Building blocks

Five ways to spot a market bottom

5 months ago

Late March’s sharp three-day rally is inevitably begging the question as to whether markets are nearing (or even past) the bottom after the savage selloff that dates back to 24 February. As suggested two weeks ago (20 March 2020), this column still has its doubts, not least because history suggests market downturns are usually littered with rallies that turn out to be no more than vicious, bear-market traps.

“The price collapse of February and March, coupled with a surge in the VIX, or ‘fear index’, to new highs implies that sentiment has already switched from greed to fear. That is usually a good starting point for some contrarian value-hunting.”

That said, the sudden nature of the downturn means that it is tempting to think the rebound could be equally sharp. The price collapse of February and March, coupled with a surge in the VIX, or ‘fear index’, to new highs (see this column, 13 March 2020) implies that sentiment has already switched from greed to fear. That is usually a good starting point for some contrarian value-hunting but there are other signals which advisers and clients can use if they are looking for signs that we may be coming through the worst.

Five signs

The first thing that markets are looking for is a slowdown in the number of new COVID-19 cases on a global basis (and not just for narrow, self-interested reasons but more importantly simply for the greater good). A slowdown and then a peak in new cases could give markets more of a chance to work out the duration and depth of the damage done to corporate earnings and cash flows and then, in turn, to assess whether the share price falls seen so far adequately reflect this or not (even if this again pales next to the importance of individuals’ health).

“Italy remains in the eye of the storm so far as Europe is concerned. It is therefore intriguing to note how Milan’s MIB-30 index hit a bottom on 12 March.”

Tracking the momentum in new cases via the mainstream print and online media is one way to do this but another way might be to look at Italy. The country Italy remains, for the moment at least, in the eye of the storm so far as Europe is concerned and all eyes are on how quickly the outbreak can be contained. It is therefore intriguing to note how Milan’s MIB-30 index hit a bottom on 12 March and has since advanced by 13% in a fairly orderly fashion. This could just be wishful thinking but it could be something more significant, so this is a trend to note.

Milan’s MIB-30 bottomed more than three weeks ago

Source: Refinitiv data

“Even though the global Mining sector is trying to forge a rally, the bad news is that copper is still stuck well below $5,000 a ton.”

More tangibly, it would be nice to see some improvement in the price of copper and, for that matter, other industrial metals such as aluminium. Copper’s ubiquity, as well as its malleability and conductivity, means it is used heavily in industry, so a rebound in activity should show up quickly. Even though the global Mining sector is trying to forge a rally, the bad news is that copper is still stuck well below $5,000 a ton.

Copper price looks dull

Source: Refinitiv data

Transport stocks are also a good barometer. If goods are selling, then shelves need to be restocked and those products have to be shipped. If they are not selling, then freight volumes suffer.

As this column pointed out several times last year, transport stocks have lagged for a while. Last week’s rally is a start but the transports have yet to prove they have broken out of reverse gear. It would be a welcome sign if they do.

Transport stocks are yet to fully get back on track

Source: Refinitiv data

Another good guide to both economic activity, but also financial markets’ appetite for risk, is junk bonds. The risks involved mean they trade quite like equity. And the Federal Reserve is currently barred from buying them, so you could argue that junk bonds are not a rigged market, unlike Government and investment-grade bonds, where central bank interference means we have little or no price discovery.

Junk bonds can be tracked quickly and easy – for free – via the price of two US-quoted exchange-traded funds, which glory in the tickers HYG and JNK. Both are trying to recovery lost ground. If they can do so under their own steam, without central bank interference, that could perhaps be a sign that markets are starting to think we are coming out of the other side of the outbreak.

Junk bonds need to follow through

Source: Refinitiv data

“Once upward momentum is established in any or all of these charts, advisers and clients need to see a break in the classic bear-market trend of a series of lower highs and lower lows.”

Once upward momentum is established in any or all of these charts, advisers and clients need to see a break in the classic bear-market trend of a series of lower highs and lower lows. Failure to make, or hold, a new peak can often see markets subside to a new trough as they grind lower. Applying that maxim to the FTSE 100, the index ideally needs to get back to 9 March’s 5,966 threshold before then making an assault on 6 March’s 6,463.

Late-March rally has to hold firm

Source: Refinitiv data

Sixth sense

Perhaps the most reliable sign of a market bottom is the least tangible of all. This is this author’s fifth major bear market, after 1990–92, 1998, 2000–03 and 2007–09. With the benefit of hindsight, the biggest buy signal of all was the absence of people asking whether it was time to buy, as this signified total capitulation. Advisers and clients can use their own judgement as to whether we are at the point where the towels are being thrown in or not.

Author
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Russ Mould
Name

Russ Mould

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AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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