By Martin Hutchinson
Contributing Editor
Money Morning
In February 1995, the U.S. economy was in great shape. The 1990-92 recession had been over for a couple of years, the Federal Reserve was beginning to ease interest rates, the Clinton administration was beginning to make progress on sorting out the United States’ modest long-term budget problem and there was this new thing called the Internet that looked as though it might bring some exciting new possibilities.
The stock market, too, was strong, with the Dow Jones Industrial Average broke through the 4,000-point level on Feb. 23, 1995, putting it almost 50% above the bull-market high of September 1987.
That level of 4,000 is equivalent to about 7,800 today, when you inflate it by the growth in nominal gross domestic product (GDP) in the intervening 14 years. In other words, if things were looking as good as they were in February 1995, and the market was moderately bullish as it was then, you’d expect the Dow to be around 7,800.
The Dow surged 2.85% yesterday (Monday), to close at 8,504. But the economic conditions we’re looking at today are nowhere near as strong as they were back in the spring of 1995. And that paints a somewhat bleak picture of where the U.S. stock market may be headed.
To get the ultimate doom-laden view, I talked last week with Robert Prechter, who for 30 years has run an investment company based on the Elliott Wave Theory, propounded in 1948 by Ralph Nelson Elliott. I’d wanted to meet Prechter ever since I had seen ads he ran in Barron’s back in the bear market days of 1981-82. The Dow was around 800 at that time, and he forecasted that the U.S. stock market was about to enter a huge uptrend, which might last as long as 20 years, and for which 3,000 on the Dow was only the first stage.
“Boy, he’s bullish,” I remember thinking – it was considered bold at that stage to forecast a Dow of 1,200, which would have been 15% above the index’s all-time peak set in 1972.
But Prechter was right.
He was also right in 1987, when he predicted the sharp bull market of that year would end, but that the pullback would be only a temporary problem before the market went on to greater things.
In the late 1990s, Prechter turned bearish, explaining that the “fifth wave” of an Elliott Wave cycle – and therefore the bull market – was coming to an end. He was a few years early, but by following his advice after about 1998 you would have avoided a decade in which your money made an all-in return of approximately zero.
He was still bearish in 2003 – as was I. In cash terms, we were both wrong and went on being wrong for the next four years, as the Dow zoomed from 8,000 to around 14,000. Of course, as he pointed out to me last week, if you accounted in gold, stocks had in fact declined somewhat between 2003 and 2007. It’s not the Elliott Wave system’s fault that the denominator in the equation – the U.S. dollar – fell out of bed through excessive money printing.
Prechter even managed to call this year’s March bottom, expecting a substantial bear market rally at around 6,300 on the Dow, close to the bottom. However, he expects the market to resume its downward trend shortly, ending with a decline similar to the 86% in real terms of 1929-32 as we are in a long Elliott Wave downswing. That would take the Dow down to around 2,000.
Personally, I would not go that far. This does not look like a reprise of the Great Depression, although it could still turn into one with enough policy mistakes – another “stimulus plan,” or a big dose of protectionism, for example. However, the downward macroeconomic momentum looks bigger than in either 1974 or 1982, bear markets that both brought real-term drops of slightly more than 50% from previous highs.
The current crisis more closely resembles the British crisis of 1972-75, which caused a drop of 72% from the high, or the Japanese crisis after 1990, which brought a drop of 70% within three years, and led to a long-term bear market that has left that market in its current doldrums, about 80% below its peak. For us to see a similar 70% decline from the Dow high, we’d have to be looking at an index that had fallen all the way down to about 4,400. At that point, it would about as cheap as after the 1987 crash, though still not as cheap as it was in 1982, before the great bull market began.
Bulls will respond that corporate earnings are still above the levels appropriate for a 4,400 Dow, to which I would respond that profits might have further to fall. So far, we have seen only a collapse of financial sector earnings, while non-financial earnings remain close to their 2007 highs, when GDP was also at record highs. A period of higher corporate taxes and slow growth – coupled with consumer spending that’s low because U.S. consumers need to save, rebuild their asset base, and pay down their debts – could well cause a further period of earnings deflation, which would return corporate profits to their historical average percentage of GDP – if not to an even lower point.
Where Prechter and I differ is on inflation. He sees a further collapse of asset prices and debt values, with consumer debt and commercial real estate wreaking more havoc on bank balance sheets. That could cause massive price deflation, and a decline – rather than an increase – in the price of gold.
Personally, I look at the over-expansive monetary policy pursued by the Fed for a decade now, and its continuance, and see inflation ahead. Inflation would also help Uncle Sam finance those deficits, so it seems more likely than not.
That difference in opinion aside, Prechter was both charming and fascinating. Maybe we can combine our views, and agree that the deflation will be of the dollar’s value, so that prices will inflate in dollar terms, but deflate in such other hard currencies as the euro, the renminbi (China’s yuan), or the Brazilian real. We shall see.
