Everyone seems to be asking the same question- is this the bottom? Personally, I don’t think so, but we are close. The basis for my conclusion is three-fold.

First, the credit market is still largely frozen and there is a lack of confidence between banks. Although LIBOR dropped significantly last week, the TED spread is still quite high. Until interbank lending and confidence is restored, I will continue to remain bearish on the market. Once the credit market thaws, I believe the market will rally significantly because sophisticated investors are using the credit market as a signal to reenter the market. Currently, the institutional money is sitting on the sidelines and is unwilling to risk money to ‘catch a falling knife’.

The second reason is based on technicals. During the Dot-com bubble, the S&P topped at 1,550 and dropped to about 800 two years later. The S&P topped out again at 1565 on October 9, 2007, and yesterday (October 15, 2008), it closed at 908. If one directly compares this situation to 2002, the S&P could fall another 10%, or about 100 points. Secondly, economic downturns typically last about 18 months, which means the market should suffer for another 6 months (or so). Granted, I do not place much faith in technical analysis because it is not correct to compare today to historical events. For example, there has not been a terrorist attack like in 2001. But, it does help to use history as a gauge for approximate price ranges.

Finally, the fundamentals of the S&P 500 appear appropriately priced. The current P/E ratio is about 13.5. If corporate earnings start to decline, the price must also decline to maintain this ratio. The big question is by how much earnings will decline? If you have knowledge about this, I encourage you to blog about this article. It would be great to know what the historical P/E ratio has been at ‘bottoms’, or the average amount that earnings have decreased in recessions. Either piece of info would give great insight into possible market behavior.

To play this market, my recommendation is to make three equally spaced purchases. (See my previous article here.) One thing is certain- you will never be able to catch the exact bottom. Over the coming months dollar cost averaging is the best approach to take advantage of these bargain-basement prices. The market has already lost a lot of its value. How much lower can it really go?

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