With Negative Sentiment Soaring, We Might Be Starting A Bottoming Process

One of the stranger things about 2007 was the huge discrepancy between different areas of the U.S. stock market. Despite widespread problems, the stock market didn’t fare badly unless you looked under the hood. The S&P 500 finished the year up 5%, hardly indicative of the issues we are facing. In fact, of the market’s ten major sectors, only two of them trailed the S&P 500 index’s return last year. Financial services (-21%) and consumer discretionary (-14%) stocks were correctly pricing in a recession (or something that feels like one) but the other eight sectors just kept humming right along.

Well, it appears we are now getting a more realistic reaction in the market to the economic challenges we are dealing with. We’ve dropped 10% in less than 3 weeks, and the selling has been much more widespread. Realistically, we were due for this type of action. That said, the negative sentiment in the market right now is deafening. We won’t know how bad things really are until fourth quarter earnings reports and first quarter outlooks are given out over the next 2-3 weeks, but stock prices are starting to price in some really bad stuff. Many contrarian sentiment indicators are signaling we could be starting a bottoming process.

Since nobody can predict when the market will stop going down, I’m not going to waste my time (or yours) hazarding a guess. I will say this, however. Investors should pay close attention to this month’s earnings reports and conference calls. Stock prices are now being driven by fear, and I think many of them are not reflecting what is likely to happen as we navigate through 2008. We could certainly fall another 5%-10%, after all things are not good and I’m not trying to say they are, but we should still be getting ready to pounce.

Personally, I am not going to be doing any meaningful buying until I see these earnings reports and listen to quarterly conference calls. But after that, I think it might be time to dip a toe in the water with cash positions. Even if we keep heading lower short term, a year or two from now I think it will pay off in spades.