Kass: Four Stages of Market Turning Points

This blog post originally appeared on RealMoney Silver on Oct. 12 at 7:07 a.m. EDT.

In March, I argued that stocks were at or near a generational bottom and I recently opined that U.S. equities have topped for the year.

It can be argued that there are four classical stages in a move from market bottom to market top and then back again.

Stage One: It is important to recognize that market bottoms are made when investors lose all sign of hope, and fear is the dominating emotion. At bottoms, bears are deified and bulls (like Legg Mason's Bill Miller) are rebuked. Seven months ago, prices were beaten down, and the news flow was consistently reinforcing in its negativity. Economic expectations were uniformly bearish, as the credit and financial system seemed broken. Investors no longer believed. The fear of being in the markets overwhelmed market participants -- so much so that on the day of the yearly low, a poll indicated that more than half of Americans believed we were entering the Great Depression II. Importantly, decades of buy-and-hold investing seemed to vanish and gave way to a preferred strategy of opportunistic trading.

Stage Two: As stocks began their ascent from the March lows, signs indicated that things were getting less-worse as the second derivative recovery commenced. The liquidity put into the system in late 2008 and early 2009 began to flow into the capital markets. Credit spreads improved as the curse of cash began to manifest. In time, fiscal and monetary stimulation began to assert a hold, and improving economic conditions followed.

Stage Three: In time (and with the impetus of higher stock prices and recognition that there were signs of economic improvement), the fear of being in began to be replaced by the fear of being left out. As deflated company forecasts turned out to be too pessimistic, the news (importantly influenced by aggressive cost-cutting) improved, and share prices moved comfortably above the March lows.