Category Archives: market bottoms

technical analysis: double bottom

November 13, 2014 By in Casinos, counter-trend movements, earnings conference calls, Energy, Hong Kong, Macau, major changes in market direction, market bottoms, Technical Analysis Tags: , , , Leave a comment

Regular readers will know that I’m not a particular fan of technical analysis, at least as a primary tool in determining the investment attractiveness of the equity market or of individual stocks.  A hundred years ago–maybe even sixty years ago–it was the tool, because there was nothing else.  Before the SEC, company financials were a joke, and they weren’t easily available in a timely manner.  Watching the trading patterns of the “smart money” was arguably the best an average person could do.

Nowadays, the SEC’s Edgar site has all US-traded companies’ filings available for free the instant they’re made.  Most companies also have extensive libraries of their own available on their sites.  Firms now webcast their earnings conference calls for all to hear.  If you don’t feel like listening, transcripts are available for free soon afterward from Seeking Alpha.  

So it isn’t so much that technical analysis is bad per se.  It’s just that like the horse-drawn cart it’s been replaced by fundamental information that’s quantum leaps better.

support/resistance

Still, there are some aspects to technical analysis that I find useful.  One is support/resistance.  This is the idea that price levels where there has been significant past trading volume, preferably over an extended period, will act as floors to support stocks as they fall, as well as ceilings to impede their advance.  Both holding at and breaking through these levels are often significant events.  In particular…

double bottom

When the market has been declining for an extended period of time, or has dropped particularly sharply (the “magic” numbers technicians use are typically losses of 1/3, 1/2 or 2/3 of the prior advance), it often stabilizes for no apparent reason and begins a significant upward bounce (+10%?).

The fact that prices are now going up isn’t enough by itself to establish they have reached an important low.  In almost all cases (March 2009 was, on the surface at least, a significant exception–see below), stocks begin falling again within a few weeks and find themselves approaching the previous low.  If the market touches–or almost touches–the previous low but begins to rebound again (in the US, the market may briefly trade lower than the previous low–we’re daredevils, after all), this is often a strong sign that resistance is forming at the old low.  This revisiting of the low is the necessary second part of the double bottom.

There can be a triple bottom, too.  More often, in my experience, the market begins a new, upward pattern of higher highs and higher lows after the second bottom.

Fundamental conditions must also be in place for this bottoming to happen.  Stocks have to be cheap; investor pessimism must be high; the downtrend must be protracted enough for at least some investors to think that conditions won’t get worse.

In essence, what the double bottom tells us is that intense negative emotion that has been driving prices sharply (often irrationally) lower has begun to play itself out.

current examples

Double bottoms happen with individual stocks and stock groups, too.

Look at the Macau casinos traded in Hong Kong.  Some, like Galaxy Entertainment, have lost half their value over the past ten months.  But the group appears to have bottomed in late September-early October.   The stocks bounced off their lows, returned near them several weeks later and appear since then to have established a new upward pattern.

I haven’t looked carefully at energy stocks–but the oils are a group where I’d be looking for similar behavior.

the March 2009 case

The S&P 500 appeared to me to be bottoming in early 2009.  As is usual during recessions, government programs were being put in place to stop the economic bleeding.  Anticipating this, investors had pretty much stopped selling.  However, in late March investors were horrified to hear that Congress failed to pass the proposed bank bailout bill/  Some (Republican) Representatives were even saying they would prefer a rerun of the Great Depression to a bank bailout.  The S&P fell more than 7% on the news, but recovered all its losses when the bill was passed the following day.  If we erase those two trading days, early 2009 exhibits a “normal” bottoming process.

 

 

what if this is a bear market…and not just a wicked correction?

September 28, 2011 By in Constructing a Portfolio, Current Market Thoughts, economics, major changes in market direction, market bottoms, market tops, Portfolio management, Recent Market Action, Strategy, Trading Tags: , , , , , , , , , , , , Leave a comment

standard definitions

Commentators often use sound-bite definitions for economic and stock market phenomena.  For example,

–a recession is two successive quarters of year-on-year GDP decline.

–a correction is a short, counter-trend, fall in stocks of 5%-10%.

–a bear market is a fall in stock prices of 20% or more.

The virtues of these definitions are that they’re brief and unambiguous.  On the other side of the coin, brief and unambiguous doesn’t represent real life that well.

adding complexity, but also relevance

There’s a time aspect to corrections and bear markets.

