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Debate Rages: Suckerâ?Ts Rally or Time to Buy?
Posted Oct 13, 2008 10:39am EDT by Aaron Task in Investing, Recession, Banking
Related: MS, ^DJI, ^GSPC, ^IXIC, SPY, DIA, XLF
On the heels of the worst week in history, the prevailing wisdom on Wall Street is the stock market is now cheap, especially relative to Treasuries and most especially for long-term investors,
With the S&P trading at 13 times expected 2009 earnings and 17.2 times on a trailing P/E basis, "buy the dip" is the mantra from many observers:

"The sell-off has gone much too far and stocks are poised to rally powerfully if the downturn is less severe than investors," according to The New York Times.
The "Ben Graham P/E" - which divides the price of stocks by their inflation-adjusted net earnings average for the past 10 years - is the lowest its been since 1989, The WSJ reports.
Even typically skeptical observers like Barron''s Alan Abelson and FusionIQ''s Barry Ritholtz were writing this weekend about the potential for a short-term market bounce of between 20%-30%.
That message, along with news of the U.K.''s injection of capital into big banks and Mitsubishi UFJ''s investment in Morgan Stanley, helped the U.S. stock market rally strongly early Monday, following the path of global proxies.

I would caution against reading too much into Monday''s action: the bond market and U.S. banks are closed in observance of Columbus Day while Japan''s financial markets were also closed for holiday observance.

More importantly, I''m highly skeptical Friday marked anything more than a temporary bottom for stocks, for a variety of reasons:

The continued lack of a coordinated global policy response, and the U.S. continuing to lag other nations in taking the most dramatic steps like insuring all bank deposits and directly injecting capital into banks.
Accelerating weakness in the "real" economy; ISI''s Ed Hyman dramatically reduced his GDP estimates through the second half of 2009 and predicts unemployment will hit 8.5% before the cycle turns.
Valuations tend to overshoot on the downside and bear markets historically don''t end until P/E ratios hit single digits.
Even after devastating declines in recent weeks, "buy the dip" remains the conventional wisdom, meaning sentiment still remains overly optimistic.
"The past week has demonstrated that trying to buy ''close'' to the bottom of a bear market can be a very dangerous strategy," Lowry''s Reports commented this weekend. Last week''s "series of 90% down days" - trading sessions where 90% or more of both price action and volume is to the downside - "is, at this point, solid evidence that the desire to sell has not been exhausted."

Veteran market watchers like Art Cashin of UBS and John Roque of Natixis Bleichroeder are using the 2002 lows - about Dow 7300 and S&P 775 - as downside targets. Yes, long-term investors should continue to fund their regular retirement accounts, as Henry and I discuss in the accompanying video.

But short-term traders - and those near or at retirement age - would be wise to keep those targets in mind.