Top Line: A new down phase has hit the market but it should not last more than a week or more than 400 points.
Tuesday's action was not what we were hoping for but it isn't the worst news either. It is a nice test for the new bulls. Do they have what it takes to hold onto their stocks?
After the market makes a strong move in any direction, we should always expect a correction. Strong moves are normally pretty straightforward in their path. Corrections don't have the nice pattern to them and this latest pattern has turned into something stronger than we expected.
We thought the market wouldn't let anyone into the market, that it would make them pay higher prices. What we found out is that there is a lot of fear out there still and a selloff at this point allows more selling from those that now feel like they've had a good run and it's time to get out.
This downtrend has the ability to go down another 300-400 Dow points. That should scare a lot of bulls right there. So, let's review our situation. The Dow put in a low at 6470 and then rallied strongly to the March 26th high near 8000. Let's call that 1500 points. From there we are having a correction that will likely take us back down to the 7400 level in the next few days, let's say next week Wednesday (we pick that day because of options' expiration that week on the 17th). The move out of that low should be a very strong one and lift us to the 10K mark in several weeks.
Anyway, 7400ish in the Dow will feel like a very big selloff indeed which it's supposed to feel that way. We can't say for sure that 7400 will happen but after today's drop, it is a likely outcome. In the scheme of things, though, the low formed will be a solid low and be followed by an explosive rally. It will make the rally from the 6470 low look weak.
The reason is that this selloff will convince most that the rally is over for sure and that new lows will be forthcoming. When the market turns around, there will be a collective head scratch and then they will all change their minds and buy. This buying will persist for a couple of weeks and the Dow should run into some "round number" resistance at 10K and then fall back for a few weeks or trade in a range for that time. We expect a drop from the 10K level to about 8500 before we get the final push which should correspond to the first run which will have gone from 6470 to 10K or about 3500 points. That would take the Dow up to the 12K level which is how we arrive at this number.
When we get to the Labor Day period of time and if stocks have gone up as much as we think, there will be no more worries about buying stocks. All systems will be go and the green light to buy will be blazing. Memories of last fall will have vanished mysteriously and the New prosperity will be predicted. That will be the time for us to vanish--well, maybe just sell our stocks.