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SL,- OT- Have seen Prechters analysis up close most of the time since '82. From '82 to '87 his calls were uncannily accurate. Since then, shooting blanks despite top notch and worthwhile analysis. Don Wollenchuck on the other hand is a top market timer that uses Elliott Wave Analysis and has caught the move up in the 90s often with what appear to be outlandish predictions that turn out accurate. The devil is in the interpretation-very hard to do. What about where we are in the cycle especially regarding the Kondratieff K wave cycle? Since 1990, I have believed the risks lie more with eventual deflation than inflation. The decade has witnessed disinflation, a great background for stock and bond market gains. Last fall disinflation nearly turned into deflation, but the Federal Reserve stepped in with three quick drops in rates and a liquidity infusion that "saved the day" and even one could argue, over-stimulated causing the excesses liquidity to flow into the one area susceptible to over-stimulation, the stock market. Deflation is still out there. Almost without question, a great driver of this economy now is the stock market. The wealth effect has allowed the national savings rate to go zero and below. The tremendous capital gains have kept housing and autos going full tilt. Consumers are confident and the unemployment rate is low. Despite this strong economy, there has been little inflation the past few years. Most companies have been unable to raise prices and some have even had to lower them-this despite a strong economy given extra boost from people spending everything they make and extra spending from great capital gains. What happens when the music stops? [and it will]. When the market experiences its first year of bear territory, what will consumers do? The situation will be reversed. Capital gains related spending will be greatly reduced. Consumers, seeing their 401Ks, mutual funds, and brokerage accts. decline will feel impelled to start saving again. A recession will ensue, but this time it will be potentially more troublesome because of the lack of recent recessions and the excesses that were allowed to build, [mostly related to stock market/employee options gains]. Corporate profits will suffer which will put further pressure on the market, as this market overall is priced for close to historic perfection. The peak in PEs in '29 were 22 and now are in the low 30s [some estimates are 50 PE if adjusted for accounting gimmickery like recurring non-recurring one time write-offs]. Dividend yield, market to GDP, and public participation measures are off the charts compared to any other period of market peaks. The '87 crash did little damage to the economy, because the public mostly wasn't in. Now every other truck driver and mechanic is involved. The impact of a bear market under these conditions is sobering. Signs of excesses abound including tract mini-mansions, a craze for shotguns going for $35,000 to $200.000, trucked in mature landscaping for new houses at $20,000 up for a mature tree, hand blown sinks $3500, huge waiting lists for the Porsche 911 Turbo which won't be out until next year, waiting lists for new private jets, etc, etc. If most companies can't raise prices under these high octane conditions, what will happen when the bear starts and the economy slips into a recession? In an effort to keep sales going and people and existing capital working, companies may very well find themselves dropping prices in a desperate attempt to keep sales going with greatly reduced demand. Deflation may have been put back in the bottle last fall, but it is still there awaiting its return when conditions are right. Now, maybe the Fed. is so competent, they can again jump start an ailing economy, or make a very soft landing, but at some point the excesses will be unwound, there will be a bear market [of more than 3 mo. duration], and it will be very tricky to manage. Japan has not managed the transition from their speculative excesses peaking in 1989 very well. Dropping interest rates to 1% sure didn't stem the deflation or stimulate the economy. Long gone are the days of '89 when heady stock market geniuses would sprinkle gold flakes on their sushi. The US does not face the real estate or banking system excesses they had, but signs of other market driven excesses abound. At some point, probably between 6% and 7% long bond rates, this market is in trouble, which means the economy is ultimately in jeopardy because of the intertwined relationship that now exists between the stock market and the economy. One huge potential beneficiary of this scenario, if and when it occurs, are US Government treasuries, especially the long end. Under the described conditions, long Govts. could dip not only to last years low of app 4.90% but could swing all the way to 4%. A purchase made in 6-7% area could provide good capital gains [30% or more plus the coupon-even more with Govt. zeroes] where few other things out there would be providing any gains, and many would be declining. Lets say for example one jumps in at 6 1/4% and is early and rates peak out at 7%. The 30 year bond would decline about 11% [offset by the generous state tax free coupon of 6 1/4%]. OK, How would stocks react to 7% rates? A ton would be down way more than 10% with no dividend to compensate. IMO, the reward vs. risk becomes compelling vs. most stocks at rates between 6-7%. The days of 200% to 1000% shooting star stock gains [over a brief span] are over. What occurred Oct.-April in terms of sheer sector mania may not be equaled in our lifetimes. Many stocks will have to scratch for any gains for awhile. Numerous stocks peaked 14 mo. ago. Others that are not overpriced or have a specific attraction may do well, but the bond market is about to provide a serious headwind for most. [One could also throw in a market discounting possible Y2K disruption in terms of playing havoc with capital spending and foreign trade]. In '87 rates went up through the spring and summer, and the market seemed oblivious. Inflation was much higher then, but the long treasury hit 10.3% the Fri. before the crash. [ I know, I went further on margin and bought a bunch of the 30 yrs. that day, only to be sold at a profit on Tue. after walking in to face a numbing margin call from my wayward stocks. Incidentally, and worth mentioning, the stocks I had were not the ones involved in the '87 excesses. I did not sell them before the crash, as I thought they were a good value and would not get hit very hard....WRONG! In a crash/big bear, they take the good girls and the bad girls]. Higher rates were ignored in '87, ...for awhile. This stock market is priced much higher than at the peak of '87, and inflation lower, so a rate that will cause serious trouble is debatable, but I would peg it at 6-7%. Bonds are becoming attractive, and the market less so. This is a somewhat one sided analysis, and ignores all the positives like new era economy, and technology led productivity increases, but the bull case [which has merits], is repeated so often, it seemed worthwhile to present a different view to stimulate thinking if nothing else. As Robert Prechter has said " A mania plays the genius for a fool and a fool for a genius, and then slays the fool for believing it." Thanks, Mike |
