Backwards Looking Leads to Bottom Blindness

An article on Seeking Alpha the other day caught my eye. Entitled "10 Reasons Why We Still Haven’t Hit Bottom", the article oversimplified a number of points and unnecessarily dramatized others.

Below are my comments on the points, which I’ll number to match the author’s system:

1) It’s much easier to say that people are looking for a bottom two weeks after the market actually put in a low, and has risen by 20%, than to consider what happened at the point in time when the low occurred. So, what was sentiment actually like? First, this chart from Bespoke shows their poll at the November 2008 “Citigroup (C) Bottom” – note that 90% of voters are expecting lower lows, and the modal response looks for a 20% loss.

click to enlarge images

The Dow quickly popped more than 15% from that point. So what about sentiment at the March 2009 low? It was remarkably similar, with 89% negative responses and a modal projection of another 23% downside.

Perhaps more anecdotally, what are people literally looking for? Using Google Trends, which captures search volume for specific phrases, consider the searches for “market bottom” over the last several months. A pair of false bottoms have materialized earlier and been revealed to be false, and the number of people searching for the term has declined over time as well. Take this for what you will; I am not defending it beyond a simple assertion that there appears to be less interest in the market as it declines further.

2) This point confuses liquidity with insolvency brought on by leverage. The Fed is putting liquidity into the system, and the yield curve has a large slope. If the Fed deserves credit for anything, it is bringing down short rates enough that banks with significant deposit bases have a cheap source of funding.

Now, many markets are struggling with liquidity issues (money favors markets backed by government guarantees), and I think the prevalence of covenant-lite loans during the last boom has postponed bankruptcies toward the latter part of the cycle. This is one of my potential sources of future pain.

3) This is a real recession, alright. But in what sense is it different this time? In point #6 the author suggests knowing something about the actual companies one invests in, as opposed to using technical analysis. Likewise, perhaps better to make judgments on the merits of a company’s value-creation strategy as opposed to a blanket judgment that being an owner of businesses (i.e., owning stocks) is a bad idea.

4) In a sense, buy-and-hold (via indexing) has been dead for some time. Annualized returns over almost any long time horizon are awful by historical comparisons; so, let people think they cannot win by owning stocks. Equities are rigged? Please, take your money out of the market and buy gold, or foreign currencies, or hide from risk (and simultaneously return) by purchasing Treasuries. Less competition will mean better future returns.

5) Maybe earnings estimates need to be cut more, and targets need to be lowered further. Will this necessarily drive stock prices lower? Difficult to tell. What is less difficult to tell is the effect restoring confidence to earnings estimates will have; waiting for the uncertainties to be removed will not get you in around the bottom.

7) America, like all countries, has its problems. It also has the most extraordinary economic system in the world, which has created unparalleled prosperity over time. Again, this says nothing about whether or not the market has bottomed, but it does give an open forum for the negative to raise concerns.

9) The author acts as if this spiral is self-perpetuating, with no hope of stopping. But all things that cannot go on forever must end, as the saying goes. For example, risk premiums eventually widen and become attractive for new investment – this leads to new jobs, more production, etc., and the cycle reverses – and, not surprisingly, it’s more likely that risk premiums are attractive when the S&P 500 is at 770 than 1,470.

10) Talk about meaningless and shrill statements. Discretionary income falls faster than household income, alright. But simply declaring “everything is 10 times worse than you think” smacks of trying to cheaply drum up fear, or round out a top-ten list.

So, now that I’m done painting myself far too firmly into the bullish corner, let me say that while I went (almost) fully invested on the day of the March lows, it was not about anticipating broader market lows. I have my own concerns about the health of the economy, and the policies pursued by our government, but I separate those from finding investments offering attractive returns with a reasonable margin of safety. Creating a differentiating thesis requires more thought than simply extrapolating present troubles indefinitely into the future.

Comments

[Larry House:]

Forgive me, but I must point out that there is no such word as "alright," (in proper English, anyway). It is "all right." We are used to "already," but there is no "alright." Sorry, just he English teacher in me.

Mar 25 10:28 AM

[Chris B:]

Agreed. I could come up with several reasons to be bullish:

1) Barak Obama seems to be fueling the pessimism of investors, most of whom are conservative, dislike his policies, and are increasingly predicting disasterous outcomes. If these investors are reacting to political distaste rather than economic reality (a judgement call you have to make) their fleeing the market could be distorting prices to the downside. We can evaluate the rationality of their pessimism by noting that, for whatever reason, the stock market has historically done better the more Democrats are in office.

