The most commonly asked question on Wall Street and Main Street these days is “How low can the market go?”  We’ll try to shed some light.

The bottom, as everyone is asking, will be reached… hang on to your hat… at 1,570.79 points on the DOW.

You’re asking how did The Institute come up with that absurd number? Well, we used a complicated formula of taking one number, doing a comparison, a percentage and a subtraction.

We compared the high of the DOW on October 11, 2007, when it reached its all time high of 14,279.96. Next, we looked at the percentage of decline experienced in 1929 from the DOW’s then all time high of 381.17 on September 3, 1929. In the following month, the DOW dropped 17 percent.

On the 24th, 28th and 29th, respectively Black Thursday, Monday and the infamous Black Tuesday, the DOW continued its rapid decline, dropping in double digits on that Monday and Tuesday.

Eventually, the DOW had begun to recover, when things began to get worse in American politics and business. Smoot-Hawley, a tariff act passed by Congress was signed into law in mid 1930 and housing prices continued falling. Banks were failing at an alarming rate as the depositor base was eroded and fewer people or businesses could meet their debt obligations, forcing banks to foreclose in record numbers.

By July 8, 1932, the DOW finally bottomed at 41.22, a whopping 89% decline from its 1929 high. During the period between October 29, 1929 and July 8, 1932, the DOW had gained strength, fallen, recovered and declined again on several occasions. However, the weakness created in the US economy as a whole by the initial declines in 1929 and the dropping values of real property forced markets to a low not seen since the 19th century.

So, in calculating our figure, we assumed a worst-case scenario and took an 89% decline from the highs of 2007, bringing us to 1570.79.

How long will it take? Probably more than a year, and like the intervenig period between Black Tuesday and July 1932, there will be short-lived recovery periods. However, a decline of this magnitude is not only possible, but likely and most probably an essential step towards recovery.

Why hasn’t it happened yet? Well, in a way, it is happening, but because of the various intervening steps by government, and the protocols put in place in the early 1930’s, the system is better supported to avoid such a crash.

Rather than experiencing a rapid and immediate decline of double digit percentages in a sngle day, we’re going to see many, back to back single digit days of decline, with most of them being around or below 3.5% in a single day.

Recovery, contrary to the fantasy opinion of many a pundit, will never be predictable by a certain date or range of time. Rather, it will be slow… snail’s pace slow, and will result in at least one or more lost decades.

It will not be a return to the heyday of 2006 either. Instead, recovery will take its slow pace, during which many standard names we know and regard highly in business may fail or be merged. We expect to see one major American automaker by 2010, probably Ford, with GM and Chrysler becoming divisions of Ford or completely disappearing. We also expect to see many banks fail or being downsized to reality.

Unfortunately, we expect to see high unemployment rise to about 12% as companies discover over time that they cannot survive this crisis. Present confidence in small business is declining. Consumer confidence in such enterprises and their willingness to pay the prices small enterprises must charge that are not competitive with larger businesses are driving a downward spiral in this age of deleveraging and deflationary pricing.

Unemployment statistics continue to fail to report small business owners and some management (part owners) and as such enterprises fail in vast number, the true unemployment rate rises.

The DOW closed yesterday at 6,547 which is 45.85% down from its high in 2007. Just a bit more than half-way to the potential bottom.

Now that’s the scary bit. In a much more realistic scenario, we believe the nation’s economic strength’s have improved considerably over the 1930’s, despite the vast similarities between the two periods in history. Legislated reforms in the 1930’s have created systemic backstops preventing the kind of collapse that occured on those morbid days.

In our recent newsletter, the Journal of Economics, we predicted, a few days before it happened, that the DOW would decline from 7,000 to somewhere between 6,000 and 6,500. Clearly, we’re getting close to this range and presently are in the 6,500 to 7,000 range.

Recent media reports suggested a DOW in the 5,000 range. While this is always possible, we believe a free fall drop would plunge the market over time further downward, but that this scenario is at present, unlikely.

In terms of recovery and upwardly mobile market activity, we believe the market will, over the next year or two experience many splendid increases, but to every investors dismay, sudden and inexplicable drops. Investors can make great fortunes if they know how to play such markets. Others who are ill-prepared to absorb major losses should be extremely cautious about investing as they may lose everything invested. We urge caution and a candid discussion with qualified brokers or investment advisors. We also suggest that investors seek second and third opinions and conduct strong due diligence efforts before purchasing any shares.

This is a time to learn from historic records, both old and new. We’ve seen how poorly investors behaved in trusting information provided by Bernie Madoff. Further, investors should be particularly cautious of schemes that appear too good to be true. The Stanford scandal similarly shows that the zeal to earn higher rewards usually results in a recession in the alarming discovery that the scheme was exactly that… far too good to be true because it wasn’t.

Risk aversion is important today and individual investors are ultimately responsible for the way they risk their own funds.

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