Market Bottoms



I touched on a subject in my previous post and wish to expound on it as I believe it is important information if we are to understand markets properly.

I am a long-term investor, focused on value and conservatism. Yet, I also have that trading knack to me and it has served me well over the years. In other words, I believe that fundamentals must work in tandem with the general sentiment of Mr. Market. Often not, but technicals may play a role.

There was a great article published by David Markel from the Aleph Blog. Here are my bullet points:

What to expect at a Market Bottom or Trough

 

  • Investor base becomes Fundamentally-driven as oppose to Momentum-driven.
  • Lots of articles to stay away from all stocks because of the negative macroeconomic environment.
  • Fundamental investors are quiet, and valuation-oriented.  Buying quietly.
  • Neophytes, Short-term Moment players and Day Traders are all gone.
  • Lot of attention to shorts.
  • Primary IPOs don’t get done, only the highest quality. Secondary IPOs get done to reflate damaged balance sheets, but the degree of dilution is poisonous to the stock prices.
  • Private equity holds onto their deals longer, because the IPO exit door is shut.  Raising new money is hard; returns are low. M&A volumes drop off.
  • Value managers tend to outperform growth managers at bottoms.
  • CNBC, and other media outlets, tout “adults” and experienced investors more often.
  • Defined benefit plans are net buyers of stock (as they rebalance).
  • No lack of promising ideas for Value investors, only a lack of capital.
  • Low borrowing, except to take advantage of bargains.
  • Money runs to hot sectors, e.g. money market funds, collectibles, gold, real estate.
  • Short interest reaches high levels; interest in hedged strategies reaches manic levels.
  • Earnings disappoint and guidance lowers for the future.  Yet stocks barely react on bad news.
  • Leverage reduces. Strong companies begin talking about how strong their balance sheets are.  Weaker companies talk about how they will make it. The weakest die.
  • Default rates spike. Only when prescient investors note that the amount of companies with questionable credit has declined to an amount that no longer poses systemic risk, does the market as a whole start to rally.
  • Accounting gets cleaned up, and operating earnings become closer to net earnings.  As business ramps down, free cash flow begins to rise, and becomes a larger proportion of earnings.
  • Cash flow at stronger firms enables them to begin buying bargain assets of weaker and bankrupt firms.
  • Dividends stop getting cut on net, and begin to rise, and the same for buybacks. Also pose attractive yields relative to other fixed income.
  • High quality companies keep buying back stock, not aggressively, but persistently.
  • Implied as well as Actual volatility is high. Investors are apprehensive  and retreating from the market. The market gets scared easily, and it is not hard to make the market go up or down a lot.
  • The Fed adds liquidity to the system, and the response is sluggish at best.  By the time the bottom comes, the yield curve has a strong positive slope.
I think we are far closer to an ultimate market bottom based on evaluation than we were in 2003, and getting even closer to an intermediate term bottom in the current consolidation, which may last until 2014-2018.
Yet, markets have a long way to go as far as sentiment is concerned. The “stocks only” or “stocks always go up in the long-term crowd” has yet to find out exactly how long long-term actually is, as well as how low those long-term gains can be, especially when a their overall yield pale in comparison to short term bond yields, and are abolished by returns for gold and real assets.

 

 

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