The Dow Disappoints ... more to follow       Sept.  2001 - Issue 13

In April of this year we wrote in "Greenspan Hangs tough" that whilst the tech heavy Nasdaq was well into a bear market, as was the broader based S&P 500 index, the psychologically important Dow Jones 10,000 level was a 'line in the sand' and, if breeched, would deeply effect investor sentiment.

Well, here we are, a short five months later and the 10,000 level has gone, and gone with a vengeance. Whilst no doubt the odd politician, central banker and indeed the occasional fund manager may try to suggest that the recent collapse was due to the tragedy of 11th September in the US, the slide had already started and was very likely to accelerate regardless of any event such as was viewed on that tragic Tuesday.

As can be seen from the chart, the Dow had been falling since its' peak value of 11723 reached back in January 2000. Although in a downward trend channel since that peak, as witnessed by the bold maroon trend channel, the 10,000 'line in the sand', as evidenced by the dotted horizontal line, acted as a strong support for the Dow right up until the end of August 2001, albeit that it was severely tested in March of this year. Our earlier commentaries had emphasised that when the 10,000 level was again breeched to the downside, it was always likely to not only retest the lows of March but accelerate towards the lows of October 1998 at the 7500 levels. The judge is still out.

The economic backdrop to the US financial markets had already markedly deteriorated after the excesses of the late 90's liquidity induced boom. Excess capacity fuelled by excessive debt accumulation by both individuals and corporates, were always likely to be followed by a multi year unwinding. It is the nature of economic cycles. The Dow is merely following the broader market indices lower. Of course the immediate reaction to the recent catastrophe was that of increased selling of stocks, human emotions have as yet to be re-programmed! But the 10,000 level had already given way and was likely to accelerate.

Meddling and alleged manipulation by Government and Central banks on the way up greatly distorted fundamental market valuations, luring into the markets a generation of investors believing that annualised returns of 30% were the norm. Government, which is already too large, have increased their meddling as the downturn becomes more obvious, ensuring that the results will be worse than if market forces were left to find their own equilibrium levels.

In the weeks following the recent attack on the US, a barrage of legislation and proposals have been forthcoming. The US congress authorised a $40 billion to counter terrorism, rebuild and subsidize. Central banks created $300 bn of new money out of thin air; compensation of huge proportions are immediately offered to selected sectors and it's even muted that Investors who bought at the top (at ridiculous levels) should be compensated for their losses. Nobody stops to ask 'where does all this money come from?' The answer is that it is sucked right out of the private economy, at a time that it desperately needs it. One way or another, the new cash will come from the private sector, either from taxes, debt payable later, or inflation. Regulators have flexed their muscles, waging war on short sellers (an important component of free markets) and consideration of criminal prosecution against businesses who charge, what they consider, too high a price. Especially daft is the idea that Manhattan real estate prices should be fixed at the pre-attack level.
As office space is suddenly highly limited, this makes no sense as it will discourage new building.

Governments will call for increased taxes, national ID cards and industrial bail outs. An increase in eavesdropping by government will regulate Internet Service Providers, ensuring that this engine of economic growth over the past decade slows.

Returning to the Dow, where to now? Calls for patriotic buying and the aforementioned monetary stimulus may just provide a decent rally, but it is unlikely to last. Even after its' 26% fall since the aforementioned peak, it is priced for a bull market high, not a bear market low.
A massive issuance of new Dollars will ensure that existing ones are devalued, exacerbating the selling by foreign investors.

Denial is still too prevalent in professional investor and private alike. As of 26/9/01 the AAII investor sentiment survey read Bulls 51%; Bears 22%, far too complacent for a market bottom.

In our earlier piece, mention was made of Goldman Sach's perma bull, Abbey J Cohen, who suggested a year end Dow target of 13000. This would now necessitate a near 50% rally over the remaining quarter of 2001. We don't think so. A more likely scenario is that the trend channel is now widened. The thinner maroon line on our chart indicates a possible trading range going forward of 7000-9000 for the Dow. 9000 may be seen but please do not hold on for a return to 11723, let alone 13000.