No. of Recommendations: 6

In a primary bear market "Phase I" is marked by quiet, concealed, corrosive attrition whereby most individual stocks begin to sink. Diversified portfolios lose momentum, and speculative juices begin to crowd out investment disciplines. Hype begins to drive a narrowing sector of the overall market and big cap stocks, which support the popular sound-byte indices, begin to attract the money which is leaving the rest of the market. In effect, the "generals" continue their charge but the rest of the army fails to respond as the troops drop out.

The next phase, "Phase II", emerges when the "generals" start drawing fire and begin to drop out. At this point, most stocks have already declined substantially from their former highs and many diversified portfolios have taken on water. Year over year rates of return have begun to go negative. A general sense of unease has crept into the collective investor psyche. Those once great rallies fail to gain traction and flame out quickly, only to be followed by another sell off to a new low point. Traders get chewed up and spit out quickly by "Phase II" markets. Volatility becomes excessive. Daily movement, both up and down, is huge but produces no net gains. This process indicates that market liquidity has completely dried up. Investors begin to shift from frog-eyed optimism towards squinty-eyed caution or even glassy-eyed panic. The process repeats itself throughout all bear market cycles.

How about "Phase III"? This phase is the mirror image of the speculative top that ended the previous bull market. It sees rational investors cast aside their brains in favor of selling at any price. Whereas, at the top they couldn't resist the final urge to throw good money at stocks that made no sense, now they find an irresistible urge to sell perfectly good stocks at throw away prices. While this might be impossible for "New Paradigm" types to imagine, it happens every time. They just haven't lived long enough to see such a spectacle.

In my opinion, very powerful "forces" (the New York Fed, the Fidelity group, Goldman Sachs, the Janus group, etc.) will attempt to prevent "Phase III" from ever occurring. They might even be successful in this effort, but traditionally, "organized support" has never worked in the long run. It did not work in 1929 or 1930. It did not work in Japan in 1990 or 1991. In the short run, it DID work in the US market in late 1998, and THAT fact led to an even larger bubble being created in 1999. However, the "tools" available to the manipulators at that time have been taken away. The Fed has painted itself into an inflation box and must tighten to retain credibility. The mutual fund industry has spent out much of its cash reserves, reducing portfolio cash (as a % of assets) to the lowest levels in recorded history. Margin debt has exploded and the potential liquidity available from day traders armed with public "confidence" has been erased. Finally the public psyche is far more fragile today than it was back in 1998. Back then, there were still plenty of paper profits floating around and the public still believed in that old "Buy-The-Dips-The-Long-Term-Is-Wonderful" nonsense. In effect, the financial "industry" still maintained credibility and "analysts" were still gods.

Now, we have a slightly different "wrinkle". MANY OF THE OLD "SHOCK ABSORBERS" ARE BROKEN. Unlike 1998, an awful lot of stocks are well below year-ago levels. More significantly, some VERY important stocks suffer that distinction. A recent article in the New York Times pointed out that among the Merrill Lynch client base, AT & T and AOL are the two most widely held stocks. Both stocks are well below their trading ranges of the past year. At 37, T is almost 40% off its high and lies buried below its entire 45 to 60 trading range. AOL is also 40% off its high, and at 53, lies buried below its 60 to 80 trading range for the past year or so. Furthermore, AT & T's "hot" wireless IPO deal, AWE is buried below its offering price and all the idiots that chased the thing to an IPO premium, are now well under water. In effect, a lot of serious, frustrating losses have been geared into today's market compared to the 1998 market. This is yet another example of a "busted shock absorber". There is now "psychic damage" where none existed a couple years ago. BIG DIFFERENCE.

CONCLUSION: If manipulative attempts to prop up investor confidence are successful, then we will not see "Phase III". The manipulation is, and will continue to focus on "The Dow". That index IS the market for much of the "great unwashed". It dominates the sound-byte, instant analysis, media idiots. The daily gyrations of the "Dow" contain all the information needed for media idiots to deliver the financial news (or "entertainment" depending on one's degree of cynicism J ). The "Dow" is very easily manipulated, either through the derivatives market, or by targeting a half dozen of the highest priced issues. If "the boys" were to selectively buy four of the highest priced Dow stocks, such as JPM, AXP, IBM, and INTC (all over $100 per share) and then ramp 'em up, say, six points each, (preferably late in the day while no one was watching), the "Dow" would "pop" an amazing 100 points and the fish-eyed fools on CNCB would proclaim a "stunning" or "soaring" or "phenomenal" rally in "The Market". The public would be calmed, hope restored, and those pent-up plans to redeem mutual fund shares postponed yet again. This exercise is a guaranteed certainty, and it has been going on all year. Whether it can continue to "prop" up something that is trying to sink remains an open question. However, based on the lessons of history, such manipulation will ultimately fail.

IF, "Phase III" is introduced, it would likely be triggered by a fall in the "Dow" below its recent low around the mid 9000 area. If it drops below the 1998 high of about 9400 the panic mongers might have a shot at engineering just that - a panic. Keep in mind that there are also powerful forces "out there" who would like to see a crash to reestablish sound values and to flush out the speculative froth that entered the market in the late 1990s. These guys are far more subtle than the hype-meisters who constantly try to pump UP the market. These guys are also much smarter and more devious than the typical "establishment bull". If all this blather sounds like a conspiracy theory, well, it's not. It's a reality.

"Phase III", if it unwinds, would likely take place during an August-October time frame. It would see glaring headlines marked by the emotionally freighted words such as "Plunge", "Collapse", etc. and financial news stories would emphasize any and all "news" items that would reinforce the down trend. The old rule states "News Always Follows the Trend" (good news accompanies an up trend, bad news accompanies a down trend.) If a late summer decline starts to roll, there are strong seasonal influences that would pull toward an October bottom. For one thing, mutual fund accounting dictates that they wind up position squaring by the end of October. If they are collective sellers, they will attempt to finish by month's end. However, this year, most people believe the election will prevent a general collapse in stock prices because "they" (that anonymous aristocracy of superior intelligence) would not like to see such an event. Well, maybe, but predicting the future is always risky, especially from the vantage point of complete ignorance.

As the frog-eyes would say, "Stay tuned, film at eleven".

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