Market Risk: Why Upside Moves Will Not Be Easy

Mark this number down: 10,428.05. That is the closing value of the Dow Jones Industrial Average on December 31, 2009. I expect the market to soon turn positive for 2010, moving the Dow Jones above its 2009 close of 10,428.05.

Why will the bear market bring stocks back into positive territory for 2010?

The “head and shoulders” pattern that the stock market completed forming in late June of this year was likely the most well publicized stock pattern in years. Many analysts and advisors turned bearish on the stock market following the formation of the right shoulder of the head and shoulders pattern.

Yes, technically speaking there has been a lot of damage to the stock market. If the Dow Jones Industrial Average ever gets above its 2010 high of 11,258, it will be quite a feat.

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If there is one thing I have learned after a lifetime of studying the market, stocks rarely do what is expected of them. If the majority of stocks analysts and advisors are expecting the market to fall (as was the case earlier this month), the stock market will not bow down and oblige.

When pessimism reigns, the market moves higher.

The bear market in stocks, which started in late 2007, has only one objective: Bring as many investors as possible back into the stock market before taking stock prices down again.

We’ve witnessed the first leg of the bear market, as the Dow Jones Industrial Average fell from 14,164 in October 2007 to 6,440 on March 9, 2009. From there, when investors were exhausted and most pessimistic, the bear moved stocks back to 11,258 in April of this year.

There is no doubt that the second leg of the bear market will soon start. But it will be on the bear market’s own timetable and own terms. The retail investor took the pain of the drop in stock prices from October 2007 to March 2009, but retail investors in general were missing from the picture as the bear rally took stocks up almost 5,000 points on the Dow Jones from March 2009 to April 2010.

Before the second leg of this bear market takes its first step, I believe that the bear will do its best to lure investors back into the stock market. That’s why I called for Dow Jones 10,000 late in 2009, and later for Dow Jones 11,000 in 2010. And that’s why I believe the market will soon turn positive again for 2010.

Michael’s Personal Notes:

The technical definition of a recession is two down quarters of GDP. In the U.S., in late 2008 and into 2009, we had three consecutive down quarters of GDP. Loyal readers will remember that I called the recession in 2007.

The U.S. has now experienced three quarters of positive GDP, the most recent GDP report being a positive 2.7% for the quarter ended March 31, 2010. Most economists have forecast positive GDP for the quarter ended June 30, 2010 (not yet released by the Commerce Department).

Hence, and technically speaking, the U.S. has endured the most damaging recession since post World War II. But the effects of the recession and the fear of a double-dip recession are far from over.

Unemployment in the U.S. is still around 10%, banks are not lending to small businesses like they used to, and our annual deficit and national debt are at record levels. The housing market is still a bust, with millions of American homeowners living in homes that are worth less than the mortgage on them. May 2010 was the worst month on record for the sale of new homes in the U.S. Thirty million Americans are receiving food stamps, and one in five American children live below the poverty line.

Recession technically over? Yes. But we are far from out of the woods on this one.

What He Said:

“If I had to pick one stock exchange that would rank as the best performer of 2007, it would be the TSX (Canada’s equivalent of the NYSE). Interest rates in Canada remain very low and they are not expected to rise anytime soon. Americans looking to diversify their portfolios, both as a hedge against the U.S. dollar and a play on gold bullion’s price rise, should consider the TSX. Most brokers in the U.S. can buy stock on this exchange.” Michael Lombardi in PROFIT CONFIDENTIAL, February 8, 2007. The TSX was one of the top performing stock markets in 2007, up just under 20% for the year.