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Searching for Signs of a Market Bottom

May 31, 2022

Investors flipped the switch last week and started buying stocks big time. The SP 500 jumped 6% last week for its best one-week gain since November of 2020. That was an election week, you might recall. Not only that, SentimenTrader points out that the market traded higher during regular trading hours from the open to the close on all five trading days, no late day sell-offs or 800 point swings from green to red. Just a steady drumbeat higher. The Dow also climb more than 6%, snapping an eight-week losing streak that matched the longest weekly stretch of declines since the Great Depression. How about that Nasdaq? It popped 6.8% as growth finally got a little break. Is this a bear trap or a bottoming? Looking at the money flows last week, investors are behaving like it's the latter.

If you think we're going back to the same dynamic of 2020 and 2021, think again. Interest rates are rising and the economy is slowing. The easy money is gone, gas is half way. But that doesn't mean that oversold sectors won't claw back some gains and overbought sectors won't cool down. But the next few years won't be characterized by red-hot growth and an accommodative Federal Reserve, unless we're headed into a recession, of course. And then all bets are off.

Meet Lindsey Bell

Ally

Lindsey Bell is the chief markets money strategist at Ally. Previously, Ms. Bell participated in developing CFRA Research's investment strategy and led its Portfolio Management Committee. She has also previously worked for JPMorgan, Deutsche Bank, Jefferies, and TheStreet. Additionally, M.s Bell is a board member of Better Investing, a nonprofit that helps create investment clubs to teach individual investors how to become successful long-term investors.

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Even though the sellers took a breather last week, it still doesn't feel like we're on terra firma in the capital markets these days. The stock market has been rather unpredictable lately, not that it ever really isn't, but investor sentiment is ultra-sensitive right now. We need some grounding, and we need some common sense. So, I reached back out to our pal Lindsey Bell, the chief markets and money strategist at Ally. It is so good to have you back on the Express. Thanks for being here. 

Lindsey:

"Thanks for having me, Caleb."

Caleb:

"I was reading your terrific blog on Ally, and you list five signs of a market bottom. I want to rip through them with you and do a little break down and see whether or not we can feel whether we're getting nearer, whether we just had it, impossible to tell. So, let's get let's do a few of these, if you don't mind. Are you ready?"

Lindsey:

"Sure."

Caleb:

"You talk about the spike in the VIX, and I've been looking at the VIX pretty closely as well. It's high, but it's not screaming like a two year old that dropped its ice cream cone. It hasn't been above 35 or 40 during this big sell-off. Is that mean the worst is yet to come or that it's kind of elevated and it may come down from here?"

Lindsey:

"Yeah, I mean, that has been the biggest question mark of the five signs that I talk about is the VIX, you usually see, like you just mentioned, a move above 45 usually means we're kind of getting to the end of this volatile period, and the worst could be behind us. We haven't seen that happen. Last week, we've actually seen the VIX come down as the market rose. So, maybe the worst is behind us. We haven't seen a massive spike like we have during the days of the pandemic-driven recession or even the Great Financial Crisis, where we got to over 80."

"So, maybe the worst is behind us. It's hard to say. With all of these things that I'm looking at, you just look at history for guidance, but there is no textbook role. So, you got to look at a bunch of different things together, and not everything moves the same way at the same time either. So, unfortunately, it's a little more of a feel than it is a quantitative definition."

Caleb:

"No doubt about it. Art more than science at this point in time or just the feel for it, but I love these. Puts sharply outnumbering calls. Another sign. We talked a bit about this on the show last week. Haven't seen a ton of puts outnumbering calls, so you don't see a huge downside bet against the markets. A further downside bet against the markets like you normally think you might in an unwinding like the one we've been it. What is it telling you?"

Lindsey:

"Yeah. And we've actually recently seen the puts versus call ratio come in a little bit more too. So again, we didn't reach super extreme levels yet, but we did reach levels not really seen since the pandemic-driven drama in the stock market. So again, maybe this is just a flushing out, a correction, that the market hasn't had in a long time. It's certainly raised investor anxiety, and I think that we got close to extreme levels, but no cigar here either."

