The Contrarian's View is published 11 times per year on a mostly-irregular schedule, and the views expressed are those of the author and editor, Nick Chase. Because nobody can predict the future, results of past suggestions or recommendations are no guarantee of future results. Material in this publication may be freely quoted provided proper attribution is given to its source. Subscription rate: Free on the Internet through the World-Wide Web service at Assumption College. Using your favorite Web-browsing program, Open URL http://www.assumption.edu. Mailed paper subscriptions, one year for $39 to The Contrarian's View, 132 Moreland Street, Worcester, Massachusetts 01609. There is a limit of 50 paid subscribers at one time; please check for availability before sending any money. Sorry, Visa and Mastercard are not available. Overseas subscription rate, U.S. $54. Unsolicited material sent to us by UPS or by courier other than the postal service is refused and returned to sender! Phone: (508) 757-2881
In the past two issues of The Contrarian's View I've looked at the probabilities for, and likely unfolding of a future stock-market crash. But there remains an unanswered question: If stocks do crash, what will follow? Will it be 1987 déja vu, with an "instant bear market" followed by another extended bull market to new highs? That would seem to be the conventional wisdom.... "buy the dips", advisors are recommending.
My answer might surprise you: After examining the major stock collapses of the 20th century.... 1929, 1962, 1969/70, 1973 "Nifty Fifty" and 1987, I feel that the current situation most closely resembles, not 1987, but 1929!
Consider the differences between now and 1987: In 1987, the speculative frenzy in stocks was killed off by rapidly-rising short-term interest rates. When the crash came, it was widely expected that a depression would follow, because we had only the 1929 experience (for those who could remember it) by which to judge. But this is an era of paper money, not gold, and the Fed, first, provided liquidity to the stock markets to keep them afloat, and second, lowered short-term rates to reflate the financial markets, thereby setting off a new (or continuation of the) bull market. The recession didn't arrive until two years later, and it was mild by postwar standards. In hindsight, 1987 turned out to be more like 1962.... a "misunderstanding" between government and business.
In the present situation, interest rates peaked last year (though the current rise could well be just a rally in a bear market), and both short- and long-term rates have been slowly declining since. In 1987, no recession was in sight; currently, the economy appears to already be tipping into recession (though investors seem to think this is the much-anticipated "soft landing").
The parallel with 1929 is eerie. Interest rates peaked in the spring of 1929, with the Fed aggressively easing thereafter; but stocks soared through the spring (like now), and didn't peak until September. The peaks reached in 1929 were mainly by what we would call today the "large-capitalization" stocks; the majority of stocks had actually topped out in late 1928, and declined throughout 1929.... just as the majority of stocks in the current "bull" market topped out in January 1994.
Economic data-gathering was not very sophisticated or timely in 1929, but hindsight showed that the economy was already into recession by the begininng of 1929; the 1929 stock market popular averages utterly failed as a "leading indicator" for the recession. Today, the collection of statistics is much improved, and we can see the economy weakening as it happens; but that hasn't prevented the stock market averages from again failing us as a leading indicator.
Finally, in 1929 public interest in stocks was at unheard-of highs, primarily through the purchase of "investment trusts" (the equivalent of today's closed-end funds). It seemed that getting rich was almost automatic; just buy and hold, and you were guaranteed to have an affluent future. Is that so terribly different from the majority of today's late-arrival "investors" who keep pouring gobs of money into mutual funds in the belief that the money managers can replicate the double-digit returns of the past twelve years ad infinitum? Like 1929, stocks (in the popular averages) have torn away from their moorings of yield and intrinsic value, and are being bought and sold only on the "greater fool" theory.... that there will always exist an eager fool who will relieve you of your holdings at even higher prices
If the current situation most closely resembles 1929, and if stocks crash again, does that mean that, this time, a depression will follow? That would seem to be the thesis of many Elliott-wave gurus (Robert Prechter, Thomas Henning, P.J. Wall, etc.) and of perennial doom-n-gloomers. Like 1929, much of the rest of the world is in depression or near-depression (Russia and the other former communist republics, Japan.... for five years now...., Mexico) or stagnant (Europe), and perhaps, like 1929, the U.S. is just "late", and the depressions in other countries will spread here.
