Is This The Bottom
Over the past few weeks, I continue to be asked, “Is this the bottom of the stock market declines?” In part because we have not seen this level of volatility or rapid decline in most of our lifetimes, we are absolutely in un-chartered territory. However, some fundamental and psychological barriers must be passed in order for a full bottom of a stock market decline to complete.
In the opening stages of a bear market, investors start to head for the exits in larger and larger numbers and a certain level of fear begins to grip the market. Investors continue to watch the market daily, hoping for an opportunity to get out of investment positions that are at risk. For a period of time, everyone is waiting for an opportunity to sell and any short-term rally becomes a selling opportunity for the large numbers of investors wanting to get out of the market.
This continued decline and lack of any consistent, sustained upward price movement of stocks, in general, causes the level of investor fear to increase to a panic in most cases. The panic becomes heightened as investors attempt daily to sell into a market where day after day the price available to sell decreases further and further. Extreme volatility in the markets, caused by this panic, causes the general stock market to begin trading in large percentage numbers. For example, down 4% one day, up 2% the next, down 6% the next day and down 3% the next. The up days are overshadowed by the down days, but the magnitude of the movement is the amazing thing. Markets that are used to daily moves of 0.2% and 0.4% are suddenly moving that far in two or three minutes.
In addition, the fundamental profitability of the underlying companies ceases to matter to investors and the prevailing wisdom is that the companies don’t know what the future holds and forecasts of company earnings have become based on bad and dated information. The market judges the earnings forecasts to be incorrect and not important relative to the price of the stock. At this point, the market is trading entirely on emotion, not on fundamentals, profitability, earnings potential or management capability and the prevailing emotion is fear or panic.
The ultimate resolution for this fear-filled general market emotion, is a complete purging event commonly called “capitulation.” Typically, this is a one or two-day market event wherein the market experiences a tremendous, single-direction drop on a level of volume that is many, many times the normal volume. Not just three or four times normal volume but ten or twenty times normal volume. This event causes all hope to leave the market and investors scramble to exit all at the same time. The investor is not concerned with the exit price and is willing to take any price that the market will offer.
In the absence of hope and with all hopeful investors now out of the market, the only investors left are those that are apathetic to the condition of the market. Those investors that have held positions, have determined that they will hold for the long term and not try to sell at this point. The buyers are those that have long-term views and really don’t care what happens to the market in the short term. If they did care and were hopeful, they would have been driven from the market.
At this point of apathy, news of the market, Federal Reserve, and Treasury fade from the front page of the local newspapers and the market becomes something that people are no longer concerned with. Trailing news stories of companies declaring bankruptcy, banks collapsing and international monetary coordination is seen as old news. The apathetic investors move forward without interest in today’s direction of the market and the healing effect of time can begin to work its magic. It is during this time period that the greatest buying opportunities in history have been created.
Now, back to the original question, “Is this the bottom?”—Absolutely not… Fear is still gripping the market, panic is starting to set in. Most investors are hopeful that they will be able to get a better price as they start to sell. We have many, many large companies that are trying to sell anything they can in order to generate cash and the only part of their portfolios that are liquid are the stock market portions. We can certainly conclude that we have not had a capitulation type event and we certainly have not reached the point of apathy as a market and as a nation.
Given the upcoming elections and all of the events of the Federal Reserve and Treasury, the market continues to be hopeful that the government can somehow turn this around. I believe that the efforts of the Federal Reserve and Treasury have been correct and will help the situation, however, the sentiment of the market participants must still be corrected in order to complete the cycle. And, we have not completed this downward part of the cycle.
Clearly this is not the bottom...yet.
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