Caleb:

"Yep, I totally agree. But it seems kind of orderly, the unwinding here. And then also another one, a few stocks trading above their moving average. Hey, there was a time—and it wasn't that long ago (six, seven, eight, nine months ago, a year ago)—where most stocks were trading above their moving averages, their 200 or their 50. Everything was going up. Everything was like a helium balloon. Not the case lately. Most stocks, especially the Big Techs, the large caps not trading above the moving average, except for the oil stocks, of course. What is that telling you?"

Lindsey:

"Yeah. Usually what we like to see is a good amount of stocks trading above their 50-day average. It means momentum is to the upside. When the opposite is happening, when there's less stocks trading above their 200-day moving average, momentum is to the downside. And when those numbers get pretty pessimistic in the single digits, we could be reaching a period of final capitulation, potential wash up."

"We never quite got there. We got in the 20% to 30% range of stocks trading above that 200-day moving average, which is... it's still kind of been stuck in neutral territory there. But if you're looking at individual securities, it certainly didn't feel that way because there's a lot of stocks that dropped very, very precipitously early and very hard and were way lower than, say, your correction or even below the bear market territory of 20%. So, it definitely hasn't felt comfortable. And I know you talk about, a lot of people talk about, this sell-off that we've been going through. It's been kind of orderly. It hasn't been too, too dramatic, but it hasn't felt great for the average investor. When you're seeing individual securities and even the market move as fast as it does in a single day, up or down, it can be quite nerve-racking."

Caleb:

"Yeah, I know what you mean. But at the same time, it feels like, and the data supports it, investors, especially retail investors, long-term investors, have kind of stayed put in their index fund, stayed put with their ETFs. You don't see a lot of trading going on, a lot of churn going on in the passive portfolio, in the passive indexing going on. And maybe that's why it feels orderly. Maybe it's institutions unwinding a ton of bets here. We don't have that retail participation we had during the meme-stock mania of last year. So, is that maybe what's going on here? It's just this passive, 'Let it fall. Let it correct. And I'm just going to have to go through the market cycle' type of mentality?" 

Lindsey:

"We've seen it at Ally Investing, in our data. Absolutely. We're starting to see a little bit of softness in trading data in that they are taking a bit of a breather here. But at the same time, since the start of the year, what we've seen is that our customers have shifted the mix of their portfolio from individual securities or individual stocks into ETFs. And that's not necessarily an unusual thing in periods of uncertainty, where you see investors shift into ETFs, which are that passive type of investing. They're more diversified, less worry, less anxiety surrounding them. You can kind of take your hand off the ball there and let it ride. We've seen that trend since January."

"Like I said, while people are stepping away from maybe the more risky trades or the more speculative trades, you're also seeing it in options activity. There's a lot less. There's have been a major drop off from the number of customers that are trading options on stocks at the peak of the pandemic to now. And so, I think some of the speculation is coming out of the market, and that is a good thing. And I think for newer, younger investors that are in it for the long haul, they're planning for retirement, they're planning for some goal that's 15, 20, 30 years down the road, passive investing can be a very, very good way to achieve those goals. It's also a great way to just get started in investing and get used to those wild swings in the market because you have that fallback of diversification, which, again, it's been uncomfortable because the market's falling just as individual stocks are falling too, but it's falling less so in the performance of passive investors who, as you know, have outperformed active investors for quite a long time."

Caleb:

"Yeah. We were just singing the praises of Jack Bogle on last week's show, talking him with Eric Eric Balchunas and his new book. So, we know what it's like. If you're in it for the long haul, it's usually the the smoother road, but it is a tortoise versus the hare type of thing. You also talk about the wide difference between risky and safe-haven bond yields. Bond market has been very peculiar, but we know a lot of money has been hiding in U.S. government Treasurys because people are thinking about, worrying about, a recession. They know rates are rising. All these things are happening. What are you seeing there with the difference between those risky and safe-haven yields?"

Lindsey:

"Yeah. And so, 'risky,' in this definition, could be high-grade corporate bonds too. A lot of market participants like to look at where those yields are trading versus the Treasury bonds but also on a high-yield fixed income versus Treasury bonds. And the spread there can get quite wide versus what the Treasury is trading at. And this one can be a little bit difficult for your average everyday investor to understand. But it's just really a difference in yields of these types of corporate bonds versus the Treasury, which is backed by the full faith and security of the U.S. government. Those haven't gotten as wide as we've seen in past periods of crises. Yes, they continue to move a little bit higher but still nowhere near extreme ranges."

