Let the Market Find a Bottom

12/03/2008 1:00 pm EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of IQ Trends, says the market may take its time to hit bottom, but then there will be good opportunities for patient investors.

According to Ned Davis Research, of 42 markets globally, 41 are now down by at least 40% from their bull market highs.

Not since the 1930s have we seen such severe bear markets in the Dow Jones Industrial Average and the Standard & Poor’s 500 index. And not since the 1930s have we seen S&P 500 volatility so high and credit spreads so wide.

It is not uncommon for 50% of the gains made during a bull market to be wiped out before the market reaches a bottom and a new cycle begins. What is uncommon is for a bear market decline to be this deep and this fast. When you consider how extremely overvalued the market was by 2007, however, it makes perfect sense that the extremes had to be taken out decisively.

In many respects, this market was a train wreck just waiting to happen. While there was a significant amount of damage done during the 2000 through 2002 sell-off, most of it was centered on the tech and dot-com bubble.

Even though there was little interest in high-quality, dividend-paying stocks during the second half of the 1990s, there was very little historic good value in this arena at the 2002 lows. In fact, the number of Undervalued stocks at the 2002 lows on a percentage basis was still consistent with levels seen at prior historic market tops.

That money flowed into dividend-paying stocks after the 2002 lows, even though there was little historical good value present, only underscores how badly investors’ perceptions were skewed about what constituted real value. 

The past is past, though, and there is nothing to be gained from asking endless “what if” questions; it is time to deal with the present and make preparations for the future.

The catalysts that drove investors and the markets to exceed long-established parameters of value to such an extreme degree appear to be in the process of being eliminated. With the 3% area of Undervalue having been decisively violated, the dividend yield on the Dow has reached or breached the 4% level on four occasions.

Accordingly, with the global economy obviously in recession, I would not be surprised to see 5% and eventually 6% (in stages) before the bear markets end. If these yield objectives are reached, it will not be because of poor earnings; it will be because investors will demand greater value.

After every market bottom since World War II, the average return after one year has exceeded 35% and over 50% after two years. In no instance was there a negative return in the first two years. Even after the market reached the Depression low in 1932, it doubled off that low in one year and tripled within three years.

Market bottoms are a process. So, instead of abandoning equities with the masses at the very point that real value is being realized, be patient, pick your spots, demand value and remember you are a long-term investor; this, too, shall pass.

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