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"The Truth About Bottoms in the Market"

By James J. Cramer
RealMoney Columnist
5/18/2004 10:44 AM EDT



"The science of bottoms always has intrigued me, in part because bottoms mostly are a triumph of psychology over facts and in part because I know firsthand that they require capitulation of bulls in order to happen.

This market's trying to find a bottom. On paper, the bottom shouldn't be far away: We are at 16 times S&P 500 forward earnings, where the market traded seven years ago. Yeah, it's been that long since it has been that cheap. My take is that next year's earnings estimates are not too high, so this could mean that every multiple point we go down here, we should be picking up adherents who knew enough to stay away when the forward multiple was much higher. When you consider where interest rates are now vs. where they were in 1997 when the forward multiple was the same, the bet would be that we are cheap enough to start the bottoming process.


Heaven knows the give-ups have been fast and furious, too. We haven't by any means wiped out the broader averages' gains from last year. However, we have had stocks make some furious retreats and give-ups that have been stunning; again, that's a nice part of what should be a bottoming process.

Oil, while obviously high, does not necessarily impact every single pore of the market, either. I am willing to accept that oil could lower the S&P multiple by maybe one or two more points, but three or four -- taking the thing down to 12 times next year's earnings -- seems too pessimistic.

So why haven't we bottomed? We have lots of terrible holders who are so scared of a repeat of 2000-2002 that they bolt the moment they are threatened with bad news. I am seeing this phenomenon particularly in the lower-priced issues. Charter (CHTR:Nasdaq - commentary - research), for example, pulled off a miracle last month, getting a debt deal done before a phenomenal spike in rates. It has been cleaning up its balance sheet, adding higher-value customers and turning the company around. For that it's been "rewarded" with a dramatically lower stock price and one that, frankly, still seems too high to the detractors. I guess they think it should trade at $1 or $2, or maybe, that it shouldn't trade at all. It was always a fantasy of mine when I was a short-seller, that management would come out and say, "You know what? We are so overvalued that we are going to stop the trading of our security and we won't reopen it until the valuation is lower and more reasonable." In the case of Charter, until it sells at a lower price per subscriber than all other cable companies, the bears won't be appeased.

Of course, I say, "Hey, fine, take it down there, I will buy more." But that's certainly not the mind of this market -- oh no, not by a long shot. This market's mind is, "You mean to tell me the stock is heading lower? Get me out now, 'cause I will know exactly when to get back in."

I wish I had such clairvoyance.


Monday, I interviewed Matt Fassler from Goldman Sachs on Lowe's (LOW:NYSE - commentary - research). He's been dead right, saying that it doesn't matter, that Lowe's could shoot the lights out but the playbook says it won't be rewarded at this stage of the cycle. Sure enough, Lowe's did more than that, shooting the lights out and hitting it into the monuments -- and the stock got hit anyway. When people see that kind of activity, they become hedge fund managers and they dump it, too.

Given that we are all in the "dump it now because it is going much lower" mode, it is hard to get any traction and extremely difficult to make a stand on anything. You never think, "I am selling such and such a stock at the lowest multiple it has traded in years" -- which is the case with Lowe's and so many other stocks I follow. Instead, you say, "I am selling this stock before the other guys start selling because when they are selling it feels really awful and I am not in the business of taking pain."

Well, not that I want you to share my pain, but I am in the business or running a public portfolio, Action Alerts PLUS, where I am forced into long-term thinking. I will buy Charter at $2.50 if the market allows me to. I will buy Nortel (NT:NYSE - commentary - research) at $2 if the market allows me to. I will buy JDSU at $2 if the market allows me to.

You know why? Because in the end, these are businesses. They are stocks until they are sold down so low that they become less a piece of a paper and more a proxy for the company itself. That's the long-term convergence between the company and the stock that seems so absurd in the short-term.

Notice that I didn't even raise the possibility that Charter or Nortel or JDS Uniphase (JDSU:Nasdaq - commentary - research) will be up some day. I accept the inevitability of their declines and I await them

But I am a strange breed right now, someone who truly wants his stocks lower so he can buy more of them. Most people want their stocks higher so they can sell them. And if they aren't going up they want out. Now.

The amazing thing is that such thinking should only be the province of hedge funds without lock-ups. Those are the only ones who truly need to worry about whether Charter's going to $2 before it goes to $8. They are the ones who can't afford to see how the Nortel saga plays out because they report monthly, sometimes daily, and have maximum liquidity and impatient partners. We individuals don't have such imperatives tugging at us, so what the heck is our excuse for such abysmal minute-by-minute thinking? Did individuals suddenly get that software that shows you where you are every minute?


