Don't wait for the market bottom

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Growing up in a family of contractors, I learned a lot about structural integrity and the dangers associated with short-term fixes. When structural irregularities are observed in a foundation, a competent contractor will do the following:

• Stop all vertical construction.
• Prop up the foundation.
• Identify the source of the irregularity.
• Fix it, make sure the fix is sound.
• Then resume vertical construction.

If a foundation is irreparable, then the site is probably no good and the engineer has some explaining to do. Thus, the existence of bonding and insurance for builders.

The above is an analogy for what we're seeing in the market today. In the previous tech-driven bull market, valuations on the S&P 500 ($INX) reached what John Hussman of the Hussman Funds terms as a "psychotic" 34 times record earnings.

Prices fell when the bubble burst. But Hussman states further that "as a result, the 2002 bear market trough occurred at the highest valuation (15 times record earnings) of any prior bear market trough in history, and failed to clear the excesses of the prior bubble."

Structurally then, the bull move that began in October/November 2002 was foundationally unsound. It can be argued that a combination of fiscal and monetary policies was adopted as a "short-term fix," but the requisite work to cure the structural irregularities for the long term was never completed.

Real value is back

This explains in part why, at the 2002 lows, a paltry 16% of what we at IQ Trends call our Select Blue Chips were classified as "undervalued," compared with the norm of over 50%.

The number of Select Blue Chips is significantly smaller today than in November 2002; 297 versus 346. As of the start of March of this year, about 27% fell into the undervalued category.

Interestingly, the dividend yield for the Dow Jones Industrial Average ($INDU), as of the start of November 2002, was 2.4%. As I write this, the dividend yield on the Dow is 2.63%.

A smaller universe of stocks with a higher percentage at undervalue levels, and an increasing dividend yield on the Dow, suggest to me that real value, good historic value anyway, is drawing close. That suggests that stock prices have come back to reality.

Where does the skid end?

Historically, the high-dividend-yield area for the Dow is 3%. Based on the current cash dividend of $313, a dividend yield of 3% would be reached at Dow 10,449.

Now, a decline to that level would be, in my view, extreme. The upper range of undervalue on the Dow (10% above 10,449) would equal Dow 11,494; not out of the question, considering the intraday low on March 10 of 11,634. The bottom may be in sight.

But I'm not trying to call the final level for the broad market decline with these statistics; they are for context only. As I consistently remind IQ Trends subscribers, the primary focus for investors should on stocks that represent high quality and good value, not the stock market.

In that vein, many Select Blue Chips already represent good historic value. I would suggest that waiting for an "all clear signal" at the eventual market bottom will, in hindsight, represent a missed opportunity.

Dinging the dollar

One aside: Without getting too political, the U.S. weak dollar policy has been an abysmal failure. The staggering price of crude oil and gold is directly attributable to this malformed economic policy.

I know that it is not within the political DNA to admit policy mistakes and then correct them. But if the policy isn't reversed soon, the foreign exchange markets are going to obliterate the dollar.