"In the business world, the rearview mirror is always clearer than the windshield"
- Warren Buffett

When I was in high school I was interested in a girl in my class. We ran in the same friend circle so we spent a fair amount of time together. This gave me countless opportunities to speculate on how she felt about me.

I over analysed every one of our interactions for clues to her feelings. In retrospect, it was obvious she had zero interest in me. But what gave me a glimmer of hope was not a rational assessment of my chances. What kept me going was how badly I wanted her to feel the same way that I did. In affairs of the heart, like markets, wanting something very badly doesn’t make it true.

Investors are on a collective search for the market bottom. And like my ill-fated romance, many investors are clinging to signs we’ve hit a low that may be figments of their imagination. The US market’s dramatic mid-trading day reversal last week was declared to be a sign of the chaos that accompanies market bottoms. The almost universal feeling that markets are likely to continue falling is judged by some to be a contrarian indicator that we’ve reached a bottom.

The problem is that many of the universally accepted descriptions of market bottoms are impossible to measure. How do you determine when investors have “capitulated”? When is “blood running in the streets” and how would I tell when it rains every day in Sydney?

Many investors have had a woeful year. The Russell 2000 Growth Index which tracks small growth companies is down close to 30%. The tech heavy Nasdaq 100 has fallen around 33%. If you disregarded our negative view on the ARK Innovation ETF you’ve experienced loses of 64%. These are substantial falls that are clearly causing lots of investors to lose hope.

A study in the Quarterly Journal of Economics found that between 1960 and 2007 the likelihood for an investor to stop investing increases the more recently they experienced low stock-market returns. And that right there is the start of finding a market bottom. But to truly reach a bottom we need investors to go a step further than ignoring their accounts and dialling back on new investments. We need them to capitulate.

Capitulation is defined by the Merriam Webster dictionary as “surrender often after negotiation of terms.” After a bubble has burst the investing equivalent of negotiation occurs with a future version of yourself. Maybe you won’t drive a Bentley. Maybe it isn’t all so easy. Maybe you aren’t cut out to be an investor. And there are signs that investors are giving up.

Quarterly trading volumes at Charles Schwab have dropped 52% since Q1 2021. Drops have also occurred at Morgan Stanley (16% drop year on year) and Robinhood (July was the weakest month since March 2021) where most of the ‘Bentley by 30’ crowd congregated. Is that a big enough reduction to signal a bottom?

It is clearly difficult to pinpoint when enough of the millions of investors have capitulated – and capitulated enough – to signify a market bottom. Another approach that is commonly used to predict the end of a bear market is valuation levels. And in theory this should be a great way to identify a market bottom. Intuitively a market bottom should also represent a low point in valuation levels. Unfortunately, this isn’t so straightforward.

During the GFC the market bottomed out in March of 2009. Far from cheap, the price to earnings (“PE”) of the S&P 500 clocked in at an astronomical 110. Investors tend to forget that the “P” is not the only part of the price to earnings ratio that is volatile. We are starting to see earnings estimates fall. According to FactSet analysts have cut earnings estimates on the S&P 500 by 6.6% in the third quarter.

If central banks have their way and slow the economy, we will start to see further cuts. Fourth quarter estimates have already been adjusted down by 4.5%. Using a volatile measure like the PE is no way to find a market bottom when there are so may moving parts impacting the data.

My own two cents is that we aren’t there yet and could keep seeing bear market rallies and further falls. But I want to be clear that I am basing that on a couple historical factors. The first is that the market has not fallen that much compared to bear markets in the past. The S&P 500 has fallen an average of close to 36% in the 26 bear markets that have occurred since 1928. During the GFC the losses topped 50%. This year we’ve reached a 25% drop during the market low last week in the US while we haven’t even entered bear market territory in Australia.

The second factor is looking at a non-volatile valuation metric like the Cyclically Adjusted Price to Earnings (“CAPE”) ratio. According to the CAPE ratio the market is trading at an average valuation level when we look back over the past 30 years. The S&P 500 is currently trading at a CAPE ratio of around 27 vs an average of 26.44 since 1990.

If my rationale for additional market falls is unconvincing, then you’ve probably already decided we’ve hit a low. If you are nodding your head in agreement, it isn’t because I’ve made a convincing case. We all suffer from confirmation bias and that will cloud your reaction to this article. But here is the thing – I have no idea what is going to happen. And neither do you. And neither does anyone else who has made a market prediction. They are all just guesses.

Years from now the outcome of this bear market will be draped in the inevitability with which we view history. At that point we can compile a narrative to explain the events. The economic and political circus in Britain may be the penultimate event in a transition to a world of higher interest rates. Conversely, Liz Truss and the British economy could be the first domino to fall. The future, as always, remains unknowable.

What I do know is that none of this really matters. Your ability to achieve your goals is not reliant on knowing what the future holds. And that is a good thing. I bought shares for the first time since March 2020 in the past week. As I foreshadowed in a previous editor’s note

I’ve had my eye on American Tower (NYSE: AMT) for several years. I got in at a price that I believe has a high likelihood of allowing me to achieve my goals. American Tower’s contribution to my future will be boring. I will hopefully hold it for a very long time and steadily collect boring dividends. Hopefully those boring dividends will grow. Mix in some earnings growth and a steady valuation level and I will get my 6.9% a year.

If the share price falls another 15% as the market continues to sink I will be disappointed. I will also buy more. This isn’t an investment approach that is going to get the juices flowing. There isn’t going to be exponential growth and American Tower won’t grace Kathy Wood’s tweets. But then again you will probably read her tweets on your phone. And in more and more of the world that data getting beamed to your phone is from a mobile phone tower whose rent is paying for my boring dividends. If you want to spend your time worrying about if the market has hit a low then go right ahead. I will be right here playing a game I can win.

What is happening at Morningstar

Last week we spent a good deal of time at conferences. It was great to meet so many of you at the Morningstar Investment Conference on Thursday and FinFest on Saturday. I’m always so impressed with the thoughtfulness of Morningstar Investors and how engaged you all are in creating a better financial future.