It's closer to the bottom, but China holds the key to the puzzle
For the first time in many years, US stock valuation are begining to look attractive. They are not a screaming buy yet, but all these real companies like DE, CAT, LMT, RTN, ISRG, MSFT must be worth something. In the long run, they should do fine.
But before we see the long run, the question is whether the US will receive a margin call from Beijing. The trouble is, debt obligations of a country whose public debt equals 80% of its GDP should not be trading at a 3-4% yield. This debt can be repaid, but in order for that to happen, creditors have to accept that the rate of printing of new dollar bills will exceed the nominal yield of treasuries. That's a loss in real terms, no two ways to say that.
If the Chinese central bank and a few other central banks across Southeast Asia decide to act rationally, they should stop investing in US bonds until they offer a satisfactory yield commensurate with inflation expectations. The growth of monetary supply has been really frightening, and 15% inflation is not out of the question. Even if Bernanke is given the benefit of the doubt, 30-year bonds should still be paying a 10% yield to compensate for the risk that Bernanke's successor will decide to hyperinflate. Yields did go above 10% in the 70s, when the debt outstanding was smaller and hence the incentive to hyperinflate was much weaker. The only thing that depresses the yields now is the Polyannish stance of foreign creditors who think they've just found a safe haven. If that changes, mortgages should go above 10%, at which point the whole financial bubble will collapse faster than Paulson falls down on his knees when he wants a 700 billion dollar present.
If, on the other hand, the stupidity of foreign bagholders is incorrigible, it becomes exceedingly likely that the US will refinance its Ponzi bubble of debt and export the bankruptcies it so richly deserved to Beijing, Tokio, Dubai, Moscow, Singapore and other places. In this scenario, the Dow should bottom out nicely around 9200, and today may actually be a great buying opportunity.
That's why predicting the market's direction is so difficult. In a rational world where people know what they're buying into, the Dow should be trading around 5000-6000 on expectations of a stagflationary shock ahead. But what seems to be happening at the moment is the eagerness of foreign countries to sacrifice their bank reserves in an effort to rescue the US financial system, and hurl themselves into the economic abyss by losing, realistically speaking, one half of their 2.5 trillion cash hoard to dollar inflation. The thing is, however, some of these countries may no longer have a choice. Russia's economy, for one, is already crumbling after the burst of the commodity bubble, and I'll bet you a whole ruble that very soon the Russian government will want to withdraw money from its "stabilization fund" to rescue its own failing oil companies--so much for the continued Russian demand for T-bills. China and others, on the other hand, can still afford to support the American bond bubble for a while.