The game of divining short-term movements in stock prices is pretty much just that: a game. Granted, it's a serious game and the stakes are huge but it's not a winning proposition, not for you. For one thing, stock prices at any given time are determined by supply and demand, which in the short run are driven by fear and greed. For another, you have to pay to play — the brokers will collect their commissions and the advisors their fees.

The real question is how accurate you can be in predicting the stock market over a meaningful period of time, such as a decade or two. This is the timeframe which matters to investors, a timeframe in which valuation can dominate emotion. The challenge here would seem to be within reach: make a credible estimate of earnings ten years out (based on current estimates and a sensible growth rate) and put a multiple on these earnings (based on the growth rate and on long-term interest rates).

For example, you could start with the current operating earnings estimate for the S& 500 Index in 2005 of $74, then assume a 7% growth rate (similar to the growth rate of recent decades) and a price/earnings (P/E) ratio of 22x (comparable to the P/E ratio on the 30-year Treasury bond, which currently yields a bit under 5%).

These assumptions would imply that the average expected return on the S&P 500 Index including dividends would be almost 12% annually — more than 7 percentage points above what you can currently earn from a ten-year Treasury bond.

Of course, this analysis assumes that operating earnings are the best measure — a better number to use is the “core earnings” estimate, which is closer to $62. Also, the growth rate of earnings, given our debt situation, could be reduced to 5%. And let's not forget the P/E multiple assumption: although a P/E multiple of 22x seems reasonable based on current long-term bond rates, it's worth noting that the earnings (the E in P/E) are based on accounting, not cash. The free cash flow of the S& 500 will always be less than reported earnings because working capital tends to increase and capital expenditures tend to exceed depreciation.

Using more conservative assumptions, the average expected return on the S&P 500 drops to less than 7% annually.

On the positive side, companies are no longer required to expense goodwill amortization on their income statements. Ironically in a financial world overrun by questionable "one-time" write-offs and pumped-up operating earnings, goodwill amortization is an annual deduction which never should have been forced on companies (and is the subject of the article, Goodwill Hunting.

Then there's the impact and implications of September 11. Money spent on an effective military or better security at home or humanitarian aid overseas is money well spent but the economic benefits are minimal in the short run. The world is now a safer place — good news for citizens and investors — but we must acknowledge how unrealistic we previously were in our understanding of the risks.

So...what does WealthEffect think of the market? Most important, you should view the market as "a market of stocks" rather than as a stock market. Predicting the market, as you can see, is a tricky game. You should focus instead on individual companies which enjoy sustainable competitive advantages and where the underlying stocks give you a reason to expect annual double-digit returns over time.

As for the market as a whole, our expectation is towards the lower end of the range over the next decade. Relative to this expectation, you can do better by picking your own stocks. You can also do worse, and likely will if you rely on a retail broker or a financial planner. This is the nature of the challenge, and you must decide for yourself whether you want to be in stocks and how to choose them.

In deciding your commitment to stocks, don't underestimate the importance of dollar-cost averaging. For example, in the My Financial Plan feature, the suggested portfolio allocations use a several-year initial timeframe with ongoing additions to your stock holdings.

Individuals can outperform the S& 500 Index (and most professional money managers) if they truly understand investing. But if you buy stocks for "a quick pop", you're not an investor. If your timeframe is measured in months, rather than decades, you're not an investor. If you expect 18% annual returns as the average individual did 5 years ago or negative returns as many people did 3 years ago, you're not an investor. If you don't know the underlying fundamentals of a company and its financials, you're not an investor. This doesn't mean you can't make money — many day-traders did well for themselves, for a time — it just means you're playing the game, not the odds.

Suggestion: Go to Market Timing vs Stock Picking