A durable bottom is the term used to define when stocks hit their low point in a correction/ bear market/crash and are ready to start a new uptrend. A durable bottom doesn’t mean stocks are going to begin rising immediately. They could bounce around for a while not dropping below the previous low. Of course, consistently identifying troughs in stock price declines in real time is notoriously difficult and doesn’t happen as neatly as described above. A lot can go into forming a durable bottom with no one clear signal identifying the ultimate trough. Troughs, and peaks for that matter, are always abundantly clear in hindsight. For what it’s worth, troughs are easier to identify than peaks are, in my opinion. Although I’m not sure that’s true during long, drawn out declines (think of the NASDAQ 2000-2003).
Capitulation is usually the ultimate sign of a durable bottom. The problem with capitulation is there’s no one clear way of measuring it. Extreme levels in the VIX are often cited but I’m not sure there’s a one size fits all level on the VIX that identifies the trough in prices. During really extreme scenarios such as the 2008-2009 Global Financial Crisis and the 2020 global pandemic, extreme levels were reached. However apart from that, the 40 level has rarely been breached during other large drawdowns. We probably don’t have enough historical data to use VIX levels as any sort of capitulation measure currently. The speed and persistence of a rise in the index is probably a better indicator to track.
Regarding the VIX, levels were very low for several years. While we can’t say with certainty what caused those levels to remain suppressed, the increased liquidity provided by the Federal Reserve may have been a major contributor to the lower trend. If that is the case, then it stands to reason those levels will be more elevated in the coming years with the withdrawal of liquidity. Whether that makes any meaningful difference in capitulation levels in the VIX is unknowable at this time.
Another useful metric to follow is the percent of new 52-week lows in prices on US exchanges. Generally, surges in the percentage of stocks making new 52-week lows can signal capitulation and the putting in of a durable bottom. Again, there’s no magical level for this metric that indicates a trough in prices. I think it’s safe to say though the current level of 20-25% is certainly not high enough to imply a durable bottom is in place. Usually, the percent of stocks at 52-week lows starts to decline as the stock market is in the midst of its bottoming process (often times making lower lows).
In the current environment, a pivot in the Fed’s approach to monetary policy could very well present a durable bottom although there’s no guarantee that would do the trick. The damage to investor psychology and growth may already be done. While it may be easy to believe the expansion of the Fed’s balance sheet was the sole driver of stock performance over the past decade, earnings did grow pretty substantially helping to drive the rise. Favorable liquidity conditions are always a tailwind for asset prices. However, offsetting headwinds could be minimize the impact.
Investor sentiment is the common denominator for all the above indicators. If you get a handle on sentiment, you can be a very successful investor. The problem is getting your arms around sentiment consistently is a lot harder than it may sound. For example, sentiment is in the tank right now which seems to imply a relief rally may be on the come if one hasn’t already started. Regardless, it doesn’t feel like we’re at the lows for this bear market. So many other variables must be considered, including liquidity and growth trends among others.
For now the VIX, the percent of stocks at 52-week lows, the Fed’s posture, and growth and liquidity dynamics seem to be pointing to more potential downside from here although a rally from current oversold levels is certainly possible.