Keep On Watching for Signs of a Market Bottom

As the S&P 500 seems to have formed a double bottom in January and March, the question in many investors' minds must be "Have we seen the bottom?" My review of some of my market indicators indicate that it’s probably a little early to flash the all-clear signal for US equities.

In particular, the problem areas of the market, namely the investment banks, housing and employment, continue to struggle, suggesting that the worst may not be over for this bear market. Here are some of the indicators that I am watching:

Insiders are bullish
Mark Hulbert reports that insiders have been buying their own stock at levels that are comparable to other market bottoms. Insider signals tend to have a very long time horizon but their actions do have bullish implications.

Investment bank valuations - more downside?Since much of the recent stresses that have shown up in the investment banks and brokers, I go back to my rule of thumb that I would like to see a price to book ratio of 1 for the investment banks. The P/B of 1x was a good signal of a market bottom in the 1974-5 and 1981-2 bear markets.

While Lehman (LEH) did reach a P/B of 1x for one day at the time of the Bear Stearns (BSC) panic, other investment banks and brokers such as Morgan Stanley (MS), Merrill Lynch (MER) and Raymond James (RJF), which is an interesting bellwether as it has no significant prop trading operations, are trading at valuations of 1.5 to 1.8 times book. Goldman Sachs (GS) is trading at valuations that are even higher than that.

I could be wrong here but my guess is that there needs to be more pain in the brokerage stocks before the market bottoms.

Smart funds defensive while overall sentiment is bullishA check in with my group of smart funds shows that their posture remains defensive. The accompanying chart shows the market beta of the “smart funds” compared to the “consensus funds”. Smart funds have a market beta, or implied market exposure, that is lower than the market while consensus funds are at or positive market exposure. Moreover, the recent Barron’s Big Money Poll shows 50% of their respondents to be bullish or very bullish, compared to 13% as bearish. This is a contrarian bearish reading.

Problem areas of the economy not stabilizing yet
This economic downturn was the result of overbuilt housing fueled by overly aggressive real estate lending. The chart below shows the S&P 500 Homebuilders relative to the S&P 500. The homebuilders remain in a relative downtrend and show no signs of stabilization, which is not a good sign for the health of the overall market.

Addendum: When you get stories like KB Home's Broad Says Home Prices May Drop Another 20%, it doesn't exactly inspire confidence that housing has bottomed.

Similarly, we have seen employment statistics starting to weaken, as is the case in any recession. Rather than looking at the payroll numbers, which are backward looking, I prefer to look at market discounting real-time statistics. My proxy is the price action of S&P Supercomposite Human Resources and Employment Services, consisting mainly of temp and employment agencies. The chart below of these stocks relative to the S&P 500 indicate that, like the Homebuilders, the Temp Agencies remain in a relative downtrend with no convincing signs of stabilization.

How far or how long before a bottom?

If my assessment is correct then the next question would be “how long or how far down before we see a bottom in the market?” William Hester at Hussman Funds, in his recent article Recessions and the Duration of Bad News, suggests that if this was an “average” recession we will likely see much more bad news in employment, housing, earnings, etc.

If this was an “average” recession the chart he shows suggests that we are currently seeing a bear market rally but a more convincing market bottom is a few months off (see the last two charts in the article).

Is this an average recession? I have no idea. All I can do is keeping watching my indicators for signs of a market bottom.

Comments

[ponchovilla]

Every day people see a bottom on Wall Street. Especially when they stick their head in the ass end of the bronze bull. There is photographic evidence. No charts required.

[john sabia]

I guess that is one way to see a bottom.....

[twotraps]

The article was complete and well thought out...but consider that prices could be at the top of a very large, uncomfortable trading range. Is it not possible to see simple rotation down 100 S&P points and Not disturb the overall formation? The overall pull-back percentage-wise has been mild so far. You need a flexible yard stick to keep up that mkt, but there is nothing unusual about price action....its just the wide ranges are very uncomfortable to sit through.

[galewhitaker]

Skyrocketing energy prices trump all arguments because they have such a negative effect on the consumer.

[ArnoldCountry]

If nothing else, one thing will be clear about this "recession" it will go down in the history books as one that has broken all the traditional "rules". An average recession??? Not on your life! The complexity of the "systems" in place are causing difficulty for everyone to see that damn forest because the trees are in the way.

[crewman84]

Here's a sign of a bottom forming....it appears Meritage Homes is RAISING prices in two communities in Sacramento and hiring land acquisition managers.

[clitosil]

raising prices in sacramento? Bwahahahaha! that was a joke, right?

[ponchovilla]

If Meritage Homes is raising prices it's a sign of a lobotomy forming.

[Voice ofReason]

You shouldn't be looking for a "bottom" look for value. There are all kinds of really good stocks that have been beaten down that will do well over the next 12-18 months.