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We Haven't Seen the Bottom Yet

04/22/2009 1:00 pm EST


Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of Investment Quality Trends, says there hasn’t been the total despair that characterizes true market bottoms, but many stocks are cheap.

Having put in the longest uninterrupted decline since the nine months following the bombing of Pearl Harbor, the markets by all measures were severely oversold and therefore long overdue for anything that even remotely resembled a retracement.

While it is natural for investors to welcome any respite from the selling, what is disconcerting is the hallelujah chorus of “the worst is behind us” and “this is the start of a new bull market” that can be heard in some corners of the investment landscape. While these heralds could be right, what bothers me is that there is such consensus that they are right.

Generally speaking, the onset of most bull markets is met with extreme pessimism, if not outright disbelief. There is a fairly simple explanation for that: True bottoms in a bear market are reached only after repetitive cycles of hope and disappointment have crushed investor sentiment.

Strong bear-market rallies, which are often based on hope, equally often end in disappointment when investor expectations are not realized. Just because a retracement rally moves 20%, 25%, or even higher off the lows does not mean the bear cycle has come to an end.

When investors think the worst is over and they are finally recovering their losses only to see a new round of declines, they eventually become disgusted with the stock market and want nothing to do with it. While there has been plenty of fear and disappointment associated with this bear market, I have yet to see the level of widespread disgust that is viscerally palpable at major market bottoms.

Given that valuations are better than any time in the last 35 years and many technical indicators are flashing positive signs are apparent, it is highly improbable, however, that such a vicious bear-market would end with a simple V-bottom recovery.

[Nonetheless,] many individual stocks have [probably] bottomed or are in the process of bottoming.This is where the buyer of stocks, not markets, establishes the basis for their future gains. If I have written it once I have written it a hundred times: gains are established on the buy.

While there is a mountain of literature that states that stocks will outperform all other asset classes over the long run, what that literature fails to point out is that is only true when stocks are purchased at historic good values. Valuations are important; low-price and high-yield matters. In that vein we are seeing some of the lowest prices and highest yields in over three decades.

Could the broad market take high-quality stocks at historic values lower in another decline? Of course. Will they stay down? Highly unlikely. At some point this bear market will really be over. When thatreaches consensus, the opportunity to establish positions at historic levels of value will be long gone.

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