Calling a market bottom is akin to predicting the weather — you’ll likely be wrong, cautions Chuck Carlson, dividend reinvestment specialist and editor of DRIP Investor.
The good news, however, is that you don’t have to be perfect with your bottom call to make money over time. You only have to be in the same ballpark and invest in a disciplined way.
What are the signs of a market bottom?
➤ Market bottoms form when stocks stop going down. I know that sounds, well, nonsensical, but there is a lot of wisdom in that simple statement. A market that keeps going down, one where the major indices continue to make lower lows, is not a market that is bottoming.
How can you tell when a market is not going down? When major indices hold previous low points. That, in essence, is what the Dow Theory teaches. Basically, the first step of a market bottom under the Dow Theory is that one or both of the Dow Averages (Industrials and Transports) refuses to close below previous low points.
You can’t have a change in the primary trend from bearish to bullish without the previous lows holding. Unfortunately, recent lows have not held, which leads me to believe that we are not at the bottom.
➤ Stocks and the market stop going down on bad news. Market bottoms occur when stocks have fully dis- counted bad news. Thus, a market that stops going down on bad news — and perhaps even moves higher on bad news — is a market that is close to a bottom. Unfortunately, this market and most stocks have continued to move lower on negative news, which leads me to believe that we haven’t fully discounted bad news and thus are not at the bottom.
➤ Stocks and the market bottom when everyone hates or fears stocks. How can you measure the popularity of stocks? One tool I like to use is our old friend, the Intermediate Potential Risk Indicator. This tool looks at the percentage of stocks on the New York Stock Exchange trading above their 200-day moving average.
When very few stocks are trading above their 200-day moving average, stocks are out of favor. To give you an idea of the level of hatred/fear investors had for stocks in the last two major bear markets, the percentage of stocks trading above their 200-day moving average fell to just 2% during the 2008-2009 and short-lived 2020 bear markets.
So where are we now? Well, the percentage has come down in the last few weeks but is still hovering above 20%. Now, I’m not suggesting that the percentage has to fall all the way to 2%. But there is still a lot of room between the current reading of 24% and 2%, which is why I’m reluctant to say this market has bottomed.
➤ The Dow Theory turns bullish. The Dow Theory does not turn bullish at exact bottoms. In order for a trend change to occur, you need several confirming moves, culminating with a successful retest of previous lows and a move to new intermediate highs.
However, while the Dow Theory won’t pick a bottom, it does a great job of confirming bottoms. Unfortunately, the Dow Industrials and Transports have yet to hold previous lows, which is the first step needed for the primary trend to change from bearish to bullish. Thus, I don’t think we are at the bottom.
Notice I’m not saying that the market has to fall to “fair value” in order to form a bottom. One reason is that I don’t really know what “fair value” is in an inflationary environment. Indeed, the market is currently grappling with how much to pay for future growth in an inflationary environment. Inflation constricts price-earnings multiples. Shrinking price-earnings ratios reduce stock prices. Basing a market bottom on “fair value” is a dangerous approach in an inflationary environment.
So, are there any buys right now? My guess is that most stocks will probably trend lower in the near term. However, one stock that I think is at levels where you can start the nibbling process is Qualcomm (QCOM).
I don’t know if this is the bottom, but the stock, down 32% from its 52-week high and trading at just 10 times fiscal 2022 earnings estimates, seems to be discounting a lot of bad news in the semiconductor space.
The yield of 2.3% provides some payback while waiting for the stock to rebound. Qualcomm offers a direct-purchase plan whereby any investor may buy the first share and every share directly.