No Betsy, It’s Not the End of the World

The most-asked question I’ve received this past week has literally been, “Michael, how much lower can this market go?” This question seems to be on everyone’s mind as they check the prices of their mutual funds and stocks daily, compliments of the Internet revolution.

Before answering this question — and I will do so — it is important that investors understand the single most important rule of investing: Trends do not go in straight lines. Investments don’t go straight up without correcting on the way up. Similarly, they don’t go straight down either, because oversold conditions always bring buyers in.

The simplest way to look at this is using a chart of gold bullion. The gold bull market (which I’m obviously proud to have called for my readers at the onset) started in 2002, when gold was under $300.00 U.S. per ounce (today, almost $900.00). But the gold bull market over the past six years has been anything but a straight line up. The metal had its ups and downs on the way up, almost like my dad used to say, “Three steps forward, two steps back, but you are always going in one direction.” I remember my phone ringing in 2006, as gold bullion fell from $700.00 U.S. per ounce to $575.00, with the question always being, “Michael, is the bull market in gold bullion over?” Patience, patience was always my advice, as no trend is ever a straight line.

That brings me back to today’s stock market and Betsy’s question. The way I interpret the charts, stocks are so oversold that I wouldn’t be surprised to see a rally to higher stock prices from where we are today. Remember, the Fed has reduced interest rates by 75 basis points. That’s big for the economy. Most banks have already written off their billions in bad loans.

Are we in a bear market? Yes. I believe we have been in a bear market since 2000, especially when you take the value of the Dow Jones Industrial Average in gold bullion or euros as opposed to American dollars.

Will the stock market go lower? Yes, eventually the market will move to new record lows. The excesses of Greenspan’s reign will be played out in a contraction for the economy and the stock market in the classical way that economic expansions are followed by economic contraction… on the regression toward the mean path.

Are stocks oversold and will they have a short-term rally here? I think so. Smart investors know that some of the important industry charts have already turned up. The Dow Jones U.S. Home Construction Index has been quietly rallying from its 52-week low of 259 to yesterday’s close yesterday of 344 — a gain of 32% when the Dow Jones Industrials were falling. The U.S. Home Construction Index is telling us that we may have a temporary bottom for the big U.S. homebuilders and the housing price sell- off. But the index also now trades at 2003 price levels — an indication that house prices could hit 2003 levels before this is all over.