Calling a Market Bottom

08/07/2008 12:00 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of the Chartist, says this bear market has a way to go before it hits bottom.

It is very difficult to gauge when this bear market cycle will eventually end. In most bear markets there are many rallies that can be significant and look like the real thing but often times they fail, with the averages making new lows. That is why we patiently wait for our key indicators to turn positive before we are willing to risk our own money.

In the last bear market of 2002, the economic picture was actually much better than what we are facing today. In 2002 oil prices traded in the range of $20-$30 a barrel, real estate prices were holding steady, and there was not a credit crisis.

Since this bear market began, we have had the collapse of Bear Stearns, the housing meltdown, bank failures, skyrocketing oil prices, surging inflation, [etc.] It is very surprising that given today’s barrage of negative news the averages have not fallen even further. Maybe there is much more downside before this market turns around.

The Dow Jones Industrial Average closed more than 20% below its October 2007 peak on July 2nd, to put it into “official” bear market status. The Standard & Poor’s 500 soon followed, crossing the 20% threshold on July 9th. Since the July lows, the stock market has rallied. The big question now: has the market reversed its downward trend or is this just another bear market rally?

Based on a study of previous bear markets, the odds favor a continuation of the decline. According to Sam Stovall, chief investment strategist of Standard & Poor’s, in the last nine bear markets since 1956, the average loss has been 32%. The average duration has been 14 months. Based on that scenario we still have another five months and 12% before the current bear market ends. But using averages to make predictions can be tricky at best.

Right now a number of closely watched sentiment indicators are reflecting high levels of investor pessimism, but have they reached the extremes typically associated with a major market bottom? There’s no question that the fear levels have risen as evidenced by the American Association of Individual Investors’ (AAII) weekly poll of investor sentiment.

Meanwhile, the most recent numbers from Investors Intelligence, the folks who track over 100 advisory services, shows levels of pessimism not seen in more than a decade. The percentages of advisors who are bearish [is] at 50%, which is their highest reading since January 1995.

While these two indicators definitely show an increase in bearish investor sentiment, [we do not see] signs of investor capitulation that we would expect at a market bottom. It looks to us that it is suggesting a rally from oversold conditions, but not a major reversal.

Our sell signal on January 15th remains in effect, and we continue to recommend that long-term investors maintain a 100% money market fund position.

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