toe in the water?–two days later: four signs to watch for

back to the drawing board

I had thought that Tuesday’s afternoon rally in the S&P from its 1106 low to its 1172 close was a significant event for the market’s psyche, since it cut with ease above what I thought was significant resistance at 1150.   Apparently not.  Yesterday’s loss of 6% by European stocks was too much for Wall Street to bear.

four signposts to look for

I think there are four signs to watch for that will indicate that the worst of the current market fall is behind us:

1.  The market holds at/above a significant technical level.  For the S&P, the closest is 1100.

2.  No more lower lows.  The most recent intraday low for the S&P is 1106.  It would be encouraging, even if the index declines from yesterday’s close, if it stayed above that level.

3.  No negative reaction to bad news.  A very clear sign that negative events have been already discounted in current stock prices is when further negative news comes to light and the market simply shrugs it off.  That certainly isn’t happening yet, since yesterday’s fall was sparked by rumors that S&P will downgrade France.  If anything, yesterday’s market action shows the opposite.

4.  Individual stocks stop falling in lockstep.  Panic selling is by nature irrational and tends to flatten everything pretty equally.  A sign that investors are reaching for emotional equilibrium again, even in a market that continues to fall, is when the strongest stocks separate themselves from the pack and begin to outperform the others. AAPL is already one example, but we need more.

CSCO will be an interesting test of this idea today.    The company reported better than expected results after the New York close yesterday and is up about 7% in after-market trading as I’m writing this.  I’m not a big CSCO fan, but the stock is only trading at about 10x earnings, and it does yield almost 2%.  It would be a healthy development for the market if the stock can hold onto most of that after-market rise in regular trading today.

a fifth indicator–one nobody wants to see it, but we may be doing so now

At the recession lows for the S&P in 2003 and again in 2009, the dividend yield on the S&P briefly rose above that of the ten-year Treasury.  That wasn’t because companies were raising their payouts; it was because stock prices were being crushed.  But it was a very clear buy signal.

At present, the yield on the ten-year is 2.1%.  The yield on the S&P, as best I can figure it, is a shade over 2%.  It could even be higher than 2.1%.

This indicator isn’t about the market psychology of when emotion-driven selling will stop.  It’s about value.  And it shows how cheap stocks currently are.  I’ve only seen investors consistently ignore this extreme relationship once in my career–in the post-1989 Japanese stock market.  I don’t think we’re in that situation in the US today.

Leave a Reply

%d bloggers like this: