Where's the Bottom?

After a weekend of meltdowns, bailouts and rate cutting, investors returned to the stock market following the collapse of Bear Stearns in a remarkably forgiving frame of mind.

Who knows? Maybe a little St. Patrick's Day refreshment eased worries on Wall Street as the Dow Jones industrial average ended March 17 with a gain of 21 points, or 0.2%, to close at 11,972. The Nasdaq and Standard & Poor's 500-stock index ended the day down 1.6% and 0.9%, respectively. Quite a comeback, considering that at the day's lows, the Dow was down nearly 200 points.

Another day, another roller coaster. Investors have been on one since market averages peaked in October, as losses in subprime mortgages and the esoteric securities derived from them have wreaked havoc with the global economy. So it's understandable that many investors are wondering if the turmoil is near an end -- and more importantly, if so, how can one tell?

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

We stand by the old adage that nobody rings a bell when stock markets hit bottom. In fact, Jim Stack of InvesTech Research, who has a pretty good track record of calling bottoms, admits: "You're doing a good job if you recognize the bottom two months afterward. And even then you don't know if it's an interim bottom, or a new market low."

Nonetheless, Stack and other gurus have a handful of favorite indicators they like to watch for a heads-up on market turns. So far, most of those indicators suggest the market hasn't hit the bottom yet.

Before we get to them, however, it bears mention that the list is notable for what's not on it. Price-earnings ratios, for instance. "You can't look at valuation," says Stack. "I'm a market historian, and I can tell you P/Es just don't work." The problem: Stock prices always move before earnings trends are revealed in published reports.

Likewise, dividend yields used to be considered a good gauge of market inflection points, but no longer. The complex interplay of interest rates, dividend yields and inflation make it impossible to divine a rule of thumb.

So what should you be watching now? Many telltale signs have to do with internal market dynamics, from stock price patterns to trading volume to investor psychology -- so-called technical indicators.

"Fundamental indicators are a blunt knife," says Sam Stovall, chief strategist at Standard & Poor's. "Technical indicators are a sharp needle -- the chances of pinpointing turns are greater."

The folks at Ned Davis Research are known for their knack for putting such market yardsticks in historical context. They're watching 12 different indicators currently, but mentioned three in particular.

First is the VIX index of options volatility. Extremely high levels indicate extreme fear -- which is the predominant sentiment when bottoms occur. The recent high was 31.2. Previous readings signifying ends of corrections of bear markets occurred at 45.1 (October 2002), 45.7 (August 1998) and 36.5 (October 1990). According to the VIX, we haven't seen a bottom yet.

Next is the percentage of stocks trading above their average price for the past 200 days. Extremely low readings indicate that a market selloff is overdone and likely to reverse. The recent low was 13.8%. Previous lows: 4.6% (2002), 12.5% (1998) and 11.1% (1990.) No bottom quite yet, according to the 200-day moving average.

Third on the list from Ned Davis Research is the ratio of advancing stocks to the number of declining stocks, averaged over the past 90 days. Extremely low readings indicate an over-sold market. The recent low: 83.9. Past lows: 78.3 (2002), 74.8 (1998) and 73.0 (1990).

Stack follows a bunch of complex, proprietary market indicators over at InvesTech. But one of his favorite non-technical technical indicators is a decline in bear market leadership -- in other words, a declining number of stocks hitting 12-month lows on the New York Stock Exchange.

That number has been up in the mid-500s recently, equivalent to about one in seven stocks hitting new lows. The number, says Stack is "not indicative of a market bottom." Look for the number to contract to fewer than 25 before the market bottoms, he says. Within the first month of a bull market, you'll see fewer than 12 stocks hitting yearly lows.

The news isn't all bad -- at least one signal is optimistic. That indicator, a contrary one, is the stratospheric level of bearish sentiment. The rationale behind it is that when sentiment is at extremes, the market is due for a turn. Investors Intelligence, a New Rochelle, N.Y., research outfit, polls investment advisers every week. The March 8 reading found 43.3% bearish and only 31.1% bullish -- the most bearish sentiment since the October 2002 market bottom.

We'd wait a bit before donning our Toro! T-shirts, however. The median length of bear markets is 15 months. Since the market peaked last October, that means we've got a 50-50 shot at hitting bottom by year-end. But to think that we're at the bottom in less than six-months time is, while possible, more likely just wishful thinking.