Stock market pros look for several telltale signs to indicate when a decline is nearing its final low. Few, if any, of those signs are present now, which suggests that the most investors can expect at the moment is a countertrend rally — and not the beginning of a new leg of the bull market.
A countertrend rally may have begun on Monday, when the U.S. market reversed course from an early-session low and closed up for the day. For example, the Dow Jones Industrial Average DJIA, -0.67% was down 488 points near the middle of the trading day and finished with a gain of 238 points — an intra-day rally of 726 points.
For a list of those telltale signs that help us differentiate a major bottom from the beginning of a countertrend rally, I reached out to Hayes Martin, president of the advisory firm Market Extremes. Over the years I have reported on Martin’s predictions of market turning points, which overall have been impressive. (For the record: Martin does not have an investment newsletter; my newsletter-tracking firm does not audit his investment performance.)
One such occasion was a month ago, when Martin said that there was a “fairly highly likelihood of one and maybe two retests of the market’s recent low before a new bull-market leg will be launched.”
The last couple of days appear to be that retest. In an interview, Martin drew attention to four key categories of indicators that are almost always present at major market bottoms:
- Panic selling: This occurs when investors freak out, dumping stocks indiscriminately without consideration of price. Martin focuses on a number of panic-selling indicators, such as the percentage of stocks trading above their 10-day moving average s— which will be at or close to zero when there is panic selling. Another is the VIX’s VIX, +3.44% term structure, as measured by the ratio of the one-month VIX futures contract to three-month VIX futures; high readings indicate panic. These and other similar indicators are “completely absent” at the moment, according to Martin.
- Widespread and stubbornly held pessimism: This category is closely related to panic selling, but sentiment indicators measure beliefs and expectations rather than market action. “Severe and broad-based pessimism extremes are lacking,” according to Martin. Another bad sign is that, whenever the market does try to rally, however feebly, “optimism reappears quickly.” (I discussed this eagerness to turn bullish in a recent column.)
- Divergences: This category refers to occasions when some segments of the market are behaving significantly better than others, such as when some market averages fall to new lows while others resist doing so. Martin says that some “impressive and potentially actionable divergences” have emerged in the past couple of trading sessions.
- Cheap valuations: Major bear market lows occur when stocks are cheap according to various valuation indicators. This most definitely is not the case today, as I discussed in a column last week. Not only are equity valuations high by almost any measure, Martin reminds us that interest rates are rising. High valuations coupled with rising rates are the worst of both worlds.
The bottom line? Just one of these four bullish categories is even mildly positive now. So it’s unlikely that we’re close to the final low of the market’s recent weakness.
Martin does allow that the potentially impressive divergences which recently have emerged may result in a strong countertrend rally, with the major market averages rising in the 8% to 15% range. But we most definitely should not throw caution to the wind: Any rally now, Martin says, will “not be anything like a new leg of the bull market.”
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]