How to Probe for Signs of a Market Bottom

March 11, 2009 by  
Filed under Investing

searchWe had a bounce yesterday.  Was it one of proverbial “dead cat bounces” that are all too common in bear markets?

The buzz from stock market analysts about finding or predicting a market bottom seems to be increasing.  Everyone wants to be told that this is it, things are as bad as they are going to get, that it’s time to make strategic buys back into the market.  Who or what is going to make this pronouncement?  President Obama?  Barney Frank?  Warren Buffet?

In one sense, calling a market bottom for purposes of making investment decisions is a form of market timing.  I’m not a fan of market timing as a fundamental investment strategy. History shows us that it doesn’t work very well.

On the other hand, we are all influenced by signs that things are turning around.  We can make decisions with more confidence if we see those signs.

But how do we see those confidence-building signs?  Where do we probe for that market bottom?

Nouriel Roubini, the infamous “Dr. Doom” of stock market prognosticators, pegged the Dow bottom at 7,000.  We can’t rely on him because we have already blown below that level.

We can’t use historical chronological measures either.  Since the Great Depression, the average bear market has lasted 15 months.  We have been in this one for 17 months and counting.  

How about a price/earnings metric to predict a market bottom based on historical P/E ratios?  Nope, that can’t work reliably because corporate earnings are as unsteady now as stock prices.  Dividends are being slashed everywhere.

Maybe we should compare declines in stock market indexes and look for a similar pattern.  That’s not gonna work either, as typical bear markets of the past bottomed out around 30% declines.  Our markets are down over 50% from their highs in October 2007.

Do we take polls of economists and various stock market experts and publish them in the paper?  I don’t think so.  Which experts would you choose and how many?  Most so-called “experts” in the stock market timing business prefer to look in the rear view mirror and tell you what just happened.

In this case, Mr. ToughMoneyLove is inclined to believe in the collective wisdom of some experts, as long as those experts are willing to put their money where their predictions are.  So who are these “experts”?  They would be top executives of publicly traded corporations.  I want them to tell us – as a group – that the road back for their companies is in sight.  

Let’s assume for a moment that the folks who run the big boy companies have a good idea about what the imminent future holds for the economy and markets.  How do we know what these executives are thinking?  There is a way:  stock buybacks and insider trading.  History tells us that increases in activity in these areas are good signs.

Publicly traded corporations are known to buy back shares of their own stock when two conditions exist:  (1) their managers believe the stock is undervalued; and (2) they have free cash that those managers are comfortable spending as opposed to hoarding.

Standard & Poor’s tracks stock buyback data.  You have to be a paid subscriber to obtain that data directly.  However, S&P does release summaries of the buyback data each quarter in a press release.  You can search for those press releases and discover what the trend is.  There were record levels of stock buybacks in 2007. The most recent press release reported that stock buybacks in the 3rd quarter of 2008 were down 48% from the same quarter in 2007.   I would like to know when a decline in stock buybacks turns into an increase.  That would tell me that confidence in future economic performance has returned to those who run our major businesses.  So I am going to keep an eye on that buyback data.

Insider stock trading trends can also be instructive.  Generally speaking (and excluding certain strategic stock option moves), if corporate executives are buying stock in their own companies, they are feeling pretty good about the economic future of that company.  Here is an academic article that discusses the predictive ability of aggregate insider trading.  

Fortunately, the SEC requires all insider transactions at publicly traded companies to be reported.  Most financial websites can provide recent insider trading data for specific companies.

What I am more interested in learning is a the existence of a general trending upward of insider buying across a broad range of businesses.  There are a few places to find that data, including Insider Cow.  (Click on “Insider Charts”)  To me, it is more relevant to look at insider share volume than it is dollar volume.  SecForm4 publishes a daily insider buying index.  When that index goes on a steady positive trend, I am going to pay attention.  That will be a confidence building sign for me.

To summarize, if you are looking for indicators that the bear is ready to hibernate if not disappear completely, why not follow the voting patterns of those who are in the corporate trenches and are willing to put their money where their confidence is?  

Watching stock buyback and insider trading trends makes sense to me – how about you?

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3 Responses to “How to Probe for Signs of a Market Bottom”
  1. MasterPo says:

    I’m thinking this is turn around is more like a dead-cat bounce.

    The initial shock of the Obama spending plans has worn off for now. But most of the plans don’t actually kick in until 2010 and later so don’t pop the bubbly too soon.

    Washington is already ramping up the PR machine for stimulus II this year.

    Like a kid with daddy’s credit card…

  2. Brad says:

    Not sure how I feel about corporate buybacks and insiders as an optimal indicator of a bottom. My biggest problem is that boards and officers have a tendency to be overly optimistic about their own companies. Which is a likely cause for them taking on ridiculous amounts of debt and risk. I suspect it will be a corroborative trend, but I would need some other indicators before I got too excited.

    On the flip side, I think your reasons for disregarding several of the other indicators are very wise. It’s very difficult to make historical comparisons on a once in a lifetime event.

  3. TMN says:

    sure p/e is unstable right now, but even using pre-crash numbers it’s still overvalued. take it down somewhere between 15 to 30 percent to account for a slower economy once we start to climb back from the bottom and it’s obvious we’re nowhere near the bottom. my money is on breaking 5000 before the year is out.

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