Davidson and Rees-Mogg, authors of Blood in the Streets and The Great Reckoning, certainly believe that we are in the midst of a worsening depression, and they publish a chart which I do think has some validity. (Fortunately for you, dear readers, they have printed it in some non-copyrighted promotional literature, so I can reproduce it for you here.) It is the ratio of M-2 to the monetary base, and it shows how effectively the economy puts the available money, as supplied by our central bank, to "work".
As you can see from the graph, the ratio peaked at over 12 in the mid-1980s, and has been in decline since, with the ratio currently (according to the figures in the latest Barron's) at 7.85, still lower than the last-plotted point in the graph. Davidson and Rees-Mogg feel this ratio shifts in long cycles (like the Kondratiev wave), and that it will return to the low numbers seen in the Depression of the 1930s, because once the process of unwinding debt begins, it continues until virtually all of the bad debts are wiped away.
In a paper-money world, I'm not so sure that all bad debt must be unwound before reliquefication begins; but I will agree that in a deflationary environment (not to be confused with the declining purchasing power of the dollar) the risk of an "accident", or of something going awry during the unwinding process, is sharply increased. This is why I look upon the current stock-market blowoff in horror; for if we get a subsequent crash, it would destroy the dream of many to become wealthy virtually without effort, just as it did in 1929, and the deep public funk caused by the loss of wealth will deepen the recession that appears to be underway, just as it did in 1929.
Already we see evidence that the deflationary trend may pick up steam.... primarily in the actions of politicians. Regardless of how glad we may be to get government off our backs, I continue to maintain that the effects of cutting government spending and balancing the budget (if it really happens, rather than just being the political posturing we've seen to date) are, for the short term, deflationary. Plus, we have Wrong-Way Bill seemingly anxious to start a trade war with Japan. But politicians are not innovators; they react to their constituents' desires, in this case, the unhappiness of people whose standard of living continues to decline in the face of apparent "prosperity".
The greatest danger a stock-market crash poses, I think, is the unbalancing of risk, particularly in an era when everything has been derivativized (if you'll accept that as a word). Regardless of what you may think of derivatives, they have become popular because they are perceived as reducing the risk inherent in taking on positions in markets. But virtually all of the computer programs which design and trade derivatives assume that risk is manageable, and that the changes in markets will be comparatively orderly.
A stock-market crash (or shutdown) is not an orderly change; it is a "discontinuity", as mathematicians might say, and in a derivativized financial world the outcome might result in a few "big winners", just like the lottery, and a number of "big losers". (Remember Barings?)
Now the big winners have no obligation to bail out the big losers; and if the big losers happen to be large banks or financial firms, central to the operating of a healthy economy, then the government, the "lender of last resort", will have to bail them out. And if the losses are too big for the government to cover, well, then we have a really serious problem, and the predictions of the gloom-n-doomers could come true. But I would hesitate to make any predictions in this area, because I don't know who has bet the wrong way with derivatives; we'll just have to see how things unfold.
The 1929 Crash was the classic case; it marked the onset of the Depression, the unwinding of bad debts, and the stock market itself sank to unbelievable lows in tandem. But 1974-1975 showed that it was possible to have a "granddaddy" bear market without a depression (just a bad recession), and the 1987 Crash demonstrated that stocks could hiccup with no subsequent recession at all. Will the 1990s demonstrate that the economy could pass through a depression ("contained", if you will) with no bear market at all?.... stocks, thanks to derivatives, act as a bond-market surrogate and continue to probe new highs as interest rates decline? Well, anything is possible, I suppose, but if I were you, I wouldn't stake my fortune on this premise.
The pending legislation most likely to be passed and signed into law includes the line-item veto (which presidents Reagan, Bush and Clinton have all asked for), which could be a powerful deficit-reduction tool in the hands of the right president; making Congress adhere to the same laws as everybody else; and regulatory reform. Medicare "reform".... that is, price-fixing.... may squeak through. The rest of the "contract" is marked by its failures, specifically the constitutional amendment to balance the budget, and congressional term limits.
