Ah, if I only knew the answer. But I had the opportunity to spend some time with my favorite economist last week, Dr. Dennis O’Donnell, and he had an interesting theory. Dennis is a very big-brained guy that still has a personality; a retired Economics Professor who now does consulting work all over the country. He also collects single malt scotch – which is one of my favorite things about Dennis. While we sipped what he promoted as the world’s only Welsh single malt, he explained his theory. (By the way – the Welsh single malt was really tasty! Light – almost colorless but with great flavor. No burn going down!)
Dennis, along with several other smart economists, believe that the Dow will continue to slip to around 6500. His rational…. 6500 represents where we were at in 1996, the last time that the Dow was valued based on real valuations. Dennis believes that when the internet bubble started in 1996 the Dow rose based on irrational exuberance not related to real value. Companies with no earnings trading for billions of dollars do not necessarily represent any value. A lot of the money made during that bubble went into real estate – where we promoted and experienced another silly bubble not based on reality. A 1200 square foot condo that was worth $80,000 four years ago is not rationally worth $400,000 today. Unfortunately, unlike the less painful dot com bubble, this tanking market is tied to real assets so we are really feeling the pain.
So now we are cleaning out the investment pipeline, and it is a tough process. And while Dennis acknowledges that there are all kind of unforeseen factors that will drive the stock market up or down, 6500 represents a “stake in the ground” that makes sense from a valuation perspective.
Three months ago I never thought I would be considering a 6500 Dow except in history books, but Dennis’s theory does seem to make sense. What the market really lacks now is confidence; a collective sense that we have really hit bottom and now is a great opportunity to buy. I would love the current level to represent that bottom, but I suspect that Dennis’s forecast has some validity. Of course, my normal caveat here. If you are in this for the long-haul with money that has a long time horizon, I would not sit on my hands and wait for 6500. If we hit 6700 and then take a 20% bump that signals a consistent upturn it would be easy to miss an opportunity. Dollar cost averaging on the way down seems to be the most rational approach. But hopefully at sometime in the near future we will all get the feeling that we have flushed out the market and hit baseline, and now is the time to invest again.