2) Trillions of dollars sidelined into money market accounts, gold, and treasuries will flee these assets at the first whiff of recovery, especially trying to get out of gold and treasuries before their values fall.

3) We had twice as many problems in the early 80's - double-digit unemployment, inflation, the cold war, rising crime, fuel price spikes, strikes, etc. Turns out if you bought stocks at that highly pessimistic point, you could look forward to two decades of parabolic gains. It's just not rational to expect all the world's problems to resolve before you are willing to invest.

4) As bad as the housing market is said to be, the foreclosure rate is still less than 10%, which means those so-called "TOXIC!" securities can still be expected to return more than 0.75 on the dollar, long-term. By that standard, the S&P 500 is even more toxic! Why do you think banks are refusing to sell these assets, marking them to market on their balance sheets instead? Yes, money was lost. Supposedly safe investments failed to yield positive returns. Yet, are "toxic" assets really worthless? Might accounting rules have more to do with bank losses than actual revenue flows?

5) Those "buy American" tariff provisions were watered down to the point of being an extra form to file.

6) Lower fuel prices mean more money (tens of billions more) in consumers' pockets.

7) The rise in consumer savings is directly reducing consumer debt, which is a healthy correction. It was the days of 0% savings rates and massive consumer leverage when we should have been worried.

8) Lower home prices and rock-bottom interest rates mean lower payments for millions of consumers for their biggest expense - housing.

9) Reduced geopolitical concerns about Iraq, Iran, and North Korea should keep commodity and energy prices low, inflation contained, and reduce investment risk premiums.

10) Consumer-targeted tax cuts are going into effect.

Mar 25 10:32 AM

[Emerald:]

Chris, you make a number of good points. However, I would add that we are in a deleveraging environment that is very different than the 1980's. Many consumers have too much debt, either on thier house or on credit cards, or both. Lower rates help but the principal balance is still too high. A number of corporations have too much leverage. The stronger credits are not looking to borrow and the banks don't want to lend to the weaker ones. The government can restore liquidity through various facilities but the deleveraging process by consumers and corporations will take a few years. Wevwill face rising unemployment, rising crime and social unrest both here and abroad over the next year as various forms of overt and less overt protectionist policies take hold. Yes, ther is a lot of cash on the sidelines but also a lot of stock value has vanished from 401k's. If you lose 50%, it takes a 100% rise in values to get back to breakeven. It will be a long, slow road to healing.


On Mar 25 10:32 AM Chris B wrote:

> Agreed. I could come up with several reasons to be bullish:
>
> 1) Barak Obama seems to be fueling the pessimism of investors, most
> of whom are conservative, dislike his policies, and are increasingly
> predicting disasterous outcomes. If these investors are reacting
> to political distaste rather than economic reality (a judgement call
> you have to make) their fleeing the market could be distorting prices
> to the downside. We can evaluate the rationality of their pessimism
> by noting that, for whatever reason, the stock market has historically
> done better the more Democrats are in office.
>
> 2) Trillions of dollars sidelined into money market accounts, gold,
> and treasuries will flee these assets at the first whiff of recovery,
> especially trying to get out of gold and treasuries before their
> values fall.
>
> 3) We had twice as many problems in the early 80's - double-digit
> unemployment, inflation, the cold war, rising crime, fuel price spikes,
> strikes, etc. Turns out if you bought stocks at that highly pessimistic
> point, you could look forward to two decades of parabolic gains.
> It's just not rational to expect all the world's problems to resolve
> before you are willing to invest.
>
> 4) As bad as the housing market is said to be, the foreclosure rate
> is still less than 10%, which means those so-called "TOXIC!" securities
> can still be expected to return more than 0.75 on the dollar, long-term.
> By that standard, the S&P 500 is even more toxic! Why do you
> think banks are refusing to sell these assets, marking them to market
> on their balance sheets instead? Yes, money was lost. Supposedly
> safe investments failed to yield positive returns. Yet, are "toxic"
> assets really worthless? Might accounting rules have more to do with
> bank losses than actual revenue flows?
>
> 5) Those "buy American" tariff provisions were watered down to the
> point of being an extra form to file.
>
> 6) Lower fuel prices mean more money (tens of billions more) in consumers'
> pockets.
>
> 7) The rise in consumer savings is directly reducing consumer debt,
> which is a healthy correction. It was the days of 0% savings rates
> and massive consumer leverage when we should have been worried.<br/>
>
> 8) Lower home prices and rock-bottom interest rates mean lower payments
> for millions of consumers for their biggest expense - housing. <br/>
>
> 9) Reduced geopolitical concerns about Iraq, Iran, and North Korea
> should keep commodity and energy prices low, inflation contained,
> and reduce investment risk premiums.
>
> 10) Consumer-targeted tax cuts are going into effect.

