This is the first of a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the past 10 years, the proportion of ‘Sell’ recommendations put out by Wall Street houses has declined from 9 percent of all research reports to 1 percent. Accordingly, investors have an excess of positive information and very little negative information. We thus intend to take the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.
To a true, all-out bear, it really doesn’t matter who wins on Tuesday. Either way, the top story on Nov. 3, 2004, the day after the next presidential election, will read as follows:
PRESIDENT (GORE)/(BUSH) STUNNED BY REPUDIATION AS PRESIDENT-ELECT (PAT BUCHANAN)/(RALPH NADER) HEADS FOR LANDSLIDE VICTORY.
PRESIDENT (GORE)/(BUSH) (SCOWLED LIKE HERBERT HOOVER)/(POUTED LIKE JIMMY CARTER) AS HE CONCEDED DEFEAT AFTER 49-STATE LANDSLIDE THAT LEAVES (REFORM)/(GREEN) PARTY IN FULL CONTROL OF HOUSE AND SENATE.
TOTAL REPUDIATION OF PRESIDENT (GORE)/(BUSH), (DEMOCRAT)/(REPUBLICAN) POLICIES, CURRENT $500 BILLION BUDGET DEFICIT AND WHAT HAS BECOME KNOWN AS THE ‘BABY-BUBBLE’ GENERATION. PRESIDENT-ELECT (BUCHANAN)/(NADER), JAUNTILY WAVING CIGARETTE HOLDER (NOW COMPULSORY FOR OVER-60’S FOLLOWING FDA CERTIFICATION OF TOBACCO AS CURE FOR ALZHEIMER’S) PROMISED ‘NEW SHUFFLE OF THE DECK FOR AMERICA’ AND SAID ‘WE HAVE NOTHING TO FEAR BUT THE STOCK MARKET ITSELF.’
NEW ERA OF RECONCILIATION EXPECTED AFTER BITTERNESS OF LAST YEAR’S GREENSPAN IMPEACHMENT HEARINGS.
ON WALL STREET, DOW CREPT OVER 3,800, S&P500 ROSE TO 526.4 AND NASDAQ TO 651.2 IN RELIEF AT (BUCHANAN)/(NADER) VICTORY AND DECLINE IN UNEMPLOYMENT TO 15.2 PERCENT.
JDS UNIPHASE ANNOUNCED A 1 FOR 10 REVERSE STOCK SPLIT, AND CLOSED UP 0.05 AT 1½.
CISCO SURPRISED THE MARKET WITH REVENUE GROWTH OF OVER 2% FROM FY 2003 AND CLOSED UP 0.15 AT 4 ; IT ANNOUNCED AFTER THE CLOSING THAT IT INTENDED TO DO SECOND 1 FOR 10 REVERSE SPLIT, MAKING 1 FOR 100 SINCE 2001.
HOT TIP FOR 2005 — GATES/BEZOS INC., THE BOWLING ALLEY AND DANCE HALL OPERATORS.
This fantasy — or nightmare — rests on only one assumption, that the ursine view of the stock market is right. Under this assumption, U.S. wealth will decline by more than $10 trillion, or 120 percent of GDP between now and 2004, from the stock market decline alone. With the savings rate currently negative, there is no cushion to absorb such a blow, which would be exacerbated by the effect of foreigners ceasing to finance the current $400 billion trade deficit. Just a 20 percent capital gains tax write-off alone on a $10 billion wealth decline is $2 billion, so a $500 billion per annum budget deficit actually represents a considerable degree of fiscal austerity in this event. Unemployment in 1932-33 peaked at 22 percent; a 15 percent level in 2004 is thus also a conservative assumption. From the Japanese and 1929-33 precedents, things might very well get somewhat worse for a year or two, particularly in the unemployment area, after the November 2004 vignette shown here.
Needless to say, the reaction of the U. S. electorate to such an unexpected catastrophe would be a fierce one, might well involve a move to an extremist third party and/or impeachment of Federal Reserve Chairman Alan Greenspan, and would almost certainly involve repudiation of the generational values represented by all of Clinton, Gore and Bush. So — could such a serious stock market crash, equal to three bear markets one on top of another, by the accepted definition, actually happen?
A level of 3,800 in the Dow, as postulated here, represents a decline of 64 percent from present levels, or 68 percent from the all-time high of 11,722.98 reached last January. On the numbers above, the Standard and Poors 500 Index would have dropped 66 percent, and the NASDAQ Composite Index 87 percent from their respective all-time highs — the latter figure being caused by the greater volatility of NASDAQ stocks and their over-valuation last spring.
This is not all that extreme an assumption. The decline in the Tokyo market in 1990-1998, top to bottom, was 68 percent, if the bottom has indeed yet been reached. The 1929 drop was 88 percent, which does not seem much more than 68 percent but is — to retrace a decline of 88 percent, the market must rise 733 percent, whereas a recovery from a 68 percent decline requires a rise of only 213 percent.
In real terms, indeed, the last real decline (I don’t count the speed bumps in 1987 and 1990) was worse than this; from 1966-82, while the market dropped only 24 percent in nominal terms, the Consumer Price Index rose 198 percent, so the real drop in the Dow was 76 percent. The figures above represent a return to levels of 1994 on the Dow, 1995 on the S&P and as recent as 1997 on the NASDAQ index.
It’s all a question of valuation. Current trailing earnings on the S&P500 Index are $51.92, for a P/E ratio of 27.5. These earnings are inflated by three factors: the current economic boom, the prevalence of huge stock option schemes for management, which dilute shareholders without such dilution being reflected in the income statement, and the habit in some companies (for example Intel) of booking share dealing profits as if they were operating earnings. As earnings decline at least 20-25 percent in a medium sized recession, we could expect S&P500 Index earnings in the serious recession outlined above to drop to around $35, 32 percent below current levels. Applying the historic average P/E ratio of 14 times to this figure gives a level for the S&P500 Index of 490.
Ah, say the bulls, but the Internet has revolutionized the U.S. economy, putting it on a higher productivity growth trend which makes historic pricing rules far too conservative. Well, has it? It has become pretty clear in the last few months that the Internet, while an important and almost wholly beneficial advance, is not in fact a replay of the Industrial Revolution, and thus is not likely to revolutionize productivity growth over more than the medium term. In short, even a Bear can’t prove the market will drop as far as outlined above, but he will take it as a pretty good sporting bet.
Is there any way 2004 could be different? Yes. There’s a 1 in 5 chance, based on historical precedent, that the president we elect Tuesday will die in office. In that case, if it happens late enough in his term, the new President Lieberman or Cheney will repudiate his predecessor’s policies, whatever they were, and squeak through a nail-biter to a full term of his own.
Sorry, guys — the party’s over.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.