Is the correction kaput, or is capitulation still ahead? That is the question many market mavens are trying to answer after world stocks’ 6.1% rise since February 11.[i] It is the question of the moment, but in our view, seeking an answer is a futile and useless exercise. It’s almost impossible to time short-term market moves—there are no all-clear signals—and trying to do so risks not capturing market gains when the broader bull trend resumes.
If you have perused the financial press lately, you have likely seen them. There are a variety of opinions as to what characterizes major market troughs. A common theme is that markets bottom out when investors are at their most fearful—after they “capitulate” and give up on their hopes a rebound soon will come. While pessimism often spikes at market low points, capitulation is almost impossible to quantify. Yet that doesn’t stop the pundits from trying. Some say a good gauge of capitulation is when at least 90% of market sectors move in lockstep, presuming broad-based selling implies a “throw the baby out with the bathwater” mentality characteristic of widespread pessimism. Others say outsized daily price drops indicate a surge of selling that often precedes a new uptrend. Some suggest a spiking CBOE Volatility Index (or VIX for short)—above 40 or 50—marks major market troughs, believing high expected volatility equals a freakout. Still others figure retail investors tend to buy and sell at the wrong times and in small orders of less than 100 shares. Therefore, a surge in small short sales would show retail investors are broadly betting on further declines, sign they threw in the towel. There are more.
These all may seem intuitive, but none of these supposed indicators work. Some occasionally coincide with troughs, but not regularly, and false signals abound. The first three signals flashed simultaneously last August 24,[ii] which was not this correction’s low. The correlation indicator triggered in only three of this bull market’s five prior corrections. Valuations fell as stocks dropped, but no specific level draws buyers en masse. None have any fundamental reason to be a hard, fast, predictive indicator. Occasional coincidence isn’t causality.
Seeking confirmation any small rebound is the beginning of a new uptrend is similarly feckless and also all the rage today. The alleged signals include: A rising advance/decline line, which in plain English means more stocks are rising than falling—supposedly indicating the rally is “real” because it is “broad” and has staying power. Some see stocks’ 50-day moving average breaking above their 200-day moving average as confirmation of a new uptrend. And, stocks retesting but not breaching a prior low point is supposedly a sign that low is solid. Lately, some point to rising commodity prices as a sign the tide has turned, especially copper, which some see as an economic health gauge. Others speculate stocks breaking their tight correlation with oil signifies “the bears are losing their grip” on the market. Others are looking for the US dollar to break its uptrend, making US exporters’ and multinationals’ lives easier. (We guess folks aren’t yet hip to the fact that the strong dollar isn’t a huge headwind.)
The fact we have mentioned eleven indicators that various sources claim must happen for a trough to be declared—and there are many more we haven’t mentioned— should signal the fact folks are grasping at straws. There is no quantifying a low point—no statistical “all-clear signal.” We’re sorry to say so, but looking for one is a fool’s errand. The low will only be clear in hindsight.
For long-term investors, it’s also quite beside the point. Yes, if you somehow identify the correction’s low almost to a tee, and reinvest at or near the ultimate trough, you boosted your returns a bit. And that’s nice! But it’s virtually impossible to do this consistently over time, and it isn’t necessary. If you’re already fully invested and need stocks’ long-term returns to reach your financial goals, pinpointing the low is irrelevant. Eventually the rebound will erase these temporary declines. Stocks’ long-term returns include the many pullbacks, corrections and even bear markets along the way.
If you’re in cash, waiting for the low to reinvest, and your goals require market-like returns over time, you’re taking a big risk by being out of stocks: the risk you miss the returns you need if stocks rise, potentially jeopardizing your long-term financial goals. In an ideal world, yes, wait for the bottom. But we don’t live in an ideal world. It sounds like tautology, but it is worth stating anyway: Investors who need returns commensurate with owning equities need to own equities vastly more often than not. If that’s you, we’d suggest taking advantage of the sale currently underway on Wall Street.
If you’re holding out for lower prices and stocks instead march higher, you may find it very difficult to buy back in. You might even wait for another meaningful pullback to give you a better entry point, but if it doesn’t come, the market may run away without you. Miss enough market gains, and you risk not being able to retire when you wanted, or not having a sizable enough portfolio to meet your needs throughout retirement.
Better instead to invest now, tune out short-term swings and think long-term, with your goals always front-of-mind. Think of the future—where stocks are likely to go over the next 12-18 months, not where stocks just went. Stocks’ underlying fundamentals remain positive. The Conference Board’s Leading Economic Indexes for the US, UK and most of Europe remain in uptrends, suggesting economic growth likely continues. The risk of broad, sweeping new legislation roiling stocks remains low as many governments are gridlocked. And investors remain mostly gloomy, a sign reality likely exceeds too-low expectations.
[i] Source: MSCI, MSCI World Index returns with net dividends, 2/11/2016 – 2/22/2016.
[ii] A combination some say signals a low.