Cult of the Bear III: Getting to Dow 6800

Updated from Jan. 18

Part I of this series reviewed our stimulus driven, real estate-reliant, post-bubble economy. Part II looked at the cycles of bull and bear markets, and how history suggests trouble ahead for U.S. stocks -- despite the strong start to 2006, prior to Friday's wicked selloff that is.

Today we focus on how it could all come together or, as the case may be, come apart. I'll detail how to get to my 2006 target of Dow 6800 -- the lowest (by far) in the Business Week survey -- and lay out a scenario for how the S&P 500 could take a 30% haircut this year.

Before the Fall

With everyone so focused on the bearish year-end forecast, many have overlooked my expectations for early 2006. As the Business Week survey shows, my first half Nasdaq prediction of 2620 was the single most bullish in the group, while my mid-year S&P call of 1350 was in the top 10 of nearly 80 forecasters. I also forecast Dow 11,800 by mid-year. (For the record, the survey was conducted in early December.)

Why the bull call before the fall? Because that's how market tops get made: In the 12 months leading up to the October 1987 highs, the Dow ran from 1800 to 2700 (a 50% gain), while the S&P 500 sprinted from under 240 to about 340 (about 42%). From October 1999 to March 2000, the Nasdaq nearly doubled. Although I don't expect anywhere near those gains in the first half of 2006, the pattern could be quite similar: A leap to new highs on some widely held assumption, which subsequently turns out to be false.

In the present case, several suppositions potentially fit the bill: The widespread expectations that the Federal Reserve will halt tightening sooner rather than later and that the U.S. consumer will keep spending. And do you know anyone who doesn't believe earnings will remain robust?

Barry fielded some tough questions on his thesis from TheStreet.com's Aaron Task. To watch the video, click here.