When will the stock market stop going down—or, at least, flash signs of stabilization?
If you’re a rattled 401(k) investor nursing big paper losses after watching stocks go from a bull market to a bear in a matter of weeks, getting an idea of how low the market will go is probably at the top of your I-wish-I-knew list.
Since the Standard & Poor’s 500 stock index was down 30% at its bear market low before rebounding 6% Tuesday after the White House took steps to offset the economic impact of the coronavirus, investors are trying to gauge if more pain is ahead or the worst of the selling is over.
The truth? Nobody really knows.
But that doesn’t mean Wall Street pros aren’t analyzing past bear markets, long-term stock charts, coronavirus-related headlines, investor-fear levels and market valuations in search of clues as to when the selling will let up.
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It’s often said that nobody rings a bell at a market bottom, or that market bottoms are “a process.” But there is an array of signals that professional investors look at to help guesstimate when the low might be in.
Here are a few things to watch if you’re searching for a bottom:
Coronavirus infections peak
One statistic investors would like to see before ringing the all-clear bell has little to do with corporate earnings, economic growth or price-to-earnings ratios: it’s a number that shows coronavirus infections are in retreat.
Investment firm Credit Suisse lists a “peak” in daily infection rates as one of the things needed for a market bottom. The firm’s global equity strategist told CNBC that during the SARS crisis in 2003, stocks bottomed a week after infection cases topped out. In the current crisis, which began in late December in Wuhan, China, Chinese stocks in the Shanghai Composite hit a crisis closing low on Feb. 3 after the rate of infection slowed.
Forecasts for Dow and S&P 500 ‘lows’
It’s the job of top strategists at Wall Street firms to crunch numbers related to economic growth and corporate earnings and predict how bad bear markets will get. And recent market calls from stock gurus suggest more losses are coming.
This past Friday, Goldman Sachs said it expected a mid-year low of 2,000 for the S&P 500, which equates to a further 21% drop from Tuesday’s close of 2,529 — and a total bear market decline of 41% from the Feb. 19 record close of 3,386.15. (Don’t panic, though. The firm sees the broad market gauge rebounding and ending the year at 3,200.)
Similarly, Credit Suisse’s worst-case scenario is a 20% drop in U.S. corporate earnings which would drive the S&P 500 down to 2,200, a decline of 13% from Tuesday’s close.
Watch the stock market’s ‘fear gauge’
Stock market sell-offs often coincide with sharp spikes in the level of a popular Wall Street “fear gauge” known as the VIX, says Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities USA.
Case in point: when the S&P 500 plunged 12% Monday, the VIX surged to a 52-week high of nearly 84, far above its low of 11 in the past year. Similarly, the VIX shot up to nearly 77 on March 12 when the stock market fell 9.5%.
“These outsized declines,” Golub argues, “are the result of a spike in volatility.” The fear gauge, he argues, would have to skyrocket above 100 for the market to suffer another big drop akin to Monday’s double-digit percentage decline.
“While this is surely possible, we believe it is highly improbable,” Golub says.
The takeaway: if investor fear recedes, stock prices will rise.
Look to earlier bear markets
Bear markets of the past do provide a roadmap of sorts for the types of declines investors can expect. The S&P 500, at its closing low Monday, was 29.5% below its record high.
So how does that compare with other bears? The average bear market loss since 1929 is 40% and lasts 21 months, according to S&P Dow Jones Indices. It turns out that bear markets that occur during recessions (which many on Wall Street are calling for now due to coronavirus business stoppages) tend to be deeper (the average pullback is 37%) than ones that don’t involve recessions (24% decline), says Ryan Detrick, senior market strategist at LPL Financial.
Look at past stock market ‘floors’
Levels at which stock market indexes like the S&P 500 stopped going down in past market routs are often viewed as a floor – or support – for future market meltdowns like we’re seeing now.
“Technical” analysts look at stock charts and draw long-term trend lines, or lines in the sand where selling stopped in the past. If those old support levels “hold,” there’s a good chance buyers will find that comforting. They’ll view that level as a good entry point to buy stocks, stabilizing prices.
Key market level: 2,350
So, what key levels should investors be watching now?
Remember the Christmas Eve massacre on Wall Street in 2018? Well, stocks in the S&P 500 stopped going down that day when the large-company stock index closed at 2,351. That’s the level Wall Street pros are watching closely now. After Tuesday’s rally, the S&P 500 is trading about 7.5% above that level.
“We’re rapidly approaching key chart support near 2,350,” says Mark Arbeter, president of Arbeter Investments.
The good news? Despite crashing 12% on Monday, the S&P 500 was able to stay above that key level, despite sinking as low as 2367.04.
What’s the next support level after that? Chris Verrone of Strategas Research Partners says “there’s a cluster of very long-term support in the 2,150 to 2,350 zone.”
Stocks become a screaming buy
If the stock market dive worsens, there will come a point where Wall Street decides that stocks have become so cheap that they’ve become a screaming buy. And when professional traders sense a huge buying opportunity, the market often can shoot up higher fast and furious, often causing investors who had fled to the sidelines to miss out.
We may be getting close to the idea that “stocks are on sale,” but we’re not quite there yet.
After Monday’s plunge, the market’s price-to-earnings ratio based on 2020 earnings estimates of $169 had fallen to 14.2. That compares to the 14.1 P-E during the near-bear market in December 2018, says Lindsey Bell, chief investment strategist at Ally Invest.
The problem is earnings estimates are likely to come down as the true impact on profitability caused by the coronavirus becomes better known.
“The market could follow that move lower in earnings,” says Bell, adding that the market bottomed in 2008 at 10 times earnings. Similarly, a valuation analysis looking at median P-E levels going back to 1957 done by Phil Segner at The Leuthold Group found that the market is still 4% overvalued.
When stock market pessimism peaks
Once every investor on earth thinks the world is ending, and pessimism is at a peak, most of the people who wanted to sell already have. That clears the way for buyers to swoop in and pick up bargain-bin-priced stocks.
One sentiment indicator to watch is the survey of bulls and bears by the American Association of Individual Investors.
Back on March 5, 2009, four days before the bear market bottom, more than 70% of AAII members polled said they were “bearish” on the market. In the latest weekly survey published on March 19, there were 51.3% bears, versus the historical average of 30.5. And when the next survey is released, it’s likely that bearishness will again show historical extremes.
The bottom line: Keep your eyes peeled for signs of a market bottom.
One more thing. Here’s a simple clue that will suggest that the worst of the selling is over: Bad news no longer sparks a massive sell-off.
When bad news is again good news for stocks, a rebound rally won’t be far away.