been Put in Place?

After numerous false calls made by CNBC pundits and other assorted gray beards, the market may indeed be in a bottoming process. To be clear, five out of five up days on the SPY, with some of them occurring on low-volume during a holiday-shortened week, does not constitute the beginning of a new bull market. However, it is refreshing to see prices stop sliding downward.

The market action of November 21 and 24 resulted in the biggest two-day rally for the S&P 500 since 1987. Some analysts are dismissive; they argue that the largest rallies occur in bear markets. This misses the point. While these large rallies take place in bear markets, they also occur at market bottoms. In October 1987, after a large 20% percent drop on “Black Monday,” the S&P 500 rallied for two days, gaining 13%. In December 1987, the low was retested, confirming the bottom.

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There are other indicators that also demonstrate the market reached its low point.

While the Volatility Index lost some of its forecasting ability when it shot right through 40 and touched 90, it is clearly showing a topping formation. Moreover, the action on October 27 and November 20 resulted in a double top. There was also positive divergence when it failed to go higher as the indexes reached new lows.

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The New Highs / New Lows also show a positive divergence. On November 20, when the market hit its most recent low, a new low was not registered.

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Warren Buffett’s October 17, 2008 editorial should also not be taken lightly. While he would be the first to tell you that he is not a market timer, he always comes pretty close to getting in near the bottom. Although the market reached an intraday low of 22% after he made his call, (SPY closed at 93.21), in a little more than a month, the market has sharply rebounded.

Assuming the market has bottomed, it does not mean that a bull market will immediately ensue. Time is needed to transition from bear mode to bull mode. While fear is a necessary ingredient in forming a bottom, buyers are also required. President-elect Obama’s recent candidate choices to fill key economic positions may have provided the confidence (or excuse?) for people to begin buying stocks.

It is also hard to ignore how cheap stocks have become. Once mighty blue chips have been knocked down to capitalizations of mid-cap and small caps. Growth stocks, normally known for having a higher P-E ratio, have P-Es so low that they now look like a stock a value investor would purchase.

Such low P-Es will bring out the value investors. Clearly, in most cases, the baby has been thrown out with the bath water. While all financials will not survive, as a whole, the banks and other financial institutions have to flourish if the economy and stock market are ever to continue to grow. The best of breed, such as Goldman Sachs (GS), may be too good for value investors not to buy.

The oil-related industry will also regain their footing and value investors realize this fact. Exxon (XOM), Schlumberger (SLB), and Halliburton (HAL) are enticing for those who want a steady increase in stock price along with a sizeable dividend. Slowly but surely, the buyers will begin to arrive.

If we have indeed hit bottom, how long will it take before we transition into bull mode? It depends. A retest of the November 20 close / November 21 intraday low is likely required. Bear in mind that the indexes may not have to actually touch or slightly undercut the lows. The 2002-2003 bottoming process demonstrates this. In the case of 1987, it took less than two months. In 2002-2003, approximately eight months were necessary for the market to enter a bull phase.

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In the more immediate future, SPY and QQQQ face resistance at 95 and 30, respectively. After that, both need to conquer their 50 day moving averages. Failure to pass through these resistance areas does not mean the bottoming process is necessarily over. Sideways movement in the market would be constructive.

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While recent market action supports the conclusion that a bottom has been established, the SPY and QQQQ should still be viewed with caution. Long-term investors brave enough to enter the market now must exercise disciplined risk management. Now is not the time to bet everything that the market has found its footing. Others less inclined to enter the market should be building watch lists.

Disclosure: No position in any stocks mentioned.