Ten Reasons to Start Getting Bullish
By Barry Ritholtz
Special to TheStreet.com
3/23/01 3:32 PM ET
Can it be that after the long, cold Nasdaq winter, spring has finally arrived? Based on several key metrics, I believe it has: We're finally seeing the end of the selloff. Ten factors are encouraging me to think in this direction.
One. The calendar is finally working in favor of long positions. As Cramer has pointed out several times, by April 15, all tax-related selling will be over. This includes individual investors raising cash to pay capital gains taxes from last year, and institutions doing the same to meet redemptions after their long slide.
It's a big positive, akin to the January Effect. When that selling pressure finally lets up, the market is free to bounce.
Two. History shows it's utterly futile to fight the Fed. Whenever the Federal Reserve has cut interest rates three times in rapid succession, the markets have responded positively. In 12 out of 13 instances over the past century -- the exception being the 1930 cuts during the Great Depression -- equities have seen average gains of 20% over the ensuing 12 months.
Is today more like the exception in 1930, or the other dozen cutting cycles? You can guess my view.
Three. The CBOE Nasdaq Market Volatility Index, or VXN, broke a double-bottom at 72 yesterday. That break is a key technical indicator suggesting that a Nasdaq reversal in trend may be nearing.
The VXN has an inverse relationship with the Nasdaq -- when the VXN falls, it's a positive for the Nasdaq. On a point and figure chart, the VXN has broken through its bullish support line at 71. "This changes the trend to negative for the VXN and suggests it will fall," according to Tom Dorsey, of Dorsey, Wright & Associates .
That implied decrease in volatility for the Nasdaq 100, or NDX, "typically suggests higher prices for the NDX or QQQ's [Nasdaq 100 Unit Trusts]" wrote Dorsey. Combine this with the extremely oversold nature of the NDX and the QQQs, and that indicates an important short-term reversal is potentially at hand.
Four. The Arms Index 10-day moving average has flashed a critical buy signal. Developed by Richard Arms, the index shows the relationship between the number of stocks that increase or decrease in price (i.e., advancing/declining issues) and the volume associated with stocks that increase or decrease in price (i.e., advancing/declining volume). In English, it measures how much buying or selling is required to "move the markets."
In the past 40 years, this indicator has accurately called a market bottom within 20 trading days following its major signal -- 11 out of 12 times. Even that one exception accurately suggested a major trend change. For a more complete discussion of the Arms index, see Aaron Task's recent column.
This most recent Arms Index signal implies that only enormous selling can move us downward. In fact, it took a billion shares after the Fed's announcement on March 20, and that wave of selling only moved the Nasdaq from plus 25 points, to down 100 points or so -- between 2:15 and 4:00 pm.
Five. A number of analysts whose models I respect -- notably Abby Joseph Cohen of Goldman Sachs and Dr. Ed Yardeni of Deutsche Bank Securities -- have noted that, as of mid-March, the S&P 500 is undervalued by 5%; by March 22, it was closer to 10% undervalued. Both use valuation models comparing consensus earnings estimates of the S&P 500 with the 10-year Treasury bond yield. At these undervalued levels, we may be headed for a major snapback rally.
Six. All three newsweeklies -- Time, Newsweek and U.S. News & World Report -- have stories on the recession or bear market on their covers. This has been a classic and highly correlated contrary indicator over the years. As I explained in my column on contrary indicators, by the time the nonbusiness press realizes the significance of the economic story, the wheel has already begun to turn.
Seven. The defensive issues are getting hit hard. Philip Morris (MO:NYSE - news - boards), up over 100% from last year, and American Express (AXP:NYSE - news - boards), another big winner in 2000, have been selling off sharply. MO is down 15% in a week from its recent highs; American Express is down by a third in the year to date. Even Berkshire Hathaway (BRK^A:NYSE - news - boards) has been soft.
That's a positive for the beaten-down Nasdaq. When the tide turns, money rotates out of the defensive sectors, and into the offensive -- growth, tech, etc., that also have been the hard hit during the decline. This includes, by the way, the stocks exhibiting the best relative strength.
Why? It's a reversal of the process that began the tech wreck. Last April, money fled expensive technology issues and sought shelter in the cheaper defensive stocks. A year later, we are seeing that process in reverse. Capital is leaving pricey "defensives," and returning home to tech stocks -- at prices substantially cheaper than they were in April 2000.
Eight. The increasing number of put purchases. Although the put/call ratio isn't at extreme levels, we saw very significant put buyers coming out of the woodwork on March 22.
Jay Shartsis, R.F. Lafferty & Co.'s director of option trading (and a contributor to RealMoney's Trading Track), was quoted by Dow Jones as seeing "very high levels of bearish puts traded in ADC Telecommunications (ADCT:Nasdaq - news - boards), Cisco Systems (CSCO:Nasdaq - news - boards), General Electric (GE:NYSE - news - boards), JDS Uniphase (JDSU:Nasdaq - news - boards), Oracle (ORCL:Nasdaq - news - boards) and Sun Microsystems (SUNW:Nasdaq - news - boards).
When beaten-down tech issues see such bearish excesses, it's a good contrary indicator.
Nine. It's become apparent that much of the bad news is fully priced into a lot of stocks. Micron Electronics (MU:NYSE - news - boards) postponed its earnings announcement for a week -- and the stock rallied smartly. If management had done the same thing last quarter, the stock would have been cut in half; instead, we saw a nearly 15% rise. Earlier this week, Corning's (GLW:NYSE - news - boards) lowered guidance was met with a yawn. Then Microsoft (MSFT:Nasdaq - news - boards) rallied after Goldman Sachs lowered growth numbers.
The positive reaction to bad news suggests that the worst of the negativity is "already priced into stocks." That's a healthy part of the bottoming process.
Ten. And last, is the historical time and price actions in bear markets. All three major indices -- the Dow, the S&P and the Nasdaq -- have lost more than two years' worth of gains and are more than 25% off their total valuations. According to Ned Davis Research, the average Dow bear market lasts 363 days and sells off 25%; for the S&P, it's 13 months and 28%.
We've hit those historical averages. While that's not conclusive, it's another piece of the puzzle suggesting that the selloff may be coming to an end.
A final thought on bottom calling: Far too many "gurus" have wrongly declared a bottom over the past few months. I'm not a guru, and I'm not looking to make such a call. I simply look at the historical evidence -- the precedents, so to speak -- and when they align strongly on the side of a reversal, I feel compelled to bring it to your attention.
Historical evidence strongly suggests that the selling is mostly washed out. Once the April 15 deadline passes, I'll be hard-pressed to find additional negative catalysts. All these factors make me cautiously bullish. |
