How to Survive a Recession

LESSON 36: Wait for the Bottom

As the pace of a recession accelerates, consumers and investors bail out of the markets at an increasing pace. This causes a long and drawn out descent. The descent is not linear, however. Along the way there are periods when the market pauses or accelerates. There are retracements and mini-recoveries. Good news offsets the overall bad economic story. The same wave-like dynamics occur in local business markets, with consumers cutting their expenses in steps over time to survive until pent-up demand and oversupply leads to periods of buying. The effect is a zig-zag pattern as the market anticipates and reacts to good or bad economic news. True recessions take some time to fully develop, and there are many changes in opinion along the way.

In nearly every economic recession there are short periods of capitulation when all hopes of a recovery are dashed by further economic bad news. Usually these are single days and weeks where the market sells off dramatically on extremely high volume at the end of a long downtrend. They are not surprises, but rather a crescendo of selling where the most stubborn long-term investors finally give up and pull their money out—at the exact bottom of the market. An astute investor or business person sees these events as major signals that the entire market may be nearing its ultimate bottom.

The signals that a major market and economic bottom is coming can be seen everywhere. The investing media is full of headlines such as “Market Makes New 10-Year Low!” or “Will Stocks Ever Go Up Again?”. National debt rises to “unsustainable” levels, and the country’s currency value falls relative to other currencies. On a local scale, bankruptcies, foreclosures, rental vacancy rates, and employment losses increase dramatically. The government may drop interest rates to extreme lows to combat these effects and stimulate the economy. Mass human psychology naturally causes these events because we are not designed to think beyond the present and near future. However, all of these events are indicators that a major cycle bottom may be at hand or nearby, and it pays to begin looking for potential opportunities to make long-term investments.

Investors should look for bottoming spikes followed by upward movements in the markets that indicate large investors are buying stock market lows.

Business owners should look for opportunities to expand by acquisition, or move into new markets where the competition has been weakened. Purchasing a home or investment property while interest rates and market demand are low can set you up for big long-term profits. Timing the exact market bottom is exceedingly difficult, so it is important not to use too much financial leverage. The idea is not to make a “perfect buy” but rather set yourself up to capture the next major economic cycle.

An effective technique to help you catch market bottoms is to graph out the major economic indicators – stock market, consumer sentiment, interest rates, etc. – and draw a downtrend line connecting the major tops and major bottoms throughout the recession period. Extend these lines forward into the future. You should end up with a channel or envelope encompassing all the indicator points and an empty area in the future. Then add a zig-zag line that connects each sequential minor top and bottom in the downtrend. You are looking for a point where the zig-zag line touches or crosses the major trend envelope lines. Where this occurs is typically a significant pivot point in the market and is often an opportunity to buy at a bottom in the market.