The current stock-market blowoff got underway in earnest shortly after the balanced-budget amendment was defeated. People will tell you that the high prices of stocks are in anticipation of a cut in the capital-gains tax, or of sharply-reduced Federal spending, but my own opinion is that investors concluded.... probably rightly.... that we are going to live on borrowed money for awhile longer, and that the deflationary threat of balancing the budget was little more than the usual smoke-and-mirrors political posturing. The deficit churns along unmodified.... in the current fiscal year, at the rate of $300 billion per year ("Treasury gross public debt", as reported weekly in Barron's), and the debt will likely reach $5 trillion late in this year.
In the "Debt Overhang" booklet mailed with the January 1993 issue of The Contrarian's View, I outlined four possible outcomes for the building debt crisis, two of which were deflationary or inflationary collapses, and the third increased taxes with a reduction of benefits. Of the fourth, I wrote:
"....the chances of it happening range between zero, zilch and none: Congress sharply and immediately cuts spending, especially in entitlement programs, without raising taxes; in fact, it cuts the capital-gains tax to bring in more revenue.... and balances the budget. Fat chance, right?" My current opinion is that not much has changed, but that we now at least see proposals in this vein represents progress.
And I will admit that another election, giving us a House, Senate and president all thinking like the current House majority could result in some real change. In a free society, excesses will tend to be corrected rather than exceeding their limits and "blowing up" on us (and this applies to the stock market, too!). The key question is, will our budget woes be corrected by our leaders, or does the system have a fatal flaw.... the lure of buying votes with borrowed or printed money is simply too great for even the most well-meaning politicians to resist? Time will tell....
Hindsight can be wonderful. You will recall, last March when "Timer's Trend" gave a buy signal, I was very tempted to put my pension funds back into the stock market. But, after having been whipsawed once in January, and realizing that stock prices were already at historical highs in relation to their underlying values, and knowing that I could still make 6% by staying in "cash", I felt that risk versus reward of being in stocks was too high to play footloose with my pension.... so I didn't switch. But I did give "age-sensitive" advice.... that is, if you are young (more that 20-25 years to retirement), follow the signal, because if the stock market should suddenly be blown away by an unexpected event, you would still have many years to recover the loss.
Well, you young folks are doing quite well, so the question I must ask myself (and on behalf of my older subscribers) is: Did I make the right choice for me? I think the answer still is, yes.... because if I had been riding this wave with my pension money, I would have been sweating out every minor decline, worrying about every adverse news event, and expending great effort trying to "pick off" the top and escape the high-risk environment before the inevitable sharp decline sets in. Instead, here I am, sleeping soundly at night and still making good money after all, though not as much as if I were in an index fund.
There is no indicator to warn, "Tulipmania coming! Everybody get on board!" Who could have told, last March, that the historical extremes of not just 1987, but also 1929, would be broken? We have never before seen yields on the averages so low.... truly, history is being made.... but that does not mean that "this time is different" and we will avoid the hangover that follows the binge. Market blowoffs from already-historically-overvalued levels occur infrequently.... the spring and summer of 1929, the spring of 1969, and the summer of 1987 are notable examples, and all were followed by crashes and/or big bear markets. We should be so fortunate to have a tool to tell us when the market is going to blow off rather than just top out and slide into a bear; if I ever find one, I'll be sure to let you know. (On second thought, maybe I'll keep it to myself and become a quadzillionaire.)
Though blowoffs cannot be predicted, we can be assured that once they occur, they can be profited from, because they run strictly on emotion, divorced from any underpinnings of value.... and eventually, as in all panics, the frenzy will subside and stock prices will return to levels commensurate with their true value (or maybe even get cheaper!). Now is the time to start buying LEAP puts on your favorite indexes, or perhaps on stocks, such as Merrill Lynch, which usually move in tandem with the overall market. If you keep in touch with the "computer warmline", you will find me doing this as time and money permit. I cannot guarantee that you, and I, will not suffer paper losses for the short term; but that we will eventually profit handsomely, I have no doubt.
