Saturday, September 06, 2008

A Bell Won't Ring At A Market Bottom

In times of market stress, it is important to have a list of events to monitor that might signal a bear market is bottoming. An important element to following events that may signal a turning point in the market is the list will remove the emotional tendency to reduce equity exposure at the end of a market cycle.

In May, Liz Ann Sonders, Chief Investment Strategist at Charles Schwab & Co., wrote a strategy piece titled, New Paradigm Ahead? I have covered elements of this article in prior posts, but the important aspect outlined in this article was it contained a list of factors for investors to look for that might give clues to when the bear market ends. In Liz Ann Sonders update on the May article, The Bottoming Process, she notes a large number of the factors that could signal a market bottom seem to be falling in place.

Her original checklist contained factors that were already in place:
  • U.S. economy slows dramatically
  • U.S. Fed cuts interest rates dramatically
  • Dollar sinks further
  • Commodity prices go parabolic
  • Speculative hoarding of commodities ensues
  • Regulators and Congress rev up the anti-speculation rhetoric
  • Commodity-hungry emerging markets suffer
  • Global growth suffers, including noticeably in China
  • Investors shift funds from international stocks to commodities
Her recently updated article details events that have occurred since May:
  • U.S. Fed enters pause mode
  • Rate differentials support dollar rally
  • Commodity prices begin to correct
(click on chart for larger image)

commodities and dollar chart
There are four remaining events that need to unfold that could finally signal higher equity prices ahead:
  • Non-U.S. central banks consider rate cuts to fight growth slowdown
  • Commodities move from U.S. economic headwind to tailwind
  • Lower commodities/inflation supports U.S. valuation expansion
  • Investors shift from global stocks/commodities to U.S. stocks
As Schwab appropriately notes, one significant issue that is depressing the market is the fall out from the housing bubble. Some positive trends are unfolding there though as noted in the chart below:

(click on chart for larger image)

home price chart August 2008Finally,
"The late Sir John Templeton once remarked, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” I [Liz Ann Sonders] like to think about the opposite for bear markets: They’re born on euphoria, grow on denial, mature on panic and die on despair. But they tend to end with a whimper, not a bang. In other words, they have generally hit a “momentum low” (the bang) followed by a period of additional weakness into the “price low” (the whimper), typically lasting about four months. As you can see in the table below, among the 21 major bottoms since 1900, only three have formed coincident with the low in price momentum: 1914, 1957 and 1970. Typically, stocks have slid 4%–5% after the momentum low."
(click on table for larger image)

market performance in bear markets and durationSource:

The Bottoming Process
Charles Schwab & Co.
By: Liz Ann Sonders
August 21, 2008

1 comment :

Jake@Compounding-Dividends said...

Good post and great quote!