How Big Will the Bear’s Bite Be?

07/17/2008 12:00 am EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of the Aden Forecast, say the current bear market may drive stock prices much lower—and the damage isn’t limited to the US.

Even though stocks had been rather lackluster, few expected to see the Dow Jones Industrial Average plunge in its worst June decline since the Great Depression. The market has spoken and it doesn’t like what it sees coming.

A major bear market is now clearly in force, across the board. This means the market is headed lower, it’s vulnerable, and a big drop is quite possible. This also means the economy will continue to worsen. So, what happened?

Despite all the bad news in recent months, the market was actually doing OK. But finally, enough was enough and the market cracked, under the pressure of even more bad news. With stocks now declining, it’s diminishing 401(k) accounts and on the heels of falling real estate prices, it’ll probably push confidence down even lower.

The risk is high for lower stock prices. Looking at the Dow Industrials, for example, you can see that it has formed a head-and-shoulders top. If this formation unfolds in a normal fashion, then the Dow could eventually decline to around the 10,000 level.

Interestingly, the average bear market decline over the past 50 years has been 29.2% on the Standard & Poor’s 500 index. Extending this average decline to the Dow and using its 2007 peak at 14,164 gives us a downside target of 10,000 as well. That level would also be near the 50% retracement, or halfway mark of the bull market rise from the 2002 low to the 2007 high.

A 50% retracement is fairly typical, and the actual 50% level is 10,725. And since the Dow’s leading indicator is not yet oversold, this could be the Dow’s next downside target. If the Dow were to close below 10,725, and especially below 10,000, it would be a bad sign.

The [booming] stock market days since 1982 are over and if the Dow were to eventually retrace 50% of its huge bull market rise from 1982 to 2007, then it could theoretically drop to near the 7,500 level, which would be similar to the bear market drop in 1974.

This weakness in the US market is clearly spilling over to the international stock markets, which isn’t surprising because the world markets always move together. Contrary to what many are saying, there is no disconnect. While the S&P is down 13%, the Europe index has dropped 20%. Renewed downward pressure is fully in force, making all markets vulnerable. In a full-fledged bear market, the good goes down with the bad.

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