DOW TO 4000

where is the bottom?

the answer depends on your assessment of the current turmoil in financial markets.

parallels are increasingly being drawn with the 1930's. wsj's jason zweig points out that investor benjamin graham's p/e ratio for the standard & poors 500 is now at 15. this is the lowest since 1989, but not that low compared to a long term average of 16 since 1881. the graham p/e has hit below 10 several times after hitting peaks since ww2, notably from 1977 to 1984, with a low of 6.6 in july 1982.

with current earnings levels, a p/e of 6.6 would take the dow to 4000, half its current level. the dow jones reached its bottom of 41 in july 1932, after losing 90% of its value over 3 consecutive years, from 386 in september 1929. it then took another 20 years to return to its previous peak. unfortunately, we have yet to see the beginning of corporate profit warnings and corporate failures outside the financial industry, and therefore earnings can be expected to drop significantly, which would even make 4000 look pretty.

at the same time, much is being said about the more effective toolkit at the disposal of policy makers today, which would allow steering the markets clear of too sharp a correction. while this may be true, it is even truer that there is no escaping gravity, and that eventually the result of such policies will delay, not eliminate the necessary corrections.

which brings us to the controversial supercycle theory pioneered by russian economist kondratiev, nevertheless given credence by a number of prominent analysts and corporate executives. according to this theory, we are currently in the debt supercycle, with u.s. consumption and global wealth driven by increasingly irrational levels of debt. in a september 2007 report, bca research posits that the end of this cycle will come when foreign creditors' confidence in the ability of the u.s. government to honor its obligations collapses, with massive foreign capital flight as a result, forcing a violent correction in u.s. consumption, and the end of u.s. economic and political hegemony.

the current turmoil however, is an "inflection point", not the end of the cycle, according to the report. it predicts that after a momentary correction, further excesses driven by debt will follow, likely in emerging markets and commodities, eventually leading to the end of the cycle.

taking into account all of the above would allow for earnings to drop well below current levels, but for policy measures to soften the landing, and therefore make 4000 still a plausible bottom.

cross those fingers.