A correction typically lasts a few weeks.  That’s because it’s normally a valuation issue–that “animal spirits” have pushed stock prices higher than near-term earnings can comfortably support.  Short-term traders sell, but intend to repurchase in short order, hopefully at somewhat lower prices.

Bear markets, on the other hand, come in two types.  Both anticipate–and ultimately reflect–widespread economic weakness that will last for a year or so.  The garden variety is a consequence of governments’ countercyclical fiscal and money actions when economies are about to overheat (too bad Mr. Greenspan forgot about this part of his job).

The really deep ones come from one-time shocks to the system.  In the past, these have been “external shocks,” like huge oil price rises.  The most recent is the self-inflicted wound of the financial meltdown.  As we experienced in 2007-2009, these ones are deeper and longer.

for the record…

…I don’t think we’re in a bear market–at least not in the world outside the EU (where stocks have already lost over a third of their value since May).

I think we’re in an unusual situation of correction in world markets, complicated by the EU situation.  In brief, the EU hoped to get away with not rebuilding its banks’ strength after the losses they took in the financial crisis, but hiding them instead.  They figured they could free-ride on the economic coattails of China and the US instead and use worldwide growth to mend.

Then the Greek crisis came.  And, instead of addressing the fact their gamble had failed, EU governments have spent the last year with their heads in the sand, letting the problem get worse.

why bring this up now?

EU stocks have lost over a third of their value since May.  US stocks are down by almost 20% (the “magic” bear market line).  Metals prices are crashing.  Stocks have been extremely volatile.

Monday morning I saw a lot of crazy stuff when I turned my computer Monday morning.

–European markets were down 5% intraday.

–Hong Kong-traded Ping An Insurance (I own it–ouch!) had lost another 8%+.  It was down by 25% in three days on rumors that HSBC was about to sell a portion of its holding (so what, I say).

–AAPL lost $10 in early trading in a rising US market on a report out of Taiwan that orders for iPad components from Hon Hai for the December quarter were lower than expected.  It turns out the orders, if they are indeed being lost at Hon Hai, are most likely going to a new iPad factory that’s opening in Brazil in December. It could equally be that AAPL is preparing for iPad3, which would be a bullish sign, I think.  But, noooo. Traders took the most bearish interpretation.

The world isn’t 5% better one week, 6% worse the next, and 7% better the week after that.  Economic processes don’t change that fast.  Human emotions do, however.  And the extremes of emotion we’re seeing now typically signal significant turning points in market behavior.  Hence the title of this post.

what to do

My best guess is that we continue to move sideways in markets ex the EU until European governments address their banking crisis.  They markets probably rally.  But that may not be for a while, so don’t bank on that.

I think the best strategy is to use days of crazy selling as a chance to buy stocks that are being irrationally sold down.  Be very picky, though.  Look for high quality names where you’re very confident about the fundamentals.  And don’t bet the farm on a single stock.

On September 6-9, for example, I bought INTC, because I saw it was trading at under $20 a share, or less than 9x earnings, and with a dividend yield of 4.3%.  As/when it reaches $24, I have to decide whether I keep it.

if it’s a bear market, then what?

Then markets are not turning up again until maybe next summer.  And, if past form holds true, we’ll see at least one more downdraft in stock prices–maybe another 10% from here, more in economically sensitive stocks and in emerging markets securities (even though the emerging economies themselves may be fine).  That will come as government statistics and company reports show economic activity dipping into negative territory.  Yes, world stock markets may have begun discounting this possibility.  But, ex the EU, they’re barely begun to, in my view.

As much as it cuts against the grain of my growth stock temperament, it seems to me it’s worthwhile thinking about asset allocation and how you’d act if a more ursine mood begins to make itself evident on Wall Street.  My portfolio is betting against this, but it never hurts to think about what happens if you’re wrong.

 

 

 

 

 

major changes in market direction (II): market bottoms

March 2, 2011 By in major changes in market direction, market bottoms Tags: , , , , , , , Leave a comment

looking at bear markets

What is the stock market?  It’s the place where the hopes and fears of investors meet with the objective, profit-making characteristics of companies, and express themselves in the prices of the publicly traded equities the companies issue.

characteristics of a bottom

time

Why is that important?  In a bear market, a key issue is time.

It’s true that, because people tend to extrapolate from recent experience, it takes time for investors to adjust to changing market conditions.  The initial bear market rally, prompted by the belief that the first leg down (of three) in a bear market is actually just a correction in an ongoing bull phase, bears witness to this.  But investors “get” the new market direction relatively quickly as the rally fades and stocks head back down.

