Seven Reasons Why the Bears Might Be Right

The stock market is poised at one of those very scary inflection points.

From here, it could fall another 3% on the Dow Jones Industrial Average or another 8% on the Nasdaq Composite. Or it could rally back to its March highs for a gain of 8% on the Dow or 13% on the Nasdaq.

Which will it be? Lower prices and more gloom? Higher prices and smiles?

News events that we can't now predict will certainly have a big role in settling the question. But I think I can make a strong case that we've got a 3% to 8% decline ahead of us before we can start looking for an end to this punishment and the beginning of the next temporary rally.

Count the Reasons

Let me lay out the case for believing that the stock market will fall further.

1. Technically, the stock market has broken down. The Dow Jones Industrial Average is now below its January 2005 low of 10,369 and has broken through both the 50-day and 200-day moving averages. With that major support for the index behind it, the next resting place is the October 2004 low at 9,750. The picture over at the technology-laden Nasdaq market is just about the same: The Nasdaq Composite is well below the Jan. 24 low of 2,009 and below both the 50-day and 200-day moving averages. There's decent support for the Nasdaq Composite at the September 2004 low at 1,879 and very solid support at the Aug. 12 low of 1,752.

2. Stocks haven't rallied on a decline in oil prices. And oil prices are more likely to tick upward than downward in the next couple of weeks. The flow of oil news has been almost uniformly positive of late, which has helped push oil prices lower. The news flow in coming weeks, however, seems full of the kind of uncertainty that makes prices move up again. With so much oil in countries with unstable politics, it's just a matter of time before some news item raises the oil market's anxiety level again. For example, the Venezuelan government has decreed that private oil companies will have to sign new contracts that give the state-run oil company a majority share of all oil projects. The government has also said that oil companies aren't paying enough in income taxes.

3. Forecasts of economic growth just keep edging downward. In some cases, the lower growth is a result of a weaker dollar raising the price and therefore depressing demand for a country's exports. So, for example, on April 14, the Bank of Canada lowered its forecast for growth in Canada's gross domestic product to 2.6% in 2005, down from 2.8% in its January forecast. In other countries, the culprit seems to be higher energy prices that are taking a toll on growth. On April 13, the International Monetary Fund lowered its forecast for European economic growth to 1.6% in 2005, down from 1.8%, and for Japanese economic growth to 0.8% in 2005, down from 2.6%.

4. The already frightening U.S. trade deficit will increase. With growth in the U.S. outstripping that in any of the other economies of the developed world, there is almost no chance that the U.S. trade deficit will fall, even if the dollar weakens further. Because the U.S. economy is growing, U.S. consumers and businesses are buying; because Japan and Europe are barely growing, buying in those economies isn't likely to increase much even if U.S. goods get cheaper thanks to a weak dollar (and a strong yen and euro). A rising trade deficit -- along with a continued lack of progress on reducing the U.S. budget deficit and on reducing the coming Social Security and Medicare shortfalls -- will keep the credit markets on edge. And that's never good for stocks.

5. The Federal Reserve will deliver more interest rate increases. Investors got a one-day reversal in the stock market last week when the release of the latest minutes from the Federal Reserve showed that the U.S. central bank wasn't thinking of raising rates in aggressive 50-basis-point jumps. But the minutes showed no wavering in the determination of Alan Greenspan and friends to raise rates in more gentle 25-basis-point lumps. Higher interest rates are still coming inexorably, just not as quickly as some investors had feared.

6. Technology earnings continue to disappoint. Latest case in point: IBMIBM, which on April 14 reported earnings of 84 cents a share, well below the 90 cents a share expected by Wall Street analysts. Revenue for the first quarter of 2005 climbed just 1% from the first quarter of 2004 after factoring out the boost from a weak dollar. With technology stocks in an earnings slump and financial stocks depressed by the prospect of rising interest rates, the stock market can't count on much from the sectors that usually lead market rallies.

7. The sectors that had been leading the market in 2005, energy and transportation to name two, are in the midst of a correction. This is absolutely normal in any rally -- and this decline will help build the floor for the next leg up in these sectors. But it certainly doesn't help the tone of the overall market. It's one thing to have IBM or Wal-Mart StoresWMT going down when Exxon MobilXOM and Burlington Northern Santa FeBNI are climbing. It's quite something else -- and very unsettling to the market as a whole -- to have recent leaders falling along with the laggards.

The Pain Isn't Over

Maybe last week's punishment was enough to shake out the weak hands and set up the next rally in what I still believe continues to be a range-bound stock market. For the week, the Dow Jones Industrial Average tumbled 3.6%, the Nasdaq Composite fell 4.6% and the Standard & Poor's 500 dropped 3.3%. And the week did finish, after all, with three days of 100-point losses or more for the Dow. Volume picked up into the close on Friday, always a good sign on a down day if you're looking for the Big Washout that marks the end of a stock market decline.

But my best guess is that we're not there yet. I think we'll need at least another week with a failed rally -- to suck in the last optimists -- and then another stretch of a few down days -- to spit them out again -- before this market decline is ready to call it quits.