How To Watch a (Stock Market) Bottom

Recently, Lisa and I were waiting to be seated at a Kittery, Maine restaurant. The hostess stood to our left; we sat waiting. I avoided looking in her direction until Lisa said, “I like those jeans.” Well, we both acknowledged the jeans and the genes. I said to Lisa, “Now that’s a bottom to notice.”

Stock market bottoms have some common technical curves that arouse investors. Unfortunately, what the investor sees often distracts them from what matters.

On Tuesday,February 27, 2007 stock market watchers awakened to a surprise. On Monday night, stocks looked just O. K. However, there were some signs of concern within the shadows of a “Goldilocks” economy. Here is what happened.

For a number of weeks prior to February 27th, markets bounced up and down on news. Neither upward moves in the market nor downward moves were driven by much conviction. Usually, this rings bells for a few market observers.

“No fixed time can be set for the readjustment of values which always follows an era of extravagant expansion,” writes Cuthbert Mills in his article, “Recent Movements of the Stock Market”. [The North American review. / Volume 146, Issue 374, January 1888] (You knew it was old when reading the name “Cuthbert.) Mr. Mills marks ages of extravagance from 1807 to 1887 when the U.S. headcount was 60 million.

Market bottoms or corrections have distinct patterns. Past predicts the future, the present mimics the past, and extravagance is an attribute of any long-term bull market. Cycles repeat, excesses get squeezed, and progress continues.

Market corrections do have inherent and intrinsic patterns. Some market observers look for new paradigms to assuage the investor. Despite those assertions, markets function axiomatically: “Irrational exuberance” gets trumped by rational commitments.

At 4PM Monday February 26th, markets grabbed “irrational exuberance” by the throat and squeezed 546.20 points (4.3 percent or $632 billion)from the Dow Jones Industrial Average. At 4:30, the Dow ticked-off investors by 416 points.

Global markets rang dissonant bells as bears chased investors from London to Tokyo. Goldilocks met the wolf and the bear on 15 Huang Pu Road in Shanghai. The wolf and bear gorged 9 percent of Chinese stock value, where this market correction started.

In 1986, brokers celebrated every trading week with catered celebrations. My brokerage firm manager said, “Watch out; with every party there’s a hang-over.” October 19, 1987 proved his point.

Just the same, markets historically have recovered. Here are a few indicators when the bottom is near or at hand.

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Prior bull market leaders build bases (usually during a 7 week time-frame)
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New market leadership emerges (i.e. new asset class leadership)
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Closing trading volume reflects buyers accumulating stocks (always institutions)
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Trading volume on days when buyers sell stocks is lower than the days when buyers accumulate (institutions committed)

“You want to stay in phase with what the market is actually doing, not what you hope it will do or what other people think it should do,” Investors Business Daily founder William O’Neil wrote in “The Successful Investor” (McGraw-Hill; 1 edition, September 1, 2003. Implement asset allocation models to participate when asset classes move makes you a historical (not hysterical) investor.

Take a long-term view. Further, recognize that diversification matters within and outside the market. Do you own a home? Take care of it as an investment asset. Are you able to add investment property to your portfolio? Search it wisely. Is there a private business worthy of your investment dollars? Read the business plan…investigate the principals…find their competition.

Don’t chase bottoms (of any sort). Too often investors step into the path of a marauding bear market whether the stock market or the real estate market.

Wish I could remember the source of this story: Baron von Rothschild had a clerk running back and forth reporting stock market moves. Markets collapsed…the clerk kept saying, “It’s worse…when do we buy?” Rothschild calmly replied, “When the blood is spilling on the streets.”

Don’t celebrate, or as I tell my children sometimes, “Don’t get cocky.” Greed breeds stock market tops, and fear instigates stock market bottoms. Casual indifference does not a market-bottom make. Pale, anemic looking investors, licking investment wounds provide graphic evidence of a market bottom.

Today, the Dow Jones Industrial Average trades at 1215; the first close above Dow 6000 was October 14th, 1996 (it took 112 years to get to that level). A 10% correction (standard and expected) equals 600 points. At 1215, a ten percent correction is 1,215 points. If it happens in a day or a week, imagine the panic, and then watch for bottoms.

Whatever choices you make, seek a long-horizon. Warren Buffett purchased his first stock at 11 years old. He bought at $37 and sold at $40 only to observe the stock climb 163 points to $200. He attributes his long-term views to this experience.

Buffett did not limit investments to stocks (and he still doesn’t). When a teenager, he earned $1200 from his paper route, bought farmland, and leased it to farmers.

Too many for too long find the stock market their treasure chest . Seek opportunities across the scope of investable assets. Remember to research the market, buy at the right time, and for the correct reasons.

And watch those bottoms (market ones, that is),

A Raymond Randall
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