The Dow: The Real Deal, or a Bubble?

By Greg Perlin

April 2007

If you've read the financial pages or watched the news, you can't miss the headlines lauding the stock market's recent ascent. The Dow Jones Industrial Average shot up past 13,000 for the first time ever on April 25, 2007, and had closed higher in 16 of the past 18 sessions. Reasons for the surge have included decent corporate earnings reports, steady interest rates, and U.S. economic numbers that have been good enough to keep buyers on board. Amid the Dow's record climb on Wednesday, April 25, we had a better-than-expected 3.4 percent rise in durable goods in March, and new home sales moved higher for the first time in three months.

While investors seem to be cheering good news, what people aren't talking about these days is the one gauge that could derail the market in a hurry—inflation. If you trade commodities, you might conclude inflation is more prevalent now than ever. Just take a look at a chart of markets such as gold, copper, or gasoline since the start of the year and you can see the trend.

I believe inflation will force the Federal Reserve not to lower rates, (as some market participants are speculating) but to possibly raise them. Consumer spending drives about two-thirds of the U.S. economy, and less spending on goods and services coupled with higher interest rates could let the air right out of the stock market. Remember the sub-prime lending debacle that made headlines last month? While the housing sector may see some signs of life from month-to-month, overall, I don't believe the situation is improving.

Trading Strategy: Sell Dow Futures

I believe during the second quarter, the stock market is likely to see a sharp sell-off as investors realize things aren't quite as rosy as they appear. I would recommend selling June Dow futures at 13,150, and put a protective stop at 13,250. My target is a move down to 12,805.

When the general public is so overly bullish and the press continues to tout these record levels, it may be a signal the market is overextended and is due for a correction. Too much complacency in any market can really catch people off guard. Remember Federal Reserve Chairman Alan Greenspan's warning about "irrational exuberance" back in the late 1990s, and the bursting of the Internet bubble?

For more specific trading strategies to suit your particular situation in this or other markets, please feel free to contact me.

Greg Perlin is a Senior Market Strategist with Lind-Plus. He can be reached at 800-437-4189 or via email at gperlin@lind-waldock.com.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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