Could the Dow Reach 4000?

There are few steadfast investing principles. Dynamic markets constantly change and investors must be willing to adapt their strategies. However, one rule we should always follow is to trade with the primary trend. Trying to trade against the underlying current of the market will surely result in losses. Those doing so think of themselves as contrarians. In reality, they are foolish.

For months in my weekly newsletter EPIC Insights, I have repeatedly stated that the primary trend is bearish. When stock markets worldwide hit synchronized lows in November 2008, we were given notice. During the subsequent rally, markets began diverging and raised hopes that the primary trend was changing. This week that hope was crushed. As the chart shows, last week markets pushed to synchronized 2009 lows, on many occasions violated their 2008 lows, and have reinforced the primary trend as bearish:

Index		Prior Low		Date of Low		Recent Low		Date of Low		New Low?
Dow Jones Industrial		7,552		11/20/2008		7,366		2/20/2009		Yes
Dow Jones Transport		2,989		11/20/2008		2,699		2/20/2009		Yes
NASDAQ		1,316		11/20/2008		1,440		1/20/2009		No
S&P 500		752		11/20/2008		770		2/20/2009		No
Wilshire 5000		7,451		11/20/2008		7,750		2/20/2009		No
FTSE 100		3,781		11/21/2008		3,889		2/20/2009		No
DAX Index		4,127		11/21/2008		4,015		2/20/2009		Yes
CAC 40		2,881		11/21/2008		2,751		2/20/2009		Yes
NIKKEI 225		7,163		10/27/2008		7,416		2/20/2009		No

With a primary bear market, we are unable to predict either the duration or severity of price declines. Instead, we turn to past experiences to guide us. Unfortunately, nothing in the past indicates promise for the immediate future.

For the economy, the current downtrend has already reached levels of prior deep recessions. However, as the storm clouds continue gathering we should expect this downturn to be more severe than any since the Great Depression. With indecisive policymakers who have used all traditional stimulative actions (i.e., interest rate reductions from the Federal Reserve and increased spending from the Federal government), we face an uncertain world with few concrete answers. Having used debt to finance our lifestyles for nearly 60 years, Americans are being forced to reduce debt and curtail spending. This combination should result in more economic malaise over the coming months.

Looking at stock market performance over prior bear markets, as shown in the following table, the picture this time around is equally bleak.

Bear Market	Market Peak	Date of Peak		Market Bottom	Date of Bottom		Value Lost	Duration
1929 Crash	381	9/3/1929		41	7/8/1932		-89%	714 days
1968-1970	985	12/3/1968		631	5/26/1970		-36%	368 days
1973 -1974	1,052	1/11/1973		578	12/6/1974		-45%	482 days
2001-2002	11,338	5/21/2001		7,286	10/9/2002		-36%	347 days
NASDAQ	5,049	3/10/2000		1,114	10/9/2002		-78%	648 days
Current	14,165	10/9/2007		7,366	2/20/2009		-48%	344 days

While the current bear market has erased 48%, in line with the declines seen in most bear markets, the duration of 344 days is the shortest on record. If you follow the belief that this bear market is unwinding 60 years of excess spending, we should expect the Dow to lose at least 70% from peak to trough and the bear market to last in excess of 600 days. Combining these data points, the market may not bottom until the Dow approaches 4,000 sometime in the next 9 to 12 months.

Finally, most major bear markets do not end until prices have reached bargain levels. This often equaled a P/E multiple near 6-7 and a dividend yield in the same area. Currently the Dow sports an estimated P/E of 11 and a dividend yield of 4.3%. In order to achieve bargain levels, the Dow would need to trade near 4,000.

The picture painted here is very ugly. Most investors have a great deal of difficulty accepting the belief that the Dow could trade to such levels. I hope I am being overly cautious, but fear my analysis will prove correct. With such a drastic selloff predicted, earning meaningful returns will be difficult. Becoming excessively short stocks will provide the opportunity to be forced from your position by unexpected bear market rallies, while going long stocks that seem cheap will lead to losses and frustration as those cheap stocks become cheaper. Instead, I will stick to my core competencies as a value investor and search for cheap stocks that offer limited risk and outstanding return potential. However, I will not buy these shares blindly but will look to use index exposure to hedge all my risks.

