The Bottom Is Nowhere in Sight

Was that the bear market's bottom? Is it yet to come?

The great market sages tell us that the best time to buy stocks is at "the point of maximum pessimism," but I don't know how one could determine that, except in retrospect. Folks seem awfully pessimistic right now. Will they get even more pessimistic?

Maybe. But whether they do or not, that pessimism is a big part of when and how the markets will recover -- and why they'll probably recover before the economic fundamentals do.

A different way of looking at it
Market historians have observed that markets have historically begun to rise several months before recessions ended. It's arguably the perception that things are no longer hopeless that starts the new bull run, more so than the economic fundamentals the markets supposedly reflect.

How could this be? Let's ask hedge fund legend George Soros.

Soros has written extensively about his Theory of Reflexivity, which -- in a nutshell -- states that the relationship between asset prices and investment fundamentals is circular. In other words, just as changes to a company's fundamentals (things like debt load and profits and sales) can affect its stock price, changes to the stock price -- due to rumors, say, or biases on the part of market participants -- can eventually have a big impact on fundamentals.

Banks, for instance, need the confidence of the public to thrive. A rash of short-selling that drives down the price of a bank's stock can damage that confidence. Even if the bank was otherwise healthy when the shorting started, the price decline in and of itself suggests trouble ahead, which could be enough for many customers to take their business elsewhere, which in turn puts the bank in real trouble.

The bottom won't be known until it's well behind us
Soros argued in a recent Financial Times article that this phenomenon contributed to the failures of Lehman Brothers and AIG. But it inspires an interesting way to look at movements of the broader market, at least over shorter periods.

It's hard for folks in the financial punditry business to resist the temptation to say that today's market movements happened "because" of this or that bit of news. But the truth is, on any given day, the market goes down because sellers are willing to take less for their shares, while buyers aren't willing to pay as much. And if people decide to sell because the market is going down, and that then drives the market down further, that's not unlike Soros' idea of reflexivity.

In other words, the markets will stay down (or go lower) until enough people think they should go up, at which point they'll go up. That's not a helpful predictor. So how should we invest?

What to do in the meantime
One way to take near-term market gyrations out of the equation is to buy value. I made the case for value stocks at some length recently, so I won't rehash the full argument here. But I do want to make this point: The markets have been unusually volatile for a few months now. Stock prices are moving through wide ranges very quickly. A stock can be a "value" today and less of one next week. If you're looking to assemble a value stock portfolio, run a screen every few days and keep a close eye (or set a limit order to buy at a specific price) on the best possibilities.

I like the stock screener from Motley Fool CAPS a lot. It gives some preset options for investors following various strategies, including value. Here are some of the names that came up on my value search:

Source: Motley Fool CAPS.

These aren't formal recommendations, just first-blush ideas. But several are worth a closer look. Take Unit Corporation, a contract oil-and-gas driller. It's not far from its 52-week low, and at first glance it appears to have been sold down because energy prices are way down.

One prediction I am comfortable making is that low oil and gas prices aren't going to last forever. If the fundamentals on this one hold up after further research, that could be a classic "good company on sale" to buy and hold for a while. And whether the bottom was last November or is still to come, it's always a good time to buy good companies on sale. But as always, do further research before buying any of these companies.

If you don't have the time or inclination to do that research yourself, but you'd like some carefully vetted value ideas to buy today, I invite you to give our Inside Value newsletter service a try. You can see the team's best ideas for new money in just a few seconds with a 30-day free trial.