The stock market has rallied over 50% since the March 2009 bottom, and investor sentiment has become increasingly bullish. With all of the bullishness in the air, smart investors should be a little concerned about the rally losing steam. The other day I stumbled across a chart of the Dow Jones Industrial Average from 1930, and it is strikingly similar to the chart of the Dow so far in 2009.
For those of you who aren't familiar with the charts during the Great Depression, there was a sharp sell off in 1929 followed by a 5 or 6 month rally, and then a devastating 90% drop from these levels over the next 2 to 3 years. Now how does that compare to the current state of the stock market? In late 2008, and early 2009, the stock market saw a steep sell-off of about 50%, and has rallied over 50% over the past 5-6 months. The big question is, will the Dow Jones roll over in September and October and continue to follow the path taken in 1930?
Currently the Dow Jones is reaching extended levels, and will find strong resistance at the great bear market down trend line which is coming in around the 10,300 level. Ironically enough, Jim Cramer says the Dow will not cross this barrier until a lot more good economic news is released. He expects a sell-off of 3-5%, but many analysts are weary of a double dip down to the March 2009 lows.
If the Dow cannot break through this down trend line, I will be more concerned about a potential 2nd Great Depression more so than just a double dip. A retest of the lows would take the Dow down to the 6,500 level, whereas if the market continues to follow the 1930's chart, the Dow could test the 1,000-2,000 level over the next couple of years.
This is a very scary notion, and presently seems impossible given the recent signs of a recovery. However, remember in 2008 few people were saying the markets would plunge 50% in just 6 months.
Currently, the housing market seems to be recovering, the auto industry is gaining footing, and the banks are strengthening. Unemployment has continued lower, wages and raises have stagnated, and there are still potential catalysts to sink the market. A commercial real estate bust and inflation are looming ahead.
The sectors that have begun to recover have been buoyed by government efforts, and there are still no signs that the consumer is ready to step up and start spending. Not surprisingly, the government aided the banks in the 1930's; however consumers were unable to spend to spur growth. Recent corporate profits have been driven by cost cutting measures, and not on pure growth. The economy is not nearly as rosy as the media would have you believe.
The Dow Jones is within a few percentage points of hitting its bear market down trend line. The Fall of 2009 should shed some light on how strong the upcoming sell off will be. For investors who have recently returned to the market, keep an eye on your investments and remember it can get worse, much worse.