Continuing a theme used in last week's fundamental trade, I advise readers to become more short of the broad market. Last week, we shorted SPDR Trust (SPY) and iShares MSCI EAFE Index Fund (EFA) with excellent results. This week's trade entails using options on SPY as a means to profit. Using a September 2009 expiration, I recommend shorting the SPY 77 calls (ROQ+IY) and using the proceeds to buy the SPY 77 puts (ROQ+UY) as this week's fundamental trade. Cover 5% of your portfolio with this trade (six contracts for my portfolio).

Comments

[foxy 44:]

the crisis will be worse 1929, means more than 714 days as above showed, we are not at the bottom, just small rebound, 2009 second part will be worse du to compagnies results

Feb 23 09:43 AM

[pacman1947:]

Sean,
Not to bring bearish sentiments to the forefront, but the P/E criterion may also portend a Dow more in the 1000 range. Earnings may plummet in direct proportion to the price drop already encountered, and repeat at least one more cycle. The spiral to the bottom may last for years, as it did back in '29 to '32.

Of course, some completely alien event may change this without warning.

Feb 23 09:46 AM

[ilmn:]

we do not know the end from the beginning or ups or downs, just guess

Feb 23 09:51 AM

[bosun.j:]

Might you be be thinking an "alien event" be an attack on Iran? Perhaps a "terrorist" attack on US soil?


On Feb 23 09:46 AM pacman1947 wrote:

>
>
> Of course, some completely alien event may change this without warning.

Feb 23 09:52 AM

[wolfdog:]

Unlike some of the comments written above, I think this author has done a very thoughtful analysis which deserves reflection. My own bias is to use DJIA dividend yield as a value anchor rather than earnings, which are too flaky and volatile. Major bottom low on dividend could dwell in the range of 4500 to 4800 on the DJIA. That said, we are all being somewhat guilty of "piling on" in this current correction and trying to outgun one another w/ bearish scenarios. That is opening the contrary window for a violent countertrend bear market rally that could appear out of nowhere with just a random catalyst as yet unknown. However even such a rally would not negate the notion of this bear cycle being more extended in duration, e. g. excess of 700 days rather than the shorter historical examples. I do agree with author that the primary trend is bearish until proved otherwise, and that is the main issue to keep in focus.

Feb 23 10:24 AM

[mr freddo:]

I believe that the author is correct in predicting another year of the bear market. My own guess was Dow 5000 and gold 2000 by the end of the year.

Feb 23 11:01 AM

[foxy 44:]

don't predict bottom, may be in 2010,2011,2012,2013 noboby knows, may be early, may be late.
and the level ?

Feb 23 11:33 AM

[scotty1560:]

I like Sean's analysis and see 3500-4000 dow before this is over.
Ditto real estate in the boom areas.. say 75% haircut.

Abuse of leverage, including me, means you basically start over.
So I look for 95-98 prices (pre bubble).
The lesson learned here is leverage can only be used at low ratios
and not for extended periods.. to much exposure to the unforeseen.
Leverage is nothing more than a sophisticated form of gambling.

Feb 23 11:35 AM

[CJJ:]

All of this extreme low calling of where the DOW will end up seems to completely ignore the fact the torrid pace of change.
As long as the neagtive loop continues...
Housing prices will continue to break down to historical means. In many areas outside of the "boom" towns this is quite close already. The "boom" areas still have a 25-40% to fall.
The savings rate will soon tick up towards 10%...By soon I mean within a year.
Credit card debt will be resolved...written down, paid off, reeled in within 1-2 years.
So this is all happening quite fast. How far down the DOW goes, who knows. But I think this idea that this thing is going to drag on for 3, 5, 10 years is a mistake. If that would be the case societal breakdown or world war would occur in far less time than that shake out.
Get ready for either the Quick Depression followed by Population Rate World Growth or Societal breakdown. In the second outcome your investments don't matter anyway.