The bottom line: While the market could go up a little further in the short term, it’s not the time to get aggressive.
[Editor's Note: When Slate magazine recently set out to identify the stock-market guru who most correctly predicted the stock-market decline that accompanied the current financial crisis, the respected online publication concluded it was Martin Hutchinson, a veteran international investment banker who is one of Money Morning's top forecasters.
It was no surprise to our readers: After all, Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives did in insurer American International Group Inc. Then, last fall, Hutchinson "called" the market bottom.
Now Hutchinson has developed a strategy for investors to invest their way to "Permanent Wealth" using high-yielding dividend stocks. This strategy is tailor-made for an unpredictable stock market that's backdropped by an uncertain economy. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]
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Hmm.. Money Morning always published a dozen of calls in opposing views… (bull and bear)…
Ultimately.. one of them is going to get it right and you can proclaim victory… like all other analysts.
Corporate earnings must fall. Double digit growth rates are unrealistic and firing American workers will help only for a flash – we cannot cut ourselves into profitability.
The Long Emergency (by Kunstler) has started indeed.
I side with Prechter on deflation. There will come a point in time when today’s bad medicine will morph into hyperinflation.
My Austrian grandfather told me about the Weimar Republic, about the impossibility of getting bank loans, etc. and how the deflationary world eventually flipped into an insane sea of paper money: he’d take a bucket of money to buy a loaf of bread – and in fact, eventually they would no longer count money, but weigh money.
Prechter is correct. Deflation pushes an economy from fear to a loss of confidence and on to panic printing presses. We are well en route.
The stock market is greatly overvalued and will have to adjust downward sooner or later. An appreciating market based upon hope is sure to spiral downward when the truth is known. Printing money to repair roads is addressing cash flow and putting some money in some pockets for a short period of time – it is NOT addressing the economic promlems. Those problems will grow and the economy will suffer. Metal commodies as well as food will escalate in price. Further printing of money generates a greater dilution of the dollar which will lead to hyperinflation for some years to come until the storm corrects all that has been altered.
Eugene Cerko
I have no doubt whatsoever that very shortly we will be
entering into hyper-inflation.Concerning China,who has given
the U.S.almost one trillion dollars in loans,what do you amagine
will be their temperment when our currency becomes all but
worthless.China does not fear us,and china can be most
aggressive in their dealings with government policys,or actions
they no longer trust.
My question is this,what do we ultimatly give them in
return for that loan.
I have recently started undestand better the fractional reserve system. It seems money is always created out of thin air. If there were a fixed supply of money and growth in goods and services we would have deflation. So then the question is who is printing the money. It is not economic growth which creates money, economic growth allows for money to be printed without inflation. However, the biggest issue I have with the fractional reserve system is where will the money come from to pay the interest. It seems the only solution is massive bankrupties. I think you know who I am sidding with for the long term.
…”Personally, I would not go that far. This does not look like a reprise of the Great Depression, although it could still turn into one with enough policy mistakes”….
then you don’t understand what is happening: there are no “mistakes”. this is the INTENTIONAL destruction of civilization. Its an open secret and its been written about by the very people in power now.
The nazi hell creatures who run our world, like that puppet uncle tom in the whitehouse knows exactly what they are doing. the key word is genocide.
Sheeple of the world: your ignorance and heartlessness have finally come home to roost and you are too corrupt to believe they would do this to you.
I totally agree with Ken Pipher. I’ve been ‘preaching’ for several years that I may not live long enough to see it but the flag that will be someday flying over our capital buildings will be the one already in place in China !! I may also not live to see it but the real culprit of the global meltdown is the population growth and the time will come when cannibalism will be as popular as sliced bread ! “Go forth and multiply” will get us there for sure. Thank you Pope and all religions !
Crash, baby, crash!
The best thing that could happen for the world as a whole would be for the stock markets to all crash down to nothing and then close down.
Stock markets are not real wealth – they are just a bunch of speculators shuffling money around and gambling on what the artificial value will be in a few hours. They don’t create wealth, they leech wealth out of the system by taking fees for their non-productive “services” and by avoiding doing any real work that would help the nation’s bottom line.
If all these bankers and speculators and “analysts” were forced to do real work of any kind, we would be able to produce real products and real services at lower cost and be able to successfully compete against workers from all over the world.
