Is The Stock Market Bottom In?

Considering the market’s recent performance, I’m sure you are wondering whether the bottom is in. With less than a week left in March, the Dow Jones Industrial Average (^DJI) is up about 10%.

Sentiment seems to have changed from February. Resistance levels are being broken, economic data is coming in better than expected and the term “zombie bank” isn’t being used so much anymore.

Good times, right?

I would love to be the person who tells you that the recovery is under way, but I can’t. We’re in a big hole and we are standing on what is, at best, a pretty shaky ledge.

It’s not that I’m bearish, I’m just pragmatic.

Let’s look at the latest plan to absorb the banks’ toxic assets. You know, all those mortgages and other debt-related securities. Treasury Secretary Tim Geithner wants private investors to buy them with help from the government. The banks get rid of the distressed debt and taxpayers get a chance to make some money.

Sounds like a good plan, doesn’t it? The markets certainly thought so judging by last Monday’s rally.

But there is a small problem. Nobody knows if the banks and private investors will be able to agree on a price. If the offer price is too low, the banks may choose to just keep the assets on their balance sheets rather than face more large write-offs. If the asking price is too high, private investors will walk away.

The lack of agreement on what the toxic assets should sell for has been the problem throughout this crisis. Banks don’t want to accept the prices that private investors are offering. And there is no guarantee that anything has changed now.

I realize that a lot of people are hopeful that the plan will work. Understand that if it doesn’t, the Dow will set new lows.

That’s the bad news.

The good news is that we are starting to see signs that the pace of deterioration is slowing.

February home sales, both new and used, rose by about 5% in February. Housing starts and building permits also improved. Those are the numbers that grabbed the headlines.

What hasn’t made headlines, however, is the trend in nonfarm payrolls. During the past few months, the rate at which the U.S. is losing jobs has stabilized:

Don’t get me wrong, losing 646,000 jobs per month is horrible, but I am encouraged that the size of the monthly losses is no longer increasing. We’ll see if this trend is holding when the March data is released on Friday, Apr 3.

Earnings estimates are not falling as dramatically either. During the past four weeks, just 3 full year profit projections have been cut for every forecast that has been raised. In January, we were seeing as many as 6 estimates cut for every one that was raised.

What’s even more surprising is that the revisions ratio (the proportion of positive to negative estimate changes) has been holding fairly steady over the past few weeks. Typically, the ratio falls when we get between earnings seasons - even during periods of growth. The fact that the ratio is holding up is a good sign.

Again, the change is relative. Profit forecasts continue to be cut across the board; it’s just that the rate of decline is slowing. Nonetheless, this change is a step in the right direction.

Don’t Wait For Confirmation Of A Turnaround

It’s still too early to declare that a bottom has been set for the stock markets and the economy. I’d like to see more signs of stabilization. I would also be more comfortable if the CBOE Volatility Index (aka the VIX (^VIX)) were to truly trade below 40 - something that has not occurred since last September.

Nonetheless, there can be gaps between what the data is suggesting and how the markets are actually performing. As an investor, it is important to understand that the market does not have to be right in order to react to it. This is particularly the case when it comes to trend reversals.

If the Mar 9 intraday low of 6,440 turns out to have been the bottom, then my call for 6,300 was close enough. There is no reward for exactly calling the bottom, but there is a lot of lost opportunity for missing out on a big rally.

This is why we added stocks to our Zacks Elite portfolios this week.

One of these stocks was Darden Restaurants, Inc. (DRI). I like the stock because of its recent, relatively good earnings report and because it should benefit from any stabilization of economic conditions. The fact that it is attractively valued was also a plus.

Another stock was Orion Marine Group, Inc. (OMGI), a company that provides construction services such as underwater pipelines, bridges and causeways. We think the company could benefit from state and federal construction projects. Estimates were recently revised upwards for both this year and next.

We also balanced these stocks with 2 other companies that were less economically sensitive, but are continuing to thrive. Our strategy is to buy into the rally, while not taking unnecessary risks.

There is never going to be an “all clear” signal to buy stocks. What you can do is constantly research stocks and use strategies such as dollar cost averaging, buying smaller positions normal and employing buy stops.

All these strategies might reduce your potential gains, but they also allow you take advantage of the big rallies when they occur.

Subscribe by RSS Subscribe by Email