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Prechter goes for the gold <bg>...
For an enhanced HTML version of the Money Daily,
visit http://moneydaily.com.
Weekend, July 26-27, 1997
Dow 400? One analyst thinks so
Sure, a 95% correction is way too extreme to take
seriously, but the rationale behind it -- that we're in a
manic market -- is food for thought
A Briefing Room special
by Michael Brush
Among the handful of stubborn contrarians in this raging
bull market, one stands out for the sheer boldness of his
projection: Dow 400.
No, not down 400. Not even a retreat to 4,000 from the
current level of around 8,000. But Dow 400. Two zeros. As
in: A 95% drop that would set the clock back to 1955.
Sound kooky? You bet. But Robert Prechter, the market
analyst behind the doomsday scenario, makes some
provocative points on his way down to Dow 400.
Chief among them: Today's market, he says, bears the
hallmarks of a dangerous mania. If he's right, we're all in
serious trouble. Why? Because when market manias
unwind, they do so in a big way -- they usually wipe out
all the gains that were earned during the manic phase ...
and then some.
But before we get into wether we're in a market mania
now, it is worth noting that Prechter is not a maniac. His
newsletter, The Elliott Wave Theorist, ($233 per year;
twelve monthly issues plus several special reports;
www.elliottwave.com/index.htm), boasts thousands of
subscribers. Prechter is also the author of a book , "At the
Crest of the Tidal Wave."
Like his book, Prechter's newsletter examines the
markets by applying the principles of "Elliott Wave"
theory, developed by an accountant named Ralph Elliott,
who lived until 1948. Elliott Wave theory is a form of
technical analysis that says the market is characterized
by a limited number of patterns that repeat over time
periods as short as minutes and as long as decades and
even centuries.
The upshot of Prechter's gloomy analysis: The markets
have reached an apex in a century-long wave, and are now
poised for a correction that will wipe out virtually all
their gains of the past several decades. Sound far
fetched? Join the crowd.
"That is not even worth a comment," says fellow bear
David Shulman, the chief equities strategist at Salomon
Brothers. Shulman's more mainstream bearish outlook
calls for an advance to 8,500 and then a decline to 6,800
in the near term.
"I have always found it dangerous to be on the extreme end
of any issue," agrees Hugh Johnson, the chief investment
officer of First Albany Corporation. "And it would be
putting it mildly to say that a forecast of 400 is on the
extreme."
To be fair, Prechter's newsletter, which attempts to
forecast price movements over the upcoming four weeks
or so, has been bullish more often than bearish on short
term trends during the past year or so.
But when it comes to his bleak outlook about the long
term, Prechter sticks to his guns. "I am totally serious
about the retrenchment to 400," says Prechter. "But I can
understand why most people wouldn't be, since it is
something that has happened only once in this century, and
once in the early 1700's [in the London stock market]
before that."
OK, so Prechter's forecast of a 95% correction is pretty
far out. But his discussion of mania in today's market
comes a bit closer to hitting home.
Your garden-variety mania, according to the dictionary
definition, is an excitement "of psychotic proportions"
characterized by mental and physical hyperactivity,
disorganized behavior and an elevated mood. In short, it is
a kind of madness that takes hold.
When it comes to markets, manias have the following
defining characteristics, notes Prechter.
* Assets are overvalued by historic standards.
* There is broad participation by the public.
* There is a persistent rise in the markets with fewer,
briefer and smaller setbacks.
* Manias grow out of long-term bull markets. At a certain
point, the public begins to act as if the markets can go
nowhere but up.
* Manias go unrecognized when they are occurring, which
helps explain why they are possible.
* During manias, investment professionals are no longer
thought to add value. Indeed, they are judged as obstacles
to investing success.
*Finally, it helps if the government has assumed a stake
in the rising market, in some way.
Does any of this sound familiar? If so, again, you are not
alone.
"There are several signs that we have moved form a
rational stage to speculation," agrees First Albany's
Johnson. The biggest sign, he says, is the huge valuations
being assigned to tech stocks like Microsoft, Dell, and
consumer non-cyclical stocks like Coca Cola, Procter &
Gamble, and General Electric. "These stocks are trading at
multiples that I just don't believe are rational."
Other characteristics of mania exist as well. Certainly,
there is widespread public participation in the market,
notes Vernon Winters, the chief investment officer for
Mellon Private Asset Management. More and more, we hear
frustration that fund managers "can't beat the index." The
bull market has been around for years, and corrections are
short and sweet, by historic standards.
And there are indeed some signs that Washington may be
getting a little too close to Wall Street. Recent
objections in Congress to the Fed raising interest rates
were nothing new. But the reasons behind them were,
notes Winters. Usually Congress is worried about the
impact of higher rates on borrowers. This time around, it
had an eye on the fears of voters about the impact of a
rate hike on the stock market. What's more, plans to
invest social security money in stocks would give the
government a greater interest in Wall Street, points out
Prechter.
Does all this mean we are in a mania now? Probably not.
As students of economic history know, true manias are
rare. They have probably only occurred three times in
history: the Dutch tulip bulb mania in 1637, the South Sea
Bubble of 1719-1720 in the London stock market, and the
Roaring Twenties stock advance of 1921-1929.
Those manias ended abruptly, but not before sending off
some signals that made it clear the euphoria was coming
to a close. Two signs to watch for, says Prechter, are the
following.
* The number of stocks advancing falls below the number
declining (known as the advance-decline line). In other
words, stock averages continue to go up because of the
success of a limited number of issues. But the majority of
stocks are drifting lower.
* Secondary or small-cap issues lag, while a select group
of blue chips roar ahead.
Before you rush out and sell all your stocks because you
see signs that these two trends exist, consider this.
Prechter's Elliott Wave Theorist has been predicting the
Big Fall since 1983. (In wave theory, "patterns always
repeat themselves, but it is difficult to predict the
periodicity," responds Prechter.)
Second, if the market is in a speculative phase, it could
just as easily return to more normal valuations by
declining gradually, rather than through a crash landing,
points out Johnson.
Finally, with economic trends so positive, inflation under
control, earnings still coming in strong, and a Federal
Reserve Bank not likely to raise interest rates soon, it is
difficult to find any reason for the market to take a sharp
dive. "I think the market is overvalued and it will fall,"
says Johnson. "But I wouldn't bank on it."
Note: To join the discussion about this column, visit
Money Online's Briefing Room on the web at
http://cgi.pathfinder.com/cgi-bin/boards/read/267/2
JW
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