Stocks May Retest Bottom: So Let the Buying Begin

Whether it comes from this Friday's jobs report or some other dose of bad news, the stock market is likely to retest the November bottom—and probably sooner than later, many market pros think.

"Despite me thinking that we've already seen the belly of the beast, I still would not be surprised to see the lows breached and some more fear coming into the market," says Jordan Kimmel, fund manager at Magnet Investing in Randolph, N.J.

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But even with the short-term bearishness, many financial advisers are telling clients to look past the bottom and start picking up small- and mid-cap stocks that traditionally lead the market out of recessions. Others see technology and commodities playing leadership roles.

"People think traditional leadership is large-cap growth and it's really not,"  says Charles Massimo, president of CJM Fiscal Management in Melville, N.Y. "Small-cap stocks always have and always will (lead out of recessions) and they will continue to do so."

Since the Dow Jones Industrial Average tumbled to 7,552 and the S&P 500 dropped to 752 on Nov. 20, the market has meandered in a fairly tight trading range while it wallows in the negativity of swelling unemployment along with poor earnings and pessimistic outlooks.

The jobs number due at the end of the week is already expected to be dismal—a 7.5 percent unemployment rate and a 525,000-worker drop in nonfarm payrolls, according to Briefing.com—and a surprise to the downside could be just the ingredient to send investors into a tizzy that tests the previous lows.

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While Kimmel says it also could be another event outside the jobs number that provides a market bottom, he thinks the Dow before long could be trading below 7,000.

"This is the most extreme period I've ever seen for people intent on missing the bottom," he says. "People are hoarding cash. All the ingredients for another bottom are already in place. The reality is the new lows are just one bad news story away."

Opportunity Awaits

Those looking inside the numbers think the outlook for the rest of the year, beyond the immediate damage, could be what provides a retest.

"Everyone has come to the conclusion that this quarter and next quarter are a wash," says Dave Rovelli, managing director of US equity trading for Canaccord Adams. "The next quarter is when you could retest the lows. If companies come out and there's no light at the end of the tunnel and guidance is bad, maybe April is when you retest."

But that's going to provide opportunity, and Kimmel says he is buying a raft of small- and mid-caps, while at least in the near term Rovelli likes technology, energy and commodities.

For sectors on the smaller-company end, Kimmel likes shipping and biotech, emphasizing that he continues to see a stock-picker's environment rather than one where plays on indexes and exchange-traded funds will thrive.

While that mentality isn't universally shared, there is growing enthusiasm for companies with less than $1 billion in market capitalization.

"What will lead us out of this is a change in psychology," Massimo of CJM Fiscal Management adds. "You'll want to start to see some of the negative news be minimized and more of the positive stuff will start to come out. That will be the first kind of change in the market. It's all about sentiment. Bear markets reverse much quicker and with much more of an upside than most people realize."

Finding Safe Harbor

As a proponent of passive management, Massimo is counseling clients to hold tight to their positions and not miss gains from when the market recovers. He urges diversification and discourages clients from using "that sense of a crystal ball" to determine which sectors will lead.

"You've just got to stick to your diversification," he says. "There's a lot less risk in holding a diversified portfolio than in a concentrated portfolio with what you think might get us out of this."

Those who believe in the theory that large-caps won't be the leadership group can play smaller companies through ETFs that reduce risk.

Some examples are the iShares Russell 2000 Index , which has risen about 6 percent since Jan. 23, as well as the Vanguard Small Cap and the Vanguard Extended Market Index , among others.

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But for those who think the market will retest the lows but not make a noticeable move higher anytime soon, the options seem concentrated on corporate debt, along preferred shares and emerging markets, which can be bought individually or purchased through ETFs.

The move toward debt reflects a continuing distrust of the stock market and delivers generally solid though not always spectacular returns while guarding against wild fluctuations in share prices.

"As a general statement, the bad news continues to outweigh the good news," says Peter Tanous, president of Lynx Investment Advisory in Washington, D.C. "That formula is never good for the stock market and it is very difficult to imagine it changing."

Until things turn, Tanous advocates high-yielding corporate bonds and emerging market sovereign debt. Those instruments provide returns as the direction of stocks remains unsure.

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"The bottom line is there are some terrific opportunities out there from a variety of high-yielding assets that have less risk than stocks," he says. "They are commanding our attention at this moment."

Indeed, even those with bullish outlooks are wary of what could happen before a new low is put in place.

"We can definitely test the lows  again on any bad news or any surprise. That doesn't mean long-term disciplined investors should not look at this as a phenomenal opportunity to restructure your portfolio," Massimo says. "This market is going to explode when it turns. You won't want to be that one person sitting on the sidelines."

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