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) -- The headline of my

Wellington Letter

on Sept. 14 was "October: High Risk for the Bulls." As they say in Washington, it's still operative.

We see many headwinds for the stock market. When Congress is in session, the stock market has historically underperformed by a wide margin. This time the effect should be even more negative, because of all the adverse legislation coming up for vote. The two biggest are health care and "the carbon tax." If these two pass, say goodbye to any substantial economic recovery over the next 10 years. Even worse, it will show clearly the direction of a once great nation as it commits economic suicide.

The "carbon tax," also known as the Markey-Waxman bill, is one of the most destructive tax programs proposed by any major government in recent history. It would impose a huge tax of trillions of dollars on most economic activity in the U.S. while our competitors abroad, such as China and India, continue to pollute and laugh all the way to the bank. The program is a reverse Robin Hood, with everyone paying and the proceeds going to a few.

In addition, the significant looming tax increases on Americans, both on the national and local levels, will be a great impediment in getting entrepreneurs to start businesses and create jobs. In fact, small-business owners will decide the struggle is no longer worth it, and they will reduce their workforce. If our politicians would get out of their limousines and talk to small-business owners, they would see that this trend is accelerating right now.

Until now we had expected economic growth numbers to be strong late this year because of the easy comparison to the same period last year. Therefore, those numbers will be very deceptive. The big, smart traders will use any buying from the public to sell into. After all, the stock market has rallied on fumes, hopes and expectations. It will be the typical case of "selling on the news."

Furthermore, any economic strength will arouse fears of


tightening. We already hear economists suggesting that the Fed has to withdraw the stimulus, and possibly hike interest rates, in order to prevent inflation -- that's like worrying about a blizzard in the Sahara. Therefore, strong economic numbers may be greeted with a stock market decline.

Economic growth comparisons will be less favorable next year. The various stimulus programs are expiring or have expired. One is the "Cash for Clunkers" auto program. Many consumers who bought a car with this program will suddenly find they can't make the payments on the additional $20,000 to $30,000 of debt.

Then we have the tax credit for buying a home. The expiration in November is causing a rush to buy now. In a number of states, the foreclosure moratoria are expiring, which will accelerate the foreclosure avalanche. The government's mortgage modification program is being overwhelmed by the deluge of increasing defaults. Now it's not just subprime -- prime mortgages and jumbos are seeing accelerating defaults.

And the biggest problem with any temporary stimulus is that it borrows from future activity as consumers move up their big purchases to take advantage of the incentives.

On the technical side, the summer part of the rally was caused by easy manipulation of stock prices by the big trading operations in a low-volume environment. The smallest and fundamentally worse stocks had the biggest gains. The astute analyst Rob Arnott calculated this: starting in April and using stocks in the Russell 1000 index, stocks over $50 a share had a five-month gain of 22%. But the stocks below $5 had gains of 116.9%. Whenever the low-priced stocks lead a rally, you know it won't last and is just short-covering. The worst stocks logically have the highest short positions.

Stocks are extremely overvalued, more so than at the 2007 bull-market top. And jobs aren't coming back. The consumer is 70% of the economy. Where will he get the money when he doesn't have a job?

Now traders are back at their desks after the long summer rally. They see that bullish sentiment is extremely high. That's bearish. They will find today's ludicrous prices appetizing for selling and short-selling. Additionally, mutual fund managers have bought the past several months just because stocks were rising, not because they thought stocks were bargains. But the smart money is using the strength to sell. This is called distribution, something we have noticed for the past several weeks even as the major indices went higher.

The bulls tell us that there are trillions of dollars "on the sidelines." Well, it's about the same amount as one year ago, just before the crash. Betting on that money coming into stocks is a sucker bet.

Sentiment among analysts is now at the most bullish levels since the bull-market peak in October 2007.


futures traders are more bullish than at the 2007 top. When everyone is on one side of the fence and totally complacent, the market is usually close to changing directions.

Finally, we have the fact that the major indices are now close to the point of the start of the global panic of October 2008. In any market, once it gets back to the start of the last plunge, there is huge resistance and the rally is likely to end.

The stock market has closely correlated with the price of oil over the past year. The connection is the appetite for speculation. Thus, when you see oil plunging, and the dollar rising, it's time to get out of stocks for a while.

(We discuss even more signals in the

Wellington Letter


The bottom line: Today's stock prices reflect the most optimistic and euphoric scenario for the future. I believe reality will return to the markets in October. The fairy tales of a "great recovery" will diminish. The inevitability of much higher taxes and possible trade wars to please the labor unions will sink in. The ability of the U.S. leadership will come into question. Rogue nations such as Iran and North Korea will be playing "cat and mouse" with the U.S., knowing there is nothing to fear from the current U.S. regime. The likelihood of Israel taking unilateral "survival" action again Iran's nuclear facilities will increase, which would unleash a Middle East war.

Smart money managers will raise cash. They realize that top-line growth in the corporate sector just isn't returning and that recent profit improvements are merely due to cost-cutting. You can't cut your way to prosperity. "Official" unemployment will rise to double-digit levels, although actual unemployment is already approaching the 20% area. Congress will consider the stupid idea of a second stimulus plan even though the first one did nothing. It means more of our money down the drain and flowing to those who are well connected. There are easy solutions, but they would never be considered by the current Congress.

Markets are psychological. After six months of euphoria, we will now start seeing the flip side.


Written by Bert Dohmen in Los Angeles


Bert Dohmen is a professional investor with 38 years of experience in the markets. The observations and important clues he obtains in trading his own portfolios in a wide variety of investment vehicles is of great benefit to all of his clients. He is a trader, not just a writer.

He founded

Dohmen Capital Research Institute

in 1977 as an economic and investment research firm. Over the past two decades, the firm's services have achieved the highest acclaim. The firm currently offers 10 services, including a long-term advisory service for the mutual fund investor that helps investors avoid the need for a money manager or financial planner. There are also fax and email services for short-term traders in stocks, options and short sales.

Dohmen's Wellington Letter has achieved numerous awards of distinction and is read by serious investors, investment professionals and corporate CEOs worldwide.