Recipe: Bear Market BottomTitle
By Ryan J. Puplava CMT, May 13, 2009
Preparation Time: a Few Months
Number of Servings: 1 every 4 years on average
Calories Per Serving: 6% to 59.8% return
Time to cook: 8 to 106 days
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
A recession or depression in a large pan
A financial market with a side of sectors
Loose monetary and fiscal policy
A hint of expectations change
Followed by a generous helping of economic recovery
Cook on high and watch for green shoots to mature
Directions: The market has experienced a bear market rally of unprecedented strength since the March low. In the last 100 years it is marked as the 3rd greatest bear market rally under the two largest rallies ever seen in the 1930s. The question on everybody’s mind should be, “Is this the start of something new or will the bear market resume its course?” If that is true for you, it is best to look at some tried and true methods at timing a market bottom.
Timing the exact stock market bottom takes a bit of a gambling by betting against the crowd, and that’s not what I’m talking about here. When I talk about timing the bottom, I’m talking about confirming the market and the economy are recovering and on a road to becoming the next bull market. To cook that recipe we need a few ingredients: loose monetary and fiscal policy, reviving consumer expectations, bottoming out industrial production, bottoming out interest rates, a normal yield curve, and confirming market technical signals.
We have a loose monetary and fiscal policy today. It is on an unprecedented level unlike any loose policy program we’ve ever seen. The combined monetary policy of the Federal Reserve Bank and the fiscal policy of the government is estimated at 29.9% of GDP. The highest amount as a percentage of GDP before that was in the early 30s at 8.3% as seen from the table below.
The next ingredient to the recipe is reviving consumer expectations. Part of the consumer confidence index is consumer expectations. Consumer expectations have improved since the market found a bottom in March. The confidence index itself remains below 40, a low level that had not previously been violated since the index was started in 1969. The index did, however, jump in April’s report after its small gain in March. The difference between those who found “jobs are plentiful” and the number who found “jobs are hard to get” improved in the April’s report. However, consumers are still very concerned over their job security, volatility in the market, stretched household finances, credit availability, and declining housing values. Despite the recent small recovery in consumer expectations, I do not consider them fully reviving yet but we seem close. The consumer needs more financial conditions to improve before the index returns to economically positive readings.
Capacity utilization has dropped below 70% to 69.3%, the first time since the data series began in 1966. Industrial production fell 1.5% in March as companies work off high inventory levels in Q1. Excluding car manufacturing, output declined 1.9%. Industrial production declined 20% annualized in the first quarter. Industrial production clearly isn’t bottoming out yet, but we’ll hear more on March 15th when the data for April comes out. Of special interest to me will be industrial production in the 2nd and 3rd quarter. During the earnings season many companies, such as Texas Instruments, highlighted that they had finished working down inventories in the first quarter and were ramping up production in the second quarter. This is encouraging to hear.
Bottom in interest rates
In the market bottom of 2003, the 10-year interest rate bottomed and rose until the summer of 2007. We currently have what looks like a bottom in 10-year yields with a higher low in March and a higher high in May. However, we may be near a short-term top as we bump up against long-term resistance. The main key here is that the 10-year bond will probably rally as investors flock back to bonds but I think that’s only a short-term trend. I’m guessing that yields are going to break higher this summer and a new bear market will begin in U.S. treasury bonds as inflation expectations climb and faith in the U.S. dollar dwindles.
When the market is ready to bottom, we have a normal yield curve in which short-term debt has a lower interest rate than long-term debt for instruments with the same credit quality. The market associates greater risk with long-term investments and therefore requires a greater rate of return further down the timeline. Banks make a profit on the short to long-term spread in rates during a normal yield curve through paying out less money on short-term deposits and making a profit on wide spreads for long-term loans. This is the picture of a healthy yield curve for a stable and growing economy. As the economy rights itself out and begins a new expansionary bull market, the yield curve will begin to steepen.
Confirming Market Technical Signals
In Martin Pring’s “Technical Analysis Explained”, there is a chapter titled: “Checkpoints for Identifying Primary Stock Market Peaks and Troughs” containing 14 factors he looks for to determine a market bottom. Going over all 14 factors would be a market observation essay all on its own. There is one point that I want to use and that is a final low is usually confirmed by a bottoming in the smoothed long-term moving averages. So let us look at the 40-week moving average for the S&P 500. Has it bottomed? Not exactly.
Everything is pointing towards an improvement to our economic environment; however, the market has gotten ahead of itself in this rally with a return of 39.6% from a March 6th low to a May 8th high. We have one part improved expectations, but we’re missing the follow through of those improved expectations into retail sales and an increase in industrial production. The technology sector signaled a short-term correction last week with its shift from sector lead to sector lag. The advance-decline line is rolling over. The S&P 500 bullish percent index is rolling over. All technicals are pointing towards a short-term top, but we have the potential this summer to confirm the March bottom in stocks and point towards a recovery in the economy in the second half of 2009 which would mix to create the recipe for a bear market bottom.
© 2009 Ryan Puplava