As professional money managers, we are also in the business of client recruitment. For the past couple of years, we have been particularly adept at making certain our clients were properly allocated. Our strategies were weighted toward international funds in the early part of 2007. During late summer in 2007 we switched assets to bonds, avoiding the October market downturn and capturing some nice gains in the early part of 2008. In May 2008, we moved virtually all assets to cash, sidestepping this severe downturn.

With that kind of recent performance, we have attracted the interest of many potential new clients. But some are hesitant to make the switch, because their current brokers or managers are telling them that this is the market bottom and they would be unwise to move now and miss the inevitable new bull market.

The problem with such reasoning is that while no one can predict exactly what the markets will do, most technical and fundamental indicators are still showing a market dominated by weakness. The current situation is unprecedented in many ways. Traditional Wall Street managers want investors to hang on because that is what is best for them, but not necessarily what is best for investors. These managers might want to keep in mind one of Wall Street’s oldest axioms: “don’t fight the trend.” And right now, the trend remains decidedly negative.

Below is a chart of the S&P 500 going back to the beginning of 1994. Notice that the current descent is much steeper than any experienced during the 2000-2002 bear market. The red line marks the lowest point of that decline, which happens to be the next level of technical support at about 780. That is about 13% below the current level. If the index were to drop below that level (and there is no technical or fundamental evidence that it can’t or won’t), then it is anyone’s guess about where the next support level would be. It could be near the 600 level marked by the blue line. That would be about a 33% drop from today’s level. If you think it can’t drop that much, think again. The Nasdaq lost even more during the 2000-2002 bear market.

On the bottom of this chart I have included two technical indicators. I could have included a dozen and they would all show essentially the same thing. Every technical indicator that I am aware of is currently negative. The middle portion of the chart with the squiggly blue and brown lines is a moving average convergence divergence (MACD). I added the horizontal green line to show that it is currently well below its lowest levels in 2001 or 2002. The MACD is a useful tool to help identify market extremes, but it cannot pinpoint exact tops or bottoms and I do not know of any tool that can.

The bottom portion of the chart is just a simple momentum indicator. Like the MACD, it is also at a level much lower than it reached in 2001 or 2002. But there is certainly nothing to indicate that it cannot go lower still.

The next chart below is the same as the one above, except it is just for a single year. I added the purple trendline just to show that the S&P 500 is definitely in a downtrend and I see nothing on the chart that would convince me that a bottom is near. The gold line is a 50-day moving average of the S&P 500. Notice that the currently price is well below that 50-day MA. Before a real bottom is reached, the gap between the gold line and the black line would have to get much narrower.

On this chart, the MACD is much clearer. Notice the separation between the blue line and the black line. A bottom will not be formed until those two line converge and the blue line crosses over the brown. Based on the current gap, that is several sessions from occurring. But even when that happens, it is no guarantee that a bottom is in place. All it means is that momentum has changed from negative to positive. That has happened several times in the past year but the bear market is still dominant.

One of the problems with technical tools is that they are virtually all lagging indicators. In other words, they do a poor job of identifying exact turning points in the financial markets. So how do we determine when the market has made a bottom? There is no one who can positively state when the exact bottom has occurred. But it is possible to identify some of the signs one might expect to see when a bottom is near or has formed.

The first indicators are usually economic fundamentals. There will be improvements in things like unemployment rates, retail sales, housing starts, durable goods orders, etc. When any one of these type of reports is better than anticipated, you might see the market react with a significant daily gain. But any subsequent bad news will send it plunging again. It will take several positive reports in a row to stabilize the daily volatility. So far that does not seem to have happened.

When the bias in economic reports turns from negative to positive, technical indicators will start to improve. The MACD will rise and cross above the zero line. Momentum will turn positive. Relative strength will rise above 50 and then stay above that level. On the equity exchanges, advancing issues will outnumber declining issues for several consecutive sessions. Again, so far that has not occurred.

Until we see confirmation from some of these signs, it does not make sense to remain invested in the markets or to jump back in in anticipation of a new bull market. These indicators all currently still show an equity market where risk outweighs the potential for reward.

When a new bull market is born, you do not need to worry about missing out. While it is possible that there will be individual market days with gains of 4%, 5% or even more, bull markets always rise much slower than bear markets fall. Look again at the top chart. It would have been tough to miss the bull market that began in 1995 and continued until 2000, or the one that began in 2003 and continued until 2007. Catching the exact bottom is far less important that missing the major declines like the one that is currently underway. Indexes normally consolidate in a sideways pattern before advancing out of a bottom. The pattern tends to be shaped somewhat like a bowl rather than a spike.

As I explained last week, Wall Street’s premise that the best investment strategy is merely to buy and then hang on until the day of retirement is not in an investor’s best interest. Brokers and advisors who are currently advising clients that they should remain invested and hope for the best could very easily be doing their clients more financial harm. Are you really going to continue to trust someone who has already advised you to sit by and take no action while your account declined 20%, or 30%, 40%, or even more?

Of course as mentioned above, the financial markets are in uncharted waters. Some analysts have compared the current situation to the start of the Great Depression, but many circumstances are completely different than ever before. I claim no special ability to be able to accurately forecast market movement and it is possible that the market could rally several hundred points tomorrow and never look back. But since I don’t profess to know what is going to happen, I will rely on the technical and fundamental tools referred to above, all of which are showing that the worst is not yet over.
F.S.