How Far Down for the Dow?

Could the market go down another 10% from here? Or 20%? I think it could be more like 50% (although I'm not sure when, having cried "wolf" before).

Bill Gross, the bond king at Pimco, spooked the market in 2002 when he opined that the Dow was worth only 5000. For analogous reasons, I've updated that metric to about 6600.

To get there, I use a measure called investment value, which is book value plus 10 times dividends. This follows the spirit, if not the letter, of Graham and Dodd investing. While there were naturally variations between individual securities, stock indices such as the Dow traded close to investment value until the successful Persian Gulf War.

But valuations since 1991 (like during the 1920s) have reflected a "new world order" of American political dominance that is now being eroded by troubles in the Middle East and elsewhere, and a highly leveraged "new economy" that is looking flimsier by the day. By calling for stocks to return to prewar valuations, I'm stating my belief that the elevated profit margins, returns on equity and earnings growth of the past 15 years that supported recent valuations are an historical aberration, and that a decade (or more) of U.S. stock market progress is about to be wiped out.

The 30 individual Dow stocks are as illustrative as any. Friday's closing prices (P) and investment values (IV) are in parentheses in the format (P, IV). Also see the table on the last page for complete valuations.

AIG (AIG - commentary - Cramer's Take) ($63.27, $50): Given its skimpy dividend and legacy issues from the Greenberg era, it is not worth its premium to fellow financials Citigroup and JPMorgan Chase.

Alcoa (AA - commentary - Cramer's Take) ($37.44, $26): This stock is trading somewhat above investment value. Its cyclicality and the collapse of takeover speculation mean that it could go below this value, however.

Altria (MO - commentary - Cramer's Take) ($70.50, $35): This stock is now a pure play on tobacco. There is downside until the stock is trading to yield at least 6%. But after the 1920s Prohibition, tobacco was one of the few items to grow in the hard times of the 1930s, and is likely to do so again.

American Express (AXP - commentary - Cramer's Take) ($57.11, $15): This is the "pick" in the credit space. But collapsing credit is the fundamental economic issue of our time, and American Express will not be spared.

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At the time of publication, Au was long Alcoa, Johnson & Johnson and Pfizer, although holdings can change at any time.

Thomas P. Au, CFA, is a principal with R. W. Wentworth, a financial services firm in New York City. Earlier he was an emerging markets portfolio manager for the investment arm of Cigna Corp. and an analyst with Unifund, S.A. of Switzerland and Value Line. He graduated cum laude with a B.A. in Economics and History from Yale University and an M.B.A. in Finance from New York University. Au is the author of A Modern Approach to Graham and Dodd Investing. Au appreciates your feedback; click here to send him an email.