The Dangers of Calling a Bottom

With the market at new lows, let’s look at the question of when will things change. Trying to pick the bottom, however, is a dangerous undertaking and is, in my opinion, best left alone.
The market is strongly affected by valuations but it doesn’t turn on them. There are a few generalities that have held up well over the years. For example, the trend is like the tide, it’s much stronger than you think. A bull market can keep rising solely on its own momentum. Likewise, a bear market also keeps riding its own momentum. If you start thing, “it can’t go any higher/lower,” it probably will.
I recently wrote about the effect of Price/Earnings Ratios on the market. The effect is rather weak especially compared with short-term momentum. If one month is horrible, the odds are that next month will be horrible as well. It’s really that simple and the first two months of this year bear that out.
When the market finally does turn, it’s often in the midst of terrible news. The initial stage of a bull is generally disbelieved (I apologize for these qualifications). Prices start rises as earnings are often still falling when means that earnings multiples give out false sell signals. Everyone starts expecting the nascent rally to fall apart. Not only is a bell not rung at the bottom, it isn’t even rung several weeks afterward.
To take one example, let’s look at Microsoft (MSFT). On Friday, the stock closed at $16.15. That’s the lowest price in over 11 years. The company has a gigantic cash horde worth $2.59 a share and not a dime in long-term debt. Take the cash out of the share price, and the company’s nuts and bolts are going for $13.59 a share.
For fiscal 2008, the company made $1.87 a share (the fiscal year ends in June). Earnings for this year will probably be around 10% lower, give or take. So even by these admittedly simplistic calculations, the stock appears to be cheap. The problem is that you could have reached the exact same conclusion several months ago as well. The market will turn eventually but it will begin with a whimper not a bang.

Posted by on March 1st, 2009 at 11:34 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.