Hi Everyone,

Where have we been? How far do we have to go? These are questions I’m sure we’ve all been asking lately about the financial mess we find ourselves in. My past emails have been more about answering the first of those questions. I’ve highlighted the current market decline and how it compares to declines in the past.

Answers to the second question are fraught with “best guesses,” so I’ve avoided the urge to speculate as such. This time, with reservations and big caveats, I’ll give it a try. But first an update on the first question:

Where have we been?

The scope and severity of this market downturn has been breathtaking. The S&P 500 (proxy for the overall market) is down almost 44% from its high in October of 2007. In this month alone it’s down almost 25% through last Friday. This October is on track to be one of the worst months in the history of the S&P, surpassing even October 1987 which included the worst one-day collapse on record. To compound problems, during this downturn all asset groups have moved down together. Normal safe havens such as bonds and commodities have not been spared the market’s wrath.

So is there any good news to be had in all this gloom? Our solace may be that when this much bad news abounds it usually means we are nearing a market bottom.

Some historical perspective: there have been 10 bear markets since the inception of the S&P 500 in 1950. A bear market is defined as a drop of 20% in market value from peak to trough. The worst of those bear markets occurred from March 2000 to October 2002 (down 49%) and January of 1973 to October of 1974 (down 48%). In both of these downturns, the market was up by double digits 3 months after the trough was reached, 19% and 14% respectively. Are we nearing our trough? I hope so, but beyond prayers being answered let me outline why I believe we are close.

The theory/guess for a near term market recovery comes from knowledge accumulated during my 25 years of experience in financial planning, extensive readings and numerous conference calls with market analysts. However, please take this prognostication for what it is, a hunch based on historical perspective and current market data. This downturn may well be different in its scope and length, something only the passage of time will tell. But here I go.

How far do we have to go?

Before the market returns to an upward track, these are some of the underpinnings that I believe need to be in place. Credit markets need to start functioning with some semblance of normality. Corporations have not been able to obtain short term loans to fund their operations and therefore have not been able to carry on business as usual. This impacts corporate earnings, which is a major driver of market returns. This leads us to Positive factor #1:

Positive factor #1: It appears as if all the lending facilities that policy makers have put in place since the crisis began are starting to thaw the credit markets. This is a good sign.

Positive factor #2: The market hates uncertainty. The fact that we don’t know who the next President will be is not helping the market. This uncertainty will be removed in a few days.

Positive factor #3: From what I can discern, a lot of the recent market volatility has come from hedge funds unwinding their stock and bond positions. Some of them have been forced to sell because of heavy redemptions from shareholders. For many hedge funds the deadline for 2008 redemptions is November 15th. So perhaps many of the shareholders in these funds that want out of the market in the short term, will be out within a few weeks’ time. Positive factor #3 is part of the reason for Positive factor #4.

Positive factor #4: As a result of all the selling that has taken place from both hedge funds and others, there is a tremendous amount of cash sitting on the sidelines. It’s been estimated that many mutual funds have more than 20% of their assets in cash and estimates of hedge funds assets in cash range from 30% to 40%. This cash will ultimately find its way back into the market and fuel the ensuing rally.

Positive factor #5: And finally, 3rd quarter corporate earnings season is coming to a close. Although reported earnings haven’t been all that bad, the guidance for the upcoming year has been pretty much doom and gloom. Once the stream of bad news stops we should be able to get moving again. Now that the expectation for future earnings has been sufficiently lowered it shouldn’t be too hard to exceed those projections. This is another positive for future market returns.

I know my market turnaround theories don’t offer a lot of comfort in the face of deep market losses. True relief will come only when we get this crisis behind us. Let’s hope that our leaders, current and future, will be able to cross the major hurdles this crisis presents. In the meantime if you need any help working through it please give me a call.

To Better Times Ahead,

Jim