The DJIA closed at 13,211 today, down 146 points and change. Today’s sell-off is being blamed on troubles with American Home Mortgage (AHM), which is looking at liquidation and is now a penny stock. So the correction I prophesied in the past weeks is well and truly here. The DJIA is down about 800 points from its recent peak high.

I had noted in earlier articles in this blog and my MONEY newsLETTER that a correction was to be expected right about now, probably of 750-1,000 points on the Dow. And a correction is actually healthy if the bull market is to continue. That, though, is the $60,000 question.

No one, including me, knows when the next bear market will resume - or if it has begun. We all know that bull markets end, and we’re into this one over 4.5 years. Is it ending as we watch, or is this another correction before the market’s final lunge to a greater high (and then a bear market)? I suspect the bull has further to run, but at some point the “housing” chickens will come home to roost.

What most people don’t understand is that great bull markets are in reality built upon asset bubbles, which really are credit bubbles. Even going back to the Dutch tulip-bulb mania hundreds of years, they are built on credit bubbles. That is what happened in the 1990s bull, much the same as this one. Astonishing amounts of credit of all types have been sloshing around the planet. From the yen carry trade to the American housing bubble, the size of this bubble is almost incomprehensible. And it is ending. The popping of the credit bubble punctures the asset bubble… then the bear comes.

Bull markets sometimes end in a double top, but as in 2,000, it can hit a peak and fall a couple thousand points from there. In 2,000, tech and speculative stocks sold off hugely, with the bigger companies declining much more slowly. In fact, that is how bull markets build: the smaller stocks take off first, then the medium-sized ones, while the big stocks underperform, and eventually the big stocks take off, too, toward the end of the bubble. The big stocks really took off this year, some in 2006. Yet as the market made new highs this year, fewer and fewer stocks participated in the rise. The number of stocks trading above the 200-MA actually declined. But the amount of stock buying on margin hit all-time highs this year. This is all worrisome stuff, folks, not just a concern for worry-warts.

The credit bubble enabled homeowners to pull money out of their houses, and 75% of the growth in GDP the last few years - and most of the consumer spending - came from mortgage equity loans. That tap is pretty much shut off.

What would a bear market look like? Expect a decline of 20-25% from the market top. We’re talking about 3,000 points or more. If the current sell-off is a correction only, then no one should get bearish again unless the market is showing signs of unmistakeable robustness - large, medium and small stocks going up toward making new highs. If only the large stocks go up, this is a sign of flight to quality and not a real continuation of the bull.

Some industries remain strong - a good sign for bull believers. I suspect this sell-off is a correction, since not quite enough stocks are turning down, and because some industries remain strong. Still, like the soldier who puts his faith in God but keeps his power dry, covered call writers are well advised to take protective measures when the market starts tipping over - such as buying multi-month protective puts, which can be sold at a profit if the market recovers and exercised if it does not. Ditto for those who are not call writers but who are sitting on highly appreciated stocks.

In fact, I am so sure of a coming bear market, that I’ve decided to gear my next seminar in October to preparing students for call writing - safely and with extremely limited risk - in a falling market and managing trades profitably even when stocks drop. Of course, these strategies work just fine in good markets, too. I may even form mastermind groups from the seminar students to trade stocks in the bear market… something no one else has ever done, to my knowledge.

Zowie, the Dow Jones Industrial Averages (INDU) have hit 14,000 - couldn’t hold it yet but did hit it. Still a bull market? For that to be, the INDU must break through 14,000 and leave it behind. But where is the energy for such a move?

First concern: since the INDU’s March 2007 bottom, it’s up roughly 2,000 points without a real correction, unless you count the 400+ point drop in June. We could be seeing the beginning of the real correction, which would be very healthy for letting the bull run some more. Or the bull could be nearing the end of the run. I’m not a perennial bear like many are, but anyone knows a bear market when we’re in one. The trick is to see it coming in advance and construct trades in a way that does not cause real damage if the bear takes over.

Housing
Home prices peaked in October 2005, inventories are growing, housing starts are slowing and subprime defaults are accelerating. Over 30 subprime lenders have gone under. Even the Alt-A mortgage segment (better than subprime but not prime) is coming under pressure. Seriously tightened mortgage lending standards are slowing the housing juggernaut, which will depress housing further. This is very troubling: nearly 3/4 of the growth in GDP - the economy - over the last few years came from mortgage equity withdrawals (MEW - home equity loans), not from tax cuts, and the MEW game is severely curtailed. Without MEW to power consumer spending and corporate spending not taking up the slack, where will GDP growth come from that fuels the stock market?

This wasn’t a housing bubble, it was a credit bubble, and the credit has been largely choked off. Two of Bear Stearns’ hedge fund groups are worthless due to ruinous speculation in subprime lending. We are not even close to the bottom of this subprime mess. And housing has not hit bottom, not by a long shot; that won’t happen even in 2007.

Corporate Earnings
Earnings have hit record highs in recent years, and earnings growth in the last few years has been the strongest in over 50 years. We’ve had five years of stellar earnings performance, which has been responsible in large measure for the bull market and its new highs. Impressive. They seem to be starting to fall, though, though some analysts see a rosier picture. Right now, we see Google, Motorola, Pfizer, Caterpillar and others either reporting losses or guiding lower for the future. Business runs in cycles, it can’t always be higher earnings every quarter.

I’m not seeing how the end of the housing bubble and falling - or even stagnant - corporate earnings make the case for continuation of a bull market. What engine will power it onward? This Powerpoint presentation on Prudent Bear concerning the economic fundamentals and what it portends for the market is fascinating… I highly suggest you peruse it.

Covered call writers are highly encouraged to stop thinking in terms of every stock going up and to begin thinking in terms of protecting trades. A market sell-off could be the beginning of a new bear (as was the market top in January 2000) or could be a correction. How will we know? The answer is, we won’t know until the market blows all the way through the traditional retracement levels. By that time, unprotected covered call trades will be hurting us seriously, or we will have stopped out of them at losses.

Conservative covered writers should be prepared to protect themselves.

I make some timely suggestions in my latest MONEY newsLETTER article about using long puts to protect covered call trades - too much detail to go into here. Please check it out. You can subscribe to my free newsletter (just need first name and email) at CallWriter and you’ll get that newsletter issue in moments.

Please note that the markets will close on Tuesday, July 3rd at 1:00 pm Eastern Time. The market also will be closed on Wednesday, July 4th. So if anyone wondered why all the CallWriter lists cut off at or before 1:00 pm today, that is the reason.

The market will reopen at the normal time on Thursday morning, July 5th.

If a stock that you own was up or down on a short trading day, the movement is fairly meaningless. The reason is that everyone’s (the market’s) attention is on the holiday; and many traders left early… or didn’t come in. So unless your stock was a bottle rocket or really slid on a short day, it is almost always of little concern.