Relax, it’s not the end of the world. It’s a spate of wicked market volatility — which might not be over.
That’s because it was caused by funds getting into trouble with leveraged bets against volatility. When volatility spiked on signs of rising inflation, they were forced to sell. Now, investors worry there are more time bombs out there, and that they might take out a bank and damage the financial system.
A look at the credit markets suggest these fears are probably overblown — at least so far. The yield spread between U.S. corporate bonds and safer Treasurys has widened a bit. But it is still tight.
“The credit market is not flashing warning signs,” says Colin McWey of Heartland Select Value Fund HRSVX, +0.99%
Nevertheless, given the uncertainties, you can expect continued nervousness — and selling. What to do now?
If you joined the crowd and bought stocks in January and you’re underwater, probably the best thing to do is ride it out. If you have cash on the sidelines, there’s a buying opportunity in here somewhere.
But where?
I recently spoke with several market veterans to round up their favorite signs that the market has bottomed. Here are seven signs of a market bottom to look for now.
Read: How to find a happy ending in this stock market
1. Seller fatigue
Nuveen Asset Management chief equity strategist Bob Doll wants to see lower selling intensity as the market retests lows. He gauges this by watching for fewer names popping up on the 52-week low list, fewer declines for the day and lower volume — as retests proceed. So far, there’s a glimmer of hope here.
“We made a new low with less intensity, and that’s always key,” says Doll, referring to the selling last Thursday (Feb. 8).
But it may be too early to give the all-clear.
“We might have to try to retest and go another couple of weeks with volatility,” says Louis Navellier of Navellier & Associates, who also likes to see volume dry up on retests as a sign of the low. “It would help if somebody from the Fed said something just to calm everybody down.”
Bruce Bittles, the chief investment strategist at Robert W. Baird, looks for the following signal that downside momentum has been broken. He wants to see two days where upside volume on the New York Stock Exchange exceeds downside volume by ratio of 10 to 1 or more. (It doesn’t have to be two consecutive days.)
“That would tell me it’s safe to go in the water. You need to see the downside momentum broken,” says Bittles. “Otherwise you get a rally and you can’t trust the rally.”
2. A flight to safety
Leuthold Group chief investment strategist Jim Paulsen likes to see a definitive flight to safety to signal the capitulation and panic that typically marks a bottom. To him, this shows up as a rush into Treasury bonds, the dollar, gold and defensive stocks like utilities and consumer staples.
Bad news here for bulls. So far, nada. Treasury bonds haven’t spiked. The U.S. dollar index DXY, -0.47% has only risen slightly. Gold and the VanEck Vectors Gold Miners exchange traded fund GDX, +1.34% have actually declined during the current market collapse. And utilities and consumer staples have not rallied.
“I still don’t see a capitulation panic in either the market action or in media and strategist comments,” says Paulsen. “My guess is we retest recent lows again before this correction is over.”
But that is only a guess, he points out.
“I sense a lot of discomfort, but I don’t sense the fear yet,” agrees Bittles at Robert W. Baird. “I’d like to see the FAANG stocks take a big hit,” he says, referring to Facebook FB, +0.17% Amazon.com AMZN, +3.48% Apple AAPL, +4.03% Netflix NFLX, +3.40% and Alphabet GOOG, +1.36% GOOGL, +0.79% “I think that could also be climactic.” He thinks a move to 21,500 in the Dow Jones Industrial Average DJIA, +1.70% would cause enough fear to mark a bottom because that is slightly below the 200-day moving average.
3. That “big puke” moment
The end of a selling phase is often punctuated by a big move down at the open on big volume followed by a quick rebound and then relative calm. This is a sign of the final flush to watch out for.
4. More fear
I was telling subscribers to my stock letter, Brush Up on Stocks, in December and January to be careful about the market, close dubious trades, raise buying power and avoid owning stocks on margin. The reason: Sentiment was off-the-charts bullish, which is bearish in the contrarian sense.
By the same token, now that the market has tanked, we’ll know it’s a safer time to buy when sentiment declines sharply and there’s more fear. One good measure to watch is the Investors Intelligence Bull/Bear ratio. Look for moves below 2, and especially below 1, to mark a buyable bearish extreme. Mid-week, last week, it was at 3.51. So it has a ways to go.
Also keep an eye on the media for heightened negativity. Recently, comparisons of the current selloff to the 2008 meltdown is a start. This is an encouraging contrarian signal. (And, no, this is not a 2008 repeat.)
Doug Ramsey, chief investment officer of The Leuthold Group, wants to see a spike above 0.85 in the three-day equity put/call ratio tracked by the Chicago Board Options Exchange. That indicates heightened interest in put buying, a defensive maneuver, related to calls, which are typically bought by optimists. So far, this ratio has not hit that level.
“I am surprised and troubled that this indicator hasn’t shot up more,” says Ramsey. “We are looking for lower lows over the next two weeks.”
5. The price of insurance
Lawrence McDonald of the Bear Traps Report watches the prices investors pay for CBOE Volatility Index VIX, +6.17% futures across time, or the VIX futures curve. If they’re paying up a lot for the near-term contract (February expiration) compared with contracts that expire eight months out, it’s a sign of peak fear. And that’s what he sees now, which means a relief rally may be at hand.
Investors are paying 12 times as much for February contracts compared with the September contract. For context, during the “Grexit” crisis in 2011 (when investors worried that Greece would leave the European Union) this multiple was 10.4. And when the markets cratered in early 2016, the multiple was 5.1.
“Buying the front month is like burning up cash because it expires soon. So when people are paying up for the front month, it is a sign of desperation,” says McDonald. “It means we are close to the bottom. We will probably have a good tradable bounce here.”
McDonald expects more market downside later this year as inflation heats up. He thinks rising inflation will compound investor losses by hitting both stocks and bonds. This could lead to more selling by panicked investors who are unused to seeing both stocks and bonds get hit at the same time. So it could get ugly.
6. A line in the sand
Some investors pick a reasonable valuation for the overall market, and wait for the market to hit that level to consider buying. For Will Riley, who helps manage the Guinness Atkinson Global Energy Fund GAGEX, +1.80% that’s a forward price-to-earnings ratio on the S&P 500 Index SPX, +1.39% of 16 times. It will have to fall to 2,450 to get there.
“Obviously the market can overshoot that, but that’s where we’d be looking to start deploying capital,” he says.
7. The TRIN
An old standby to mark near-term lows is a technical indicator called the Trading Index (TRIN). To derive it, take the number of advancing issues divided by the number of declining issues. Then divide that by the advancing volume divided by declining volume. When the TRIN denominator shrinks because declining volume is extreme relative to advancing volume, the TRIN ratio goes up. This signals extreme bearishness.
The key takeaway on how to read this gauge: Two trading days with a TRIN above 2 is a buy signal, says Bittles at Robert W. Baird. They do not have to be consecutive days.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested FB, AMZN, NFLX and GOOGL in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.