How Far Will It Go?

10/22/2008 11:00 am EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of Investment Quality Trends, consults the newsletter’s founder, Geraldine Weiss, for her insight into the market’s current behavior.

With four plus decades of observing and analyzing stocks and the markets, [our founder, Geraldine Weiss’s] acquired wisdom and insight are worthy of intellectual consideration.

“Investors today are looking for answers to the demise of the bull market. I believe, however, that the potential election of Barack Obama is weighing heavily on the stock market and has extended the bear market further than it otherwise would have gone.

“Either consciously or subconsciously, investors are thinking, if Obama keeps his promise to raise taxes on capital gains, dividend income, and inheritance, why risk my capital in the stock market? Is the risk worth the reward? When the answer to that question is ‘no,’ stock prices fall.

“How far will it go? Historically, the Dow Jones Industrial Average fluctuated between dividend yield extremes of 6% at undervaluation and 3% at overvaluation. That profile of value guided the stock market through every bull and bear market, the worst of which in modern times began in 1966 at overvaluation and was not completed until 1974.

“The bull market that began at undervalue in 1982 rose to overvaluation in 1992, when an incredible thing happened. For the first time in history, the Dow Jones Industrial Average continued to rise above its historically etched low yield and formed a new profile of investment value. What formerly was the yield at overvaluation (3%) became the new floor of undervaluation. And a rise to 1.5% identified a new selling area.

“According to the current composite dividend for the DJIA ($323.47), the price at overvaluation is a far distant 21565 and the price at undervaluation where the dividend yield is 3% is 10782. When the price of the DJIA recently broke below 10000, the 3% yield was violated significantly.

“One wonders if the average now will revert to its long-time profile of value and decline again to yield 6%. Based on the current dividend, that would indicate an eventual price area of 5,000. If the composite dividend is reduced, that price at which the yield is 6% will be lower.

“The good news is that in the current price area of 8000, the dividend yield is about 4%, which should provide temporary relief and could provide a good trading rally. However, I would not trust the rally to reverse the primary trend, which is down. But this, too, will pass. And as day follows night, bull markets follow bear markets.

”Now is the time when quality and value are most important. Blue chip companies that have long-established records of dividend growth can be purchased and held by investors. Dividends should be well protected by earnings [and] debt levels should be low.

“Eventually you will even see stocks priced below book value, below the net asset value of the companies they represent. This can be an important opportunity to construct a portfolio of blue-chip stocks that will provide financial security for the rest of your lives.”

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