(3/2/2007) The Dow 400 Point Plunge, 10% to 15% correction likely
Prognosis by Sam Mishra, MBA (MIT Sloan)

A historical perspective on corrections can serve as a good primer in the aftermath of the recent Dow 400 point plunge. Remember Alan Greenspan and irrational exuberance, in late 1996, 10 years ago? What was happening to the markets then, and where we are headed now? Let's analyze.

From March to July 1996, Dow corrected 10.16% from a high of 5755.86 to a low of 5170.81. Then came Alan Greenspan and his speech highlighting the irrational exuberance in our stock markets. From March 97 to April 97, in less than two months, Dow corrected again from 7158.28 to 6315.84, or 11.76%.

Routine corrections of 15% were the norm afterwards. From an August 1997 high of 8340 to an October 97 low of 6936, Dow corrected 16.83% in less than 3 months. Again, from July 98 high of 9413 to a Sep 98 low of 7380, Dow corrected a whopping 21.76%.

This bull market in the late 1990s reached its peak in January 2000, when Dow climbed to 11980. No one saw it then, but we were into a bear market, with the Dow going all the way down to 7397 in March 2003.

March 2003 onwards, we have been in a bull market again for the last four years. We have had corrections of less than 10% twice. In Feb-March 2004, Dow corrected 7.6% from a high of 10794 to a low of 9976. Again, in Mar-Apr 2005, Dow corrected 9.6% from 11027 to 9962.

The fundamentals which have driven this bull market in the last four years are sound: low unemployment (currently 4.6%, a really low number), sound GDP growth (at least 2% every year), a bubbly yet healthy real-estate market (the recent sub-prime lending meltdown and the ensuing foreclosures not withstanding), low inflation in the 2% to 3% range, and low interest rates. Consequently, this bull market can continue, albeit, with a healthy correction of at least 10%.

Since we have not had a correction of 7% or more in 2006, I am assuming that a correction of 10% or more this time around is needed. Smart investors should see this as a buying opportunity. Please expect the Dow to correct at least 8% to 11800 at the minimum. Given the recent plunge of 400 points, a bigger correction of at least 13% to 11175 is equally likely. Buying stocks when Dow is trading between 11175 and 11800 in the next few weeks / months will be a good long-term investment strategy for those who believe that stocks ultimately outperform bonds, gold, and real-estate.

Note: The above article is an anlysis of the current stock market, and serves to illustrate one way to analyze the market ups and downs. This portal does not give any investment advice; please check our Terms of Service.

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