Here is my back of the napkin, over-simplified view of today's market. All you other napkin cogitators are welcome to chime in. If the DJIA might have been 10% over-priced at 14,000, and over all earnings fell 10% from there, then is it reasonable to remove 20% from the top to find the bottom?
That would put the bottom at 11,200 for the DJIA. This wild guess might make some sense if earnings stabilized somewhere in the next few months. I'm not sure that is likely, so we might test the 11,000 mark some time this year.
The Federal Reserve Board's plan has to be to achieve stable markets. They have to cut interest rates until they balance consumer and business requirements and the bleeding stops. The problem is that Chairman Bernanke and friends are only affecting short term rates. This has reduced the cost of funds to people using things like home equity lines, but it has not affected long term home mortgage rates much.
Long term rates seem more related to inflation pressures and that will only be stimulated further by the Fed continuing to stoke the fire, increasing oil prices, and commodities and smacking down the once "almighty dollar." Soon our children will be asking us why the dollar was ever referred to that way.
I do not think the overall economy is as bad as some might suggest, however. I think this is because the pain is not evenly distributed. Some parts of the country are truly depressed, like Michigan and Ohio, others, like the Washington DC Beltway area, are not.
If it is natural for markets to overshoot value to the high side, then it is equally natural for markets to overshoot value to the low side. For this reason, I do think the DJIA might break 11,000 to the downside before we see a recovery. One thing that would help a great deal would be if politicians would campaign -- and govern -- on issues like less spending instead of more. Ever-increasing deficits and increased taxes are not the fuel of strong economies.
Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm. He writes the columns Chasing Value and Serious Money.
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Reader Comments (Page 1 of 1)
3-04-2008 @ 2:18PM
primros103 said...
Ok, soon as the gangsters stop manipulating the outcome of the so-called free market, it will go to where it belongs 9,000. Hold onto your jock-straps fellas!
3-04-2008 @ 2:55PM
Sheldon L said...
Way too cynical primros, too many large companies are growing earnings outside the US. Even if the US economy hurts, many companies will see some global earnings growth.
3-04-2008 @ 11:52PM
thebigkill said...
My concern is less on how low the bottom will be, and more on how long it's gonna take to hit bottom. Let's consider the SP500. In an index where financials comprises 17.64% of the pie (http://www2.standardandpoors.com/spf/pdf/index/SP_500_Factsheet.pdf), and that pie is writing losses in the billions, that makes the whole pie taste a little sour. That's why we have much more room for downside overall. The whole market is unfortunately getting punished, although the bearishness likely won't relent until that 17.64% gets healthy again. The faster they finish their purge, the faster we'll see sustainable upside. And it's impossible to write it all off in 2 quarters, because why would I write off bad debt if it's not bad debt yet. There was a lot of borrowing in the past 7 years thanks to Fed cuts from '01 on, and it'll take some time to settle the accounts. It'll probably be a slow purge first with these residential property loans, then commercial property loans, then corporate leveraged debt loans. Once financials acknowledge they can't unload all the risk they acquired on an insurer, correct the debt they carry, then banks will be piloting in clearer skies. We might be better off with higher Fed rates because it higher Fed rates helps fixed rate mortgages. Lower Fed rates helps ARM's, which nobody wants anymore. A higher Fed rate will urge fixed income institutions to drop cash on long-term 30 year instruments, which drives the yield lower. The problem is the Fed was pressured to use the funds rate as a short-term instrument when it should be reserved as a long-term instrument. Who's the genius that appointed this guy anyway? Oh right...