Capitulation - Have We Found A Bottom In The Market? by:Julia Lee
What is a bear market?
Generally a bear market is one where the market has decreased by more than 20%.
In Australian the last high point in the market was reached on 1 November 2007 and since then it's dropped 36%. So the Australian market has been in a bear market for the last 11 months.
How does a bear market end?
The end phase of a bear market is called capitulation. Capitulation is when investors give up on stocks. Generally the view is that stocks are a bad investment and there is mass selling over a short period of time.
The problem this time around is that the media is full of talk of capitulation which in itself indicates that total capitulation hasn't come yet. When real capitulation arrives, few will recognise it and ring a bell.
Volatility is another indicator of the end. The Volatility Index or VIX index on the Chicago Board of Options reached an all-time high last week indicating extreme volatility. Extreme levels of volatility are usually associated with turning points in the market and not usually associated with trend continuation.
Most brokerage houses are taking a cautious 'wait and see' attitude.
What can you look out for?
Capitulation or the end phase of a bear market usually involves extremely high volume and sharp declines. Panic selling and capitulation usually signal a bottom of a bear market. There will be talk of people stashing money under mattresses and generally a flight to safe assets such as bonds and cash.
Capitulation is when there are no sellers left in the market and only exhaustion. The only problem is that it is very hard to pick the bottom.
What should you do?
With many market watchers calling the bottom of the market, it's time to be increasingly cautious. It does look like we are in a bear market rally with a potential gain of 20% or greater but the long-term trend still remains bearish.
Total capitulation hasn't happened yet. For that, you'd have to have exhaustion.
For most people, it's hard to know where the bottom is. One fact is that prices are at very low P/Es so perhaps for the very brave it's time to start accumulating.
Just don't expect the bumpy road to be over.
Australian market perspective
Our markets are down 35% in the past year but things need to be viewed in perspective.
From the start of the bull run in 2003 to the peak in 2007, markets increased by 150% and that's not even including the dividends. If you include dividends then that figure rises to 200%.
The best scenario would be if we have indeed seen a bottom, and you bought in at the bottom, by the time the market gets back to the Nov 2007 level, the market would be up by more than 70%.