Dow at Major Crossroad: 11,400
We're approaching a very exciting and crucial time in the US equity markets. The Dow is less than 100 points away from 11,400, the level that stopped the 1990's bull market right in its tracks, resulting in a terrible bear market that ended at 7,200.
From 1999 to 2001, the Dow attempted to break 11,400 four different times, only to come crashing down again. Another time, in early 2000, the Dow briefly passed 11,400 for a few weeks, then dropped 2,000 points. Click on the chart below for a larger version:
Clearly, Dow 11,400 is THE most important resistance level in this index, and we're closing in on it. Depending on how the market treats the resistance, we can either enter a bull market or a bear market.
If the market closes above this important psychological barrier, its possible to have a strong bull market, perhaps lasting several years. Some possible causes for this may be the rapid and healthy corporate earnings growth, low unemployment and the white-hot growth of China, India and other emerging markets. Collectively home to 1/3 of the world's people, China's experiencing +9% annual GDP growth, while India boasts +7% growth. The growth of these economies has helped lift hundreds of millions of people out of poverty in the last decade alone, while helping to foster an emerging middle class. This large middle class is an excellent potential consumer market for globally-produced goods and, consequentially, a boon for the global economy.
Additionally, Japan, the world's 2nd largest economy, is said to be emerging from the deflationary downward spiral that started with the pop of the Nikkei bubble in 1990. The combined effects of the current economic conditions can be summed-up with the saying, "a rising tide lifts all the boats." The IMF projected the global economy will expand by 4.9 percent this year and 4.7 percent in 2007, a very hearty growth rate, indeed.
If the Dow has a firm close above 11,400, I will likely take a long position in stocks. Yes, you've heard right. The owner of a bearish site MIGHT buy stocks. I'm not a permabear, but a capitalist who makes money on either side of the market. I will place a stop loss in my stock at a level corresponding with Dow 11,400. If it drops below this level, all bullish bets are off.
An alternative scenario (and equally plausible) is that the bull market could bump its head on the 11,400 ceiling, and embark on a bear market, in a 2001-like "deja vu all over again."
The impetus for a bear market is +$73 per barrel oil prices (and maybe higher soon), gasoline at over $3 per gallon, and higher interest rates which will pop the housing bubble. Once the housing bubble implodes, foreclosures will increase and consumers who use their homes as ATM machines will feel the pinch and curtail their spending. Now the housing wealth effect which has made home owners feel very wealthy, will run in reverse.
The homeowners who will be hurt the most, with the rise in mortage rates, are the ones who let themselves get duped into taking on adjustable rate mortgages or ARM's. With an ARM, monthly mortgage payments rise as interest rates rise. Homeowners who overleveraged themselves with jumbo-mortgages will face dramatic increases in monthly payments, forcing many to foreclose- especially if the job market weakens. According to the Mortgage Bankers Association, ARM's constituted 34 percent of mortgage applications in 2004, a staggering figure indicating many people who think interest rates will be low forever and housing "always goes up." Sounds alot like the other historic bubbles I wrote about for this site.
More worriesome is the statistic from the National Associations of Realtors, saying that 36 % of the home sales in 2004 were second home purchases, ie. mostly speculative buying and "flipping." As housing deflates, these speculators will add more fuel to the fire as they attempt to unload their houses.
Added to the bearish mix is Iran's lunatic President Mahmoud Ahmadinejad who threatens the stability of the world, due to his aspirations to bring about Armageddon and the "Coming of the Hidden Imam." The Western world MUST attack Iran- either kill or be killed. Death isn't exactly a fear of a nation thats on a suicide mission.
Inflation is also a casualty of the kind of rapid global economic growth of the past few years. The sheer demand for copper, cement, oil and other raw materials from China and India is evidenced by the 4 year commodity bull market, sending each commodity to record heights. The cooling of these economies may result in deflation, dragging the rest of the world down as well.
If the market fails to break 11,400 and drops, I would likely short housing stocks, because these will be among the worst performing groups.
One interesting observation I'd like to share is that the current Dow MAY be experiencing a similar pattern to its sideways pattern that lasted from the mid-1960's until 1982, as the Dow repeatedly attempted to breach the 1,000 level, only to result in four different bear markets. A 20-year stagnation ensued as the Dow stayed flat. The market was more akin to a massive 20-year bear market, at least in real terms, as inflation reached dizzying levels.
Now, in 2006, is Dow 11,400 the same as Dow 1,000 in the 60's and 70's? Click on the chart below to see a larger version:
I'm not saying this scenario is a guarantee, but rather it is something to keep in the back of your mind. A similar stagnation also occurred in the early 1920's as the Dow struggled at the 100 level.
In my opinion, there are many potential reasons why the market might stagnate in the next 20 years. The end of cheap oil and the unuse of alternative energy sources is a great reason. Another is the Western world fighting against a relentless, decentralized terrorist enemy, causing society to live in constant fear. Policing the Iran and Iraq may reduce the US's economic vitality. Economic stagnation might also be caused by the astronomical debt loads that have become in vogue with governments around the globe. The graying of developed nations' populations will also contribute to the slower economic growth in the future. A nation of retirees simply can't have the innovation and rapid development of a nation with youthful workers.
Will the market break 11,400 or hit its head? I can honestly admit that I just don't know. I'm thoroughly confused as much as I'm amused. Then again, as a trader, I don't have to predict, I only have to react which in this case means seeing how the market reacts at this monumental psychological level. Very soon, I will make a post announcing which road the market decided to take, and how to use this information to your advantage.
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