MOVING FROM EXTREME TO EXTREME In our Decision Point Alert newsletter I have stated that I believe we have begun a secular (once-in-a-century) bear market, and that my downside estimates are 3000 for the Dow, 500 for the S&P 500, and 500 for the Nasdaq. I have been asked what mechanism would drive such a decline and how I arrived at such "insane" downside targets.

The market moves in a zigzag path, moving from extremes of overbought to oversold ,or from overvalued to undervalued. We can clearly see this mechanism at work in the chart above, and recently it reached extremes of overvalue not seen at any time since the mid-1930s (unfortunately we do not have data prior to that). To accomplish this the S&P 500 has moved upward in a long-term parabolic arc, a technical formation that normally ends in total collapse and a return to the area where prices were basing prior to the start of the parabolic rise. As you can see, the parabolic on the S&P 500 has broken down quite decisively.

When estimating the downside target of 500 for the S&P 500, I simply used the green line in the chart above, which represents a P/E of 10 for the S&P 500. This is wildly optimistic if we compare it to the basing area which preceded the parabolic breakout, say, 100-200. Of course, in a severe decline the P/E Range line will move lower, and the downside target will move lower as well.

For my downside estimate of 3000 for the Dow, I calculated what the Dow would be if it had a yield of 6%, an historical level of undervalue. And for the Nasdaq I used the top of its basing area prior to its parabolic breakout, which was about 500. These are all rough estimates and are not set in cement.

The characterization of these downside targets as "insane" strikes me as amusing. What is insane is the 330% rise in the S&P 500 in only six years. Also, these targets do not represent the end of the world as we know it. In 1994 the Dow was at 3500, the S&P at 450, and the Nasdaq at 750, and the world was working just fine then.

The mechanism behind the huge rise in stock prices has been an economy driven by high employment and nauseating excesses in consumer spending and debt. The negative reciprocal of this mechanism will be required to drive stock prices to downside extremes. Just as the huge economic expansion fed upon itself, severe economic contractions feed upon themselves. People stop spending money because they lose their jobs or because they are afraid of losing their jobs. Companies stretch out their payables and marginal companies fail because of it, causing more companies to fail. This results in increasing job losses and bankruptcies. It is really not at all complicated or impossible.

The coincidence of the collapsing price parabolic and the current economic contraction leads me to believe that we have already begun an unstoppable downward spiral in the economy and stock prices. I have also said that you won't have to pry this forecast out of my cold, dead hand. I don't make forecasts for dramatic effect, and I don't become emotionally attached to them. If we see evidence that the economy has recovered, and/or the stock market (NYSE, Dow, S&P) starts making new, all-time highs, I'm not going to be stubborn about my outlook. For now, the evidence strongly suggests that, having enjoyed extremes in a positive direction, we are doomed to suffer extremes in the opposite direction.

--Carl Swenlin

http://www.decisionpoint.com/ChartSpotliteFiles/010331SPPE.html

-- Carl Jenkins (somewherepress@aol.com), April 03, 2001

Answers

Bear market! What bear market? The Wall Street Journal says to lap up the bargains. Anyway, Easy Al Greenspan will fix it all up with his two pronged approach - print more "money" and lower interest rates. The current rate of "money" increase is 20% per year, which seems like a pretty good clip. He has a ways to go to match the Japanese in interest rate reduction though (currently zero), and I do hope it is more effective than it has been for them (tottering on the brink).

-- Warren Ketler (wrkttl@earthlink.net), April 03, 2001.