With successive thousand-plus point drops in major indexes hitting us day after day like a champion prizefighter’s punch to the gut, it’s hard to watch and harder not to wonder “when will it stop?” When will we hit bottom?
Watch the stock market’s ‘fear index’
Stock market sell-offs often coincide with sharp spikes in the level of a popular Wall Street “fear gauge” or “fear index” known as the VIX. (See https://www.investopedia.com/terms/v/vix.asp )
Case in point: when the S&P 500 plunged 12% Monday, the VIX surged to a 52-week high of nearly 84, far above its low of 11 in the past year. Similarly, the VIX shot up to nearly 77 on March 12 when the stock market fell 9.5%.
The takeaway: if investor fear recedes, stock prices will rise.
This will likely be preceded by calmer headlines in your newsfeed.
Look to earlier bear markets
Bear markets of the past do provide a roadmap of sorts for the types of declines investors can expect. The S&P 500, at its closing low Monday, March 17,2020 was 29.5% below its record high of 3,380.16 on February 14, 2020.
So how does that compare with other bears? The average bear market loss since 1929 is 40% and lasts 21 months, according to S&P Dow Jones Indices. It turns out that bear markets that occur during recessions (which many on Wall Street are calling for now due to coronavirus business stoppages) tend to be deeper (the average pullback is 37%) than ones that don’t involve recessions (24% decline).
Track the S&P 500 Index here https://us.spindices.com/indices/equity/sp-500
Track the Dow index here https://www.morningstar.com/etfs/xtks/1679/quote .
Look at past stock market ‘floors’
Levels at which stock market indexes like the S&P 500 stopped going down in past market routs are often viewed as a floor – or support – for future market meltdowns like we’re seeing now.
“Technical” analysts look at stock charts and draw long-term trend lines, or lines in the sand where selling stopped in the past. If those old support levels “hold,” there’s a good chance buyers will find that comforting. They’ll view that level as a good entry point to buy stocks, stabilizing prices.
Key market level: 2,350 to 2,150
So, what key levels should investors be watching now?
Remember the Christmas Eve massacre on Wall Street in 2018? Well, stocks in the S&P 500 stopped going down that day when the large-company stock index closed at 2,351. That’s the level Wall Street pros are watching closely now. After Tuesday’s rally (March 17, 2020), the S&P 500 is trading about 7.5% above that level. After the close of Wednesday’s drop to 2,398.31, it is about 2%
What’s the next support level after that? Traders suggest that there’s a cluster of very long-term support in the 2,150 to 2,350 zone.
Stocks become a screaming buy
If the stock market dive worsens, there will come a point where Wall Street decides that stocks have become so cheap that they’ve become a screaming buy. And when professional traders sense a huge buying opportunity, the market often can shoot up higher fast and furious, often causing investors who had fled to the sidelines to miss out. Warren Buffet of Berkshire-Hathaway has been building cash reserves for nearly two years and will likely find solid opportunities in the coming months just as he did during the 2009 Financial Crisis.
We may be getting close to the idea that “stocks are on sale,” but we’re not quite there yet.
After Monday’s plunge, the market’s price-to-earnings ratio based on 2020 earnings estimates of $169 had fallen to 14.2. That compares to the 14.1 P-E during the near-bear market in December 2018.
The problem is earnings estimates are likely to come down as the true impact on profitability caused by the coronavirus becomes better known.
As noted by some analysts, the market could follow that move lower in earnings. The market bottomed in 2008 at 10 times earnings. Similarly, a valuation analysis looking at median P-E levels going back to 1957 found that the market is still 4% overvalued.
When stock market pessimism peaks
Once every investor on earth thinks the world is ending, and pessimism is at a peak, most of the people who wanted to sell already have. That clears the way for buyers to swoop in and pick up bargain-bin-priced stocks.
One sentiment indicator to watch is the survey of bulls and bears by the American Association of Individual Investors. (Visit https://www.aaii.com/sentimentsurvey )
Back on March 5, 2009, four days before the bear market bottom, more than 70% of AAII members polled said they were “bearish” on the market. In the latest weekly survey published on March 19, there were 51.3% bears, versus the historical average of 30.5. And when the next survey is released, it’s likely that bearishness will again show historical extremes.
The bottom line: Keep your eyes peeled for signs of a market bottom.
One more thing. Here’s a simple clue that will suggest that the worst of the selling is over: Bad news no longer sparks a massive sell-off. (See “fear gauge” noted above).
When bad news is again good news for stocks, a rebound rally won’t be far away.
Until then, remember that investing is simple but never easy.