Are We Closer to a Bottom Than a Top?

09/12/2011 9:57 am EST


Terry Savage

Author, The Savage Truth on Money

There’s been so much volatility and panic in the stock market lately, maybe it’s time to step back and take a longer perspective.

When “everyone knows” that a recession is coming, when “everyone knows” that the Fed is “pushing on a string,” and when “everyone knows” that the politicians are going to mess up the economy again, and when “everyone knows” that the European currency is in trouble—well then maybe all the bad news—or almost all of it—is already in the market.

This column has never been about market timing. But I would like to convince you to stick to your appropriate stock allocation in your retirement plan—and to keep on investing in stocks with every new contribution.

Here are just a few reasons to be bullish—for the long run—from some market analysts who make a good argument for standing against the crowd.

Volatility Extremes
Jim Stack of InvesTech Research notes that a number of his indicators have been in extremes never seen before.

For example, he notes that in the big selling rout on Monday, August 8, the number of declining stocks outnumbered advancing stocks by a 77:1 ratio—a ratio so extreme that it has never been seen before, including on Black Monday in 1987, when the Dow Jones Industrial Average plunged 22.6%! On that day, the ratio of decliners over advancers was "only" 49:1.

Stack is a market historian who keeps track of these kinds of statistics. He notes that the panic selling days last month were rounds of panic buying, where the ratio of up-to-down volume exceeded 15:1 for three days within one week. He notes that “in over 50 years of volume data, we’ve never seen two days [with that extreme ratio] within two weeks—let alone three in one week!”

And one other stunning Stack statistic: “ The S&P 500 Index closed up or down more than 4% in five of the six days during the wild swings of August 3-11. The last time that occurred was in June 1932!”

Indeed, these are unusual times, based on stock-market history. And those, along with other fascinating indicators, have Stack wondering whether this extreme volatility is more characteristic of a bear market bottom than the start of a new bear market.

Stack does acknowledge that fading consumer confidence could lead to another recession—bad news for business. But he points out that it’s a rare opportunity to buy blue chips like Coca-Cola (KO), Microsoft (MSFT), and Wal-Mart (WMT), stocks held in his managed portfolios, at price earnings ratios between eight and 13 times trailing earnings.

Stack thinks it more likely that “we could be at or near a classic buying opportunity that would propel the market considerably higher over the months ahead, as those recession fears dissipate.”

NEXT: Measuring Stick


Measuring Stick
With the Dow Jones Industrial Average trading at just below 11,000, it may appear that stock prices are still relatively high. The peak for the past 12 months was 12,876, made on May 2. And the 12-month low was made almost exactly a year ago—at 10,403 on September 10, 2010.

But just remember, the Dow Jones Industrial Average closed at 6,763 on March 2, 2009. You survived that disaster, and caught the upside rebound—unless you panicked and sold at the bottom.

It’s easy to simply measure the performance of the stock market by the Dow Jones Industrial Average—a number that makes headlines. Few are as conversant with the levels of the broader based S&P 500 Index. But that’s the marker for a different kind of bullish argument.

At the stock-market peak in 2000, the ratio of the S&P 500 Index to the price of one ounce of gold was over 5.5x. At the market lows, in 2009, that ratio bottomed at 0.8x. And today the S&P/Gold ratio is even below that level—currently at 0.7x.

You might ask why you should compare stock valuations to gold. Some see gold as the most universal form of currency, an inflation hedge because it cannot be debased the way paper currency can. Since, over the long run (20 years), the stock market has typically beat inflation, it seems fair to compare stock prices by this yardstick.

If you consider the S&P in terms of gold, the stock market is now down about 85% from its peak in 2000 before the dot-com bubble burst. While the market may have further to decline, it is interesting to consider whether we are far closer to a bottom than to a top in the market—at least based on the ratio of stocks to gold prices. (Or, yes, maybe gold will fall—something it seems unwilling to do as currency values are called into question.)

Bears Meet Bulls
Every trading day, the bears and the bulls meet to disagree about valuations. Every time a stock is traded, someone is selling and thinking they’ve gotten the best price. On the other side of the trade is a buyer, expecting prices to move higher. So there will certainly be plenty of disagreement over these bullish arguments.

It’s just that with almost everyone so worried about recession and so bearish on the market, I thought it might be time for some contrary opinions. And that’s The Savage Truth.

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