Stage Set for Monumental 2002 Crash

A torrent of investment advisors and financial analysts screaming have been loudly proclaiming that a "new bull market" was born on Sept. 21, and that a financial and economic recovery will unfold this year. A careful study of the cycles, however, will contradict this assertion and prove just the opposite. Year 2002 will be a year when many fortunes will be made by selling short, and will be punctuated as well by enormous loss of capital (shades of 1929)

The psychological stage must be set for every market crash. There must be widespread optimism and ebullition before it can begin. A taste of this can already be found in the financial newsletter press, as many respected newsletter writers have actually used the term "new bull market" to describe the Dow from the September lows to this point.

Last week, even the mainstream press seemed to get aboard the new bull market bandwagon by publishing several news articles touting the death of the bear and the resumption of the bull. A Reuters newswire headline from earlier in the week proclaimed, "Bear-hunting is over, welcome Baby Bull." The article asserted, "Anyone who still has their rifle aimed to shoot the bear, it's OK to put it down now. The bear has left town." Hugh Johnson, chief investment officer of First Albany Corp., was quoted as saying, "2002 is going to be a very good year. All the conditions are in place for a bull market." His statement reflects growing professional confidence (or perhaps wishful thinking?) in the market's chances for 2002. As our analysis has showed for some time, this hope will be sorely disappointed.

Incidentally, Johnson's asset management firm manages $660 million and advises $1 billion in investment capital, and if you add up all the other Hugh Johnsons out there who control or influence countless billions, imagine what the impact of their being wrong on the market will be this year.

He enumerated several reasons why he believe the market is a buy, and they are very representative of the emerging investor consensus . Among them: The Fed has eased [interest rates] 11 times since last year; economic indicators are turning positive, including an improvement in consumer expectations and a decline in weekly initial claims for unemployment benefits; and M2 money supply is growing fast enough to drive both the economy and the growth in the market.

The first two of these reasons really have no bearing on where the market may be headed since the market discounts these events well in advance, and both have already been discounted. The last of these is a common fallacy. Because money supply growth has been exploding in the past few months, many erroneously assume there will be sufficient liquidity in the financial system in the event of another crash or sustained decline. What they do not understand is that the Dow (as Michael Jenkins is fond of saying) is not a leading indicator of the market and economy, it is THE indicator, and compared to the Dow money supply figures mean little. The Dow has already factored into the equation what a growing M2 money supply means and it has rendered its verdict: "Despite the money supply growth, Year 2002 will be one of falling markets." Is this possible in the face of explosive money supply growth? Sure it is, especially when you consider the trillions of dollars worth of commitments out there that could come unraveled faster than Enron many times over. The drawdown on the monetary system during a time of steadily dropping prices would be sufficient to wipe out any excess liquidity that is out there in a very short time. The bottom line is, it doesn't matter how much money is in the system, but how much the market can drain away before more can be created to sufficiently satisfy all demands for money.

Here's another telling quote from that same article. Robert Wachtel, senior vice president and market analyst at Prudential, stated, "If you look at the track record of bear markets, we've had two back to back," Wachtel said. "The last time we had three bear markets back to back to back, was from 1939 to 1942. So it's been 60 years since we've had three years of bear markets" in a row." But Wachtel fails to understand is that 1939-1942 was during the final declining phase of the last 55-year K-wave cycle and 60-year financial cycle. We are now in a very similar position to where the market was in 1939-1942! This means that history can, and will, repeat.

What is surprising to us is the number of highly respected financial forecasters who are moderately bullish our outright bullish on the market's prospects for 2002. The highly-respected Mansfield's Chart Service published last week their 2002 Market Forecasts edition, in which they survey approximately 40 top investment analysts of their expectations for the coming year. For the year ahead, the group consensus was as follows: 69% believe the Dow would reach highs of between 11,000-13,000, with only 31% believing otherwise. 62% believe the Dow would stay in a range between 9,000-11,000. Only 20% believe the Dow would decline to 8,000 or lower in 2002, with 80% stating an emphatic "no."

Thirty-two percent answered "yes" to the question, "Do you believe that we are in a secular bear market which will not make a bottom until the latter half of 2002?" - while 68% responded with "no." When asked, "Do you regard the market at current levels as fairly valued, 56% responded "yes," while 28% thought it was undervalued and only 17% thought it was overvalued. When asked if they would substantially increase equity exposure on a further significant decline, 72% responded "yes" with 28% responding "no." When asked if they believe the U.S. economy will recover from the current recession in 2002, 50% responded in the affirmative with only 24% responding in the negative. Only 9% thought the economy would remain in recession throughout 2002.

One of the very few investment advisers reviewed by Mansfield that we agree with is Bernard Schaeffer of Schaeffer's Investment Research. Schaeffer has a track record of being right on the market more often than not, so his predictions have weight. Here is how he answered the Year 2002 survey: Dow forecast: Decline to 8,000 or lower: Yes. NASDAQ forecast: Bottomed in Sept. '01: No. Decline below 1500: Yes. Rally to 2500-2800 area: No. Secular bear market: Yes. Market at current level is: Overvalued. Reduce equity exposure on near-term strength: Yes. Post "9-11" tragedy present any positions: Gold. U.S. economy will stay in recession: Yes. Industry group favorites: Gold. 5 best stocks: KKD, NVDA, NEM, ODP, PCLN.

Here is how he summarizes the market situation for 2002: "Wall Street strategists are the most bullish since the 1990s, the same group that was bearish heading in the rally beginning in late-1994. These high expectations leave the market vulnerable in the midst of the current bear market, optimism about the economy in 2002 and little signs of a "V-type" recovery. Full capitulation has yet to come." We concur with Mr. Schaeffer's assessment.

The bears will come out far and away the big winners on Wall Street in 2002. The "big one" we've all been waiting for will shortly begin, and with it will come a multitude of precious opportunities. Are you prepared?