Cult of the Bear III: Getting to Dow 6800

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 0.12493117.

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 Google (GOOG Quote) or Apple (AAPL Quote) has a miss, or simply lowers guidance to reflect the slowing consumer. Or perhaps Home Depot (HD Quote) and Lowe's (LOW Quote) feel the pinch of slowing housing and refinancing activity.

Given the heavily promotional holiday-price cuts, I expect that many retailers -- Wal-Mart (WMT Quote), Target (TGT Quote) on the low end, Tiffany (TIF Quote) and Nordstrom (JWN Quote) 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 -- Boeing (BA Quote), United Technologies (UTX Quote) and 3M (MMM Quote) are all vulnerable -- we can easily see a day when the Dow is down 300 points.