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Last fall, I opined that the market could go down 50%, that is, below 7000 on the Dow. Now that we've moved meaningfully toward that figure, I'm more convinced than ever that it will be reached. That's because a number of stocks in the Dow are already well below my earlier target levels. That means that the other stocks will have to fall less than originally anticipated to bring the aggregate to the target.

The 6600 I hypothesized last fall was based on the so-called investment value, which is equal to book value plus 10 times dividends. This can be said to be the "bond value" of stocks; the rest is like a call option based on growth prospects. The U.S. stock market has sold at a premium to bond value for such an extended period of time -- basically since the 1991 Persian Gulf War victory -- that most people now under the age of say, 45, can't remember a market that didn't sell at a premium to bond value. But at market bottoms, the Dow goes to half of bond value. These include times like 1932 (which predates me), and 1974 (of which I have a strong and painful recollection, because of a personal "recession" that coincided with the national recession). It's possible, though not probable, that the Dow will get to one-half of investment value, that is 3300-3500.

The individual Dow 30 stocks are as illustrative as any. Last fall's prices, (P1), recent prices (P2), and last fall's investment values (IV) are in parentheses in the format (P1, P2, IV). I have omitted AIG ( AIG), Altria ( MO) and Honeywell ( HON), because they were kicked out of the Dow, but have not included their replacements, Bank of America ( BAC), Chevron ( CVX) and Kraft ( KFT). When I predict about a one-third further drop in the Dow, it is based on a belief that just over half of the remaining 27 stocks collectively have the potential to decline about 50%, while the other half has a collective potential downside of less than 20%.

Alcoa ( AA) ($37.44, $21.38, $26.00): It has gone below investment value. It can't go down much further ... or could it?

American Express ( AXP) ($57.11, $32.55, $15.00): As I said last October, despite being "the 'pick' in the credit space ... collapsing credit is the fundamental economic issue of our time." American Express was not spared.

AT&T ( T) ($41.95, $27.75, $32.00): Fell below investment value. A good pick for a forced choice.

Boeing ( BA) ($93.90, $55.46, $21.75): Started downward, as predicted, but only about halfway to a bottom.

Caterpillar ( CAT) ($73.57, $59.89, $26.00): Started downward, as predicted, but far from a bottom.

Citigroup ( C) ($42.36, $17.75, $46.75): Fell well below its former investment value because neither dividend nor book value was secure. Where is the new investment value? Your guess is as good as mine.

Coca-Cola ( KO) ($58.76, $51.03, $22.00): Started downward, as predicted, but far from a bottom.

Disney ( DIS) ($34.27, $29.75, $19.50): Still expensive.

Du Pont ( DD) ($47.16, $39.48, $26.00): Started downward, as predicted, but far from a bottom.

ExxonMobil ( XOM) ($92.14, $75.80, $35.50): My earlier remark stands: "Often traded at a discount to investment value in the 20th century, and that's a long way down."

General Electric ( GE) ($40.04, $23.10, $22.50). It became "a 20-something, not a 30-something stock," as predicted, and it's very close to investment value.

General Motors ( GM) ($37.60, $8.51, $2.25): The dividend went down the tubes, as predicted. The company may well follow.

Hewlett-Packard ( HPQ) ($51.40, $44.90, $18.20): Started downward, as predicted, but far from a bottom.

Home Depot ( HD) ($30.76, $24.99, $22.75): My former comment still applies: "Home may be where the heart is, but it's no longer an ATM, nor is the company that serves it."

IBM ( IBM) ($112.28, $114.46, $28.50): See Hewlett-Packard.

Intel ( INTC) ($26.30, $17.27, $11.00): Started downward, as predicted, but only about halfway to a bottom.

Johnson & Johnson ( JNJ) ($64.23, $66.90, $32.00): "Flight to quality" boost now makes the stock expensive. It is no longer "less risky" than Merck ( MRK), given the decline of the latter.

JPMorgan Chase ( JPM) ($45.02, $41.00 $51.50): Looks cheap, but is it really?

McDonald's ( MCD) ($56.42, $60.16, $25.00): "Flight to quality" boost now makes it expensive.

Merck ($53.11, $30.34, $24.50): It has lost most of its former premium to investment value.

Microsoft ( MSFT) ($30.17, $25.01, $8.60): See Hewlett-Packard.

Pfizer ( PFE) ($24.07, $17.65, $22.75): Trading below investment value. It may have found a bottom in the high teens.

Proctor & Gamble ( PG) ($70.80, $66.75, $35.00): Former comment still applies: "As safe as they come, and for that reason, a stock that is likely to trade at a premium to investment value. Probable downside is only to about $50."

3M ( MMM) ($86.62, $68.33 $34.00): Former comment still applies: "Basically a cyclical company that does a good job at hiding the fact. As such, the stock deserves a premium to investment value, though not nearly as large as the current one."

United Technologies ( UTX) ($72.78, $56.66, $33.50): See Boeing.

Verizon ( VZ) ($40.96, $30.62, $33.00): Notes on the "other half" (AT&T) apply here.

Wal-Mart ( WMT) ($43.82, $58.45, $25.00): "Flight to quality" boost now makes it expensive.

Of the 27 stocks under consideration, my investment value model rates only five as both fairly valued and of reasonable quality: Alcoa, AT&T, General Electric, Pfizer and Verizon. A second group includes statistically cheap stocks of questionable quality -- Citigroup, Home Depot and JPMorgan Chase -- that might be close to bottoms if there are no more "black holes" -- a big "if." A third group consists of expensive, but relatively high-quality stocks that I believe have "only" 25% downside in a Dow 7000 scenario (which is to say that they'll outperform a market that declines by one-third) -- Coke, Disney, Johnson & Johnson, Merck and P&G. The fourth and largest group (over half the total) consists of overly expensive, mostly cyclical stocks: American Express, Boeing, Caterpillar, Du Pont, ExxonMobil, General Motors, Hewlett-Packard, IBM, Intel, Microsoft, McDonald's, 3M, United Tech and Wal-Mart.

Of the six stocks that were in the index for only part of the stretch between last October and now, AIG and Bank of America are cheap but of questionable quality, Kraft represents expensive quality, and Chevron and Honeywell are expensive cyclicals. Altria may be fairly valued.
At the time of publication, Au was long GE, Pfizer and AT&T, 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.