Dow 6,000, Part II

My previous article, Why the Dow Is Headed to 6000, generated many comments. Perma-Bulls are not persuaded. Persuaded or not, I thank everyone for taking the time to comment on my article. I hope we can build a community (bull and bear, trader and investor) that takes our beliefs seriously, respects one another, and strengthens our community to everyone’s benefit.

At the risk of overstating the obvious, I’m a short-term trader and my recommendations are intended for short-term traders, not long-term investors. Unless otherwise stated, please keep that in mind when looking at my stock and ETF recommendations (what may be a great short-term trade may be a horrible long-term investment, and vice versa).

Retesting March Lows

The titan of finance, J.P. Morgan, was once approached by a journalist who asked: what will happen to the stock market? The titan leaned over, and whispered “the market will fluctuate.” Look at this chart below:

click to enlarge

If on Feb. 9, 2009 you followed the trading advice of the bulls laughing at the bears, you would have lost a bundle. If on March 9, 2009 you followed the trading advice of the bears laughing at the bulls, you would have lost a bundle. The key is to trade the market you have, not the market you want. But you must also keep your eyes wide-open; taking the market “noise” with a pinch of salt to ignore whipsaw.

The Dow 6,000 target mentioned in the previous article is not an arithmetic target cast in stone (e.g., the Dow will stop at 6,000 sharp), but rather a conclusion that the Dow will retest the March lows. Retesting the March lows means that we may close around the 6,469 range, but not actually hit it (e.g., get to 6,600) or we could break the 6,400 level altogether (more likely scenario). The markets have gone up too far, too fast on positive sentiment regarding a quick recovery that is not plausible. One should not infer from this statement that there are no positive items within the economy, or that one must be a perma-bear convinced the Dow is headed to zero. Rather, it means that we’ve moved more on sentiment than sound structural reasons (the fundamentals) justify.

Quick-Recap

The previous article provides seven fundamental reasons why the global capital-market rally was based on sentiment and not sound structural economic changes. March lows may be retested because of...

1. Current economic situation. This is not a doomsday forecast. I’m not arguing that the sky is falling, only that the rationale offered to justify the rally is not persuasive. The markets will eventually go much higher, but between now and “eventually”, get ready for another retest because things are not as rosy as we’ve been told. And markets rarely bottom just once…there are subsequent retests. When it comes to trading, I remember the words of John Carter, Mastering the Trade, “The moral of the story? When Wall Street decides to package it up, put a bow on it, and sell it to the public, that move is over.” (pg, 15,). Take the market “noise” with a pinch of salt.
2. Economic headwinds...The Economist has a great article on recession and reduced wages for those who still have their jobs… “The recession and pay: The quiet Americans.” I don’t want to offer more “evidence” and turn this into a PhD dissertation on Macro Economics. Suffice to say that my previous article offered seven fundamental reasons why we still have strong headwinds ahead of us…and sometimes you won’t get that from the Fed, because they don’t get paid to undermine public confidence…they have to act “responsibly” and “reassure the markets”.“Stabilization” or improvements in the economy are artificial and unsustainable (e.g., excess government spending, etc). Again, this is not a doomsday forecast. The economy does have positive traction. But is that enough to warrant a recovery in the near future; or do we still have economic pain ahead of us due to the historically unprecedented leverage by consumers and banks?

The conclusion is overwhelming: although the big-picture fundamentals may not be getting worse (so say the optimists), although the sky is not falling…the current situation is still bad (that much is a fact, bull or bear). And all that is the “good news”! The “bad news” is that the decline is global (making a gradual rebound that much more difficult and slower).

Déjà Vu, All Over Again

Will the markets continue to act irrationally (i.e., continue to go up) before the retest? Of course that’s possible. I mentioned several times in the previous article - what the market thinks matters, even if you think the market is “wrong”. I’ll say it again: the key is to trade the market you have, not the market you want. But you must also keep your eyes wide-open; take the market “noise” regarding a quick recovery with a pinch of salt, to ignore whipsaw. And I believe the market may deliver another wicked body-blow…maybe not today, tomorrow, or this week…but soon enough.

The “catalyst” that gets us retesting the March lows need not be another Lehman Bros., or a showdown with Iran, etc. I don’t believe it need be an earth-shattering event that triggers another sell-off and retest of the March lows. Rather, it might be as simple as institutional money deciding to change course and get out, a herd of elephants suddenly changing direction….dont stand there wondering why they changed direction, don’t stand there arguing with the elephants, just make sure you get out of the way.

But why 6,000? As we all know, and can agree upon, market’s tend to overshoot (both going up and down). So although the economic fundamentals are bad and justify a correction; and although the economic fundamentals may not be bad enough to justify 6,000; we can retest that level nonetheless because of sentiment and markets overshooting. Put sentiment and markets overshooting in the context of the seven fundamentals I’ve previously covered, and the sell-off can get ugly. As I’ve already mentioned: markets rarely bottom just once…there are subsequent retests.

What’s Next

Again, to quote J.P. Morgan, “the market will fluctuate.” It is very likely that we will retest the March lows, but the correction will come when traders/investors least expect it. The more complacent the market gets, the more vulnerable we are for another correction. And what happens after the retest? The sun will rise, firms will hire again, and life will go on…eventually. And as always, you should not think and trade as a “bull or bear”. Instead, you wake up every morning and decide where your dance-partner will lead you (long or short positions)…you trade the market you have, not the market you want…and remember the words of John Carter in Mastering the Trade, “The moral of the story? When Wall Street decides to package it up, put a bow on it, and sell it to the public, that move is over.” Take the market “noise” with a pinch of salt, my friends…it’s not the end of the world, but we’re not out of the woods yet, the market loves to catch traders-&-investors wrong-footed.

Trade defensively and consider shorting via the Direxion 3-times leverage Bear ETFs (BGZ, TZA, FAZ).

Disclosure: No positions as of submitting article.

Comments

[jeandit75:]

well, you got taste. I have a tendency to agree with your views. My main problem when discussing the market right now is people tend to only try to see the positives and forget all about risks: 1) CA going bankrupt, 2) banks toxic assets gaining momentum with the mortgage resets, 3) consumers savings rate increasing, 4) market manipulation by the administration.
I don't know if your forecast of the Dow at 6000 is right but I certainly agree that before we can make further moves higher, we'll have to look through these risks and in the meantime, a double bottom in the enonomy and the market has to be taken as a very high probability.


On Jun 30 11:44 AM Serge Hagopian wrote:

> thanks for the complement, bro...that's my wife :-)

Jun 30 12:02 PM

[j_remington:]

You must have skin in the game to be more convincing. However, the bulls were clinging to consumer confidence on this climb. So, bears will have their moment again.

Jun 30 12:50 PM

[berated:]

Question to all: what influence will/does the rumored manipulation of the markets by Goldman Sachs, et al have upon technical analysis and the general near-term market trend predicted by Serge (and more than a few others)? Thanks for any responses.

For Thiazole:
The long-term problems (eg, decay, tracking error) with holding leveraged ETFs are well-known to anyone who has done their homework (and I cannot imagine investing my money into anything that I haven't researched). Serge did say he was a short-term trader in the beginning of his article:

"...I’m a short-term trader and my recommendations are intended for short-term traders, not long-term investors. Unless otherwise stated, please keep that in mind when looking at my stock and ETF recommendations (what may be a great short-term trade may be a horrible long-term investment, and vice versa)."

Jun 30 12:57 PM

[thiazole:]

I've got to say, you have a lot of followers who abuse the thumbs down. The whole purpose of thumbs is to say if a post contributes or distracts from the discussion. Giving it because it doesn't agree with your view is the wrong reason. If you can't at least rebuke a post, you shouldn't be giving it thumbs down. Having a bunch of people post the same thing because they all agree with each other isn't a discussion - it is group think. Let's encourage discussion instead of everyone just patting each other on the back.

Jun 30 01:05 PM

[MatrixSurfer:]

I have pondered your question - which I think is a legitimate one - along with possible influence on the markets of moneyed interests such as Soros. While I have never been a conspiracy theorist, I am faltering somewhat these days. Given the holes in the regulatory system, it seems entirely plausible to me that manipulation is possible in the short term. However, I do not think you can disguise poor fundamentals for long, and as a contibutor above noted, monitoring 'longer term' indicators should filter out the effect of short-term manipulators. At least, as per 'the one', I "hope" so. And I'd like to be wrong about the GS/treasury/market connections. This aspect of developing investment strategies in today's environment is still unfolding. I still can't believe that I look at political contribution lists before recommending stocks to clients these days...but I do.


On Jun 30 12:57 PM berated wrote:

> Question to all: what influence will/does the rumored manipulation
> of the markets by Goldman Sachs, et al have upon technical analysis
> and the general near-term market trend predicted by Serge (and more
> than a few others)? Thanks for any responses.
>
> For Thiazole:
> The long-term problems (eg, decay, tracking error) with holding leveraged
> ETFs are well-known to anyone who has done their homework (and I
> cannot imagine investing my money into anything that I haven't researched).
> Serge did say he was a short-term trader in the beginning of his
> article:
>
> "...I’m a short-term trader and my recommendations are intended for
> short-term traders, not long-term investors. Unless otherwise stated,
> please keep that in mind when looking at my stock and ETF recommendations
> (what may be a great short-term trade may be a horrible long-term
> investment, and vice versa)."

Jun 30 01:21 PM

[six:]

A voice in the wilderness shouts the truth few are willing to believe!

LESS PEOPLE WORKING, THOSE WORKING ARE MAKING LESS, THE MONEY THEY ARE MAKING THEY ARE SAVING!

You can listen to the ever optimistic or you can listen to the facts.

Jun 30 01:44 PM

[ken3602:]

Everyone who is waiting for a mild correction will soon find they were wrong. When we consider fundermetals only, market can go much lower than March low, but a strong support around 666 of S&P 500 will surprise all of us. I think institutions and even retail investors will feel safe(?) buying at this level even if they see no green shoots or an immediate rebound anywhere near. This is how a double bottom happens. Pretty much psychological support based on the previous bottom. The only thing we should still consider as a possibility is something completely unexpected happening. If it occurs, no one will even know where the bottom would be.

Jun 30 02:38 PM

[ros21:]

I disagree with you. You article is misleading. What you are not mentioning in your article is that the March lows represented a depression similar to a "dooms day" scenario. The reason why the market rose from the March lows is because the market realized that we are not in a doom's day scenario even though the economy has not improved much since March. Today’s market price is representative of the current recession that is slowly easing, and to test the March lows again is wishful thinking. I think the market will stay flat untill more tangible improvements are realized in the economy.

Jun 30 05:26 PM

[SeekingTruth:]

Fluff, hope, media propaganda, program momentum trading, and a general ignorance of economics and market fundamentals have been the major factors in the recent overly strong and quite unjustified rally.

The power market forces at play are beginning to sense that the retail investor is growing more wary and more reluctant to throw the dice and place more chips on the table.
The power brokers like GS know when a correction pullback will work in their favor and are well prepared for it, desire it , plan for it, and will certainly add to it's strength and acceleration precisely when it is most advantageous to them, and not a moment before.
And so , on and on it goes. The power professionals of today know very well how to play down as well as up and can give the appropriate nudges to assist the transitions at inflection points how and when they wish.
Small investors that do not grasp this and adjust to it , will continue to be disappointed and find that the majority of their long term investments will remain flat to down.
The author does well to point out that , in so many words, that we are in a technical trading market, and without those technical tools, and very good ones necessary at that, your investments are at extreme risk.
This has not always been so, and will not be so at various times in the future ( a phase dependent cyclic phenomena), but it is true right now.

Jun 30 08:21 PM

[Fighting Yoda:]

1. The author says he is only a short term trader but his entire thesis is around long term drops.

2. Never buy these leveraged ETFs - they are meant as day trades only. Maybe it suits the author and the like but definitely not others.

Jun 30 09:50 PM

[untrusting ...:]

Well you may disagree, but you present no facts, research, or historical comparisons that support your opinion. Thus it makes much more sense that you are the one exhibiting wishful thinking in stating that the market will stay flat. If you look at virtually any reasearch or historical comparisons (such as dshort.com), you would clearly understand that the odds heavily favor at least one (and maybe more) significant correction(s) over the coming months/year. But you are welcome to gamble your money. Many of the rest of us are not at the levels this market is now at, and it is not even necessary to do that in order to earn decent returns. The fact is there are simply much safer ways to make money in this market without taking buy/long risks in this dangerous market and at these type of high valuation levels.

On Jun 30 05:26 PM ros21 wrote:

> I disagree with you. You article is misleading. What you are not
> mentioning in your article is that the March lows represented a depression
> similar to a "dooms day" scenario. The reason why the market rose
> from the March lows is because the market realized that we are not
> in a doom's day scenario even though the economy has not improved
> much since March. Today’s market price is representative of the current
> recession that is slowly easing, and to test the March lows again
> is wishful thinking. I think the market will stay flat untill more
> tangible improvements are realized in the economy.

Jun 30 10:55 PM

[Investing1:]

Everyone forgets to look at the fundamentals. The short side double weighted ETFs were trading at -2.90 divergence and -4.0 MACD at the peak of the market advance a few months back. Now, as we head into the summer sell off season the divergence and macd has narrowed with the divergence POSITIVE and the MACD less than -1.0 in many of the short double ETFs. That signifys huge strengthening in the internal shift to a down slope of the market to a retest.

Simple truth is that we have had strenght to support but each and every support is getting weaker and weaker. What concerns me is that the trading floors were all sent by the government over to trade the bond pits to lower interest rates significantly the past two weeks. When we get back from the hoilday will the trading floors be back in buying equities and futures to bump the market on such low volume?

Additionally, With the strong W pattern to many of the long double ETFs that I treack every night and their failure to break from that W pattern to sustainable growth is interesting to me. They drop 3 days and then rally 2. They drop 4 days and then rally 2. They drop 3 days and then rally 1. Look at the charts of the MVV, SSO, DDM, QID, BGU...

Additionally, Chinese stocks make up nearly 50% of the IBD top 20 this week. Yes, Chinese stocks that trade in the US are nearly 50% of the top stocks trading in the US. Infact, there are few US stocks trading up in this market to a grade they reach the top of IBD. Interesting...

Yet, China just crushed 4 of the top stocks this week when they stopped the practice of allowing the online gamers to offer virtual money to players that those players can then trade for real assets and services. That has crushed the prospects and low cost process of these massive online games. At the very least it will increase their back office opperating cost significantly. 3 of these top stocks are in the top 20 of the US stock market.

That, to me is striking. However, the rise in China can fuel the US to rally. Look no further back then 2007 when we had this same phenomeon. In the IBD top 200 there were tons of Chinese stocks breaking higher and that lifted the market to a point that it rallied heading into the October sell off when folks suddenly realized that the economy was bad.

Lastly, as mandates from the government have increased nearly 20% this year alone, the cost of doing business in the US has become nearly confiscatory. Indeed, today 2 new nuclear plants were taken off the drawing board since the costs to build them could not find financing. If any form of Cap and Trade passes that will be the death nail for US equities in the near term and will be awesome for attached countries like Canada as all Us based companies will flee the US for other jurisdictions. As Canada is cutting regulation and taxes on corporations they have a huge welcome mat out.

Cap and Trade is just a new Smoot Hawley. History is repeating itself.

Jul 01 12:15 AM

[Barking:]

Well these certainly are interesting times...a person can seemingly find facts and figures to support just about any argument these days. And of course we are ALL welcome to our opinions.

I agree with you Serge...I think there is a real potential for another big drop....BUT...dont under estimate the "powers to be" (Fed, Tres, Wall St) and their ability to manipulate this market. At this point I`m not surprised by much of anything I see...so would 'they" prop up this market or try and control a massive drop?? I think so...so for right now...its tough for me to "get short". For now....I`m sitting in cash & gold while the market sorts things out.

Oh ..and Serge...please make all of our days brighter by posting a better picture of your beautiful wife !!! LOL...Thanks !!

Jul 01 09:44 AM

[Fred Voetsch:]

A very reasonable viewpoint.

When the primary trend of the market is down (some will disagree with this) and the secondary trend is up and has been up for 4 months it is a good time to take profits or even look at shorting the market.

Why? Because “the market will fluctuate.”

Jul 01 02:09 PM

[dirtyharry:]

Since the March low, about 1.5 million MORE people are unemployed. While housing sales have gone up slightly, foreclosures have accelerated. We have an entire wave of Option ARM loans that are only just beginning to reset, giving their owners payments twice the size they are used to paying on properties in which they are severely under water.

My point: The economy is in WORSE condition today than it was on March 9. Consumer sentiment doesn't matter - it won't save the economy. If idiot consumers are feeling better but they don't have the money to spend, their "feelings" are irrelevant when it comes to boosting the economy.

When the market begins to slide again, which could easily be within the next two months, watch how quickly people become fearful and seeing the doomsday scenario again. They will sell, and sell hard. Proper valuation based on earnings and consumer spending power is actually well below the March low - perhaps as much as 1/3 below the March low. I'm not suggesting that we'll crash below the March low, because as was mentioned, psychologically we might pull in buyers with the double-bottom scenario.


On Jun 30 05:26 PM ros21 wrote:

> I disagree with you. You article is misleading. What you are not
> mentioning in your article is that the March lows represented a depression
> similar to a "dooms day" scenario. The reason why the market rose
> from the March lows is because the market realized that we are not
> in a doom's day scenario even though the economy has not improved
> much since March. Today’s market price is representative of the current
> recession that is slowly easing, and to test the March lows again
> is wishful thinking. I think the market will stay flat untill more
> tangible improvements are realized in the economy.

Jul 01 02:11 PM

[Fred Voetsch:]

On Jun 30 09:50 PM Fighting Yoda wrote:

> 1. The author says he is only a short term trader but his entire
> thesis is around long term drops.
>
> 2. Never buy these leveraged ETFs - they are meant as day trades
> only. Maybe it suits the author and the like but definitely not others.


The leveraged short ETF's should not be bought as investments but I have enough experience with several (SDS and SRS) to say that you can do very well with them over the course of weeks, as long as you understand them and how they move and deteriorate over time.

SDS is a very stable short, leveraged ETF. If you had bought it in late 2007, believing the market was heading downward, you would be even now, which is much better than if you had bought a long S&P 500 ETF.

The key is to buy into aging rallies and to sell into panics and to never over-extend yourself with these.

Jul 01 02:16 PM

[perceptions...:]

The likely chance of retesting March lows, this year, are 90%

The likely chance of retesting the all-time DOW high of over 14,000, any time in the next 10-20 years is around 10%.

Jul 01 08:56 PM

[jayminho:]

dude..
they guy is a damn etf trader.. what do you expect from him ? he got to sell his fish..
like a messager of apocalipse, he now says all is doomed and advertises the bear leveraged etfs.. pretty soon he will be doing the inverse..

anyway..
what can i say about a guy who gets more comments on his chick than on his article ?!

Jul 02 09:25 AM

[cach:]

you know whats my question, if there are so many of us (realists who know the market can not go up forever without any real recovery) who in the world is left out there to sell?
with so many bear traders....how do you push the mkt down?

Jul 02 01:34 PM

[Danny Furman:]

Serge really explains his views thoroughly and every investor should really appreciate that. As to the leveraged ETFs, I don't have much experience with them but believe they are a MUST for anyone who (like myself) mostly invests long term but shorts for hedging purposes or when THE MARKET IS OVERVALUED. Last Wednesday, which saw an irrational ~200 point gain in the DOW, is the time to buy them.

"When Wall Street decides to package it up, put a bow on it, and sell it to the public, that move is over.”"----nuff said

Jul 06 12:56 AM