Crash watch: From current levels, the odds of a stock-market crash (or shutdown) ahead have risen to about 75%, coming probably no earlier than September. (October still looks mighty dangerous!)
Notice to Internet readers: To date, there is no adequate Macintosh software tool available that will allow me to "convert" the portfolios printed in the paper version of The Contrarian's View (which are actually spreadsheet tables in a word processor) into something that can be viewed by a World Wide Web browser. Consequently, they are omitted here; just the summaries and commentary follow.
A. "Hedger's Delight" - real portfolio, includes commissions:
SUMMARY - "Hedger's Delight" :
Original cost: $10,455.77
Present value: $ 4,960.04
Increase: $-5,495.73 [-52.56%]
Yield: $ 22.00 [0.21%]
The performance of this portfolio from January 1987 to the present (adjusted for the dilutive effect of added cash) is -51.32%, for a compound annual rate of return of -8.14%.
B. "Present and Future Income" - real portfolio, includes commissions:
SUMMARY - "Present and Future Income" :
Original cost: $ 9,548.98
Present value: $12,370.38
Increase: $ 2,821.40 [29.55%]
Yield $ 133.30 [1.34%]
The performance of this portfolio from January 1987 to the present (adjusted for the dilutive effect of added cash) is +44.96%, for a compound annual rate of return of 4.48%.
C. "Crapshooter's Folly" - real portfolio, includes commissions:
SUMMARY - "Crapshooter's Folly" :
Original cost: $10,817.13
Present value: $16,732.43
Increase: $ 5,915.30 [54.68%]
Yield $ .00 [0.00%]
The performance of this portfolio from January 1987 to the present (adjusted for the dilutive effect of added cash) is +70.44%, for a compound annual rate of return of 6.50%.
D. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG" :
Original cost: $ 2,988.00
Present value: $ 3,244.00
Increase: 256.00 [8.57%]
COMMENT on "PIG" : There is no change from the May issue. ("PIG" did not
meet in June.)
Although the group did buy some shares of Silicon Graphics in May, I don't
have the details yet.
Original (1983-86) cost: $ 8,326.19
Present value: $19,340.28
Increase: $11,014.09 [132.28%]
Current yield: $ 886.19 [4.49%]
The performance of this portfolio (including its predecessors) from January 1, 1987 to the present is +76.35%, for a compound annual rate of return of 6.93%.
F. CREF Pension plan; I switch between indexed stock/bond/money funds:
Date Sold Bought
13Mar92 stock @ 56.65 MM @ 13.41
29Apr92 MM @ 13.48 bond @ 31.19
19Jun92 bond @ 32.14 MM @ 13.55
29Jun92 MM @ 13.57 stock @ 56.74
24Jul92 stock @ 56.76 MM @ 13.61
29Oct92 MM @ 13.72 stock @ 58.61
23Dec92 stock @ 61.48 MM @ 13.78
16Jan95 MM @ 14.83 equity-index @ 26.44
20Jan95 eq-index @ 26.19 MM @ 14.84
Values, 23Jun95: stock, 81.63; MM, 15.22
Gain, 1988: 18.91%; 1989: 14.48%; 1990: 8.28%; 1991: 27.93%; 1992: 10.20%; 1993: 3.08%; 1994: 4.07%
Gain, January 1 through March 31, 1995: 0.48%
Total gain since January 1, 1988 (7.25 years): 124.01%
Compound annual rate of return: 11.77% (My long-term target: in excess of 15%)
Gain shown excludes the impact of additional monthly cash contributions.
Buying CREF stock on January 1, 1988 and holding it gained 138.24%, for a compound annual rate of return of 12.72%.
COMMENT on "Timer's Trend" :
We're still on the March 14 buy signal, and
waiting for a sell signal from the more sensitive 10% exponential....
don't wait for the formal "Timer's Trend" sell signal, because risk is
simply too high.
