Spotting a Stock-Market Bottom

From the stock market's peak in October, major indexes declined roughly 20%, then rebounded about 5% between mid March and mid April, often surprising investors with rallies in the face of dismal economic news. Dare we ask: Is it time to don the Toro! T-shirts? (Olé.)

We stand by the old adage that nobody rings a bell when markets hit bottom. And overly eager investors can compound bear-market losses by embracing phantom bull markets too soon. Nonetheless, some signs indicate that a market turn is imminent, if not already here.

Jim Stack, of InvesTech Research, looks for a weakening of bear-market leadership, measured by a declining number of stocks hitting 12-month lows on the New York Stock Exchange. In March, that number was as high as 726, equivalent to about one in five stocks that trade on the Big Board. At market bottoms, fewer than 25 stocks are hitting new lows, and within the first month of a bull market, the number dwindles to fewer than a dozen. The good news is that the number of stocks hitting new lows has come in below 25 a few times of late, although Stack isn't yet convinced that the market has hit bottom.

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The eyes of many seers focus on the VIX index, which measures the volatility of options on Standard & Poor's 500-stock index. Record-high levels indicate extreme fear, which is when bottoms occur.

The VIX's mid-March high was 32.24 -- not quite as lofty as levels that heralded ends of previous bear markets or corrections, such as 45.1 in October 2002 and 45.7 in August 1998, but close to the 36.5 reading in October 1990. You could interpret such below-threshold volatility to mean that we're due to get slammed again. More likely, says S&P strategist Sam Stovall, the current downturn will follow 1990's relatively subdued lead.

Looking ahead. With even the head of the Federal Reserve admitting that we may be in a recession, it's crucial to remember that stocks anticipate turns in the economy. Since World War II, stocks have bottomed about six months into a recession, on average, says Steve Leuthold, of the Leuthold Group. By his reckoning, a recession began last November (recessions, like market bottoms, are only confirmed in hindsight).

From the bad-news-is-good-news department, the collapse of Bear Stearns may augur well for the market. A recent report from JPMorgan Securities (coincidentally, a unit of JPMorgan Chase, which is buying Bear Stearns) notes four such failures in the past 25 years, ranging from Continental Illinois Bank, in 1984, to the Long-Term Capital Management hedge fund, in 1998. After each of the failures, the S&P 500 was up an average of 10% after six months and 17% after a year, turning higher within two to 15 days of the event.

Another contrarian indicator is pervasive bearishness among investment advisers. The rationale is that the market is due for a turn when sentiment reaches one extreme or the other. An early-March poll of advisers by Investors Intelligence, a New Rochelle, N.Y., research outfit, found that 43% were bearish and only 31% were bullish -- the most bearish sentiment since the October 2002 market bottom and a convincing sign that the last of the bull-market holdouts had given up. After all, when the bears have no one else to convert, the market has nowhere to go but up.