Dow 8,000?

I was reading “Dow could plunge to 8,000,” which supports another view of the potential downside market risk. Here are some highlights:

Dozens of companies this past month posted blow-out earnings but instead of being thankful, investors stomped their feet and sold. The result: The Dow Jones industrial average fell 3.5 percent in January, the worst month for stocks since the depths of the bear market last year.

Investors want more, and they want it now.

One explanation for this surprising ingratitude is that they already had bid up stocks to a level that assumed very good profits. So when those expectations were met this past month, well, investors were less than impressed and decided to cash out.

Or maybe fear is driving the selling, too. Debt levels are simply too high for strong economic growth and big stock returns, according to the latest investor letters from two respected moneymen — Bill Gross, managing director of bond giant Pimco, and Jeremy Grantham, founder of Boston asset manager GMO.

Avi Tiomkin, chief investment officer of Tigris Financial Group, says that as businesses and families have struggled to pay off debt and cut spending, only the Federal Reserve and fiscal stimulus programs have kept the economy afloat.

And that means big trouble when those supports are withdrawn.

Tiomkin says a big rise in stocks such as we experienced in 2009 is not unusual after such a deep fall, and that those advances often lead to deep declines — and will again this time.

“We could see 8,000 on the Dow, easily,” Tiomkin says.

Dennis Delafield, co-manager of the $700 million Delafield Fund, says investors are finally realizing what everyone else has already figured out: The recovery won’t be strong.

[My emphasis]

This supports the tune I have been singing since the middle of last year in that the recovery is floating on nothing but air bubbles based on stimulus packages. While I am not sure whether Dow 8,000 is a reasonable downside target, a severe correction is all but guaranteed; I am just not sure when it will happen. However, given the strength of last year’s rebound, we may be closer than we think.

All it takes to unravel this market is a major economic event, externally or internally, or simply realization that the recovery is showing signs of a slowdown and not turning out to be as strong as was priced in by the market.

Stimulus programs can’t be enacted forever. However, I could envision them coming back with another vengeance after the next market drop. This will result in another rally followed by another downturn. As I posted in “Going sideways for 5 years,” that’s why I believe in a “w” type of sideways pattern with wide ranges and not narrow ones as was suggested by the reader.

Of course, this is just my guess, but it does not really matter whether it turns out exactly like I envision, or whether we see a scenario unfolding with a slightly different outcome.

The key is that you need to control the downside risk at all costs, and that means to never ever invest in anything without an exit strategy.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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