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BACK in early May, I told investors that the DJIA
would not, better yet, could not make a new all-time high. This was a
follow-up to an earlier missive entitled "This Time I'm Right" in
which I discussed the ominous signs presented by the financial markets at
that particular moment. Furthermore I stated that no one before had ever been
able to turn a primary Bear Market into a new Bull Market, and the Bernanke
led Federal Reserve Bank wouldn't be the first. A couple of days later, on
May 10th to be precise, the June DJIA futures contract hit an intraday high
of 11,700, a scant 75 points below the all-time of 11,775 posted back in
2000. So close and yet so far! Since then that same June DJIA futures
contract has shed close to 1,000 points as it closed at 10,877 on Friday,
June 9th, and I don't think we're done yet. Strangely enough, little in the
way of commentary regarding the decline has found its way onto the financial
news channels. If you listen to CNN, you get the impression that it's just
another day at the office. The silence is deafening, and given the fact that
I believe we are beginning a new and very destructive leg down in a Bear
Market, I would like to revisit some of the reasoning that led me to call a
top. Also, I would like to discuss what we can expect on the way down.
I would like to present the exact same charts, with
one addition, that I included in the last article along with some new
thoughts. Below I've posted my usual comparison with respect to the Daily
Charts of the DJIA ($INDU) and the Transportation Index ($TRAN). In both
charts you'll see the May 10th top mentioned previously as well as the
subsequent fall. As I love to point out, there was a significant difference
between the two tops though as the Transports made an all-time high while the
DJIA made a high for this bear market rally. It's that very difference that
amounts to a major non-confirmation with respect to the primary move. As
I told you last month "the breakdown that follows immediately after
the May 10th top is just the beginning of this second leg down that is going
to plumb the depths of the DJIA like nothing that any one living has ever
seen. There are still some people walking the earth that were around when the
Great Depression of 1930 reeked havoc on the U.S. economy. I believe that
decline will pale in comparison to what is coming down the road. The only
thing analogous may be the market collapse that occurred in 1907 where, if it
weren't for the efforts of one man, J. P. Morgan, the entire financial system
of the U.S.
would have collapsed. Unfortunately Mr. Morgan has long since passed
away, and since I last brought up the subject, nothing has happened to change
my mind.
Getting back to our charts, you may recall that both
indexes were flirting with their respective 50-dma's a month ago. Now they're
both well below the 50-dma, the DJIA is bouncing of its 200-dma, and it
should get worse before it gets better. Also, each new low has been confirmed
by both the RSI and the MACD:
With respect to the DJIA, we are thirty-three days
off the high and I expect the decline to continue for another twelve days. That's
June 22nd to be exact and 45 days from the high and 135 days from the last
low. The closest level of support comes in at 10,836 and then 10,652. After
that there is nothing until 10,303. My bet for a low on the 22nd would be at
or close to 10,300. There may be a two or three day counter trend move along
the way, and if that does happen, we have good resistance at 11,002, 11,167,
and 11,227. 1
Next on my hit parade, I have another pair of daily
charts, the S & P ($SPX) and the Philadelphia Housing Index ($HGX). The
latter is extremely important as it mirrors the housing market and it's been
"the relentless appreciation in homes, month after month and year
after year, has allowed Joe Consumer to go to the financial well almost at
will. The humble abode has become Aladdin's magic lamp; rub it and it pays
for schools, credit cards, SUV's, vacations, and even second or third homes. Well
the Daily Chart of the HGX is saying, no screaming, that the party in housing
is over." The HGX has broken down completely as the 50-dma has
crossed below the 200-dma and we are now trading well below both. With
respect to the S &P, we see a bit more of a
breakdown than we did with either the DJIA or the
Transports. In fact the S & P is now trading below its 200-dma even
though it doesn't appear to be as oversold as the other two.
Although I didn't spend a lot of time on it in the
last article, I would like to include a Daily Chart of the Consumer Index
($CMR) as it's been the consumers ability to take on more and more debt that
has allowed the economy to move forward. I believe the consumer is now tapped out and
 
that's really bad news for the Federal Reserve, and
anyone else worried about the economy. After putting in a slightly higher top
in May, the index has broken down below the 50-dma, and is fast approaching
the 200-dma. Unfortunately for the bulls, I do not expect it to hold there
this time around.
Lately, the bonds and dollar have been rallying on
the news that the Federal Reserve is concerned about stagflation. Imagine
that! The Fed has suddenly discovered that the economy is slowing while
prices are rising. Sarcasm apart, I really have to wonder what rock they've
been hiding under for the last nine months. It's the worse of all possible
worlds for the Fed and it poses a real dilemma for their new wizard, Mr.
