Calling a bottom is never something that should be undertaken lightly. In fact, attempting to do so is almost always a fool’s errand. For the vast majority of market bottoms, they can only be seen in retrospect. But studying a little bit of history does show several conditions that exist at or near all market bottoms. The tough part is remembering the market repeats in predictable cycles, just long enough for everyone involved to be clueless every time.
Here’s a little insight into what we’re watching:
- Attractive valuations – stocks become cheap enough relative to the past price/earnings ratios, the risk-free rate of return, etc.
- Massively negative sentiment – people need to be afraid and have fear that things will ONLY get worse.
- Capitulation – people just give up, go to cash, and start HOPING for the market to go lower so they can avoid the future pain and then get back into the market when things stabilize.
- Stabilization – each bottom has a day or series of days where the market gains some footing.
- Follow Through – a technical definition about continued strength after we see a reversal off extreme lows, leading us to believe that potential more upside could be coming.
- Wall of Worry – stocks continue to be hated, but the rally is looked upon with skepticism
- FOMO (Fear of Missing Out) – This is when those people who capitulated near the bottom re-enter the market at higher prices.
We have seen clear and undeniable evidence of #1. One of the fastest growing semiconductor and computer processing companies on the planet now has the same P/E multiple as a company that makes bleach. Most names in the retail sector have traded back to September 2018 prices or lower. There are numerous other examples.
As we’ve written in previous blog posts, sentiment as shown by weekly surveys of advisors throughout the country show that investor sentiment is now the lowest in the past 30 years (lower than 2008 or COVID).
Capitulation has NOT occurred just yet. This is what everyone is waiting for. That “give up” moment where the decline ends with a “stinger in the tail”. The March 2020 decline saw a two-day capitulation event, falling 1500 Dow Jones points (7.5%) before recovering more than 4000 points (23%) over the next three trading days. While we didn’t get capitulation in the traditional sense (a one day or two day event), we did see a 4000 point decline in the Dow Jones Industrial average over a 4 week period (-12%). THIS STEP IS THE STICKING POINT. Will we get a “whoosh” to the downside before the real bounce, or was last week “the bottom”? Time will tell.
We saw a bounce off 52-week lows last week. The low on the S&P 500 last week was 3810. The longer we hold those lows, the likelihood we build upon that level grows. Are we starting to stabilize? We will only know in retrospect.
And that brings us to today. The best thing I can say right now is that every market bottom has included a reversal day (5/12) and a follow-through day (5/17). What I would stress is that even though these conditions are present at market bottoms, every time these conditions exist, doesn’t mean we’re at a market bottom. I like to think of it logically, in the way that all zebras have stripes, but not all striped animals are zebras.
We’ve been stressing patience and waiting for the signals to show themselves, and now we have a quantifiable, data-driven signal that a bottom may be in place. We will be looking to aggressively add capital if market breadth continues to improve and price confirms our outlook with a break above the May 17th prices on multiple indexes. We feel this will offer a very attractive risk/reward, but nothing has been decided just yet.
We will be rebalancing for the vast majority of our client base over the next few days to potentially take advantage of the signals the marketplace is giving us.
– Adam