Three Pieces of Bad News for Stocks

03/09/2009 12:00 pm EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of The Aden Forecast, lay out the best- and worst-case scenarios for stocks following the market’s recent sell-off.

The stock market has broken down big time—not once or twice, but in three very important areas.

The first big negative happened on February 19th, when the Dow Jones Industrial Average closed below its November low, hitting an over six-year low. As you’ll remember, the Dow Jones Transportation Average had broken below its November low on January 22nd. So, the Dow Industrials confirmed the bearish action in the Transports.

Based on Dow Theory, this means that stocks will continue falling until they reach bargain-basement prices, which has normally coincided with price/earnings ratios in the single digits and dividend yields at the 5% to 6% level.

Currently, the price/earnings ratio for the Dow is about 23x and the dividend yield is around 4.45%. So, stocks still have a long way to fall.

The second big negative was that the Dow also closed below 7470. This level was extremely important, because it marked the 50% level of the huge bull market that started in 1982 at 776.92 and ended in 2007 at 14,164.53. 

But by breaking below the 50% level, the Dow is now telling us that the current bear market is going to correct that entire 25-year rise. That is, the Dow could decline to near the level where the bull market started in 1982 near 1,000. This would be the worst-case scenario.

The third negative happened on February 23rd, when the Dow broke below its 2002 lows. And since the stock market leads the economy, the implications are currently very bearish, too. It means that the situation is going to get worse, possibly for quite a while, before it gets better.

But [for now] the stock market is extremely oversold, and it’s way overdue for at least a decent rebound rise. Note that the Dow is now the most oversold it’s ever been, even more so than in 1974. This means that the Dow could start moving up at any time in at least a rebound rise, following its steep decline.

This would be a better-case scenario and hopefully, that’s the way it’ll work out. If so, it would provide a good opportunity to get out of some of our stocks at a much better price. It would also suggest that all of this government spending will eventually help soften the blow and keep the recession from spiraling into a full-blown depression, which would obviously coincide with the stock market’s worst-case scenario.

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