Stocks: Where Do They Go From Here?

If there is one thing I have learned from years of investing and obsessing with stocks, it is that no investment goes up or down in a straight line. After days of going down, the stock market is entering a severely oversold condition, from which we can expect to see some bargain-hunting by the patient money sitting on the sidelines. As we all know, Warren Buffett has already started buying stock. So, in the immediate term, I see a rally naturally developing from today’s oversold market conditions.

But in the short term, it’s another story. The amount of technical damage to the stock market has been substantial. Just consider the following:

— Both the Dow Jones Industrial Average and the Dow Jones Transport Average have simultaneously hit new multi-year lows. This is a classic Dow Theory sell signal.

— The stock market performance yesterday was one of the worse single days we have seen in history. Of the approximately 3,200 stocks traded on the New York Stock Exchange, over 3,000 stocks were down.

— Outstandingly, over 50% of the stocks that traded on the NYSE yesterday hit fresh, new 52-week price lows.

Therefore, considering the amount of technical deterioration of the market, there is a very strong possibility that the Dow Jones Industrial Average will eventually test its 2002 low of 7,286. I only see two rays of hope:

The performance of the Dow Jones U.S. Home Construction Index has actually been positive. While the index is down 15% for the year, this important barometer of home-building stocks is actually up 3.3% over the past three months. This compares to a loss for the Dow Jones Industrials of 25% for the year and a loss of 12% for the past three months alone.

Secondly, the bond market has suddenly come to life. Bonds lead the market, thus the bond market is either seeing a better general business environment down the road or it is expecting sharp interest-rate cuts.

Where do we go from here? Consumer confidence in the economy has been substantially altered by all the continued negative news. Consumer spending this holiday season could be at a 10-year low. I’d stay away from the retail stocks, except the big discount retailers like Wal-Mart. Expect the U.S. Federal Reserve to reduce interest rates soon in the Fed’s effort to spur consumer spending.