Throughout the first eight months of 2012, investors could not
be dissuaded from buying stocks. Bad news was met with a shrug,
while good news were heartily embraced. These days, the half-full
glass is now perceived as half-empty. Case in point: A solid
employment report from the Department of Labor on Friday, Nov. 2,
capped off a solid week of economic data, but investors used the
seemingly good news of 171,000 new jobs in October -- a nice 21.3%
month-to-month increase -- as an excuse to sell.
And that's important information. You should always tread
cautiously when investors appear to be in a cynical mood. Sure, the
markets are now a bit more appealing after a modest pullback from
recent highs, but there are still ample headwinds in place that
could lead stocks to grind lower into year's end. I discussed these
about a month ago.
Yet even as you take a cautious stance, you have to watch for
the key signs of amarket bottom. When youspot one or several of
these indicators, then it will be time to pivot back into a buying
Here are five key indicators I'm tracking...
1. The Fiscal Cliff discussions
Soon after the election is over, you'll start to hear about
potential legislative compromises to avert the dreaded "
." Make no mistake, a compromise will be reached, either in coming
weeks or soon after the inauguration in late January. But it's the
outlines of what such an agreement will look like that you need to
monitor, not the actual agreement itself.
Once investors get a sense of what kind of economic drag the new
plan will have, they will grow more comfortable about economic
prospects for 2013. The 3% to 4%gross domestic product (
) decrease that the Fiscal Cliff would result is intolerable. But
an agreement that affects theGDP by 1% or 2% can be absorbed by
aneconomy that has recently shown fresh resilience.
Value investors are never pleased to see a market drift lower
slowly, as has been the case during the past four-six weeks.
Instead, they want to see investors throw in the towel in a big
way. A look at early 2009 is instructive. The S&P 500 fell 8.5%
in January of that year and weakened further as February got
underway. Yet it's what was happening in the final 30 days of that
market rout that is noteworthy: On Feb. 10, 2009, the S&P 500
dropped nearly 5% in once session and then delivered additional
drops of 2% to 3% in coming sessions, culminating in a 4% drop on
March 5. A few days later, the bottom appeared to have held and the
stunning market rebound began on March 9, 2009.
In recent weeks, the market has shown very little dramatic
action, with only a few days of even a 1% drop. For many, we
haven't had the full blown selloff we need to see before the next
leg of thebull market can kick in.
3. Watch the retail investors' surveys
On several occasions in the past, I've noted that markets tend to
bottom right at the moment when individual investors grow alarmed.
So keep tracking the weekly sentiment survey the American
Association of Individual Investors (AAII)
releases every Thursday
Investors have actually just grown morebullish with 35.7% of
them now expecting market upside. You want to see this bullish
figure drop below 25% for markets to truly be washed out.
4. A lower bar for 2013
Companies have spent much of the currentearnings season lamenting
how the challenges in Europe, along with our own Fiscal Cliff
concerns, are affecting discretionary spending choices. But you
won't necessarily find this downbeat view amongWall Street
analysts. Heading into any subsequent quarter, analysts tend to
start their forecasts at a fairly optimistic level and then
invariably lower those forecasts as the quarter progresses (right
up to the end when companies can magically manage to "top
This process is likely to play out for the fourth-quarter and
next year's forecasts as well. Analysts are only slowly adjusting
their forecasts to the more sober tone seen on recent quarterly
conference calls (and you never want to get in front of a stock
that is subject to ongoing downward revisions). You'll want to see
this process play out, perhaps during the next two months, so the
market can then be set up to overcome an easier hurdle in terms of
2013 (and 2014) forecasts.
5. Track the value metrics
With the major indexes still within striking distance of multi-year
highs, it should come as no surprise that the market is no longer
inexpensive (as was surely the case in 2009 and 2010). The S&P
500 trades for around 16 times trailing 12 monthsearnings , which
is roughly 1% to 2% above the historical norm. This means we'd need
to see stocks fall by 10% or even 15% before they move below
typical historical valuations. My personal rule of thumb: Focus
only on stocks that already sport trailing earningsmultiples that
are well below themarket average . They could represent ports in a
storm if the seas get choppy.
Risks to Consider:
As an upside risk, investors may soon take note of the fact
that recent economic reports have actually been better than feared
and the economic forecast for 2013 may not be as grim as I and
others have feared.
Action to Take -->
This is a great time to brush up on the stocks you want to own when
the economy truly strengthens. You can spend this time determining
the "no-brainer" price for these stocks and pounce if they fall to
that level. In addition, this is a great time to lock in profits on
any big gainers in order to raise fresh cash for the eventual
buying opportunity that will emerge.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.