"Usually in the past we've seen an 8% difference between high-yield fixed income and the Treasury. Right now, we're about 4.5%, 5%. So, ways off there, which is a very good thing because, as you know, you hear the old adage that the bond markets is the smart money. They're the ones that really know what's going on. So, that's another one of my favorite ones to just keep an eye on, especially for those people that are really only invested in or primarily focusing their investing on stocks or the equity markets, just keeping tabs on the bond market and other markets in general. It's a really smart thing to do just to get a holistic picture of what's going on in the marketplace."

Caleb:

"No doubt it's all connected. Stocks get all the show time, but bonds really run things around here. That's where the real money is. All right: dismal investor sentiment. We know, looking at the American Association of Independent Investors, their survey, their bullish/bear survey, investors are pretty bearish. And usually that's a turning point. That's usually the sign when things start to turn around, when things are the darkest, that's when we start to see the light. Is that what we're seeing with the sentiment surveys? Not just there, but the CNN Money's Fear and Greed Index. I know the Investopedia Anxiety Index is hot, not as hot as it's been, but a lot of these individual investor sentiment surveys are telling us people are pretty dire. Is that usually a good sign?"

Lindsey:

"Yeah, it's usually a contrarian sign. Usually when every normal person out there gets very bearish, very nervous about the market, it can be an indicator that things are bottoming. The worst could potentially be behind us. And if we look at the AAII, American Association of Individual Investors, if we look at their weekly report, Bulls versus Bears, that really peaked from a negative perspective in late April. It's still very bearish by historical standards, and it's been very bearish for quite a while now. So, we could start to hopefully see, especially after last week's turn in the market, if that... or stabilization, maybe I should say, in the market, if that continues for the weeks ahead, you could probably see the bulls win some ground here. But it's hard to say. Again, we got super, super-negative and the contrarian indicator... it's taken a while to really set in and say that this is the time, this is the bottom, this is where you should start putting more money to work."

Caleb:

"And that's just the thing. We can't know when the bottom happens until it's formed, until you get that real support. Several days in a row of buying. We saw a little bit of that last week, but it's not a trend. And Lindsey, you and I know this, and I think everybody that pays attention knows this, we're not going back to where we were. We're not going back to 0% interest rates. We're not going back to inflation below 2%. Not for a long time. We're not going back to all the wind at the backs of risky assets, which was pushing a lot of investors into the market, whether it was those that extra money during the pandemic or whether there was nothing else to do or whether there was just this attraction because of those dynamics, it's not going back to the way it was. But it is going into a new dynamic. So, given that and what we're facing, what are the new rules and principles investors should be focused on, especially those that have that ten-year-or-more time horizon, Lindsey?"

Lindsey:

"Yeah. It's a massive change in the winds that retail investors, that everybody, is facing right now. So, like you said, we've had the wind at our back for a very long time, and a lot of newer investors haven't experienced a true rising-rate environment. Many people that have been in the market for a while now haven't experienced high inflation levels. Even if the data is starting to show a little bit of a waning (potentially) in inflation, the question is how quickly can that come down, and how quickly do we get back to that 2% level? The Fed is clearly interested and committed to being very aggressive to help slow demand. You're already starting to see demand and growth began to show signs of slowing now just simply because what's happened in the bond market with interest rates already as well as what we're seeing in inflation."

"So, you're starting to see the impact on demand. Just look at what... all you have to do is for a primary focus is look at the bond market. The good news is that the consumer still remains very healthy. The question mark is how long can the consumer continue to absorb these higher inflationary prices and dig into their savings rate? We saw last week we got the PCE personal consumption data, and it was a positive sign that the consumer has been able to again absorb and withstand the higher prices of things. But that's not going to last forever. And I think that's really what investors are concerned about, and which is why you see a lot of different knee-jerk reactions in the market over the last couple of weeks, especially as retailers reported earnings. The question is, the consumer's holding up well now, how long does it last?"

