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By Arnie Kaufman While volatility is bound to remain high, the chances are that a bottom is now being formed. To be sure, it will take time to repair the significant technical and psychological damage incurred in the decline. Those who have been betting against stocks won't quickly abandon the strategies that have worked so well for them for so long, and buyers will find it hard to muster a great deal of courage after the many failed rallies. Nevertheless, the market has shown increased resilience lately, perhaps signaling the long-awaited improvement in the supply-demand relationship. And excesses appear to have been corrected.

At its recent low, the S&P 500 had given back 59% of the huge bull market gain from 1990 to 2000. That's close to the average 62% retracement seen during the other postwar bear markets.

Price-to-earnings ratios typically are looked at in conjunction with interest rates to determine appropriate valuations. Given the sharp decline in prices and the steep drop in the 10-year T-note yield, stocks are now reasonably valued. According to the widely used Fed model, and applying S&P earnings estimates for 2002, the S&P 500 is 15% to 20% below fair value.

Earnings estimates have been inching downward, and liberal and abusive accounting practices make the quality of earnings questionable. On the other hand, the stage of the economic and earnings cycle argues for above-average valuations, as profits could be at the beginning of a multi-year expansion.

If an upswing is unfolding, gains in the period ahead could be substantial. In recoveries from bear markets since World War II, it has taken an average of less than 15 months to recoup all of the losses in the S&P 500. Even in the case of the particularly severe 1973-74 bear market (whose steep 48% decline was matched by the latest slide), half of the loss was recouped in the following 15 months.

We recommend shifting 5% of assets from bonds to stocks. Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook


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