My Thoughts on the Dow’s New 52-Week High

And Why it Could be a Cause for Major Concern

Dear Bottarelli Research Member,

I’ve been predicting it for the last few weeks — and today it has officially happened.

As a quick refresher, I have been receiving a lot of emails from Charter Members asking me when it’s time to overload the ledger with puts. In response to these questions, I said that we needed to hold off in the near term — as I predicted that we would witness new 52-week highs on the major market averages before witnessing the next significant sell-off. Today that prediction is coming true, as we’ve just hit new 52-week highs on the Dow, S&P, OEX, SPY, and DIA (the NASDAQ, in case you’re wondering, is a total lost cause — trading nearly 50% off its last high-water mark).

Now here’s what I find interesting. If you look back at the stock prices of the Dow’s components the last time the Dow was hovering around 11,700, you’ll notice that 10 of these 30 Dow components are higher today than they were five years ago. Caterpillar (CAT – NYSE), for example, has gained 293% since last Dow high. And then you have Disney (DIS – NYSE) and Proctor & Gamble (PG – NYSE) hitting new 52-week highs today. Exxon (XOM — NYSE) has been strong, of course, but virtually everything else is notably lower since the last time the Dow was hovering around 11,700.

The question that I find reoccurring in my head is “if 20 out of the 30 Dow components are notably lower than five years ago, then what is driving this latest upside push?”

It’s certainly not CAT, because that stock has been getting hammered lately despite wonderful forward projections. Perhaps it’s the oil companies, but even they have gotten smacked down since mid-August. To be honest, I can’t quite figure it out. It’s like the market is rallying on nothing but thin air, and this causes me to get concerned.

In fact, in the shower this morning, it struck me that our current market environment is strangely similar to the situation we were facing in early May — which is the last time the Dow hit a new 52-week high. On May 11^th, for example, the Dow hit a high of 11,670. Everyone was jumping for joy, but that was certainly short-lived. By June 13^th, the Dow closed at 10,706, a whopping 964-point haircut in just over one calendar month. Ouch!

Now that we’ve once again reached these levels above 11,670, I think it’s wise to take a precautionary stance. That’s one reason why I took profits off the table on all our open call positions. It’s another reason why I continue to recommend holding our put position in JOE. Although the markets could muster up a few more days of upside gains, we’re getting awfully close to the day that the bulls become completely exhausted. So, if I could quickly dust off the crystal ball and take a peek inside, here’s what I expect will happen over the next three months:

In terms of this week, I think we’ll see the market continue to sheepishly rally to secure the new 52-week highs, and perhaps set a new all-time closing high on the Dow. This action will take us until the end of September. Then, starting in October, I suspect that we’ll witness heavy selling pressure, as investors and fund managers alike lock in their profits caused by the new 52-week highs. This profit-taking will reverse the recent sector shift I noted earlier — as money shifts out of tech (like Oracle and Cisco) and moves back into the top oil and oil service stocks that got beaten down recently. In fact, we’re seeing this today as both ORCL and CSCO are trading in the red and names like RIG, MRO, and VLO are all up (highlighted by new broker upgrades on VLO and FTO).

As we head into October, my thinking is to shift our directional bias over to the downside — which entails holding puts on non-oil names that have run up recently — in addition to holding puts on the weaker names that have failed to participate in the market’s recent upside swing. After all, if they can’t rally in good times — how can they rally during a down-turn? Quite simply they can’t, and that’s why we need to be holdings puts .

To equal out the ledger, I’d like to continue selectively picking calls on the oil and oil service-relates stocks that could be in for a rise in October as investors realize that these names are low and once again represent a good value — even if oil is at or under $60 a barrel (which it won’t be for much longer).

Then, as we head into November and December, I expect to see the markets attempt to stage an end-of-year rally — as investors once again get positioned in the names that did well for their portfolios in the first three quarters of the year. They can rationalize re-entering these names since they’ve come well off their highs. Of course, we’ll also see some end-of-year window dressing, as fund managers attempt to boost their yearly returns before writing their summary letters to their investors. This would cause some choppy volatility in mid-to-late December, but that’s nothing we can’t handle with quick call and put trading.

And finally, we’ll close off the 2006 calendar year with the Dow around 11,490, which is around 210 points lower than current levels but still 643 points above its closing level of January 3rd 2006 of 10,847, good for a 5.9% gain on the year.

As for today, I plan to spend the afternoon searching for possible call and put candidates to trade towards the end of the week — and early next week. When it’s time to act, you’ll be the first to know. Until then

Lock and load!

Sincerely,