Citi Research Discusses a Dow Crash Scenario

I get to see a variety of Wall Street research reports, and one that came through the email this week was a shocker. No, it didn't come from a perma-bear who's been looking for the market to crash since 1960.

The report is from CitiFX, or Citigroup Foreign Exchange, dated August 24, entitled "We hold with our freaky chart scenario on DJIA.....BUT"

But what? I wish I could just post the report with its great charts, but it is copyrighted, so I will quickly boil it down.

The rocket scientists who put this together at the CitiFX technicals team looked back at 1987, 1990 and 1998. In looking at '90 and '98 here's what they say:

"1990: The Djia peaks on 17th July 1990 and turns. This is the start of a correction that takes it down 21.8% over 63 trading days over shooting the 200 week moving average by 0.5%
1998: The Djia peaks on 17th July 1998 and turns. This is the start of a correction that takes it down 21.6% over 31 trading days
2007: The Djia peaks on 17th July 2007 and turns. This is the start of a correction at a time when the 200-week moving average was sitting 21.50% below the peak."

Fascinating that the 17th of July is duplicated. CitiFX goes on...

"With the 2 prior occasions averaging 21.7% down over 47 trading days the sweet spot (If this correction goes according to plan) would be to see the DJIA at just below 11,000 on or around 19 Sept 2007 and no later than 11 Oct 2007."

For the 1998 and 1990 scenario, the report concludes: "Our base case view has for some time been the 1990 focus as equities got hit in the crossfire of housing and Kuwait while the credit crunch of 1998 also caught equities in the crossfire. As a consequence we believed (and still do) that the Equity move is the sideshow again not the main event. "

This CitiFX report also examines 1987 where the market was center stage. They call '87, "our much less desired/favoured scenario". But they point to a variety of situations in '87 that are similar to today:

• "The last 2 years have been very good years for the stock market in an extremely strong bull market that began 5 years ago.
• This has been fuelled by leverage buyouts/merger mania
• Massive amout of money raised by packaging low quality fixed income securities that have high interest rate due to high risk of loss
• Large IPO issuance
• Inflation concerns have become elevated
• We have a new leader at the helm of the Federal reserve.
• USD has been declining amid concerns about the trade and budget deficits
• U.S. long end yields have started to push up sharply again to new high in the move having corrected back for a number of months"

All of the above were '87 characteristics. Talk about deja vu all over again.

Says the CitiFX report, "As we have noted this is not our base case scenario, but smarter people than us who we respect have articulated concerns about a 1987 dynamic."

The report concludes: "Bottom line we hold our view that these are trying times and that the worst is not over. We also hold our view that lower yields will be seen in the months ahead on the back of credit, housing, the economy and equities. We believe that as this develops the Fed WILL show leadership, will cut rates as necessary and will ultimately stabilise the situation.
If we are wrong in this assessment then as we have said previously, without the Bernanke PUT we may have to entertain the idea of the Bernanke crash."

Will this come to pass? I have no idea - but it's food for thought that within the canyons of Wall Street, at a firm like Citi, this stuff is circulating.