Where will be the Bottom for Dow Jones?

I had stumbled upon an article “In the Long Run, the Dow’s 40% Nosedive May Actually Turn Into a Safe Landing” by Martin Hutchinson. This article argued that for those whom believe in fundamental stock-market valuation, the Dow Jones would be trading at 7.829 as of today which in line with the nominal GDP since Feb 1995. The author attributed the many economic difficulties were due to a change in U.S. Federal Reserve Policy which took place in spring 1995, where Federal Reserve had adopted a broad money supply which contradicted to its policy of monetarism from 1979 to 1995. Nevertheless, the shift in policy in 1995 had not caused much inflation as it coincided with the arrival of Internet and cheap cell-phone technology that enabled manufacturing to outsource globally, suppressing price increases and inflationary pressures. After 2000, other countries followed Fed’s lead to loosen monetary policy and caused asset prices to soar worldwide with the exception in Japan.

The article arouses my interest to find out any truth in the author’s words. Based on the data gathered and as shown from the chart, there was a good correlation between the Dow Jones and U.S. GDP growth from 1980 to 1995 attributing to the monetarism policy adopted by Fed Reserve. After Alan Greenspan had turned to a more-expansionary policy, the stock market had rose 225% vs GDP (Unadjusted) growth of 93.89% (1995 -2008). If indeed we were trading based on the fundamental of U.S. economy, the article reflected the stock market as of now, the market were trading at roughly 10% overvalued, according to Dow Jones closed at 8,579.19 (10 Oct 2008).

Nevertheless, in a bear market, it is possible for the Dow to trade at below 7,829. As such, coming to this, where would be the bottom will be? Thus, if we put our basis when the year of monetarism policy started (1979) and estimated based on the year-to-year GDP growth rate, the Dow Jones would find a roughly good supporting ground at 4,281 as shown in the chart.

Source: Data based on U.S. Department of Commerce: Bureau of Economic Analysis

BIBLIOGRAPHY

1. Martin Hutchinson (2008). In the Long Run, the Dow’s 40% Nosedive May Actually Turn Into a Safe Landing. http://www.moneymorning.com/2008/10/10/high-dividend-yields/, 11 Oct 2008