In Search of a Market Bottom: Position Yourself for Profits No Matter Which Way the Market Moves

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

In a Money Morning commentary back in April, I suggested that while we'd hit a new market bottom, we almost certainly hadn't hit the market bottom.

So have we now?

That's tough to say, although three seemingly unrelated bits of data suggest the ultimate market bottom may be lower still, meaning investors aren't out of the woods, yet. Let's take a look:

• Since 1990, there have been 13 declines of 10% or more in the Standard & Poor's 500 Index. And while each drop of this magnitude tends to precede a rally of six months or more, an ultimate market bottom typically hasn't been established until we've seen an average reading of 36.3 in the Chicago Board Options Exchange Volatility Index - usually referred to as the VIX Index. Generally regarded as a proxy for fear in the markets, the VIX Index closed yesterday (Monday) at 28.48, which is still 22% below the "worry line." Still, the VIX rose nearly 4% yesterday alone, surged as high as 29.30 - and late last week was at 25.3, a 13% move in just a matter of days. If there's a takeaway here it's that stock prices are likely to fall further still.

• Approximately 75% of the stocks on the New York Stock Exchange (NYX) are "oversold," according to various definitions of the term. Each time the reading has reached this level, there's been a subsequent stock-price rally of about 4% in the six months that followed. But here's the wildcard: This happened only three times in the 1990s, but it's already happened seven times so far in the current decade. This suggests to me that any rally that does start at this level may be shorter in duration than investors would like to see - unless there's a dramatic reversal in investor confidence or a change in geopolitical terror.

• In recent speeches around the world, Federal Reserve officials have been making noise about taking over some financial institutions while allowing others to fail. Based on some earlier events, this suggests that the Fed may be trying to telegraph to the markets and investors that we're not out of the woods yet. We can only imagine that the Fed, through close inspection, has determined that it needs the legal framework in place to avoid a catastrophic meltdown should the measured de-leveraging it's attempting fail for any reason at all.

Does that mean it's time for "Katy to bar the door?"

Probably not.

Since World War II, downturns have lasted an average of a year each, with the deepest depths (the market bottom) achieved about halfway through. So right now, if the markets hold and the Fed does manage to pull a Harry Houdini - using such maneuvers as the bailouts of The Bear Stearns Cos. Inc. (BSR), Fannie Mae (FNM) and Freddie Mac (FRE) to avoid a catastrophic meltdown - we're still on track for an election-year rally that would last through the middle part of 2009.

Under that scenario, we could be in "market bottom" territory right now.

Several Wall Street firms have apparently embraced that scenario, and are feeling quite bullish as a result. That's a hope we're finding harder and harder to hang onto, yet that's exactly what we need to do and for one critical reason: History shows us that when investors panic as they have been recently, valuations don't tend to immediately change with them.

That means two things:

• There are incredible bargains that actually are still in the making.
• And there's literally no rush to position yourself for a stock-market rally that may be still months from starting - but which will definitely come.

So how do you play this period of intense uncertainty?

• Don't do anything rash. People make bad decisions under pressure and indiscriminately dumping stocks in a bad market certainly qualifies as a big mistake.

Take advantage of the market's turmoil to establish an appropriate mix of growth and income stocks like the 50-40-10 structure (50% "base building" stocks, 40% global growth and income and 10% the speculative shares we have labeled the "rocket riders" for the thrilling but volatile flights they often take investors on) that we advocate in our monthly newsletter, The Money Map Report. Not only can this help prevent a "downside slide" if the already uncertain economic outlook gets even worse, it preserves the potential for profits in an upside recovery. And let's face it: If you're on the sidelines, you may miss the train when it pulls out of the station.

• Buy global blue chips that derive a substantial portion of their revenue from overseas markets where the economies remain stronger than their U.S. counterpart. We call these stocks "Global Titans," and have found them to be a major haven in some of the financial-market storms we've seen in recent months. Begin by looking for positive earnings and follow the trail to include choices with low or no debt. And wherever possible, concentrate on high yields. Our studies suggest that dividend yields between 2.5% and 3.71% form a definite "sweet spot" that leads to markedly higher returns over time.

News and Related Story Links:

• Money Morning Financial Analysis:
  A Currency Conundrum: Beware of the U.S. Dollar's "Head Fake" Rally.

• Money Morning Special Investment Report:
  Money Morning's Top 10 Reasons Why We May Have Hit A Bottom, But Not The Bottom.

• WorldWideWords:
  Katy bar the door.

• Money Morning News Analysis:
  Although Top Brokers Predict Record Rebound in U.S. Stocks, Dissenters Abound.