This scenario won't collapse the market, but makes it vulnerable.
Perhaps the first-quarter rally has trouble gaining traction in the second. A modest downslide starts, as first-quarter earnings are reported. The bulls declare it a mere retracement and buying opportunity. But it turns out not to be; by the second quarter, the cyclical high for 2006 already has been put in.
How does this possibly get us to 6800? The Dow is calculated via a divisor, currently
A point of each Dow stock's movement is equal to a little over 8 points on the index. It's not too hard to imagine that as earnings slow, stocks begin to soften. A loss of 5 points on each component adds up to a Dow drop of 1,200 points (40 points times 30 stocks = 1200) -- that brings us to Dow 9800. And that's only 5 points; a 10-point-per-Dow-stock drop would drive the average to 8600.
All it will take will be a modest earnings slowdown, and the Dow slips below 10,000. That happens, and apprehension levels rise in earnest. Dip-buyers who bought stocks 1,000 points higher are upside-down.
Now imagine what happens if any of the highfliers -- say
(GOOG - Get Report)
(AAPL - Get Report)
has a miss, or simply lowers guidance to reflect the slowing consumer. Or perhaps
(HD - Get Report)
(LOW - Get Report)
feel the pinch of slowing housing and refinancing activity.
Given the heavily promotional holiday-price cuts, I expect that many retailers --
(WMT - Get Report)
on the low end,
(JWN - Get Report)
on the high end -- will see the margin pressure impact earnings.
The spillover effect will be substantial. And if the same happens in any one of the pricier Dow components --
(BA - Get Report)
(UTX - Get Report)
(MMM - Get Report)
are all vulnerable -- we can easily see a day when the Dow is down 300 points.