Hey, where is that bailout rally? With $700 billion of socialist medicine injected into the system stocks should surely go up in value? At least that was the hope of shell shocked investors that have endured what is now a very entrenched bear market.
Instead, we were handed losses on Friday that cascaded around the globe over the weekend. Those losses overseas set the stage for a drop in the United States that didn’t end until the Dow was more than 800 points lower.
Surely this must be the capitulation we are all looking for. The volatility index, or VIX, was well over 50 and fear was in the market. Down volume overwhelmed up volume, but total volume was not high enough to give those looking for a bottom a clear signal.
It didn’t help the case for capitulation to see the index rally some 500 points before closing down 370 points. Although painful, the market is moving lower in an orderly fashion.
There really is no panic. Instead there is a simple realization and reckoning that the economy is undergoing a painful adjustment. The world is de-leveraging and as it goes through that process spending must adjust downward.
With that adjustment comes lower profits. That is why stocks are moving lower. It would be nice to see professionals admit this fact, but you hear very little about valuations during this crisis.
There is way too much focus on calling a bottom. I’m reminded of my children asking, "are we there yet" while going on long car trips. No we are not there yet.
So when will we get there? To start, I would submit that as long as the pundits keep predicting a bottom, a bottom we will not have. Nope, best to stop asking and in so doing the clock will most certainly move quicker. (See also: "Finding the Stock Market Bottom" and "Where, Oh Where, Is the Bottom.")
For a clue into the future, investors would be wise to take a hard look at the chart of the Nasdaq Index in 2000-2001. That painful contraction in values took many months to fully process.
If you recall, after the Nasdaq peaked near 5,000 in early January, a massive bear market began to cut values in a major way. A sharp correction pushed the index to 3,500 by the end of that spring.
An excellent buying opportunity?
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Sorry Charlie! A summer rally was instead an opportunity to minimize losses. The index fell to 2,500 by the end of 2000 capping off near 50% drop in value.
If you thought you hit a bottom at 3,500 you lost nearly a third of your investment, but surely 2,500 was the new bottom. Investors could swoop in a find great value in these beaten down stocks. If you held on to your positions, certainly do not sell now when a rally is forthcoming.
I recall training for a marathon during the winter of 2001. One of my running friends asked if we had hit a bottom. I said no. According to my analysis, the bottom would be put in at around 1,600.
He didn’t believe me, but he wishes he did. The Nasdaq actually fell further than I expected finally bottoming at around 1,200 in September of 2002. Currently, 7 years later, the Nasdaq is fumbling around the 1,800.
Do you see a pattern here? If not, you cannot be helped. Something like you can lead a horse to water, but you cannot make him drink comes to mind.
Anyway, there is a definitely similarities here as we look at the market today, but it is more than just looking at the chart. The real commonality between the Nasdaq of 2000 and the market today is the adjustment in valuation to the reality of the time. (See also: "Calling a Bottom.")
With the Nasdaq, investors realized that many of the companies that had been bid up in value had little chance of delivering the profits that were necessary to sustain nosebleed valuations.
Today, we have a market that is much more reasonably priced, but is now adjusting to a world of lower profits or even losses for many previously solid companies. Even though we are not dealing with a similar craziness in valuation, an adjustment to the future is necessary nonetheless.
Yes in the period of low interest rates, stock values may in fact deserve multiples to earnings in the mid-teens, but such a case does not make as much sense in a period of recession.
Ultimately, the current adjustment will take time just as it took time for the Nasdaq to correct in 2000. I think it is safe to say that a turnaround in economic conditions is not forthcoming any time soon.
Is it the end of the world? Absolutely not, but the direction of the moment is down. By the way it is not down because of panic. It is down because of a rational adjustment to valuations.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com and check out:
