October's 5-Year High Does Not Bode Well For Bulls

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Includes: DIA
by: Michael Markowski

Dow's Five Year October 2012 High does not Bode Well for Bulls

The Dow Jones Industrial Average composite (NYSEARCA:DIA) hitting a five year high early last month does not bode well for the bulls. On October 5th the Dow Jones 30 Industrial average or composite traded to 13610 which was a five year high. The level that it had attained was within 4% of its all time high of 14164 which occurred on October 9, 2007.

Of all the months of the year the month of October is the spookiest month of them all. Throughout my 35 year career in the investment business which began in 1977, I remember October as the one month that was and is still feared or revered by both the bulls and bears. October is the one month which hosted all of the crashes (1929, 1987 and 2008) for the stock market over the current and previous century.

Since hitting the five year high on October 5th the average has declined by approximately 5% to 12932. I am predicting that the recent high that was set on October 5th will prove to be cyclical high in an ongoing secular bear market. I am also now predicting that the venerable average will not get to an all time new high until 2015 at the earliest. Finally, I am predicting that the Dow will not eclipse its October 5th high for at least a year or two for the following reasons:

  • October is more than just the month that the market crashes. The month which features Halloween also tends to produce multi-year highs and lows. The multi-year highs and lows that have been set in previous Octobers have proven to be good indicators at predicting market reversals. After the dotcom bubble burst in 2000 the Dow made a five year low in October of 2002. That low was just above the previous multi-year low which had occurred in October of 1998. The Dow bounced off the 2002 low and went to an all time high in October of 2007. It than made an about face and crashed to a five year low in October of 2008.
  • The probability has increased significantly that the tax rates on long term capital gains and dividends will increase in 2013. Its primarily due to the outcome of the recent 2012 US elections. Taxes are likely to increase significantly. The tax cuts that were initiated by the former Bush administration will expire on December 31, 2012. President Obama was reelected and the Democratic Party was able to maintain its majority of the US Senate. Therefore, the President and the Democratic Party now have significant leverage over the Republican controlled US House of Representatives. Without the passing of new legislation the taxes will increase sharply. Unless the Republicans are willing to let the taxes automatically increase to above where the President himself has said that he wants them at they have no choice but to cooperate. They will have to agree to what Obama wants. The likely result will be increases in tax rates for both dividends and capital gains. The higher taxes on dividends will make the shares of those companies who pay dividends less attractive according to Bill Gross who is the CEO of Pimco. Its one of the world's largest investment managers. Groos told CNBC that he believed that an increase in the tax rate on dividend income to 25% from 15% could result in a market decrease of up to 10%. The other problem is that with a looming long term capital gains rate tax increase many investors will sell their holdings between now and the end of 2012. Their sales will put significant selling pressure on the markets.
  • Unfavorable US Presidential term cycle. Historically, during a US President's four year term, the best year for the market is the third year. The worst is the second year with an average return of only 0.60 % and the second worst is the first year with an average return of 2.0%. Since the Dow is already 5% below its five year high and must now climb by 10% from its present level to get back to its all time high the odds are that it will not eclipse the recent high until 2015.
  • Long term sentiment is turning increasingly negative. I listen to CNBC and the other business channels throughout the day. I also do a lot of reading about what is going on in the economy and the markets. During the month of October I heard and read commentary that I never thought that I would read or hear in my lifetime. The big question is what business is Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), Hewlett Packard (NYSE:HPQ) and Dell (NASDAQ:DELL) going to be in five years from now? Perhaps an even better question is will Hewlett and Dell be in business five years from now? Both have share prices that are hovering at or just pennies above their 17 and 15 year lows respectively. What all of these four have in common is that they have been completely dependent upon the PC for the last two decades. They each dominated different aspects of the PC industry. Now their business models are being rapidly obsolesced by the smart phones and the tablets. None of these four former stalwarts have a clue about what they are going to be selling in five years.

Of all of the above items which can have a negative impact on the US equities markets the recently surfacing and growing uncertainty surrounding Microsoft, Intel and Hewlett Packard is the most troublesome. The sentiment for these three will continue to erode until they can convince Wall Street that they have the new products that will enable them to grow in the future. All three of them are members of and represent 10% of the 30 companies who are members of the Dow 30 industrials composite index. Given the shift of the sentiment to negative for the three, I believe that the odds are slim that the Dow and the market will be able to get to new all time highs unless these three can come up with some solid answers.

While working in the brokerage industry in the late 1970s and 1980s I experienced the malaise of the markets. It was caused by the steadily weakening sentiment that accompanied the nifty fifty. Ironically, Apple, Microsoft and Intel were among the core companies that arrived on the scene to change the sentiment from negative to positive in the 1980s as none of them were ever members of the nifty fifty.

Even though the sentiment of the market is now in steady decline I do not predict a crash for the Dow Composite 30 or the other indices such as the S&P 500 index (Pending:GSPC), etc. However, I do believe that Dow has not yet hit its bear market low for this secular bear which began after the market hit its peak in October of 2007. Instead I am predicting that investors will be nickeled and dimed to death as they watch the value of their holdings erode very slowly over the duration of the current secular bear.

The table below depicts the performance the duration of the secular bear and bull markets which have occurred over the past 210 years. The returns for the current secular bear which began in 2007 and is expected to last until at least 2015 have been approximately a negative one percent per year.

Click to enlarge

A video that covers the current secular bear and the factors that are driving it is available. The recording of an interview that I recently gave which covers my views and thoughts on the US markets, economy, secular bear market, Online Financial Sector, Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), Enron and StockDiagnostics.com is available at YouTube.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.