Dow will fall to 3,000, says Russell

published 31 October 2005

There's nothing like a month-long rally to calm equity investors' nerves," says Lex in the FT. US markets have rebounded from their 2004 nadirs of mid-August, with the S&P 500 having climbed from the bottom to the top of its trading range. But does this mean that US stocks could finally make a decisive break upwards?

Not according to Dow Theory, one of the most respected approaches to technical analysis, says Jaqueline Doherty in Barron's. This says that the Dow Jones Transportation Average and the Dow Jones Industrial Average both need to be hitting new highs for a real bull run to begin: "the transports haul what the industrials make, so a robust transportation sector should indicate a healthy industrial sector". But while the Transports have been hitting new 52-week highs, the Industrials are still off by almost 2% this year. The Industrials' failure to "confirm" the Transports' move shows that "there's a problem", says Richard Russell, Dow Theory's most renowned exponent. What's more, the longer the Industrials take to confirm the Transports' move by eclipsing their June highs, the worse it will get. This is hardly encouraging, but Russell's longer-term outlook is positively terrifying: he expects the Dow to slide to 3,000 before the post-bubble bear has finished its work.

So what could cause such a nasty slide? One worry is the burgeoning budget deficit, given that the baby-boomers will begin to retire in four years' time, says Russell on his website Dowtheoryletters. com. If you factor in future liabilities, such as Medicare payments for the boomers, America's fiscal gap balloons to more than $40 trillion, implying that drastic tax hikes and expenditure cuts are needed to close the gap. In addition, "it seems only a matter of time" before debt-addled consumers - whose savings have reached historic lows - rein in their spending; indeed, "it's happening in certain areas already", as weak car sales attest. Companies' cash hoarding also implies a lack of confidence in the economy. And with the S&P on a p/e of 20 and yielding just 1.76%, the "great move" back to undervaluation - a p/e of 5 to 10 times - that generally follows a huge bull run is far from complete."Just as in 2000, stocks climbed higher than almost anyone thought possible,I'm betting that stocks will sink further than even the bears think possible."