Prepare Now for a Market Bottom

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You can't watch a business television show today without some pundit lamenting over the bottom of the market. Have we reached it? How low can we go?

Much of this discussion is folly. I looked at a chart today that compared the current decline in the S&P 500 vs. the last two crashes in 1973 and 2000. What is striking isn't the similar peak-to-trough price declines but the fact that the speed of this current crash has been about twice as fast as the others.

During the oil crisis of 1973-1974, the market fell around 47% in 21 months. The dot-com bubble slide in 2000 to 2002 caused the market to fall 47.4% in 31 months. Our current decline started in October 2007, and as of yesterday, the S&P 500 is down 48% in just over 13 months.

S&P 500 Crashes

Click here for larger image.

Source: http://calculatedrisk.blogspot.com/

So the question is, what is more important when evaluating whether a bottom has been put in place -- the magnitude of the price decline or the length of time of a bear market?

There are many ways to interpret the data. Some market pundits would say that the most recent percentage decline has been one of the worst on record when we compare it with other such corrections. So we could be getting close to a bottom.

There is no doubt that stocks look cheap. The problem with this analysis is that just because a stock is cheap, it doesn't necessarily mean that it has stopped going down. The main concern is that fundamentals haven't bottomed, so even though the price-to-earnings ratio, or P/E, looks cheap, there is no confidence in the "E." Therefore, it's difficult to value whether anything is in fact cheap.

Other analysts and pundits would say that since this correction has lasted only 13 months, the markets could go down even more, especially if history repeats itself and it takes another year to sort this out. Since there are no rules out on how long a correction needs to take place, this is also a hard case to make.

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