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Will Nasdaq Fall Another 90%?

It could if Bill Gross is right.

In Part 1 of this article, I discussed bond fund manager Bill Gross' recent claims that the fair value of the Dow Jones Industrial Average is around 5,000. (If you haven’t had a chance to read Gross’s letter yet, I'd strongly encourage you to give it a read.) One of the problems I have with Gross’s logic is that he calculates the worth of the DJIA using only one measure: dividend yields. When I applied Gross’s logic to the Nasdaq Composite, I found that it would produce a fair value calculation of around 150 for that index. To me, this doesn’t seem reasonable by any stretch of the imagination.

Errors of Omission
Before I go into some other issues I have with Mr. Gross' reasoning, I should make clear that I'm not exactly bullish on the short-term direction of the market right now. Stocks today seem fairly valued, at best. In fact, many of the stocks I look at on a daily basis still seem too expensive to buy, and I don't expect a new bull market to appear until stocks are screaming bargains and everyone hates them--and we're not there yet. The forward P/E ratio of the S&P 500 is around 18 right now, not exactly a trough valuation.

Even so, Gross' argument seems too bearish, given that he neglects to mention some things that are significantly different now than they were in 1900. (Gross uses 100 years of historical valuation data--the period from 1900 to 2000--to frame his argument.) He ignores five key developments over the past 100 years that could weaken an argument based on comparing valuations of a century ago with those of today.

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