Apocalypse Now

A bit more than a month ago, in this very space, we put forth a very gloomy prediction, that the stock market would not hit bottom, and begin to build a base, until we at least tested the October 2002 lows on the S&P 500.

We advised against trying to buy stocks until we reached that point. Unfortunately, that prediction has come to pass. The S&P 500 closed today at about 750, falling below its closing low of the last bear market, (776.76), established on October 9, 2002. I say "unfortunately," because like most Americans in one form or another, I own stock. I never want to see the market go down, even if it means that my predictions will turn out to be accurate. Had I shorted the market, that would be a different story. Alas, as with my prediction that oil prices were headed lower, I did not put my money where my mouth was. It sort of reminds me of all of those people I knew growing up who would say things like, "I could've bought that building twenty years ago for next to nothing."

At least I resisted the temptation to add to my stock holdings. Hopefully, our readers have resisted doing so as well, and recognized the false rallies over the past few weeks for what they were. What I find particularly troubling is that the market didn't hold at the 775 level. The next few trading days will be very important, to see if the index continues to fall further below the last bear market bottom. If it does, who knows where the bottom of this thing is.

So, as always, we ask the age-old question: What do we do now?

My advice would be to continue avoiding stocks. Even when prices stop falling, we probably need to see a significant period of base-building, where the market trades sideways for a while, before really moving up. Of course, the market could put in a big bounceback rally, but the risk of losing more money in this market is greater than the risk of missing out on a rally. Besides, once it does recover, the market will still have plenty of upside left, even after its first upward surge.

Supposedly, Baron Rothschild, when asked to explain his success in the stock market, stated: "It's simple. I never attempt to buy at the bottom, nor do I attempt to sell at the top." (I say "supposedly," because the investment field is filled with quotes that are attributed to very famous people, when in all likelihood, someone else is really responsible for the quote. I guess a quote has more impact if it is attributed to an extremely succesful person).

There are also other ways to position one's self for a rally in the stock market, while limiting the risk involved. I hope to discuss a strategy or two in an upcoming post.

In the meantime, sit this one out. Granted, stocks appear to be extremely cheap now, looking at things like the dividend yield on the S&P 500 vs. short-term Treasury yields, or, more importantly, the earnings yield of the S&P 500 (the inverse of the P/E ratio) vs. Treasury yields. However, just like stocks - or other assets - can be expensive for years at a time, they can also remain cheap by historical valuation standards for long periods.

Sometimes, that new paradigm can be a real kick in the pants.