Three Things That Could Signal A Bottom In Equity Markets

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An electronic board showing the graph of the recent fluctuations of market indices is seen as a man works on the floor of Brazil's B3 Stock Exchange in Sao Paulo
An electronic board showing the graph of the recent fluctuations of market indices is seen as a man works on the floor of Brazil's B3 Stock Exchange in Sao Paulo, Brazil, July 25, 2019.

Things look gloom and doom for equities on Wall Street. Interest rates are rising. The U.S. and European economies are heading into a recession. The Russian-Ukraine war is turning into an economic war between America and its allies vs. Russia and China. And companies are beginning to report lackluster earnings.

But with equity markets losing anywhere between 16% and 28% over the first half of the year, a simple question lingers among experienced traders and investors: Has the market hit bottom? While it's hard to say, there are a few things that could signal a bottom.

The first is the price of food and energy, which are the critical drivers behind the surge of inflation. It has forced central bankers to reverse the monetary policy, taking liquidity out of the economy and pushing world economies into slower growth and possibly, an outright recession. Any signs that energy and food prices are ebbing will be followed by the tapering of inflation, interest rate hikes, and the resumption of economic growth.

“Ultimately, we believe the market will rebound when investors sense that inflation is no longer a problem and that risks related to the Fed’s response to inflation have passed,” Quo Vadis President John Zolidis wrote in a note to his clients. “In other words, stocks should start going up again when the outlook for interest rates stabilizes, and investors start to anticipate positive economic growth resuming.”

The second thing that could signal a market bottom is downward earnings revisions. They usually attract significant attention on social media, depress investor sentiment, and cause brief sell-offs. But they set equity markets up for the next bull market, as earnings will eventually begin to beat the lower market expectations.

“On a very basic level, stocks trend to go up when companies beat earnings expectations and earnings grow, and stocks lose value when earnings come in below published estimates or decline,” noted Zolidis.

When will this process unfold? “We expect that analysts will start aggressively lowering estimates soon and anticipate that this will create horrible, shocking headlines in the media. Some investors will probably sell on this news,” says Zolidis. “However, we look forward to this as a positive. Significantly lower earnings expectations are often a precondition for stocks bottoming, in our experience.”

The third thing to watch is for signs of easing the Russian-Ukraine war. It will ease pressures on food prices, as Russia and Ukraine are major grain producers and exporters, and Russia is a significant oil exporter. In addition, it will taper the pace of sanctions and counter-sanctions on Russia and its allies on the one side and America and Europe and their allies on the other.

But how and when this will happen is everyone’s guess.

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