Bottom Feeding II

When that happens we cannot simply follow the rules of “normal” markets. Most investors with time horizons measured in weeks and months would be better served waiting for the market to return to some form of “normal” before testing the waters and feeding on the fallen.

Before getting into the details, I must first say that I am looking for a short-term rally to follow through on what we saw in the days leading up to the Thanksgiving break. If you are a short-term trader, fell free to play. If you are a long-term investor with multi-year rime frames, I agree with uber-investor Warren Buffett that there are excellent values to be had.

But if you fall in between these extremes then please consider this.

All of our analysis tools, and I am talking about technical, quantitative and fundamental, are based on certain assumptions of the world and many of those assumptions are not true these days. Right now, one of the most important, a healthy credit market, is no longer functioning the way it was. Another is a reasonable expectation that good companies can make money and grow their businesses.

The first limits liquidity and when that is hampered so is investment in stocks. The second has been dwarfed by the psychology of fear, as all the news is bad. It seems that a vast majority of pundits are talking about deflation and depression. Who can blame anyone for wanting to sell his or her stocks, even at current levels?

One of the more widely watched indicators, the Chicago Board Options Exchange volatility index, aka, the VIX, aka, the fear index, moved into the record books in October and has remained at levels that have only been seen right after the crash of 1987. The indicator was not around for the crash of 1929 or the 1974 bear market.

What this means is extreme fear permeates the market and under such conditions we cannot really get a handle on what is going on. Momentum indicators may scream “oversold,” yet the market heads lower. Volume indicators may remain below average to suggest that the sellers are getting exhausted but down go prices anyway.

Certainly sentiment indicators, such as the VIX, are at levels that might have suggested the mother of all buy signals in the past. Yet an extreme VIX got even more extreme. I contend that having the VIX fall back to more normal ranges will be one of several changes we need before we can think it is safe to buy, not just trade, stocks again.
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The next question anyone should have is why we have to wait until the Dow gains hundreds and hundreds of points before we can acknowledge a market recovery. After all, isn’t the idea to buy low and sell high? That is an awful lot of profit to leave on the table before starting getting back in the market.

In November, traders did indeed buy low and sell high but their trades lasted a few days if that long. As mentioned earlier, active individual investors typically have an investment horizon on the order of weeks or months, not days, so that amount of buying and selling is not palatable to them. Neither is the risk of being even one day early.

When the market finally moves back above all of the turmoil of the past three months we’ll know that the tide has turned for real. I won’t be foolish enough to guarantee a bull market from there but at least we will be on the right side of the trend. Confirm that with a “normal” VIX and any other of a zillion other indicators, such as cumulative volume, momentum and/or moving averages and chances are it will indeed be safe, or at least safer, to buy stocks that still look cheap.