Dave, thanks for the good reading. I shortened. ( Part 3 of 3 )
ALL OVER AGAIN
In the 1929-1932 stock market collapse, one of the primary reasons for the
extended plunge was that investors bought shares on only 10% or 20% margin,
so that a moderate decline wiped out their entire investment, and triggered
a chain of margin calls that continued to depress the market until stocks
were trading at nearly a 60% discount to historic mean value (equivalent to
about 1200 for today's Dow Jones Industrial Average). In 1998 investors are
required to put up 50% margin, and most open-end mutual fund participants
have bought their shares with 100% cash. However, this requirement only
applies to individuals; hedge funds, brokerage houses, banks, and other
professional traders are still able to buy shares on 10% margin or even
less, depending upon the risk tolerance of their clearing houses.
Since such a large percentage of the money managed today fits into this
category, the triggering of margin calls is already causing a similar effect.
Many hedge funds and brokerage trading departments are teetering close to
amassing serious red ink, or outright bankruptcy, and must use every rally
in the market to sell in the hope of salvaging their business. This is
analogous to a large crowd of people trying to exit a room where there is
only one door and the smoke is spreading rapidly. The number of respected
brokerages which are suffering enormous trading losses is growing daily,
and this only reflects those which are honest enough to admit their red ink.
It is virtually certain that several respected names on the Street are not
going to survive the bear market. As these brokerages go belly up, whoever
assumes their remaining assets will be forced to liquidate them, further
depressing the market, as most mutual funds are fully invested and in a
period of net redemptions cannot afford to purchase shares even if their
fund managers believe they represent good value. At a critical point the
average investor will have a net loss on his or her stock holdings, which
historically is the point at which individuals will exit the market en masse,
as in 1931 and 1974. Although I had thought that this would take nearly a
decade, I have since revised my time projection by half. A long-term double
bottom is historically the most likely scenario. Because of the cascading
sell order pressure, I have reduced my official Dow bottom target from 2000
to 1500. The greatest point drop should occur in 1999 and early 2000 as
stocks initially regress to the mean for a resting period and probably an
election-year bounce in the second half of the year 2000 before resuming
their decline. The largest percentage loss is most likely to happen as the
bottom is approached in a final selling climax as the Dow goes from 3000 to
1500 (or less). Look for the Dow to first hit 3000 in the year 2000.
Of course, there will be sharp short-term rallies now and then, such as when
interest rates are lowered or pessimism becomes temporarily extreme
(the strongest short-term rallies in U.S. history were during the darkest
Depression days), but the cascade of sell orders heavily hitting these
upward moves will prove decisive.
My simple question to anyone who is invested in the stock market: Why?
The only reason before this year was "because it's going up".
Now even that statement is no longer true.
The primary difference between a gambler in a casino and an investor in
mutual funds is that the gambler knows there is a possibility of losing money.
We have seen the Goldilocks economy, but the full title of the story is "
Goldilocks and the Three Bears". Just as in the children's tale, the next
character to appear is Baby Bear; i.e., a Dow drop of about 25% from the
peak to some level below 7000. Wake up, slumbering baby boomers--Baby Bear
is here, and Mama Bear is waiting in the wings for her grand entrance. |