In a bear market, the more important factor is that it takes time for companies to work off inventory, revise capital spending plans, figure out whether to halt projects already underway, and trim payroll.  With today’s sophisticated supply chain management software, the ripples of slowdown from the retail storefront that people spread very rapidly to suppliers.  This spreading call to adopt a defensive posture intensifies the slowdown.

Most important, though, it takes time for countercyclical measures by governments to be put into place and to start to work.  It takes time for economies to stabilize and begin to heal.

How long?

In the case of an inventory cycle recession, the process of stabilization probably takes a year.

As we’ve seen in the two recessions of the past decade, when structural factors are involved, the process may take two years.

The conclusion from this:  it makes no sense to start to look for a bottom until a substantial amount of time from the top has passed.

valuation

Because emotions run faster than changes in the corporate environment, stock values (after being pummeled) may stabilize and move sideways for a period of time during the later stages of a bear market.  The most important indicators, to my mind, with the lest important first, are:

1.  Economically sensitive, commodity-like cyclical stocks may trade at a discount to book value.  This essentially means that the companies are on sale for less than it would cost to build the plant and equipment they own, after repaying all debt.

2.  Companies sell for less than net working capital.  This is the same idea as #1, except that in this case the firm is selling for less than what you would get after running down inventories and collecting what trade creditors owe, and repaying all financial and trade obligations.  You get the plant and equipment, trademarks and brand names, distribution network…and everything else…for free.

3.  Some companies, usually weaker ones, trade at a discount to net cash on the balance sheet, meaning what’s left over in the bank after paying off all trade and financial obligations.  Stunning, but it happens.  Just check out March 2009–or November 2008.

4.  The dividend on stocks exceeds the coupon on the 10-year government bond.  This is a very unusual case, but something that occurred both in 2003 and 2009.  Typically, in my experience, the market to watch is the UK, a very income-oriented market.  When the FT 100 yields more than long gilts, the bell that we’re at the bottom is ringing loud and clear.

Strikingly, this phenomenon also occurred in the US in 2009–when Republican legislators in Washington inexplicably, and scarily, voted against rescue of the financial system.  They seemingly voted for a decade of the dust bowl, riding the rails, selling apples on street corners and 25% unemployment (in other words, the depression of the 1930s) as the best course for the economy.  Talk about cutting off your nose to spite your face–and frightening the wits out of investors.

an end to layoffs

I’m a great believer that the economic intelligence of the average citizen is very under-appreciated.  The first indications of slowdown come from the storefront; the first indications of corporate stabilization come company decisions to end layoffs.  This news spreads like wildfire through companies.  Salesmen sense a better tone with customers, line managers see more smiles–or at least fewer frowns–on the faces of top management.  These changes in corporate atmosphere—which I think any employee can sense in his own company–are also powerful indicators of a market bottom.  They’re part of the healing process.  They translate into a less defensive attitude on spending.  These changes, which you can see immediatle at work, take many months to be reflected in government statistics.

a selling climax

This is sometimes called a selling panic.  The idea is that investors finally lose the emotional control that they have been maintaining throughout the bear market and, gripped by fear, begin to sell large amounts of stock with no regard to price.  They do this either until they run out of things to sell or they become exhausted from the strong emotions they are experiencing.  In theory, you can’t work up this negative emotion again quickly.  And as you recover your senses you’re embarrassed and remorseful for having acted so stupidly and irrationally.  You also realize that you’ve participated in the final selloff and that the worst has passed.

This doesn’t always happen.  The big bear market of 1981-82 ended with a whimper, with no final selloff.

In contrast, during four weeks in November 2008, for example, the S&P dropped by 25%. Shockingly–to me, anyway–this huge November selloff wasn’t the bottom.  Thanks to Washington, another selloff of the same magnitude occurred in February-March 2009. That was the first time in 30 years of investing that I’d seen that. I wish I hadn’t.

revisit March 2009–you’ll be surprised

Pick any stock and look back to its price in early March 2009.  You probably won’t believe how cheap it was.  And, yes, the dividend yield on US stocks was higher than the long Treasury, there were stocks selling at a discount to net cash and corporations were beginning to work out that they had fired too many people.  All the signs of a major bottom were there.  Of course, except for possible rehiring, all the other signs were there in November 2008.