Mar 25 10:58 AM

[User 349208:]

Larry,

Get off your soap box about grammar; this is the Internet. Besides, 'alright' is indeed in the dictionary:

www.merriam-webster.co...

Also, don't forget to proof your own comments if you plan to throw stones... You say, "Sorry, just he English teacher in me." I think you're missing a letter.



On Mar 25 10:28 AM Larry House wrote:

> Forgive me, but I must point out that there is no such word as "alright,"
> (in proper English, anyway). It is "all right." We are used to "already,"
> but there is no "alright." Sorry, just he English teacher in me.

Mar 25 11:28 AM

[Larry House:]

User 349208, I am certainly not throwing stones. I respect all the contributors and comments on this site. My soap box is no higher than yours.

Mar 25 11:42 AM

[Jim Bob Jones:]

While reflecting on my own personal plight and reading a few blogs each day it behooves me to warn the retiring baby boomers that have taken the same percentage hit (up to 60%) (thanks to WFC) to learn how to do their own trading. Most working class people do'nt spend the time required to manage their assets but they had better learn fast or the rest of their small fortunes will be buying the CEO's another large home or Gulfstream. Buy and hold is dead except for your escort.

Mar 25 01:41 PM

[Mad Hedge F...:]

It's not over till the fat lady sings. Now that traders are partying again on Wall Street, we have to ask, what will take the punch bowl away? The unemployment rate shooting over 10%, which could happen in April or May, would be my first pick. Losses on option ARM loans could accelerate, taking out a few dozen more regional banks, WAMU style. Another, until now apparently healthy corner of the financial market taking huge undisclosed positions in securities we’ve never heard of, could suddenly blow up. A giant hedge fund could close at any time, freezing existing investors in place, and dumping gigantic positions on the market. Defaults on some big, high profile commercial real estate projects could also pull the rug out from under the market. Given the magnitude of the move up over the past two weeks, we might even see a short seller bite the dust. And of course, if any of the administration’s $3 trillion in bailouts/ reliquifying/stimulus hit a wall that would trigger a sell signal. Party on ebullient traders, but do so close to the exit.

Mar 25 01:43 PM

[James Cullen:]

Mad Hedge Fund Trader,
I'm completely in agreement - those are the kind of concerns I have, which keep me "close to the exit," as you say. Raising cash from 15% to 25% or so...
Hopefully I'll have time to more fully explore those negatives in another article soon.

Mar 25 02:53 PM

[Larry House:]

I'm not sure how you get that number for the DOW, Cetin, but that is fine by me. This is no time to be totally out of stocks, but it is time to still be cautious.

Mar 25 05:17 PM

[Fighting Yoda:]

All these are trading rallies, we had sevral in the recent past - this is just another. This too shall pass.

I think the market will hit new lows, but individual stocks or sectors may not. Have your shopping list ready for the next dip.

Mar 26 12:06 AM

[A.W.Bost:]

Mr. Doug Poretz,

My my sir you are absolutely right. I said in November that this downturn will and has completely and fundamentally changed people forever. What wall street and others have not realized yet is that the spotlight has now turned to them and their companies and now especially on our Government. Being born in 1987 our generation has been almost completely blind to everything that has gone on with everything. We spent A LOT of money on things we never needed and now we all now realize (with unemployment and our pocket books) how important we need to plan for our future and save every penny. We have all now become completely frugal which has begun and will continue to kill corporate profits. This downturn is completely different from others in the way internet affects our lives. The internet is THE X-FACTOR and gives us unlimited knowledge about everything. We are puppets no longer. There has been a rude awakening for us and now everything is planned for and bought with a purpose. This rally is hilarious because the BIG BANKRUPTCIES have yet to begin. There needs to be a humongous washout with the excess of everything, especially horrible companies that continue to plague us and dilute the resources that are left. WSJ front article "COMMERCIAL PROPERTY FACES CRISIS" shows a taste of what is to come. No one is spending anything at all anymore. THERE IS NO MORE MONEY and everything left will be for (essentials first, pay debt, save the rest, and then very calculated bigger items). This country went from one extreme to other and no one should underestimate the severity of this flip and how long it will last. I believe it will last for a long, long time because my generation is just starting to have their own families and we will do anything to save for our future kids and not be caught in this situation again when things really do matter. THIS WILL BE THE GREAT RECESSION #2, and Gov't is just exacerbating everything. I now hate my Government, and the biggest example is what they have and continue to do with GM and Chrysler. Our only ray of hope is when our beloved troops come back and reignite this very broken puzzle. THERE NEEDS TO BE A WASHOUT OF THE WASTE AND UNTIL THEN THE BOTTOM WONT BE MADE.
-Careful College Student


