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

Given the heavily promotional holiday-price cuts, I expect that many retailers -- Wal-Mart (WMT - Get Report), Target (TGT) on the low end, Tiffany (TIF) and Nordstrom (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 -- Boeing (BA - Get Report), United Technologies (UTX - Get Report) and 3M (MMM - Get Report) are all vulnerable -- we can easily see a day when the Dow is down 300 points.
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AAPL $93.74 0.00%
AA $11.17 0.00%
BA $134.80 0.00%
DD $65.91 0.00%
GOOG $693.01 0.00%


Chart of I:DJI
DOW 17,773.64 -57.12 -0.32%
S&P 500 2,065.30 -10.51 -0.51%
NASDAQ 4,775.3580 -29.9330 -0.62%

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