With the U.S. stock market sinking to Stygian depths, one question is being asked repeatedly: When will it end?
No one can answer with certainty, of course, but it appears that many conditions for a reversal -- at least an end to the steep decline -- are in place.
In the last four trading days alone, the
industrials have lost 840 points, volatility has soared, bearish sentiment has deepened and valuations have come down.
According to Don Hays, president of Hays Advisory Group, the market is 37% undervalued based on the
valuation model, which compares the
earnings yield with the 10-year Treasury note. "That's as much undervalued as it was in 1979, which is amazing," Hays said.
Meanwhile, bearish sentiment -- a contrarian indicator -- has reached levels not seen since 1992, when Fed Chairman Alan Greenspan was starting to raise interest rates.
Hays said that every time the CBOE Volatility Index or VIX has moved above 45 in the past, it has typically been a "fantastic buying opportunity" and has remained that way until it moves below 20. The VIX zoomed to 50.48 Tuesday.
David Skarica, publisher of the newsletter
Addicted To Profits
, agrees that many indicators are suggesting that stocks are oversold. But he is concerned that the recent positive action in the VIX hasn't been confirmed by other volatility measures like the Nasdaq 100 Volatility Index and the Nasdaq Volatility Index.
"I've been telling people not to buy yet," he said. "In a bear market, when important support is broken, you usually trade about 10% to 15% lower than the previous low. The previous low was 8000
on the Dow so I'm not looking for it to bottom until it gets to about 7200."
Based on his chart observations, Skarica believes the Nasdaq won't start to rally until it hits 1100.
Judd Brown, a researcher at the Hirsch Organization, publishers of
The Stock Trader's Almanac
, said he isn't expecting a bottom to occur until early August. Citing data from Ned Davis Research, Brown said that bear markets have historically required "a 30% drop in the Dow after 50 calendar days or a 13% decline after 145 calendar days."
He considers the most recent bear market to have started on March 19, because that's when the Dow peaked after climbing 29% from the September lows. On Aug. 11, the Dow will be at least 13% lower than the March 19 high, Brown said. "That is when you should start looking for a bottom."
Brown said "natural bottoms" are much harder to call than "forced bottoms," which occur when some extraordinary event or catalyst prompts a major selloff. "The natural bottom will occur in a banal and uneventful way."
In other words, the much-anticipated capitulation likely will happen over a an extended period rather than in one blowout spate of selling.
Once the market does hit a low point, however, Brown said the chances of a strong rally are good. Historically, the market has climbed 50.2% on average from the midterm election-year bottom to the pre-election-year high.
Still, Skarica is skeptical about any longer-term gains, saying stocks usually trade sideways for a long time after a bubble has burst.
Paul Desmond of Lowry's Reports, a provider of technical research to individual and institutional investors, said he isn't convinced the worst is over yet. He said that while some technical indicators have been hitting extreme levels recently, not all of them are accurate prognosticators.
Volume, for example, has been very heavy over the last three days, with about 2 billion shares traded on the
New York Stock Exchange
each day, but Desmond points out that volume has traditionally been quite anemic at major market bottoms.
He'll be more convinced when downside volume and price declines increase. Over the last 70 years, every significant market bottom has ended with a series of days in which downside volume and declining prices equaled 90% or more of the total volume and total price changes for all NYSE-listed stocks, he said.
So far this year, no such downside volume or price changes have been recorded. If and when they are, Desmond said investors should closely watch the action of buyers for further clues about the market's direction.
"If a retail store were to drop prices by 40% and no buyers showed up for the sale, it would be fair to say this isn't the final discount the store is going to offer," he said. "You should watch for a series of 90% downside days and a 90% upside day."
Despite predictions, markets often don't move the way pundits expect. And whatever indicators the analysts choose to focus on, certain fundamentals of the overall stock market are improving every day.
While accounting woes continue to plague Corporate America, CEOs and other executives are much less likely to skew their books in the wake of recent developments, meaning earnings numbers should be more reliable going forward.
Furthermore, the economic backdrop remains strong. Industrial production continues to climb, personal income is rising, unemployment remains at low levels, inflation is tame and interest rates are sitting at a 40-year low.
"I wish I did have a magic indicator which said this is the bottom," Hays said. "But you just won't know until you look back on it."