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October 13, 2008
How to Spot a "Bottom"
Savvy investors are closely watching the securities markets in an attempt to spot a "bottom," a point at which prices stop failing and begin rising and do not "test" or hit the low point again for some time (if ever). Once investors with cash spot a bottom they become buyers, accelerating the price rise. So what are the indicators of a "bottom."
1) The technical definition of a bottom is a price at which buyers begin to out number sellers and this imbalance sustains itself for some time. But using this definition we only identify a bottom once it has already happened. What are contemporaneous indicators, if any.
2) A strong contemporaneous indicator is when forced sellers have been tapped out. The traditional forced seller is the investors subject to margin calls, stock bought with borrowed money. Once more important than now, the market on Friday show strong evidence of margin calls, even on company insiders. Also acting as forced sellers are mutual funds and private equity funds that face investor redemptions. Investors demand cash and the funds' managers have to sell securities, often their strongest, to raise cash to pay their departing investors. Other forced sellers include banks and financial institutions that are falling short of capital requirements and must sell hard assets to raise cash to meet the specific requirements of a capital maintenance rule. When the forced sellers have been tapped out, the heavy selling pressure retreats and buyers often return to the markets. Friday may have been such a day.
3) Others who attempt to project bottoms appeal more to the psychology of traders. When stock prices tumble and then have a day of wide and wild up and down swings, the self-styled market psychologists "smell a bottom." Other psychologists look to the degree of winning and weeping among populists, when the amateurs start to notice and complain, and the forecasts of doom and catastrophe get severe and emotional, it is time to buy -- "there is blood in the streets." Friday was such a day.
October 13, 2008 | Permalink
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Comments
I'm not certain we have seen a bottom. I do think we've seen a temporarily overzealous sell off, but I think the longer lasting effects of this crisis will continue to drag on the markets for some time. Comparing this to other recessions (of which my only real experience is that of other’s past recollections, and not my own), this recession seems likely to be longer and harder than most others, due to the underlying cause: residential real estate. Recessions are the free market's way of digesting over capacity. Length is often a function of whatever was over produced; the longer the half-life of that oversupply, the longer the recession. The post-2000 recession was due as much as anything to Y2K over investment in technology. Tech has a short half-life. Today's recession will be due to an overabundance of residential real estate. Almost nothing has a longer half-life. Not even commercial real estate comes close. The only reason this might be false is that we are seeing an unprecedented amount of government interference and moves toward socialism. How fast and effective that government interference will be, for better or worse in the long run, really does appear to be the key variable in how this recession plays out.
Posted by: Mike Rosemeyer | Oct 14, 2008 7:23:39 AM
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Posted by: Rachael | Oct 17, 2008 10:06:35 AM
