The 10,000 mark means it’s time to short the Dow
EQUITY bulls must have felt rather smug last week when the Dow Jones Industrial Average (DJIA) broke through 10,000 on the back of bumper profits from investment banks JPMorgan and Goldman Sachs. Good results from Google, Intel and IBM also added to the market optimism that has been fuelling the index’s meteoric rise.
The third quarter earnings season had been widely tipped to give the market either a fresh boost or to direct it lower. So far at least, the former appears to be the case, much to the bears’ disappointment.
Should the momentum be maintained throughout the earnings season and companies consistently deliver results above market expectations, then the correction in the stock markets may fail to materialise, at least for the time being.
Tom Salmon, head trader at spread betting-provider ShortsandLongs.com, says: “The 10,000 level on the Dow remains the key figure and as we forge our way through earnings season it will remain so. Only after will we have a clearer picture to be able to view the latest rally. The current trend however seems to be to buy on the rumour and sell on the fact. And the rumour is certainly winning for now.”
For months, bears like Societe Generale’s Albert Edwards and RBS’s Bob Janjuah have been calling for a decent-sized correction in the markets. Even three months ago, many investors would have thought 10,000 on the Dow and 5,000 on the FTSE miraculous and unattainable levels that wouldn’t be seen for months.
But the $1bn net loss reported by Bank of America-Merrill Lynch on Friday brought the banking party to an abrupt end and encouraged investors to take profits, pushing the Dow lower to close at 9,995.91 for the week.
START SELLING
And with the Dow hovering around the 10,000 mark, many market players may be thinking that now is the best time to go short on the index and start selling US equities.
Writing on his blog, financial commentator Felix Salmon tells individual stock investors that the current rally has given them a chance to sell up and get out of the market with fewer losses than they would have incurred in recent months. “Of course, stocks could go up further from here. But that’s not the point. Unless you can afford to see your stocks fall, you shouldn’t be invested in them,” he says.
Spread betters currently long of the indices should take heed and start thinking about a contingency plan should the Dow, the S&P 500 and the FTSE 100 start to fall back Despite the scale of the rally – 60 per cent on the S&P 500, more than 50 per cent for the Dow and 50 per cent for the FTSE 100 – bears have long been arguing that the sharp rises have been based on very thin trading over the summer months and that too many would-be market participants are not getting involved because of the potential for a correction and relatively pricey equities.
Bear David Rosenberg of asset management firm Gluskin Sheff has argued repeatedly that this rally is based more on optimism than fundamentals. Even a good start to the third quarter earnings seasons doesn’t seem to have changed his tune.
He says: “Markets can go up because of few sellers, large buyers, or both. This has been, for all intents and purposes, a low volume rally, driven by traders and portfolio managers desperately trying to make up for last year’s epic losses.”
There has been an unprecedented expansion in the price/earnings (P/E) multiple of the S&P500 between the market low and the end of the downturn – this recession has seen an expansion of 9 times, compared to a previous high of 5 times in the post-war period.
Rosenberg notes that so far this year, and particularly the most recent period, the general public has made historically high inflows into fixed income mutual funds. “During the same time, inflows into equity funds have been very small, particularly in the context of a rare 60 per cent rally over six-months,” he adds.
With a lot of cash still sitting on the sidelines there is still plenty of opportunity for the market to correct lower and then consolidate. Spread betters currently long of the indices should take heed and start thinking about a contingency plan should the Dow, the S&P 500 and the FTSE 100 start to fall back consistently from their recent highs.
If the Dow does fail at current levels and strong selling pressure comes in, then you could realistically expect a pullback to around 8,500 on the index.
However, when going short on the Dow, you should ideally have your stop losses placed just above the 10,000 mark so that if we do see the index test and successfully break through this resistance level then your short position will be well protected.
If you are taking a punt on the S&P 500, then the next major Fibonacci retracement level of 50 per cent on the index is 1,121. With the index currently nearing the 1,100 mark, this could be a key level to watch this week.
CALENDAR THE WEEK AHEAD
Monday 19 October
William Hill (UK)
Apple (US)
Texas Instruments (US)
Tuesday 20 October
Greggs (UK)
Coca-Cola (US)
Pfizer (US)
BlackRock (US)
BNY Mellon (US)
Caterpillar (US)
Wednesday 21 October
Cadbury (UK)
Home Retail (UK)
Elan (UK)
eBay (US)
Morgan Stanley (US)
Thursday 22 October
Debenhams (UK)
Luminar (UK)
American Express (US)
McDonald’s (US)
Friday 23 October
BSkyB (UK)
Microsoft (US)