Is market turning? Stay skeptical

By Jim Jubak

Has the stock market bottomed?

Certainly many investors think so -- enough at least to have led a 25% rally in the Standard & Poor's 500 Index ($INX) from the March 9 low to April 3.

But we've been here before. After the low of Nov. 20, 2008, the S&P 500 climbed an almost identical 24%, then tumbled 27% to set a new low for the bear market that began in October 2007.

And frankly, I think it pays to wait right now. The structure of this stock market and the growing conviction that any economic recovery will be tepid have made short-term trends even more unreliable than usual. I want to see a turn confirmed and confirmed again before I put more money into stocks.

Bear market bottoms, I fear, ain't what they used to be. We're all so acutely focused on catching one that we've likely changed the bottom beyond all recognition.

A new species of bear

Calling a market bottom has always been hard. Bear markets are notorious for their head fakes and failed rallies. In fact, it's by repeatedly sucking in investors with these glimmers of hope, then crushing them with 20% plunges, that bear markets inflict much of their damage.

But making that call is especially difficult in this bear market.

First, the nature of the market has changed. So much information is available at the click of a mouse and so many investors are trying to trade in and out of bear market rallies that volatility has increased and the direction of the market can turn on a dime. Trends are much bigger, but they peter out more quickly. Few trends mean anything for the long term.

Second, the increasing conviction that the economic recovery from the current recession will be anemic has increased investor anxiety about missing the turn. If the recovery is weak, stocks are likely to deliver most of their gains in the first six to nine months after the turn in the market before settling into a grinding period of small -- if any -- gains.

Not your parents' bear market

Compare this bear market with the great bear of 1973-74. From Jan. 11, 1973, through Oct. 3, 1974, the S&P 500 fell 48%. (For comparison, the S&P 500 was down 58% from Oct. 9, 2007, through March 9 of this year.)

Like the current bear, the 1973-74 bear was punctuated by strong, hard rallies that ended with the market falling to new lows. From Aug. 22 through Oct. 29, 1973, for example, the S&P 500 climbed 11%. Another big rally, from Feb. 2 through March 15, 1974, took stocks up 10%.

The duration of those rallies isn't that much different from the eight weeks of the rally off the November low in this bear market or the four weeks and counting of the current rally off the March low. But the size of the rallies in the two markets is quite different: The rallies in the current bear market are about twice as large.

Some of this, I'd say, is because the current tools of investing allow more investors (institutions, of course, but individuals, too) to try to jump on trends -- and to jump on them earlier. Institutions are using cheap computing power to identify and exploit price trends more quickly. For a few hundred bucks or less, any individual investor has access to charts and technical commentary that point out trends -- not with the speed and power of the giant institutional investors, perhaps, but in a far more timely fashion than in the pen-and-paper era of 1973.

A big toolbox for playing trends

Once institutions and individual investors have identified a price trend, they now have tools to leverage their exposure to the trend or to limit their risk when the trend fails. Institutions have an alphabet soup of derivatives and options to leverage their bets and pass along part of the risk.

Individuals, too, can now play the gain using exchange-traded funds that promise to go up twice as fast as an index or to insure against loss by rising when prices fall. In the bad old days, investors would have started to sell to protect their gains when stocks rallied. Today, as I've seen in my e-mail recently, investors instead buy a reverse ETF -- one that will rise if stocks fall -- and hold on.

The combination leads to more-powerful rallies, because fewer investors sell to lock in modest gains, and to rallies that abruptly turn into big drops in stock prices when everyone finally becomes convinced that the trend has turned.

This increase in lock-step anticipation of trends makes me wonder whether this bear market will end with the kind of capitulation that has ended many bear markets in the past. Capitulation is that final wave of selling in a bear market, when investors finally throw up their hands and say: "Sell everything. I can't stand the pain anymore." But if everyone is following the same indicators and if everyone is waiting for -- and trying to anticipate -- that moment of capitulation, it's quite possible that capitulation will never take place.

A world of weakness

We might well miss a great capitulation, too, because everyone is trying to get a jump on what increasingly looks like an anemic economic recovery. A growing number of economists now believe the U.S. and global economies aren't going to bounce back quickly from this downturn. The recovery from the 2001 recession wasn't any great shakes itself, with 2.5% annual growth in U.S. gross domestic product. But this one looks even weaker.

The Congressional Budget Office projects that the U.S. economy won't get back to full-trend growth until 2015 -- and that the full-trend growth rate will be just 2.3% a year. Even with the full $787 billion of the Obama administration's stimulus package in effect, according to Northwestern University economist Robert J. Gordon, it could take until 2012 or 2013 for the economy to recover to the level of output in 2007 before the recession hit.

As grim as those projections are for the United States, economists are offering even bleaker scenarios for other major global economies. The Japanese economy is now projected to contract by 6% in 2009 -- a worse performance than the 4% decline predicted for the United States -- and to shrink further in 2010. Germany's economy is projected to contract 5.3%, and some German economists are now talking of a lost decade of growth akin to what Japan suffered through in the 1990s.

Continued: Stock stagnation looms

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