Caleb:

"How long does it last? We're seeing credit card balances rise. Obviously, the savings rate coming down. Now, it's not going to be as high as it was, again, two years ago, a year and a half ago because of those government distributions. So, not a lot of discretionary wealth in the money, the extra money, a lot of it's going into the gas tank. A lot of it's going in to fill the fridge. You can't deny that. We're paying $5,000 a year on average as a household for gas now, up from $2,800 a year last year. Things change, right? So, okay, weird. This is the new, new normal. If you're investing in this environment, again with that horizon, are you thinking about a barbell approach here or are you thinking about... not? You know, the growth days of hi-tech are over for now. So, if you're looking to grow and you want a little risk, what do you do?"

The Commerce Department reported on Friday that the Personal Consumption Expenditures Index rose just 0.2% in April, down from a gain of 0.9% from March. That's yet another sign that inflation may have peaked here in the United States. The report also showed spending by U.S. consumers continued to grow in April, with expenditures rising 0.9% last month. But households were also dipping into their savings accounts to deal with rising costs. That and credit card balances are starting to swell again. Consumer expectations for inflation for the next 12 months is 5.3%.

Lindsey:

"Yeah. I think I've been saying for a while now, you've got to have that diversification. You've got to look at it and consider a barbell approach because, especially at this point in time, having high quality in your portfolio... the last several months has been a reminder of why you need to have diversification. You can't simply just rely on what's working and what the hottest stocks are. Of course, there's different strategies around that, momentum strategies and things like that. But for the average investor, the average person, having a barbell approach, having significant diversification can work well in your favor, especially for a long-term time horizon."

"So, on on the safer side of things, on the more defensive side, what I've been looking at is dividend-paying securities. I always like to look at the Dividend Aristocrats because if you look at that from a long period of time, well, there may be periods of slowness. You're not beating the benchmark every single year. What you do see over the long time is with compounding of those dividends, as you do end up eventually significantly outperforming if you're in it for the long haul. That doesn't mean, if you're young... your whole portfolio should not be in that. But it's a good defensive position to have within your portfolio."

"Also, we're in the summer months, as you know, Caleb, this is a slower period for the market, and the defensive sectors typically do well. Healthcare is one area that I could take a look at from a defensive approach there. On the other side, now, growth is still growth at the end of the day. And that growth looks a lot different than it did in, say, 2000. So, when the hot tech stocks back then were barely making any money and being valued off of insane multiples, eyeballs, and different things like that.

"Valuations for the tech sector, for some of the stalwarts within the tech sector that have solid growth plans and significant cash flow that isn't being negatively impacted by the current slowdown in the market, I think those are some areas that you can start to look at right now and start to pick up because we've just seen a lot of these names, if you look at them, have done a full round trip to valuations and... well, maybe not valuations. Valuations are still a little bit hot, but they're getting closer. But from a price perspective, they've done a round trip to back to where they were pre-pandemic. And while growth has been pulled forward for a lot of these names, it hasn't completely disappeared."

"And we as a society are becoming significantly more entrenched in technology. And everything is becoming integrated from a tech perspective and all of that. So, I think you have to be selective, and you might not be able to just buy the sector outright anymore. But being selective and finding individual opportunities within the growth of your places within tech. I think there is still opportunity. And then I also think that we're going through a period of slowdown, and what happens after a slowdown? Once we get on to the other side of this, you can start to look for for some of the value-oriented plays that typically do well at the beginning of an economic cycle. So, that's kind of the playbook as I see it right now."

Caleb:

"Yeah, it's a rebuilding. It's a chance to reset. And you're getting in at some discount or some leveled-off prices. As Aunt Jane said on last week's show, things kind of reverted to the mean, didn't they? They sure did, to say the least. Okay, let's talk about folks that are either in retirement or the pre-retirement folks. Lyndsey, that whole 60/40 approach used to be the way to go. Portfolios were somewhat efficient. You get to kinda de-risk over time as you get close or into retirement. You still believe in that, you still counseling folks on that, or how should those people think about the next ten years of their ability to build wealth in the capital markets?"

