Dow Jones at 6,000?

Therefore, investors should continue to sell US equities on any rallies, as weakness in high tech stocks will spread in time to all other sectors. Moreover, my target remains for the NASDAQ to eventually bottom out at below 1,000, the S&P 500 around 700 and the Dow at 6,000.

To many market observers, the continuous bullish stance of US investors, even after the sharp NASDAQ decline from its high in March, the collapse of Internet companies and recent earnings disappointments of major companies, has come as a big surprise.

Up to now US equity mutual funds have this year attracted more than twice the comparable year-earlier total. Obviously, the public's optimistic expectations with respect to the future stock market's performance have not been dented. Neither by the sharp decline in the NASDAQ, nor by the spate of companies' earnings shortfalls and the oil price surge.

The fact that recent unfavorable developments have had little impact on investors' psychology isn't entirely surprising, though it shouldn't provide current shareholders with much comfort about the market's future resilience to adversity.

As I have explained in the past, an investment mania has much to do with mass psychology, crowd behavior and 'herd instinct'. What is important to understand is that individuals long to be part of a crowd, and once part of a crowd, they behave very differently than when alone. The 'voice of the herd' is a powerful driver of people's actions and it is common for crowds to identify themselves closely with one or several leader and an idea.

According to Sigmund Freud, the leader has a similar impact on the individual as a hypnotist: the individual loses himself by identifying himself with the leader. Thus, there is an intimate relationship and close association between a leader or an idea and the crowd, and over time the crowd becomes totally dependent on its leader or on the idea in which it believes.

Moreover, because of the intense attachment of the crowd to its leader(s), the loss of the leader or of his 'prestige' usually leads to a panic. Freud explained that ideas can also be 'the leader' of a crowd, and the people who represent them become, in such a case, 'secondary leaders'. This would seem to be the case during investment manias.

The idea of 'large profits' is the driving force of the mania, while the successful investors, central bankers and speculators, who enjoy great prestige and are written up in magazines and interviewed on television, are the 'secondary leaders'.

In an investment mania, the imagination of the crowd is captured by the notion that great wealth can be gained from participating in the boom. And, therefore, instincts, simple reflexes (Pavlov), release impulses, self-perpetuating habits, the suggestive power of the media, association with and imitation of successful investors, emotional excitement, insistence and irrationality, all override 'individual judgement' and 'thought'.

Driven by these impulses, the intelligence of a crowd is always inferior to the intelligence of the individual. Already Gustave Le Bon observed this in his book, 'The Crowd.' He wrote that, 'the reasoning of crowds is always of a very inferior order' and that, 'however great or true an idea may have been to begin with, it is deprived of almost all that which constituted its elevation and its greatness by the mere fact that is has come within the intellectual range of crowds and exerts an influence on them.'

Among similar lines, Carl Gustav Jung wrote that a large group consisting of decent people is, in terms of morality and intelligence, like a large, stupid and violent animal, and that an assembly of one hundred very influential people forms a blockhead.

Typical examples of crowd actions are the witch-hunt, the crusades, communism, socialism, the Nazi movement, lynching, revolutions, and so on. What is of interest to us, in terms of the US stock market, is the question as to when a crowd reverses its expectations, abandons an idea, or panics.

In other words, when will the investing public abandon the US stock market and send stocks through mutual fund redemptions to far lower levels? Common to crowds is a certain 'loss of touch with reality'. Le Bon says that the crowd is 'not prepared to admit that anything can come between its desire and the realization of its desire' while 'the notion of impossibility disappears for the individual in a crowd'.

Le Bon also adds, 'a long time is necessary for ideas to establish themselves in the minds of crowds, but just as long a time is needed for them to be eradicated.' At the same time panics occur when there is an imminent danger or when the association and sentimental attachment of the crowd is weak or has been weakened by the loss of 'prestige' of its leader.

According to Le Bon, prestige is a mysterious force, which gives 'great power' to ideas propagated by affiliation, repetition and contagion. He writes that, 'prestige in reality is a sort of domination exercised on our mind by an individual, a work, or an idea. That domination entirely paralyses our critical faculty, and fills our soul with astonishment and respect'. Prestige of a person or an idea is gained through success, but once success is replaced by failure, prestige is called into question and a panic can ensue.

Therefore, investors' faith in equities could be eradicated suddenly if there was a serious danger of loss of capital, a situation which would arise if stocks drifted down much further or if there was a sudden and unforeseen very unfavorable economic or political development. But, if we look at recent events, it is more likely that the continuation of the 'prestige' or success the stock market has enjoyed in its 18 years bull market is now increasingly called into question.

This especially, given the large number of earnings warnings and the earning disappointments which were recently announced. Thus, while the high tech bubble has already been punctured, I expect that it will take quite some time before the idea that stocks will always outperform all other assets is rejected.

But, once it has been rejected, the idea will be out of favor for a very long time, as we know from Japan post - 1990 and from other asset bubbles, which came to an end (such as gold and silver after 1980). In the meantime, however, investors will have to continue to live with very high volatility, and recurring sharp bear market rallies.

Finally, I should like to mention that 'propaganda' plays a very significant role in the formation of crowds and their believes - a fact leaders like Lenin, Stalin, Mussolini, Hitler and Mao understood perfectly well. All these leaders had a very low opinion of crowds and believed that crowds depended on strong leadership, which had to be achieved by means of 'enthusiasms' and 'interest.'

Thus, in order to keep the masses in a state of easy manipulation (loss of critical faculty, credulous and receptive), they had to be relentlessly bombarded with propaganda. Hitler said that the propaganda could also contain some 'big lies,' since the crowd would never suspect a leader to be as reckless as to spread 'big lies.'

There is in my mind no doubt that the propaganda machines spreading 'big lies' have kept despots like Hitler, Mussolini, Stalin, and Mao, and so on in power for far longer than would otherwise have been the case. In the same way, a bull market can be kept alive far longer than one might think possible through clever propaganda, which aims to continuously fuel the 'enthusiasm' and 'interest of the investing public'.

This is not difficult to understand given the widespread monetary interest among politicians, corporate leaders, financial institutions, strategists, CNBC, CNN, and the public in the bull market never ending. Just about everybody gains from rising equity prices, large transaction volumes, merger & acquisitions, new issues, the launch of new financial products, large number of eyeballs or viewers, and so forth.

So the propaganda stressing the merits of equities will continue, and lead from time to time to the powerful bear market rallies, I alluded to above. The Wall Street propaganda machine will never admit that a bear market is already underway, but will advise investors to switch from one group of stocks into another in order to generate commission income.