With the way stocks are being whipsawed, investors often ask me how to tell when the market is ready for a rebound. While there’s no way to ever be 100% certain, I usually just let history be my guide.
And history has a very interesting story to tell right now.
Just take a look at the following chart. Since 1927, the markets have shown beyond a shadow of a doubt that the worst of times for the U.S. economy have literally proven to be the best of times for stocks when it comes to choosing a time to buy.
The best buying opportunities are typically found when the market is represented by points inside the box located in the lower left-hand corner of the chart. This is when valuations are most favorable, as they were in 1932, 1941 and 1982.
When the markets are anywhere above and to the right of the box, they are statistically more at risk of falling than rising. There are naturally times when the markets rise from points above the box, but those are the historical exceptions.
For instance, take a particular note of March 2000, represented by a point way up in the right-hand corner. Take a minute to drift back in time and recall just what everybody was saying then about U.S. President Bill Clinton’s "New Economy," the Dow Jones Industrial Average heading to 15,000 (and beyond), the Internet-technology boom, etc.
Everyone was encouraged to buy in. One of the reasons why I refused to buy into that - pun absolutely intended - is because of this valuation chart. I could see that the markets were ludicrously overvalued at that time versus any other period going all the way back to 1927.
The markets certainly aren’t that overvalued now.
GDP Declines Bode Well for the Dow
Interestingly enough, this data is supported from another angle using gross domestic product (GDP) data. Since 1947, of the 11 times the quarter-over-quarter change in GDP was a minus 4% or more, the Dow was higher by an average of 25% one year later and 35% two years later.
What the data in this second chart tells us is that the latest projections suggest we’re right in line with historical norms, given that economists expect that the U.S. economy suffered a mind-numbing decline of 4.35% in the final quarter of last year. When everyone else believes the worst, that’s when you should be buying.
Obviously, we have to take this kind of phenomenon with a grain of salt, but any time one data source corroborates another, it’s worth noting - particularly when there are companies out there that meet our very strict investment guidelines.