My partner on television, Larry Kudlow, calls it a "healthy decline." I am sure that many of you sneer when he does. What's healthy about losing money? But how about if the correction is affording us a moment to buy more cheaply than we had two, three or four months ago? How about if the correction allows us to buy Alcoa (AA:NYSE - commentary - research) at a price that it will rise above after it preannounces that it can't make the estimates because of energy prices? How about if the correction allows us to buy Lowe's at a multiple to earnings that it has never traded at so we can make money hand over fist next year? Is next year too long to wait to make money? Do we have to make the money this afternoon, or else it's asterisked as not worth making?

To me, I look at it as I did in September and October of 2002, when I was buying Conexant (CNXT:Nasdaq - commentary - research) and Lucent (LU:NYSE - commentary - research) and Nortel and JDS Uniphase every day because, well, they were going down every day and I was under the at-the-time "mistaken" impression that stocks got cheaper as they went down. I heard the thunder then, too, about what a clown I was to buy defunct companies, as if they were headed to -$4 or something. The common and perceived wisdom at the moment was that all those companies were going bankrupt. Curiously, I heard the same common and perceived notion Monday. I just wish the stocks were lower so it would be more meaningful to me.

When I was at the hedge fund and my performance dipped, I would go into paroxysms of despair. I had a record: no down years, 24% compounded after all fees, only a handful of down quarters, constant progress, no slip-ups. I hated myself, loathed myself, if I slipped even for a day, because I knew that the money would disappear as soon as it happened. Sure enough, I did slip for two months in 1998, and two-thirds of the money came out like it was water. After 15 years of no slip-ups, I saw most of my client base disappear overnight after a couple of bad weeks.

vowed then to make it all back, to go out at the high and to never care again about a couple of bad weeks, that what mattered was the ability to find bargains created by others' pain and the pain in the stock market in general. I would never again fret that my partners would take the money because darn it all, I was never going to have partners again. The clarity of thinking that allows is beyond comprehension, let alone explanation.

Now, I sit and watch as prices come down and all I can say, as I did earlier, is that this market doesn't even know how to come down right. It doesn't give you the chance you really need to sink your teeth into it. You have to buy it piecemeal because the give-ups are all piecemeal.


But don't ask me to leave it now, because tomorrow it might be at 9500. I have never, ever been clairvoyant enough to know that it stops at 9500 and then makes a U-turn.

Let me leave you with one final point. In 1987, I was in cash for the crash. It was something that I lived off of for years. But I had tremendous self-loathing about that call, too, in part because when the market bottomed in December 1987, did I buy tons of General Motors or Coke or 3M or Pepsi or Merck at prices that later would look like wizardry? Nah, I stayed cautious, too worried that if I committed, I would lose my precious "I didn't get hurt in the crash" credential. I erred on the side of buying nothing and just daytrading for small gains.

It left a lasting impression on me when, not more than a couple of years later, stocks had exceeded the prices they hit before the crash. Had you just bought the most active list of stocks the day before the crash and held them -- arguably the dumbest day in history to buy -- you would have made fortunes.

Why didn't I buy? I was worried about how it would look to others if I did. I was worried that someone would think me reckless.

So I developed my style of getting rid of marginal positions when trouble brews, circling the wagons around a handful of positions I truly love not as stocks but as companies and picking at them with buys all the way down to, well, who knows where? I just hope it's lower than here because I truly like my companies. It was a consequence not of the crash but of the aftermath of the crash and the foolish conventional worries I had about "looking bad" and being second-guessed by others.

Oh, don't get me wrong -- I am still second-guessed by others all over the place, every day. But there's a huge difference: The second-guessers aren't my bosses. I have a fantastic luxury now: I can ignore them. And I do what I should have done at my hedge fund, which is buy what I like when I like it with my own money.

Sweet. Even when I am losing money, it's sweet.

Because I know what will happen. Because the acquisitions I make at the most distressed moments, like the ones I should have made in December 1987, like the ones I made in the great pain of 2002, allow me to live off the fat of the land for months when things get better. This isn't like a Gap store; distressed inventory bought now actually could be worth more next month or next quarter or next year and doesn't need to be dumped at some factory store in Reading, Pa. That I know this now, and so many others still don't seem to realize it, means I haven't done a good enough job of explaining what has worked for me.

That's OK; plenty of time to do that.

Now come on market, come down, come to me, at my prices. Let's do some business. "

(in www.realmoney.com)