Having read Prechter’s Conquer the Crash, I think I understand the Elliot Waves and inflation/deflation pretty well now. In Chapter 9, Prechter makes the distinction between currency inflation and credit inflation. If the government were really printing money at the Bureau of Engraving, that would be currency inflation, which can go on indefinitely, and was the kind the Weimar Republic got from a desperate government that was broke and deeply in debt. But in the U.S. we have seen credit inflation. Bank deposits are created out of thin air when a willing borrower borrows money. That creation of deposits inflates the “money” supply. But credit is different from money. It is access to money, rather than money itself. Debt creation has acted like money creation since the 1930’s. Debt destruction, such as when a borrower defaults on a loan, destroys the extended credit. When that happens, the credit that acts like money disappears back into thin air. We have entered a time when the social mood behind Elliott Waves has turned toward conservation rather than expansion. To put it another way, people are not in the mood to borrow and go into debt. That means willing borrowers are fewer are farther between while debt defaults, especially on overpriced real estate, are accelerating. That means credit is being destroyed faster than it can be created, which is what happens in deflation. I recall reading within the last year that there is somewhere in the neighborhood of $64 billion in currency, and about $52 trillion in credit in the “money” supply. If most of that credit gets destroyed, we will see a massive contraction in money supply, and existing cash will buy much more. If all but $1 trillion of that credit were to be destroyed, for example, surviving dollars would buy about 50 times as much. If that credit contracts to just $100 billion, we could expect cash to buy about 500 times as much as it does today. And similarly, those in debt would owe roughly 500 times as much in real terms. Social mood is composed of people with minds of their own, herding as their way of coping with uncertainty. And until social mood turns up to favor expansion again, the only way we will get inflation is if the government actually turns on the actual printing presses at the Bureau of Engraving and prints actual currency. The government knows if they do that, however, that would be tantamount to government default, and they will not be able to borrow another dime without paying very high interest, and will then be forced to pay for all government spending with actual tax revenue, and will be strictly limited by taxes it can collect.
If you are trying to attracted business and you think you would like to attracted the people with money (baby boomer’s). Take a look at baby boomer’s next time you are out and about, you might notice that they are wearing glasses, that means they cannot see as well as they would like too, so why are you using a small font and why are you using a hard to see color, sorry just a question, but it also lets me know how smart you are!
Thanks for the article, and also to Robert (no.9) – could be Prechter himself talking, and I think he’s right. (Fewer thanks to Richard B., who needs to know that the Pope only represents one wing of one religion, a religion that is not at all against birth control, as the Greek Orthodox Church, Anglicans and others will confirm to him). But I write because Martin Hutchinson’s article contains one massive unlikelihood: ‘Maybe we can combine our views, and agree that the deflation will be of the dollar’s value, so that prices will inflate in dollar terms, but deflate in such other hard currencies as the euro, the renminbi (China’s yuan), or the Brazilian real’. I doubt that Prechter or many others could ally themselves with that, but as you say, ‘we’ll see’.
Robert are you saying that due to the government programs we are entering a time of inflation?
Very interesting comments
This article is misleading. After the 87 crash, Prechter turned
perma bear. He didn’t view the 87 crash as a temporary setback. If he turned bearish in the late 90’s it was only after missing the entire move from 4000 to 10000.
@john 87 was temporary, look it up. Try wikipedia.
A 2000 dow would prove to everyone I’ve been talking to that I am right. And it will happen soon!
I am saying that I agree with Robert Prechter that we are on the verge of seeing a massive DEflation, with a major wipeout of credit, and am preparing accordingly. We might see inflation start up AFTER deflation has made itself obvious to all. But barring the Bureau of Engraving starting up the actual printing presses to print actual currency, that won’t happen until people are on balance in the mood to ask for credit to start buying things once again. Estimates from Elliot Wave that I have read predict that to still be years away. More likely the government at some point is not going to have the money to honor its existing programs and start defaulting on them. But you can bet the government will make darn sure to honor its Treasury securities as a matter of its own survival.
My best guess for when the big drop written about should begin would be sometime in the late summer or in the fall. During that wave, we should see what Ellioticians call the “point of recognition”. That’s when the public will recognize unmistakably that the dominant trend has changed. And there’s an extra nasty with the current wave of what they call cycle degree – the breakout of war near its low. I think a couple possibilities for whom the enemy might be in such a war have become obvious in Iran and North Korea. It occurred to me recently there could be another possibility – civil war if the Obama administration crosses some red line such as trying to disarm the populace, which tens of millions would undoubtedly recognize as the administration putting itself in a state of war against the people. In light of the strong likelihood of some kind of major war, having some retreat to go to, away from other people, would be wise.
One last thing on 1987 – in the 1978 edition of Elliot Wave Principle, Bob Prechter predicted that 1987 would be a likely year for the cycle wave V bull market he was predicting to end, based on Elliot Wave guidelines on waves 1 and 5 tending toward equality. Guidelines, unlike rules, may or may not play out as predicted, and in this case that guideline did not. It turned out that the bull market he predicted lasted quite a bit longer than originally forecast, more closely rivaling cycle wave III than wave I in terms of time and magnitude, and the wave structure was not yet complete in 1987, and therefore the wave of social mood the stock market reflected was not yet over.
[...] (Prechter was recently interviewed by Money Morning Contributing Editor Martin Hutchinson. To read that report, please click here.) [...]