The Bull Case fully stated:
cbs.marketwatch.com
Seven signs of a market bottom
By Michael Davey and Cedd Moses, CBS.MarketWatch.com
Last Update: 1:02 PM ET Oct 19, 2000 NewsWatch
Latest headlines
NEW YORK (CBS.MW) -- Given the extreme and enthusiastic saturation we saw in technology-related stocks and mutual funds early this year, perhaps we should not be surprised by the severity of the recent market sell-off. Gravity has a stunning record when virtually everyone is vested in the same result.
Updated:
10/21/2000 1:54:22 PM ET
Seven signs of a market bottom
By Michael Davey and Cedd Moses, CBS.MarketWatch.com
Last Update: 1:02 PM ET Oct 19, 2000
The obsession on investors' minds lately, however, is whether or not their shares will recover. Is the stock market pricing in a dramatic slowdown just around the corner in the economy? Could it be that the greatest secular bull market in U.S. history has come to an end?
Let's keep a little perspective. We know that the market has a tendency to overdo things, price-wise, both on the upside and on the downside; but we should also remember that the market sells-off faster in a downtrend than it rises in an uptrend. Given the meteoric rise in stock prices ahead of this correction, one could argue that as far as the major indices are concerned, we are not as bad off as one might logically expect.
Is the market really pricing in a dramatic slow-down for the economy, or have we simply taken our medicine, so to speak, for the excesses that climaxed back in March?
In certain sectors, investors have had to swallow more than medicine, unfortunately. But again, markets normally fall faster and harder than they rise. Buyers who were late to the party with a Yahoo, or investors who bought Qualcomm at nearly $200/shr (split adjusted) early in the year because it was to split 4-for-1, have had a very bitter pill to swallow. But given the extreme rise in prices and the extreme saturation of so many stocks such as these at the time, this correction had probably less to do with the market anticipating a significant downturn in the economy and more about normal market forces dictating some sort of equilibrium. As with most market manias, the end is ugly, and the Internet mania earlier this year was no exception.
As evidence supporting the underlying health of the economy, take a look at the relative strength in the financial sector. While most of this group came under selling pressure in recent weeks, it remained well above the lows set in July. Relative strength in the financials bodes well for lower interest rates and higher stock prices. The healthcare sector has also remained strong, and in particular the biotechs. We have remained positive on biotechs throughout the year, and pinpointed this group as having the best potential upside back in May. While the biotechs did rise dramatically late last year and early this year, they had nowhere near the degree of saturation as the infamous tech and Internet stocks.
Other evidence of a half-full glass is the resilience in the leadership stocks. We track a quantitative daily screen which ranks the leading stocks based on price and volume action, positive momentum changes in analysts' mean earnings estimates (earnings "drift"), and relative strength measured between 1 and 50 days.
In late February we saw disturbing, toppy chart patterns developing in the leading stocks coming through our screen, but in recent weeks we have seen just the opposite: the chart patterns of the leadership stocks have been very compelling, and in some cases downright powerful. This would be consistent with a market that is poised to rally, not fall through the floor to oblivion.
It appears that the pieces for a significant bottom in the market are falling into place, something which could be confirmed by our S&P 500 model as soon as today (our Nasdaq model already generated a new buy signal last Friday). We staged a dramatic recovery in stocks on Wednesday, whereby the Nasdaq and S&P 500 held last week's low on an emotional retest, and both the CBOE put-to-call ratios and VIX volatility numbers reached historically high levels, indicating that sentiment had reached an extreme. Strong earnings reports after the close, namely from market bellwether Microsoft (MSFT: news, msgs), may now provide the catalyst for a market turn.
There at least seven positive and relevant factors which indicate a market bottom is at hand:
1. Signs of capitulation in Wednesday's trading.
2. Extreme pessimism in p/c ratios (highest since Oct 98' bottom).
3. VIX readings at extreme high levels.
4. Momentum indicators improving.
5. U.S. Election around the corner (historically bullish for stocks).
6. Earnings pre-announcement season is behind us.
7. Leadership in Financial, Utility and Healthcare stocks
The question of whether or not we are embarking on a significant rally still remains, however, and for that, interest rates will be key. The discount rate is still at 6 percent, which has led to many bear markets since the 1920s. As such, we likely need rates to drop before a significant rally can be expected.
If oil prices can come back down, that should really help the rate picture, as it will allow the Fed to become more accommodative. Conversely, a further trend of higher oil prices should keep the Fed on hold from lowering rates.
As far as sectors, we continue to like healthcare, especially the biotechs. The group held up extremely well in this correction and remains highly ranked on our quantitative Industry Groups by Strength screen. The biotechs still appear to have the greatest upside until year-end.
Within technology, which is still poorly ranked on our screen at this point, the software group currently ranks highest, and that group recovered the best among the techs on Wednesday. But another potential leadership group is the networking sector. Although big networking names such as Lucent and Cisco have been lagging, others within the sector have begun showing up on our quantitative stock screen and held up well during the decline.
Energy is still highly ranked, at this point, but we have recently reduced exposure here due to the toppy pattern developing in crude oil prices.
Remember, from now until the end of the year is historically a time when the year's leadership stocks tend to trend higher, as fund managers want to own the winners come year end. To find the new winners we track our quantitative screens, as we mentioned, but we are also on the lookout for companies that blowout earnings estimates and subsequently trade higher on strong volume. Buying high and selling higher is a technique that doesn't work all the time, as many of this year's horror stories grimly illustrate, but it is a strategy that can work at the right time.
The quantitative screens and trading models mentioned above are published daily at MarketBUG.com.
A few comments
1-4 - yep we got those signs of a bottom. We got them in April and August too. We bounced and still ended up lower. These indicate we should hold 3,000 for the time being and could get a nice rally off of it. But do not prove that the market will not break 3,000. It's bottomed several times this year only to go lower.
Earnings - doesn't matter if earnings are good this quarter - and they haven't been for the most part. What matter is what future earnings are going to be. The economic slowdown has only begun. No reason to expect earnings won't follow.
7. Leadership in healthcare and utilities is not neccesarily a positive sign for the broad market. Banking sector looks a little ambigious at this point Sectors such as retail, construction which lead the broad market - dependent upon consumer spending - are dropping which isn't a good sign. Biotech strength is interesting and does seem to indicate that there is a lot of speculative money in the market and adds to the bull case.
One tenent of the bull case is that the Fed will lower interest rates in the 1st or 2nd quarter of next year. It isn't clear if this is the case at all and it's possible that the Fed will be forced to raise rates - this is a complicated issue which I'll defer to later.
Bottomline - my thinking is that we are not in a bull market. We've been in a bear market since April and are at best only in the middle of it. |
