Can anyone “call” a stock market bottom? Nope. But by tracking the right signals, you can get close.
Three “stars” I follow to spot market turns say we’re just about there.
When a selloff is peaking, these three signals typically pop up:
1. Extremely negative investor sentiment.
2. Extreme media bearishness.
3. Robust insider bullishness.
In short, when those in the know (insiders) are quite bullish, while those prone to excessive emotion and crowd behavior are gloomy, the stars have aligned, telling us to aggressively deploy cash.
To be sure, we could see another push down in stocks. Selloffs are often punctuated by a giant drop on large volume to clear the air, often at the open. This is what we saw last August. We haven’t seen this yet.
But that’s not a given, so now’s the time to step up your buying. Here’s why, followed by five stocks to consider.
Investors are having a depressive moment
Nearly all the sentiment indicators I track are extremely negative, which is very bullish in the contrarian sense. Some examples:
--One key go-to fear gauge, the CBOE Volatility Index (VIX), shot up above 30 recently, and it’s still in the mid-20 range. Generally, anything above 21-23 shows enough fear to confirm a “buy” signal.
--Various put-call ratios are showing extreme negativity. This means that put buying, a bearish bet, far outweighs call buying, a bullish bet.
--A recent survey from the American Association of Individual Investors (AAII) showed only 18% were bulls. Amazingly, that’s the lowest reading in 10 years and below levels in 2008 and 2009, points out Bruce Bittles, chief investment strategist at Robert W. Baird, a brokerage.
--The Investors Intelligence Bull/Bear Ratio recently dropped for the sixth week in a row to 0.74. That’s the lowest since late September, points out Ed Yardeni, of Yardeni Research. It recently advanced to 0.89, but that’s still low. Generally, anything below two is negative enough to confirm a “buy” signal, in the contrarian sense.
The media are quite bearish
Scare stories and gloom-and-doom headlines abound. We hear that Europe is going to “fall apart” because of the “immigrant crisis.” Or that we’re about to go through 2008 all over again. Yikes. Many of the gloom-and-doom arguments are simply irrational.
Banks are much less levered than they were in 2008, so a repeat is unlikely. Oil prices are supposedly plummeting because of weak energy demand in China, thus confirming that its economy is collapsing. Yet China’s oil imports have held steady. Go figure.
And as if on cue, we just got a classic magazine-cover indicator. According to this contrarian indicator, business publications put gloom and doom out on their covers right around the bottoms during selloffs. The Economist just published a doozy — a portrait of Chinese President Xi Jinping on a flying dragon in what looks like an imminent crash landing.
Meanwhile, insiders are getting more bullish
A good way to measure insider sentiment is to track the ratio of insider selling to buying. A declining number here signals greater bullishness among insiders.
This ratio has been steadily declining — turning more bullish — since the market selloff started in December. A rolling eight-week sell-buy ratio tracked by the newsletter Vickers Weekly Insider recently fell to 1.19. Anything below two, by this measure, is bullish. “Insider sentiment remains extremely bullish,” says David Coleman, of Vickers.
No recession at hand
Why are insiders so bullish in the pullback?
Probably because from their front-row seats on the economy, they see trends that confirm what several strategists are telling us: The U.S. economy is not going into recession.
“It looks to us as if stocks are pricing in a 50% chance of a recession. We think the odds are actually closer to 25%,” says Bob Doll, of Nuveen Asset Management. “We remain convinced that fundamentals are more solid than equity prices reflect.”
If global economic growth does get much worse, central banks in Europe and Asia have room to increase their stimulus, says J.P. Morgan Chase economist David Hensley.
Meanwhile, in the U.S., hawkish Federal Reserve officials have spooked the markets by suggesting 2016 will bring four more rate increases. But that is unlikely, says Deutsche Bank strategist David Bianco, given the tone of the stock market selloff.
“Global markets across asset classes are urging the Fed to hike very slowly and cautiously. Smart policy setters heed market signals,” says Bianco. “Thus, staircase hiking is unwarranted this year. We think the Fed should wait until at least June for the next hike.”
Stocks to buy
If you are going to make an aggressive contrarian bet on stocks now, it makes sense to go all the way and skip defensive areas like consumer staples.
Instead, go with the groups that have been crushed the most. These include: Biotech, hammered because it is considered high-risk; retail, hurt because of worries about weak consumer spending in December; and energy and banks, hurt by worries about low oil prices and exposure to energy-sector debt.
In retail, consider American Eagle Outfitters Inc. , where CEO Jay Schottenstein was recently a big buyer of Eagle shares. American Eagle has a huge cash position so it is relatively safe. It pays a 3.4% yield. Eagle’s Aerie lingerie brand is challenging Victoria’s Secret, a division of L Brands Inc. .
Among names hit by plummeting oil prices, consider Exxon Mobil Corp. which has solid cash flow and financial strength backing its 3.9% dividend yield. Also consider J.P. Morgan Chase & Co. , where an insider was recently buying the stock, hit in part by unfounded worries about the bank’s exposure to energy loans. (They’re just a small share of the loan book.)
Buybacks to the rescue
If we’re near a bottom in the selloff, it’s worth asking: What might turn things around?
No one knows for sure. But it could be as simple as more stock buybacks. Historically, January has been a strong month for stocks. But it’s been a weak month for three years running — possibly because companies have held off on stock buybacks only to pick up with them again in February, says Bittles, at Robert W. Baird.
Thus, a “good rally” in February is possible as companies start up their buyback programs again, says Bittles.
By Michael Brush,
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