Lindsey:

"Yeah, it's a question even my parents are asking me. They're in retirement, and they're looking at their portfolio, and they're wondering if they should be shifting more of it into fixed income. But you look at the performance of fixed income, and it's not been the stabilizer or the safe haven that it has historically been. So, I think we have to think about it differently, and I think it depends on what point you are at and how close you are to retirement or if you are in retirement. And I think at this point in time, it's going to be a tough slog for a lot of aspects of the fixed-income complex."

"And so, I think with keeping that in mind, you need to consider areas where you are going to be able to see high yields in the most safe and efficient manner. So, like I talked about, I think you got to consider that fixed-income portion of your portfolio. It doesn't necessarily have to be in the traditional sense of fixed income. You should still have some of that for safety's sake. But I think that you can consider other alternatives to fixed income that are very close to fixed income, whether that's real estate or utilities. I think that's one area you can look at within the equity market as well as dividend, high dividend, like I said, The Aristocrats, I talked about that earlier. I also think that if you're in retirement, considering I bonds at this point in time too. You can only invest $10,000 a year, but it's something to consider. And you have to stay invested in a security like that for at least a year to not lose the interest that you're earning. But if you believe that inflation is going to remain above historically low levels for a long period time... I think that this is a product that you can use. It's, again, going to be a very small portion of your portfolio, but it's something to consider to help diversify."

Caleb:

"Great advice there. All right. Last thing, Lindsey, on the way out here, what's one key thing you're going to be watching over the next six months or as we head into the summer? Is it the consumer? What's that key indicator, the Lindsey Bell indicator, that we should focus on that's just going to give us that that temperature reading on which way this whole thing is headed?"

Lindsey:

"For me, it really is the consumer. I've always turned to the consumer, and I think it's probably part of my background because I used to cover retail stocks way back in the day, but the consumer represents the vast majority of our economic growth. And I think the consumer's been telling us all year, as worried as investors have been about the trajectory of growth, the consumer has been standing on solid footing."

"And I'm going to continue to watch some of those indicators that we talked about earlier, whether it's the savings rate or the debt-to-income rate as well as just cash at banks and deposit accounts. And consumer confidence because the consumer's been saying one thing and doing another thing. So, you got to keep an eye on retail sales, you got to keep an eye on consumption. And then you also, to offset that, have to take into consideration what what inflation is doing. We are also operating in an environment where the job market is one of the best job markets in our lifetime too. So, that is a significant support to the consumer."

"There are question marks whether you're going to start to see some weakness there as corporations start to rein in their spending and think about their profit margins from a different type of perspective. But to the extent that they need the help and they need employees and there's this massive shift among employees and among industries, I think the consumer could come out and continue to win. Wages are growing, and you just got to take all of that into consideration. It really comes down to the health of the consumer because the consumer's actions won't lie. And they, again, are the heartbeat of our economy."

Caleb:

"Yeah, you said it. And they have been saying one thing and doing another. Consumer sentiment at a ten-year low. Spending has hung in there. So, great point, great points as usual. And I feel better just having spoken to you. Feeling a lot more grounded, feeling a lot more relaxed. I thank you so much for joining us again, Lindsey Bell, the chief market and money strategist for Ally. Great to have you back on the show."

Lindsey:

"Thanks so much for having me."

Term of the Week: Capitulation

It's terminology time. Time for us to get smart with the investing and finance term we need to know this week. And this week's term comes from my pal Frank Holland, a terrific reporter and anchor at CNBC. Frank recommends capitulatory this week, and while that precise word is not in our glossary, it stems from capitulation, of course, and we haven't quite seen full capitulation or a throwing in the towel from investors quite yet. Well, according to my favorite website, capitulation happens when a significant proportion of investors succumbs to fear and sells over a short period of time, causing the price of a security or the market to drop shortly amid high trading volume.

We usually get a relief rally after a period of capitulation. So, is that what we saw last week? Trading volumes and volatility are both relatively low right now, which makes us think investors have yet to capitulate. But maybe they won't, like they did in 2020, 2018, or 2009. We have to see some follow through on the stock market trends this week. If it churns higher, the base may be in place. If it fails, look out below. Good suggestion, Frank. We're sending you a pair of Investopedia's finest stocks, and we'd like to see those featured on CNBC the next time you're in the anchor chair.

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