Investment—Finding A Market Bottom

Finding a market bottom is not as straightforward as you might hope, it's a complicated process.  For example, Thomas Lott—a former hedge fund portfolio manager—said that he uses multiple approaches:

We analyze yield curves, technical data, prior bear markets and corporate earnings among other metrics looking for signs of a bottom.

In this article, we will list some ways to identify a potential market bottom and start with Marko Kolanovic's playbook first.

Marko Kolanovic

Based on JPMorgan's Marko Kolanovic, if you believe stock market will transform into something bigger than just a bounce, then consider the following plays according to the investment bank:

1.  Longs in small-caps (P/E ratio is below Lehman bankruptcy and peak COVID)
2.  Longs in Biotechs (~1/3 of the companies trade below cash)
3.  Long China (reopening and stimulus are powerful tailwinds), including Tech/Internet
4.  Long Cyclicals vs. Short Defensives
5.  High Beta Growth, including ARKK ETF. Many of these names have lost as much as similarly viewed names in the Tech Bubble.

IWM / XBI / FXI

In the below figure, we have listed the current prices of IWM (i.e., small caps), XBI (i.e., bio techs), and FXI (i.e., China) in the same diagram.

Figure 1.  Small caps / Biotechs / China (courtesy: stockcharts.com)

Cyclicals vs Defensives

Cyclical stocks include discretionary companies, such as Starbucks or Nike, while defensive stocks are staples, such as Campbell Soup. Cyclical stocks usually have higher volatility and are expected to produce higher returns during periods of economic strength.

So, we can use XLY (i.e., discretionary stocks) and XLP (i.e., defensive stocks) ratio to measure the strength of cyclical stocks' relative to defensive stocks'.

Figure 2.  XLY / XLP (courtesy: stockcharts.com)

High Beta Growth vs. Cash

As Marko Kolanovic said, high beta growth (e.g., ARKK) should perform better if a market bottom is in.  For example, we may measure the relative strength between ARKK and COWZ.

Note that COWZ is a strategy driven exchange traded fund that aims to provide capital appreciation over time by screening the Russell 1000 for the top 100 companies based on free cash flow yield.

Figure 3.  ARKK / COWZ (courtesy: stockcharts.com)

Major S&P 500 Low by Calendar Month

Finally, as @AriWald shared on Twitter:

"Major market bottoms have occurred in October more than any other month" 

Figure 4.  Major S&P 500 Lows since 1932 by calendar month