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Aug. 17, 2011, 12:28 p.m. EDT
By Peter Brimelow, MarketWatch , Edwin Rubenstein
NEW YORK (MarketWatch) "” This probably won't be popular, but we think last week's lows may well have been a bottom.
We base this conclusion on the work of Professor Jeremy Siegel of the University of Pennsylvania's Wharton School, author of the classic book, "Stocks For the Long-Run." (Note: Siegel should not be blamed for the conclusions we draw from his data.) See Siegel's web site.
Siegel's most famous finding: Counting capital gains and dividends together, and adjusting for inflation, stocks have accumulated on average in real terms at a remarkably consistent 7% or so over the past 210 years.
Shown on a log scale, this consistent trend appears as an impressive upward-slanting straight line.
We first illustrated this upward-slanting straight line in April 16, 2003, column. Read the column on Stocks: Little room to zoom.
The reason for our present conclusion: for more than two centuries, stocks have fluctuated around that long-run trend in a fairly defined channel.
Bull-market peaks are generally some 80% above trend. In 1999, Siegel's broad stock measure reached 86.4% above trend.
Conversely, bear-market lows are some 40% below trend. After the Crash of 2008, we calculated that stocks had reached comparable lows. See Oct. 23, 2008, column and See Jan. 18, 2009, column
This was not a popular conclusion. But stocks did rebound.
We last looked at Siegel's data in early 2010. Despite the 2009 rebound, stocks were still 27.9% below trend. We concluded that stocks had more upside potential than downside risk. See February 25, 2010, column.
And stocks did get higher, but then came July's break.
We now calculate that as of the Aug. 8 low, stocks were 35.2% below trend. (We use the S&P 500 /quotes/zigman/3870025 SPX -4.50% as a proxy for Siegel's broad measure of stocks: the Dow Jones Industrial Average /quotes/zigman/627449/delayed DJIA -3.81% made its low on Aug. 10).
S&P 500 by the minute over past 10 days.
Our conclusion: stocks could certainly go lower. A full 40% below trend would be around 9,000 on the Dow. Or stocks could move sideways, which would eventually amount to the same thing relative to that trend line, because of its relentless compounding.
But stocks won't stay down. They are not massively overvalued. Upside potential now substantially outweighs downside risk.
Note carefully: These relationships are very approximate.
Over the longer term, however, they prevail.
Thus, when we first started following Siegel's work, in the 1990s, stocks were far above trend, approaching levels associated with market tops.
We concluded, therefore, that the market was overvalued. And apparently it was, but it took years to break.
In our early MarketWatch columns, we pointed out that, despite the 2000-2002 crash, stocks had never gotten anywhere close to the levels associated with historic lows.
We concluded that stocks had more downside risk than upside potential. But they stooged along sideways for years and even managed a blow-off before finally tanking. See Feb. 23, 2007, column
Eventually, however, stocks did tank.
And now, eventually, stocks will go up.
Edwin S. Rubenstein is president of ESR Research in Indianapolis .
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