Bernanke. In order to slow the trend in rising prices you should raise
interest rates and cut back on liquidity. On the other hand, a slowing
economy requires lower rates and more liquidity. Rising rates would be the
death knell for what's left of housing while lower rates will destroy the
dollar and everything that is attached to it. How so you might ask? Simply
put, the rest of the world is raising rates as prices rise, and that makes
their currencies and bonds more attractive with each rate hike. The U.S. must
find a buyer for all of its dollar denominated debt, and if its interest rate
isn't competitive, there won't be a lot of takers. That's not a pleasant
thought for the world's biggest debtor currently on a spending spree.
The real question is how will it all end? I believe
the DJIA will make some sort of ¨bottom¨ on the 22nd of June and then
begin a rally. This rally will be very important. If I'm right, and the top
is in, we should stop below the latest high of 11,700. Actually, I suspect
that we'll stop somewhere around the 50% retracement from our low, whatever
it will be, and the previous high mentioned above. For example, suppose we
bottom at 10,300. That would be a decline of 1,400 points and a 50%
retracement would amount to a 700 point rally, i.e., back to 11,000. How long
will the rally last? Me best guess would be 23 days. That's half of the
current decline, assuming it lasts 45 days, and would be a sign of weakness. And
that's when the problems will begin. The decline that follows this projected
rally will be quite vicious and, at the very least, test the 2002 lows of
7,200. Personally I believe that we'll make new temporary lows somewhere in
the 6,600 area, and maybe even lower. Sooner or later the market has to find
"value". Stocks were selling for more than 20 times earning at
11,700 and paying less than a 2% dividend. In order for value to be found in
the market place, we need to see a PER of 10 or less along with a 6%
dividend. Since the pendulum usually over swings in both directions, I
wouldn't be surprised to see a PER as low as 5 or 6 when the bear finally
takes its last breath. My target for a bear market low is actually Dow 3,000!
What will our world be like with a DJIA at 3,000? A
lot different than it is today! There will be a lot of victims and that will
include what's left of the US's
industrial base. As their market cap disappears, companies like GM will
disappear along with it. The standard of living for the average American will
take a real beating. Personal bankruptcies and defaults on mortgage payments
will be the norm rather than the exception. I suspect that the average
American will express his or her displeasure in the form of demonstrations
and general civil unrest. All of these adjustments will lead to dramatic
social, economic, and political changes. The initial response will be the
band-aide approach, but eventually radical surgery will be the only viable
choice. It won't be a pretty sight. Finally, it is worth mentioning that the
damage is not confined to the shores of the United States; the TOPIX, Aussie,
and FTSE to name a few all demonstrate a price movement similar to what was
illustrated above in the DJIA. We are going to see a world wide search for
value. Ominous to say the least!
I would like to close with a quote from my last
article. The 'rescue package' that the Federal Reserve launched in 2002
was done so in cooperation with the European and Asian central banks and
required the creation of here-to-for unimagined amounts of liquidity. Together
the central banks of the world literally flooded the market place with
liquidity. Japan
alone printed twenty-seven trillion yen. At the time, Japan was in the grips of a long deflation and
Europe was worried about the possibility of
entering a deflationary period. Today nothing could be further from the truth
as both Europe and Asia are now engaged in a
restrictive monetary policy with an eye on possible inflation. Currently no
one else out side the U.S.
has the slightest interest in bellying up to the liquidity bar for another
round of printing press mania. That leaves the United States all alone and faced
with some grim alternatives. As
I see it the U.S. can either:
- do the
right thing by cutting debt and spending while raising taxes and thereby
sending the country into a Depression, or
- It can
print money until hell freezes over, and since the debt is denominated
in U.S. dollars, the debt in real terms will decrease with the value of
the dollar.
Politicians never do the right thing (it must be
genetic) so that only leaves us with door number two. The latter policy
should lead to inflation, if not hyperinflation, and will most likely produce
a dollar crisis before the end of 2007. That will be bad for all things
American.
As the damage mounts, new figures will arise in the
political arena. That's happening now in Latin America with Venezuela's
Hugo Chavez. The same thing will happen in Europe.
These individuals will tend to espouse nationalism and make promises
that appease the masses. This happened in 1930 with devastating results and I
suspect that history will repeat itself. Given the types of weapons that
exist today, that's not a pleasant thought. No one "knows" how this
will all end, but I suspect that it will end just the way it did in the late
30's, and countless times before. Hopefully I am wrong. If we are lucky, the
bleeding will stop with a decline in the financial markets, but given the
political turmoil I see in Europe and Latin America,
it wouldn't take much to bring about complete chaos.
Enrico Orlandini
Dow Theory Analysis
Ignacio Merino 636, Santa Cruz,
Miaflores, Peru
Phone: 001-51-56-973-5599 - Fax
: 001-51-19-280-8796
Email: ebo@dowtheoryanalysis.com
Website: www.dowtheoryanalysis.com
For those of you interested in receiving
information on the Funds we manage, please feel free to e-mail us at ebo@dowtheoryanalysis.com and we will respond as soon as possible.
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