Time to Say Goodbye to the Bear?
Don't call Jim Stack a bull -- yet. The veteran market strategist was one of the most bearish analysts at the start of 2008, and he has remained cautious. But Stack sees classic signs that investors are capitulating to the downward slide in share prices, signaling that the bear market will likely end soon. "We're reaching the point where we really question whether there's much more downside risk," he says.
For Stack, the glass is currently both half full and half empty. "Until we see solid evidence that a market bottom is in place, it's difficult to take a strongly bullish outlook," says Stack, who publishes the newsletter InvesTech Research from his perch in Whitefish, Mont. "On the positive side, we have all the extremes in pessimism that typically accompany a bear-market bottom -- a once-in-a-lifetime buying opportunity."
Another big plus: Stocks are dirt-cheap, whether you consider price-to-cash flow, price-to-book value, price-to-sales ratio or dividend yield. "This is a 1929-style bear market for lots of big companies, such as Dow Chemical, General Electric and International Paper, which have each fallen more than 80%," Stack says. The yield on Standard & Poor's 500-stock index is 3.6%, and stocks of many solid companies are yielding 5% or more. That's especially significant given how low interest rates are.
So, although Stack isn't ready to declare the bear dead, he currently recommends that clients keep 58% of their assets in stocks. That's a lot more than he's been suggesting the past couple of years.
Stack uses a bushel of technical indicators and fundamental economic measures to assess the market's direction. Many signals have flipped to the bullish side.
Investor capitulation is one of the final signs he looks for at a bear-market bottom. Says Stack: "By definition, capitulation occurs when investors ultimately decide to abandon the stock market in lieu of safer alternatives. It's often accompanied by panic selling and steep declines on high volume."
In other words, bear markets often end amid just the kind of sound and fury we've been witnessing of late.
How will Stack know the new bull market has begun? "One of the most important signposts is downside selling pressure drying up," he says. Stack wants to see a dramatic drop in the number of stocks hitting new 52-week lows. "Once everyone who wants to sell has sold, then pressure dries up."
Not long after the market bottoms, the number of stocks making new lows falls to fewer than 100 -- and that number remains fairly constant for a time. "If you see two or three weeks of that, it's meaningful," Stack says. After bear-market bottoms in 1990 and 2003, the number of new lows dropped to less than 20-and stayed there for months. (October 9, 2002, marked the low point of the bear market that began in 2000, but some analysts think the downturn actually ended the following March.) On March 5, a day on which the S&P 500 fell 4.3%, 728 stocks trading on the New York Stock Exchange hit new lows.
You'll make the most money on the upside if you hop aboard the market shortly after it signals that it has hit bottom. Stack says most investors will miss a big chunk of the rebound, so he's recommending a healthy allocation in stocks. "By the time you feel comfortable that the bottom is in place, you'll be uncomfortable going in because the Dow Jones industrial average will be up 1,000 or 1,500 points."
Don't expect the economic news to turn rosy anytime soon. The economy generally hits bottom about five months after a bull market begins. "As the market goes up, it's going to move higher on bad news," says Stack. "The bad news isn't going to go away."
Here's the sweet part: Stack thinks we're in for a doozy of a bull market. After the market bottoms, he anticipates back-to-back years of 20%-plus returns.
Why? Because stocks are so cheap and because this bear market has been so deep and protracted. Plus, the current bear arrived just five years after the 2000-02 bear market, which was also severe. The past decade has been miserable -- the S&P 500 lost an annualized 4% through March 6, according to Morningstar. From the market's peak in October 2007 through March 6, the S&P plunged 56%, making this easily the worst bear market since the Great Depression.
The odds of the current recession turning into Great Depression II are slim, says Stack: "The U.S. economy is very diverse and amazingly adaptive. And even if we're undergoing some of the same pressures of 1929, you have to bet that all these Nobel Prize-winning economists know something because the Federal Reserve and the Treasury are applying a textbook bailout. While the headlines are filled with everything that's going wrong, maybe it's time to ask what the market will do if some things start to go right."
Steven T. Goldberg (bio) is an investment adviser.