How to Know When the Stock Market Has REALLY Hit Rock Bottom

With the coronavirus wreaking havoc on the U.S. economy, it had been one of the darkest months for stock-market investors in memory. Then in the past few days, everything seemed to change — or did it?

Since hitting to a low of 18,592 on Monday, the Dow Jones Industrial Average has rallied for two straight days, including an 11% return on Tuesday alone. As of mid-day Thursday it was back above 22,000 on track for another daily gain. It's enough to leave investors' heads spinning. “How many days in your life do you remember a 10% move in the Dow?” asked Eric Marshall, president of mutual-fund firm Hodges Capital. “That’s become almost normal."

But have we really seen the bottom of the bear market? It's not an easy question to answer.

History doesn't offer much of a guide. Tuesday’s remarkable rally represented the biggest single-day gain since March 1933 — a day which did turn out to be the bottom of the Great Depression's bear market. But the Dow also rose by roughly 10% on two occasions in October 2008, and we all know how that turned out. It was nearly five months before stocks found their bottom in March 2009.

“In the end we’re going to have seen a lot big wild swings, and every one of them will make you a believer in whatever way the market's going at that point of time,” says Jim Paulsen, chief investment strategist for money manager Leuthold Group.

There are, however, certain coincident indicators to look for to distinguish a dead-cat bounce from a gain that might actually stick around.

The Dollar Stops Spiking

For much of March, financial markets simply stopped working. All investors wanted was their money back, in cash, and, more specifically, in dollars. That’s the reason Jerome Powell’s Federal Reserve has repeatedly intervened with massive interest rate cuts, expanded foreign exchange funding, a back-stop for short-term corporate credit markets and even a promise of unlimited purchases of Treasury bonds.

Just as U.S. individuals and businesses of all sizes were forced to make survival their top priority in recent weeks, financial markets abruptly became “all about solvency and survival,” said strategists at brokerage Jefferies, in a recent note to clients.

Before the stock market can find stability, the Fed's fixes will have to show signs of sticking. To that end, the Jefferies strategists are looking for a weaker dollar coinciding with more moderate interest rates on corporate debt and inter-bank borrowing. That would show that demand for cash is easing at the same time as fears about bank and corporate survival are subsiding.

The virus slows

There’s always an element of what Donald Rumsfeld once called “known unknowns” in financial decisions, but this time around, that's truer than ever.

“When all is said and done, it’s about the virus: How long does this virus remain active? Where does it hit, and do we have any way to counteract the virus in terms of medication and getting people back into the economy?” says Quincy Krosby, chief market strategist at Prudential Financial.

If the coronavirus pandemic takes a turn for the worse, the stock market is likely to follow suit. And it’s unlikely that stocks will stage a sustained recovery unless global public health shows signs of doing so first.

Several drugs — including ones by biotech giant Gilead Sciences, vaccine developer Moderna and Mylan Pharmaceuticals — are showing glimmers of promise in treating the condition. But medical science has to learn more about Covid-19 before the stock market can move beyond it.

Stability in Treasurys

The Treasury market is like the stock market’s sober older brother, the one who doesn’t indulge in all the intoxicating binges, bungee-jumping and histrionics that the stock market is known for. When the stolid Treasury market is freaking out, it’s hard for the stock market to maintain calm for long.

There’s an economic rationale to this. The 10-year yield is the benchmark for bank loans of all kinds, including many mortgages, and can have a big impact on the housing market. From January to March 9, the yield plummeted from 1.8% to below 0.4%, before rebounding almost as violently to over 1%. It’s still lurching around wildly, recently trading at 0.8%.

A week or two of stable Treasury yields could restore the bond market's steadying influence on the stock market, say Wall Street veterans, such as Quincy Krosby, of Prudential Financial.

The economy stabilizes

Over the medium term, movements in the stock market are surprisingly accurate indicators of economic activity. All recessions since World War II have been preceded by bear markets on the broad Standard & Poor’s 500 and the index has seldom sent false recession signals in that time.

This bear market, like the ones in 2008 and in 2000, also appears to be hearkening an impeding recession. On Wednesday, jobless claims leaped to an incredible 3.28 million, shocking economists. Just as with earlier recessions, the stock market is unlikely to make sustainable gains until there are clear hints of improvement in the economic outlook.

The passage of the economic stimulus bill, likely to happen this week, is one good sign for the economy. It was one item on brokerage Jefferies’ list of prerequisites for an end of the stock rout. If the hiatus in economic activity – the closures of factories, stores, restaurants, hotels and services businesses of all kinds nationwide – is a matter of weeks, then $2 trillion could be enough of a safety net for all the workers, corporations and consumers affected.

On the other hand, if the shutdown drags on for months, even $2 trillion will be a drop in the bucket. As long as people are sheltering in place, they cannot spend the checks the government plans to send out anywhere except Amazon.com. "It's really a call on the timeline," says Lorenzo Di Mattia, manager of hedge fund Sibilla Global Fund. "Stimulus will be effective once we get over the virus."

The VIX falls

While the past few days' stock-market returns may look promising for anyone hoping for a bear-market bottom, one other critical piece of information has not been present. The CBOE Volatility Index, or “VIX,” has remained above 60, a level it had rarely tested in the 11 years since the financial crisis ended.

The VIX measures the price of insuring stock portfolios on the equity options market. It's known as the "fear gauge" because it measures the premiums investors are paying for peace of mind. Most Wall Street pros would take any stock rally with a pinch of salt unless the VIX comes out of the terror zone, meaning that it would have to drop by half.

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