Sunday, November 23, 2008

Market Talk

I think we're close to the bottom.

If you look at the DJIA over the long run, in the last twenty-odd years there are a essentially two periods. The first lasted from 1985 to 1995 and exhibited relatively predictable, non-volatile growth. It coincides with the quickening of globalization, deregulation, and financial innovation. The second period is the "Bubble(s) Period," starting in the mid-1990s and covering the dotcom boom and bust and then the leverage/credit boom and bust.

If you work on the assumption that the growth of the first period was more rational and sustainable over the long run, and the growth of the second period was mere froth, then you'd expect the market to collapse until it was roughly back in line with the long-term growth average consistent with the first period.

I separated the data from the first period (it's in red), added a trend line, and projected that line forward until today. If the market had grown at the more rational, 1985-1995 pace (ie if the false bubble wealth had never been created), we'd be somewhere in the 7500-8000 range today.

The market closed in that range several days last week. Does that mean we've hit the bottom? I think the answer is yes, more or less. It could probably fall even lower temporarily, maybe even closing below 7,000 (especially if Citigroup fails). And it's certainly not going to climb anytime soon. But it doesn't have too much farther to fall.

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