Why the Stock Market Will Eventually Test its March Lows

by Michael Lombardi, CFP, MBA

Yesterday, I gave you my six reasons why stocks are moving higher right now. And I promised that today I would tell you why the stock market would eventually test its lows of March 9, 2009. So here it goes:

Historically, bull markets end when price/earnings multiples get above 20 and dividend yields fall below two percent. Bull markets also end when speculation reaches a frenzied state. The bull market that started in 1982 came to a spectacular end in October 2007 — an unprecedented 25-year run.

Historically, bear markets end when price/earnings multiples get below 10 and dividend yields rise to six percent. Bear market also end when no one wants to buy stocks, pessimism is at extreme levels and stocks are at great values.

On March 9, 2009, when the Dow Jones Industrial Average hit a multi-year low of 6,440.08, stocks did not represent great values. The dividend yield on the Dow Jones got only above four percent for a short time. The prices earnings multiple did not get anywhere near 10.

Today, the Dow Jones sells at 47 times earnings and a dividend yield of 3.5%. By any stretch of the imagination, this cannot be called bargain territory for stocks. Stocks became severely oversold on March 9 (they fell down quickly in a very short period of time). What we are witnessing now is a rebound from that oversold level. Eventually, the bear market will need to finish its business and bring stocks to a level at which they are great values again. That means the lows of March 9, 2009, will need to be broken.

Finally, if we look at the bull market from 1982 to 2007, we see that, during that time, period interest rates went straight down. I
remember 1982 and the high double-digit interest rates of that time very clearly. The stock market does well when interest rates fall. With interest rates at their lowest level in history, looking forward, interest rates can only go one way — up. And that’s something the stock market will not like.

Michael’s Personal Notes:

Is tourism making a quiet comeback? Could be. If we look at the best performing stock indices of the past three months, we find the Dow Jones Tires Index is up 131%, the Dow Jones Gambling Index is up 79% and the Dow Jones Hotels Index is up 75%. As silly as it sounds, it looks like people are getting in their cars, going to casinos and staying at hotels. Does Vegas look like its booming? Not yet. But remember the stock market is a leading indicator. As I noted yesterday, I believe that the falling value of the U.S. dollar against other world currencies would be a boom for domestic U.S. travel this year. And maybe that’s what these indices are telling us.

Where the Market Stands:

When I was a kid, one of my favorite TV programs was “Star Trek.” I remember a particular episode when a captain from an enemy ship said, “That captain Kirk, he is a treacherous one.” I feel the same way about the stock market these days. Just when the Dow Jones looks like it’s about to break above its 2009 high, this treacherous market pulls back. The Dow Jones Industrial Average is down 5.4% for 2009. I’m still classifying the current situation for the stock market as a rally in the confines of an overall secular bear market.

What He Said:

“As for the stock market, it continues along its merry way oblivious to what is happening to homebuyers’ wealth. [Since 2005 I have been writing about how the real estate bust would be bigger than the boom.] In 1927, the real estate market crashed and the stock market, even back then, carried along its merry way for two more years until it eventually crashed. History has a way of repeating itself.” Michael Lombardi in PROFIT CONFIDENTIAL, November 21, 2007. It is now widely recognized that the real estate market in the U.S. started its path downwards in 2006 and that the stock market followed suit in 2008.