Stock Market: Could the Dow Go To 5,000?

The Equity Rise Team recently had the privilege of attending a lecture by the renowned and nationally recognized economist Roger Arnold.  Roger is a sought-after advisor to hedge fund managers, government agencies, and very high net worth individuals (read:  billionaires).  He is a true expert at deciphering the relationships between political, economic, and social systems, and how they are all reflected in the financial markets.  So when it comes to economic trends both globally and nationally, interacting with Roger Arnold is much like the old E.F. Hutton commercials - when Roger talks, investors listen.  He was remarkably prescient in forecasting the collapse of blue-chip institutions like Bear Stearns and Lehman Brothers back when the concept was laughable to most.  Just this year, his thoughts from back in January on the 2010 directional behavior of the equity markets and interest rates have been spot on.

Hopefully that's enough of a build up to take what Roger has to say with some level of seriousness.  Because if you're planning on growing your nest egg in the current stock market, you may be in for disappointment over the next few years.  Although the Dow now hovers in the 10,000 - 11,000 range, Roger predicts it is heading to 5,000, and possibly lower.  In fact, some of his economist colleagues have concurred with this line of thinking, but take it even further to the 1,000-3,000 range.  So what could possibly cause such a slide in the Dow?  Hasn't the market shown its resiliency in the face of troubled economic times?  Well, therein lies the rub of why the markets have stayed strong FOR THE TIME BEING.

As Roger explained, there has been an unprecedented infusion of extremely cheap cash to banks as part of the stimulus packages.  This money was given to the banks with the good intentions of having the "financially smart folks" at the banks use the money to make more loans.  More loans means more economic activity, and more economic activity leads to the virtuous cycle of more consumption, more jobs, and improved earnings in our economy.  Unfortunately, the banks were not mandated to loan out this money - it was simply expected that they would do it in their own best interests and in the U.S. economic interests.  Of course, the banks had other ideas.  While sitting on stacks of bad loans and looking at ugly accounting books, the prospect of making even more potentially bad loans in the current economy wasn't too appealing.  Especially when they had other options for making money that seemed less risky and could bring gains more quickly.  Enter the stock market.  With the government handing them untold loads of money at essentially no cost to the banks, why not invest it in equities?  Well, they did.

If you've been scratching your head wondering why the stock market has stayed buoyed in the midst of a huge recession, you can thank the banks.  Actually, I take that back.  You can thank the U.S. taxpayers, who send their money to the government, who has been giving it to the banks (nearly free), who have been investing it in the stock market and reaping the benefits on their own books.  The problem is, this is an ARTIFICIAL situation caused by the errant allocation of massive stimulus funding.  There is NOT fundamental support of the stock market prices across the board.  In fact, the conventional institutional buyers - pension funds, 401(k) plans, mutual funds - have been net sellers as these prices have run up.  They are not the entities in the market buying at these prices and providing fundamental support for downward pressure.  Rather, they've either been sitting on the sidelines watching as the banks get free money to spend, or they've been selling to the banks as prices have risen beyond what the numbers suggest is reasonable.  This situation is untenable in the long run, and when the government's money flow stops or recedes, there is no conventional institutional support to keep prices this high.  And once that ball starts rolling downhill, there will be little to stop it in a recessional economy.  Hence, the prediction that the Dow will sink to 5,000 or below before fundamental forces - not government bailouts - take over to bring stability to the market.

So when will this occur?  To that end, Roger couldn't offer precision because of the myriad political and economic variables that always make "timing" a fool's game.  But the point is that directionally, Roger sees severe natural downward pressures on the stock market before we see any natural upside pressures.  There's only so much bailout money that can only last so long to keep things propped up artificially.  Of course, only time will tell if these are accurate predictions, but they were certainly made with some extraordinary insights and analysis that you won't typically hear in the mainstream media.   So while I personally have no idea if these are overly bearish sentiments, I thought Roger Arnold was eminently credible in his presentation (as always), so I wanted to pass along food for thought.