=============================TIMER'S TREND===========================
Fri 7 Apr 95 . | # | 4192.62 | .+ *
Mon 10 Apr 95 . | .# | 4198.15 | .+ *
Tue 11 Apr 95 . | # | 4187.08 | .+ *
Wed 12 Apr 95 . | . # | 4197.81 | .+ *
Thu 13 Apr 95 . | .# | 4208.18 | .+ *
Mon 17 Apr 95 . | # | 4195.38 | .+ *
Tue 18 Apr 95 . | #. | 4179.13 | .+ *
Wed 19 Apr 95 . |# . | 4207.49 | .+ *
Thu 20 Apr 95 . | # | 4230.66 | + *
Fri 21 Apr 95 . | . # | 4270.09 |~+~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 24 Apr 95 . | . # | 4303.98 | .+ *
Tue 25 Apr 95 . | .# | 4300.17 | . + *
Wed 26 Apr 95 . | .# | 4299.83 | . + *
Thu 27 Apr 95 . | # | 4314.70 | . + *
Fri 28 Apr 95 . | .# | 4321.27 |~.~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 1 May 95 . | .# | 4316.08 | .+ *
Tue 2 May 95 . | .# | 4328.88 | .+ *
Wed 3 May 95 . | . # | 4373.15 |~.~+~~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Thu 4 May 95 . | .# | 4359.66 | . + *
Fri 5 May 95 . | .# | 4343.40 | . + *
Mon 8 May 95 . | . # | 4383.87 | . + *
Tue 9 May 95 . | . # | 4390.78 | . + *
Wed 10 May 95 . | . # | 4404.62 | . + *
Thu 11 May 95 . | . # | 4411.19 | . + *
Fri 12 May 95 . | . # | 4430.56 |~.~~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 15 May 95 . | . # | 4437.47 | . + *
Tue 16 May 95 . | . # | 4435.05 | . + *
Wed 17 May 95 . | .# | 4422.60 | . + *
Thu 18 May 95 . # . | 4340.64 |~.~*~~~~~~~~~~~~~~~~~~~~~~~~~
Fri 19 May 95 . # . | 4341.33 | .+ *
Mon 22 May 95 . | . # | 4395.63 | + *
Tue 23 May 95 . | . # | 4436.44 | .+ *
Wed 24 May 95 . | . # | 4438.16 | .+ *
Thu 25 May 95 . | .# | 4412.23 | . + *
Fri 26 May 95 . |# . | 4369.00 | . + *
Tue 30 May 95 . | # | 4378.68 | .+ *
Wed 31 May 95 . | . # | 4465.14 |~.~+~~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Thu 1 Jun 95 . | . # | 4472.75 | . + *
Fri 2 Jun 95 . | . # | 4444.39 | . + *
Mon 5 Jun 95 . | . # | 4476.55 | . + *
Tue 6 Jun 95 . | . # | 4485.20 @| . + *
Wed 7 Jun 95 . | # | 4462.03 | . + *
Thu 8 Jun 95 . | . # | 4458.57 | . + *
Fri 9 Jun 95 . | # | 4423.99 | . + *
Mon 12 Jun 94 . | . # | 4446.46 | . + *
Tue 13 Jun 95 . | . # | 4484.51 | . + *
Wed 14 Jun 95 . | .# | 4491.08 | . + *
Thu 15 Jun 95 . | . # | 4496.27 | . + *
Fri 16 Jun 95 . | . # | 4510.79 | . + *
Mon 19 Jun 95 . | . # | 4553.68 |~.~~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Tue 20 Jun 95 . | .# | 4550.56 | . + *
Wed 21 Jun 95 . | .# | 4547.10 | . + *
Thu 22 Jun 95 . | . # | 4589.64 | . + *
Fri 23 Jun 95 . | # | 4585.84 | . + *
=====================================================================
{, } = "Timer's Trend" (4% and 10% exponential) SELL ({) or BUY (}) signal
[, ] = 4% exponential change unconfirmed by 10% exponential (not a signal).
@ = market overbought or oversold. I or & (on baseline) = 10% exponential SELL.