On Mar 25 10:32 AM Chris B wrote:

> Agreed. I could come up with several reasons to be bullish:
>
> 1) Barak Obama seems to be fueling the pessimism of investors, most
> of whom are conservative, dislike his policies, and are increasingly
> predicting disasterous outcomes. If these investors are reacting
> to political distaste rather than economic reality (a judgement call
> you have to make) their fleeing the market could be distorting prices
> to the downside. We can evaluate the rationality of their pessimism
> by noting that, for whatever reason, the stock market has historically
> done better the more Democrats are in office.
>
> 2) Trillions of dollars sidelined into money market accounts, gold,
> and treasuries will flee these assets at the first whiff of recovery,
> especially trying to get out of gold and treasuries before their
> values fall.
>
> 3) We had twice as many problems in the early 80's - double-digit
> unemployment, inflation, the cold war, rising crime, fuel price spikes,
> strikes, etc. Turns out if you bought stocks at that highly pessimistic
> point, you could look forward to two decades of parabolic gains.
> It's just not rational to expect all the world's problems to resolve
> before you are willing to invest.
>
> 4) As bad as the housing market is said to be, the foreclosure rate
> is still less than 10%, which means those so-called "TOXIC!" securities
> can still be expected to return more than 0.75 on the dollar, long-term.
> By that standard, the S&amp;P 500 is even more toxic! Why do you
> think banks are refusing to sell these assets, marking them to market
> on their balance sheets instead? Yes, money was lost. Supposedly
> safe investments failed to yield positive returns. Yet, are "toxic"
> assets really worthless? Might accounting rules have more to do
> with bank losses than actual revenue flows?
>
> 5) Those "buy American" tariff provisions were watered down to the
> point of being an extra form to file.
>
> 6) Lower fuel prices mean more money (tens of billions more) in consumers'
> pockets.
>
> 7) The rise in consumer savings is directly reducing consumer debt,
> which is a healthy correction. It was the days of 0% savings rates
> and massive consumer leverage when we should have been worried.<br/>
>
> 8) Lower home prices and rock-bottom interest rates mean lower payments
> for millions of consumers for their biggest expense - housing.
>
>
> 9) Reduced geopolitical concerns about Iraq, Iran, and North Korea
> should keep commodity and energy prices low, inflation contained,
> and reduce investment risk premiums.
>
> 10) Consumer-targeted tax cuts are going into effect.

Mar 26 11:48 AM

[Allan Frain:]

As if the Federal, State, Municipal, Personal, and Trade deficits have ceased to exist and our Government/Banking cartel can now be trusted in a manner that they could not be a few weeks ago.

Mar 26 12:52 PM

[PainfullyAware:]

We are currently in a state of fatigue - Fear has subsided to rational levels and scrutiny has been heightened across the spectrum of humanity.

All, but the most optimistic and those who have never had a grasp of reality, are holding their breath to see what happens next.

We Are About To Leave The Eye Of The Storm.

Kindness Is Never Wasted.

Mar 26 04:32 PM

[silver-bug:]

Just because the market hasn't bottomed yet doesn't mean there can't be a temporary bear market rally - which can be mistaken as a bullish signal. Those who get caught up in the illusion will be guillotined when the herd of foolish cattle will stampede off the cliff.

That doesn't mean you can't make money, but it means you have to stay alert.

Mar 26 05:37 PM

[Stone Fox C...:]

It seems very improbable that the market would still yet hit another bottom. The market is fatigued on the downside. We no longer have the fear of the financial system collapsing and the gov't has all but declared it isn't going to allow the economy to continue declining. The rational for lower lows has no reality. Saying that, you've got to be prepared just in case in happens.

Mar 27 12:47 AM

[You're Kidding:]

The best thing any investor can do for the long term right now, is investigate the idea of "dividends," AND the idea of "compound interest," AND how reinvested dividends and compounding work together, AND what MLPs are, AND how the tortoise beat the hair to the finish line in their big race.

Real time, color, graphical, compound calculator, with slider inputs for immediate, scenario exploration:

personal.fidelity.com/...

This post is the most important investment advice you have ever read, or will ever read, and if you pay attention to the lesson, you will get down on your hands and knees, with tears in your eyes, and thank your lucky stars for being fortunate enough to have had the spark of intuition and desire to have investigated it.

Mar 27 03:42 AM