Wednesday 22 October 2008

Four Reasons Stock Market Hasn’t Reached Bottom Yet

The search of a market bottom likely will continue through the rest of the year and into 2009, as signs begin to emerge that a turning point is near but not yet upon Wall Street.

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Four Reasons Stock Market Hasn’t Reached Bottom Yet

CNBC.com
21 October 2008

The search of a market bottom likely will continue through the rest of the year and into 2009, as signs begin to emerge that a turning point is near but not yet upon Wall Street.

Market analysts have been racing to call a market bottom in recent weeks as stocks have shed more than 30 percent of their value from the highs of a year ago this month.

But the emerging consensus is that a true bottom – and a subsequent turning point – won’t happen until at least the early part of 2009.

Here are four factors cited by experts that remain in the path of a Wall Street capitulation:

The VIX

The much-cited Chicago Board Options Exchange’s Volatility Index skyrocketed past 80 last week, more than double the normal sign for a high level of market panic.

Since then, the VIX has eased substantially, but remains well above levels suggesting investors have calmed down and are ready to send stocks back up in an orderly, sustainable fashion.

During the credit crisis, the Dow has seen an astonishing number of days when it has finished up or down several hundred points, once swinging 1,000 points in a single day.

That doesn’t bode well for a stable investing environment.

“We can’t have these monstrous swings up or down on a daily basis,” says Richard Sparks, senior analyst at Schaeffer’s Investment Research in Cincinnati. “That doesn’t create any foundation for future buying and doesn’t create a situation where people would want to put their money at risk.”

But on the positive side, Sparks points out that the Vix on Monday closed below its 10-day moving average, which it hasn’t done in a month.

“When that’s happened, when it’s traded a number of days above the 10-day moving average then moved below that, it’s a pretty positive sign for the market,” he says.

But even a low VIX doesn’t necessarily mean a turnaround. The barometer stayed low for much of the market’s run downward, spiking only recently during the latest wave of bad banking news and subsequent government bailout plans.

“When the VIX gets down to about 40, which was the previous high, then that means that everyone’s become complacent again,” says Peter Miralles, president of Atlanta Wealth Consultants. “The question is, are they complacent for good reasons? The pendulum has swung and we’re seeing high volatility. Unfortunately the volatility all came at one time toward the downside.”

Credit

When the stock market began falling off its October 2007 highs, it was a precipitous drop in the banking sector that brought the major averages down.

A few months later, oil prices began to soar as a hedge against falling stocks. Soon, the two began marching in reverse lockstep – when oil prices rose, stocks fell, and vice versa.

Now it is lending rates, particularly the London Interbank Offer Rate, or Libor, that seems to have Wall Street’s ear. If Libor is up, stocks are generally down, though that wasn’t the case Tuesday.

Analysts say getting banks to loosen their purse strings and put money back out on the street again is pivotal towards stabilizing the stock market and the economy.

“Any kind of loosening up of the noose on the credit markets would free up individuals to do some spending, it would free up corporations to do some spending,” says Rick Pendergraft, head of the Investor’s Daily Edge newsletter. “If we can see a little better increase in spending both at the consumer level and the corporate level, then I think we could get a better idea of where this economy is heading for the next six months.”

Miralles says the credit freeze has begun to thaw, but it’s still unclear as to how long it will take stocks to benefit and how much credit concerns will continue to weigh on the economy.

“Is the second shoe going to drop as far as the economy goes?” Yes, but is it already factored into the market? That’s the big question,” he says. “We don’t know that.”

Earnings

If an early earnings snapshot is any clue, corporate profits seem to be right around already-lowered expectations. But several large firms, including Dow bellwethers Dupont and Caterpillar , are warning of tough times ahead, which contributes to the uncertainty of whether a bottom has formed for stocks.

In fact, many analysts say third-quarter earnings are almost an afterthought – save any big surprises either way – and fourth-quarter earnings will provide the real clue as to whether the worst has passed.

“If the credit markets don’t get freed up, the earnings for the fourth quarter are what scare me the most,” Pendergraft says.

But part of the strategy for corporations now could be decreasing outlooks so as not to watch their shares get hammered if the quarter is a bad one.

“If you lower expectations now you’re not going to get hurt that bad because everybody else has kind of priced this in,” Pendergraft says. “Corporations are lowering the bar for themselves and taking advantage of the environment that they’re in.”

Credit card companies American Express , which already reported positive results, as well as Visa and Mastercard will provide more clues to credit, consumer and corporate health.

“August, September and October are (traditionally) just difficult months,” Miralles says. “We’re now heading into the best months of the year. The calendar is with us for a little bit of a rally, and we just need more time. We need to get some earnings behind us to see how everybody’s doing.”

Conviction

Judging by volume levels, longer-term investors essentially took the summer off, leaving market gyrations in the hands of traders and hedge funds.

Those foraging for a market bottom are waiting for those with further horizons to get back in to show belief that things have calmed down and the water is safe again.

“On Monday it was a 900-point day, but it still is the case that when the market is lower, volume is higher than days when the market is up,” Sparks says. “What I would be looking for to suggest that we’ve made a volume is a lessening in volatility, more good breadth and more volume on days when we go higher.”

The upshot for the search for a bottom, then, may not offer much consolation.

“Time,” is Miralles’ one-word answer to what it will take to know if a low has been reached.

Likewise, Sparks says there will need to be a continued series of positive signs to indicate that Wall Street has successfully weathered its latest--and arguably its most vexing--crisis.

“I don’t think you’re really out of the woods yet with respect to the volatility and the downtrend that we’ve seen,” he says. “We can’t look out ahead and see much light on the horizon.”