Prepare for worst, market seer warns
An analyst who’s made credible market calls already this year says the real bear market is just starting. Plus, my 10 large-caps to offer some protection.
By Jon D. Markman
5/5/2004
Six months ago, astride the great Nasdaq rally of 2003, just a handful of analysts raised their voices to express concern about the dangers of a stock market driven forward far more by highly simulative government tax and monetary policy than by fundamental business conditions.
One was Michael Belkin, an elite independent researcher based in Bainbridge Island, Wash. In an interview published here on Oct. 22, the former Salomon Brothers analyst argued that the 2003 advance would end in a fourth-quarter skid mark, as “bubble fuel” was drained from the system in an “involuntary de-leveraging” process. Its main victims, he predicted, would be technology and housing-complex stocks -- and particularly shares of semiconductor makers such as LSI Logic (LSI, news, msgs). Beneficiaries, he said, would be the shares of large consumer products makers such as ConAgra Foods (CAG, news, msgs) and energy companies such as Amerada Hess (AHC, news, msgs).
For the next three months, Belkin was dead wrong. The market continued to shoot straight up, and readers e-mailed repeatedly to ask why we had given him any credibility. And yet now, with the passage of time, his views don’t look so dumb after all. The Philadelphia Semiconductor Index ($SOX.X) is lower by 5%, though LSI Logic is down by 15%. And most of the large-cap tech and biotech stocks that make up the Nasdaq 100 Index ($NDX.X) have gone nowhere, with Intel (INTC, news, msgs) down by 18% and Amgen (AMGN, news, msgs) down 6%. Meanwhile, ConAgra has jumped 23%, and Amerada’s up 35%.
The recent setback is nothing, however, compared with what’s coming, he says now. In an update interview this week, he said his research suggests that the market will revisit its October 2002 lows, and he is sticking to his prediction of a “high-volatility dislocation” -- you might call it a crash -- en route. He still singles out semiconductors as likely victims, but has now added emerging markets to a long list of investment areas he expects to get clobbered; meanwhile, he still likes consumer products companies and energy as potential hedges, though he doubts they will provide positive absolute return.
The dawn of the ‘real’ bear market
His most interesting assertion is that it turned out that March 2000 was not the peak of the bull market that began in 1982: It was only the peak for the S&P 500 ($INX), Dow Jones Industrial Average ($INDU) and Nasdaq ($COMPX). The agonizing bear phase that followed in those groups over the ensuing 2½ years was counterbalanced by a steadfast rise in small-cap and midcap stocks, particularly ones categorized as value plays. In other words, agile money managers were able to sidestep the big-cap growth bear market by switching to, or hedging with, small-cap and midcap value plays.
When the S&P Smallcap 600 ($SML.X) and S&P Midcap 400 ($MID.X) indices reached historic highs in October last year and continued to make new highs through March of this year, bulls asserted that their success showed the bear market had ended and a new secular bull market had begun. But Belkin’s view is that the real bear market is only now set to begin, with all market capitalization, sector and style groups -- not to mention foreign markets -- pushed to extreme valuations by an imprudent monetary policy that set interest rates far below the inflation rate.
By allowing the official overnight federal funds rate to lag well behind the inflation rate, he says, the Federal Reserve made the worst of all possible central bank mistakes -- encouraging as much unproductive speculation in the past year as it did in 1999, when it flooded the world with dollars in anticipation of trouble from the Y2K bug. For this handiwork, he labels the men around the Fed board table “worse than the board of Enron” for their obsequious obedience to Chairman Alan Greenspan.
“They’re all total wimps; the board is all yes men, academics who just rubber-stamp their boss. And they’ve now given us the biggest bubble in everything that I’ve ever seen,” he said. “Through 2000 it was mostly the tech stocks, but now it’s everything.”
Belkin fears that emerging markets have the furthest to fall, because they attracted the most excess capital during the past two years. “When capital is fearless, when investors feel bulletproof, they put money into the riskiest areas,” he said. “That has pushed emerging markets into the worst extremes in my experience of about 20 years, including the periods preceding the big collapses in the ‘90s of Russia, Latin America and Asia. The Fed has essentially bubble-ized the whole world.” He estimates that the Nasdaq, S&P 500 and German DAX have about 42%, 30% and 45%, respectively, to fall to revisit their 2002 lows, but the Brazilian market could fall as much as 58%.
A rocky road ahead
Belkin depends on a model of the interconnected world market in equities, commodities and debt that he created at Salomon Bros., and updates every week with fresh data. Many of his measurements are proprietary, but in the big picture, his model sees all markets as big expansion and regression machines, always moving to extremes in one direction and then contracting to a baseline and shifting to the opposite extreme. His data show that the appetite for U.S. equities “has been rotting from inside all year,” despite tremendous inflows of cash into mutual funds from investors earlier in the year.
The peaks of inflow came in the first few weeks of the year, then tapered off, then hit a crescendo again the first week of April, and have since tapered down back to lows. His view is that when the market can’t make progress after that much fuel, investors inevitably get frustrated and slow or halt their contributions. And then the real trouble comes when fund outflows begin.
The analyst said he has been warning his clients, primarily large U.S. and European financial institutions “not to get caught up in the Fed con game and positivity,” and to prepare for the possibility of a “high-volatility collapse” that will see a return to the treacherous, unstable days of 5% up and down days in the Nasdaq. “The declines after bubbles are more violent and pronounced the more people are positioned wrongly, and I’ve never seen so many people on the wrong side of everything -- bonds, emerging markets, small-cap stocks, and techs -- just as inflation and interest rates are getting ready to explode,” he said. The Fed, he believes, can hold back interest rates only so long, and then the market prevails. In the past seven weeks alone, the market has pushed two-year and five-year Treasury bill yields up 90 basis points, which is the equivalent of almost four of Greenspan’s “baby step” 25-point moves. In addition to tech stocks, he believes the financial services group, especially brokers, will be hard hit.
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