The chart to the right is particularly interesting because it shows the log-linear trend for the Dow over its entire life (1897 to 2009). Rarely do we get a history of 112 years.
This chart is interesting because there should in theory be a relationship between price increases and the money supply, or the nominal value of money and the size or real value of the economy. We can take the Dow Jones as a measure of this because prices between stocks should find a comparative value equilibrium based on yield.
We can see from the chart that the Dow in 1929 was far more overvalued than it is today; but that the Dow today was more seriously overvalued in 2007 than the 1965. More recent consolidation and sell-offs have brought the Dow back to support, which should provide a basis for market support, but the market could not be considered good value.
The question we have to ask is - Was the collapse of asset values in 1929 the result of poor Fed and government policy, or was it because of the extent of the exuberance. In as much as the 2000s was almost as exuberant as the 1920s, we might conclude that we are going to fall back to the base line trend (index level of 3.5). The alternative is the prospect of the markets going sideways for 20 years with brief, unsustainable rallies. That strikes me as a long time, but that's exactly what the market did back in the 1970s (1965-1985). There were gains in nominal terms, but after adjusting for inflation, the market effectively went sideways for a long time.
The implication is not that investors should sit on cash for the next 20 years, as it will be eroded by inflation. The challenge ahead is to pick the bottoms and tops as the market passes through a period of protracted consolidation. These will be significant rallies of at least 30% I would suggest.
Andrew Sheldon www.sheldonthinks.com