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 Purchase Jon Markman's book "Swing Trading" at MSN Shopping. Related Articles All roads now lead to inflation While fear festers, value funds prosper Related Resources Check how the Dow stocks are doing today Look up todays top-rated stocks SuperModels Recent articles: • How mutual funds stole your money, 11/12/2003 • Readers want to know: Rally or no? , 11/5/2003 • China is no job-stealing bully, 10/29/2003 More... | SuperModels Why bears see a 5,000 Dow 'Realism' will be rewarded next year, bears say, as an economy juiced up with tax cuts, low rates and more defense spending finally runs out of gas. By Jon D. Markman Bears on Wall Street are considered flinty, irascible creatures with hearts of lead. But they have hopes and dreams just like anyone else. And when they stretch their legs on the Corinthian leather chairs at their private clubs, light up cigars and stare out across the blinking nighttime lights after a day of clawing the guts out of optimists, they fantasize about the future just like you and me. Except they call their reveries realism, and they wonder what the rest of us are smoking. The realists have not had a fun year in 2003, but they are a mostly patient lot and figure theyll get their turn in 2004. In fact, they think theyll get so many turns itll be time for some unseemly cartwheels by the time the presidential election rolls around. To put a number on it, which most decline to do for the sake of appearances, credible market critics figure the Dow Jones Industrials Average ($INDU) could drop at least 25% to around 7,300 from its current perch just below 9,700. And if the wrecking ball really gets rolling, they dont see Dow 5,000 as out of the question over the next three years. Core argument: the economy will run out of gas The crux of their argument, which Ill explain in detail in moment, is that the U.S. economy is like a car with a single gallon of gas that is sprinting on a dead-end road from service station to service station for top-ups. The gas is fiscal stimulus (tax breaks and federal spending financed by foreigners) and monetary stimulus (artificially low interest rates). Bears believe that the economic recovery has not generated enough high-paying jobs to be self-sustaining. And limits on adding more debt will starve our national SUV of fuel. The inevitable result, they believe: an economic stall leading to a plunge in consumer confidence and stock prices. Could they be right? Look at it this way: For the Dow to fall 25% to 50%, the average return of 30 large companies stocks needs to be -25% to -50%. That wouldnt be unprecedented, but it would be very rare. Individually, several Dow components have fallen by more than half in recent years, including 50% to 75% declines in Microsoft Eleven Dow stocks are currently at least 50% off their all-time highs. But the 30 Dow members seldom sink in synch by that much, as one or two sectors -- for example, energy, consumer staples or health care -- hang tough to keep the average up. The worst collective moves of the postwar era were -36% from August through November 1987 and -44% from December 1972 to December 1975. Stocks took two years to recover from the first, and seven years to recover from the latter. Will the Dow regress to the mean? Yet raw percentages are only numbers that anyone can throw around. Researchers who study price-trading patterns, called technical analysts, believe that broad market indexes such as the Dow tend to regress to their long-term mean during major bear phases to a level known as the 200-month moving average. Another way to put it is that they expect peak index levels to sink to the average level of the prior 16 years. The Nasdaq Composite ($COMPX) did exactly that when it fell 75% from around 5,000 in March 2000 to around 1,100 in October 2002 -- hitting its 200-month moving average on the nose before rebounding in the past year. The Dow declined only a third as much over that period, about 26%. Now, if the Dow were to regress to its long-term mean in the coming year or two, analysts would expect it to bottom out at its own 200-month moving average. The 16-year mean of the index is currently 5,854. But that number would get smaller in proportion with a decline, so the long-term mean would ultimately be closer to Dow 5,000 than youd care to think about. The good news, in a way, is that if such a plunge were to occur, it probably would happen rather quickly. For unlike bull moves in the market, in which prices tend to inch up amid swelling skepticism, the wickedest parts of major bear moves tend to happen with lightning speed amid an exhaustion of hope. The rule of thumb is that stocks fall twice as fast as they advance. In bears view, few things need to go wrong for their prophecy to transpire. In fact, they say signs of an imminent demise are already evident to anyone who cares to look, which is why they call themselves realists. Case in point: The question of whether the economy is adding or losing jobs. Employment, of course, is the bedrock of a nations success because stable citizens with rising incomes buy more stuff, keeping the virtuous cycle of production and consumption in motion. Mainstream economists cheered two weeks ago when the Labor Department reported that the country gained 126,000 jobs in October -- the best advance in months. But critics scoffed that the figure was inflated by so-called seasonal adjustments the government makes using a counting methodology called ARIMA, or autoregressive integrated moving average. The technique is similar to pro-forma reports issued by companies to smooth, or pretty up, erratic earnings from quarter to quarter. The government essentially says, hey, the economy always loses jobs in winter, so lets remove that effect and see how the period compares to other similar periods. In contrast, bears point to a report from outplacement firm Challenger, Gray & Christmas that companies said they planned to lay off 171,874 workers in October -- the highest level in a year, and twice Septembers number. "While perhaps shocking to some, the October spike follows a trend of heavy year-end downsizing that has occurred since we began tracking job cuts in 1993," CEO John A. Challenger said in a statement to reporters. Seasonal adjustments might be good for eggheads in Washington, bears say, but they dont help pay the mortgage or buy new DVD players. They claim the country is on track to lose 2 million real jobs through January even though the government will claim the addition of 430,000 seasonally adjusted jobs. Even Wal-Marts confused Weird, huh? This cognitive dissonance cracked the market upside the head last week after Wal-Mart Stores Wal-Marts bewilderment was no surprise to Lacy H. Hunt, chief economist at the fixed-income house Hoisington Investment Management. He has a stack of charts two inches high that support his belief that bonds will outperform stocks for some years to come as the economy works its way through severe structural imbalances. Top of the list:
If shares of a company as remarkably successful as Wal-Mart were to crack amid a decline in investor confidence in its ability to grow, you can bet that many lesser companies would be much harder hit. And that is the version of reality that bears see when they daydream this winter, waiting patiently for the acrid smoke to clear before the bulls eyes. Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, Markman was long the following securities mentioned in this column: Microsoft, Intel and Merck. | ||||||||||||||
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