Feb 23 12:28 PM

[Aristophanes:]

The Dow first broke 4,000 on February 23, 1995.

That is only 14 years ago, so in the context of stock market history, is a very short time. It is entirely conceivable that this level of market activity and value will be seen again as money is scared of equities. The "ownership society" wants nothing to do with these markets.

Another way of looking at it:

Will net household wealth in the US decline to the 1995 level with all this de-leveraging?

This is highly likely.

Good analysis.

Feb 23 02:16 PM

[@TexasER:]

Can anyone tell me how long will it take for the world to invent new industry to re-employee 20-30% of the population?

If someone can just tell me that, I’m ready to call this bottom!

Feb 23 02:50 PM

[winslow:]

No one can predict where the market will be in the future. Some will portend to make educated guesses. It is very possible for the market to drift slowly downward over the next 3-4 years, so as to not scare everyone...and then at that time the DOW will be around 3000. Perhaps capitalism only works for those who come out on top...and that sounds like communism to me....the masses led by the elite powerbrokers.

Feb 23 03:24 PM

[HiSpeed:]

Yes - With everything we've seen in just last year, anything is possible.

Feb 23 05:56 PM

[the ilster:]

Yes I agree. there is absolutely nothing that I can think of to be bullish about. I have looked at this over and over and just dont see it. We are toast do not count out social unrest as a result of this outcome

Feb 23 09:41 PM

[Moon Kil Woong:]

DOW 4,000, well anything is possible except for maybe saving Citibank.

Feb 23 09:49 PM

[jeerio:]

does anyone know what % of traditional investors are still 'all-in' the market? if everyone gets out, problem solved and we can start over next week.

i got out in August 07 at 12,800 Dow, told Smith Barney the system was broken. should have waited til October, but oh well. only trading since then, and only using 10-15% max of my capital, rest in CD's at about 4.2% and a few old bond issues.

i simply can't imagine the thought process required to still be in this market in any committed way.

Feb 23 11:38 PM

[GoMyLittleS...:]

"Yes - With everything we've seen in just last year, anything is possible."

Yes, anything is possible, absolutely.

Except going up. As all of you are so preoccupied looking at your own belly buttons to see how incredibly biased you are.

"i simply can't imagine the thought process required to still be in this market in any committed way."

And this, my friend, is why life will pass you by.

Feb 23 11:56 PM

[PainfullyAware:]

Biased? - You may want to consider the balance of Good News Indicators Versus Bad News Indicators. Author Steven Hansen does a good job of laying out the stats and giving a skeptical slant to the meaning of both good and bad; He is not easily overcome by irrational emotion.

Until the Shadow Banking Hole is resolved, the future looks pretty bleak.


On Feb 23 11:56 PM GoMyLittleSheep wrote:

> "Yes - With everything we've seen in just last year, anything is
> possible."
>
> Yes, anything is possible, absolutely.
>
> Except going up. As all of you morons are so preoccupied looking
> at your own belly buttons to see how incredibly biased you are.<br/>
>
> "i simply can't imagine the thought process required to still be
> in this market in any committed way."
>
> And this, my friend, is why life will pass you by.

Feb 24 10:48 AM

[Teutonic Kn...:]

Am no expert, but I spurted out a few times elsewhere before muttering that the Dow at 2000 is really the support and the real bottom. Reason, once again, just look at the 30-year index chart - that was it got started.

For those who might have short memories, C used to be a $2 stock back then somewhere, and now people are crying to see dipping below $2. So was MSFT, it was a $3 stock...

Feb 24 07:57 PM

[throwerw:]

LOL thank you everybody for selling your shares to me. nobody got rich from being scared when everybody else feels the same way

Mar 04 03:37 PM