Is It Time To Take Cover?

Hat tip goes to reader Nitin for pointing to this article in the NYT about the latest thoughts from Robert Prechter in “A Market Forecast That Says ‘Take Cover:’”

WITH the stock market lurching again, plenty of investors are nervous, and some are downright bearish. Then there’s Robert Prechter, the market forecaster and social theorist, who is in another league entirely.

Mr. Prechter is convinced that we have entered a market decline of staggering proportions — perhaps the biggest of the last 300 years.

In a series of phone conversations and e-mail exchanges last week, he said that no other forecaster was likely to accept his reasoning, which is based on his version of the Elliott Wave theory — a technical approach to market analysis that he embraces with evangelical fervor.

Originating in the writings of Ralph Nelson Elliott, an obscure accountant who found repetitive patterns, or “fractals,” in the stock market of the 1930s and ’40s, the theory suggests that an epic downswing is under way, Mr. Prechter said. But he argued that even skeptical investors should take his advice seriously.

“I’m saying: ‘Winter is coming. Buy a coat,’ ” he said. “Other people are advising people to stay naked. If I’m wrong, you’re not hurt. If they’re wrong, you’re dead. It’s pretty benign advice to opt for safety for a while.”

His advice: individual investors should move completely out of the market and hold cash and cash equivalents, like Treasury bills, for years to come. (For traders with a fair amount of skill and willingness to embrace risk, he suggests other alternatives, like shorting the market or making bets on volatility.) But ultimately, “the decline will lead to one of the best investment opportunities ever,” he said.

Buy-and-hold stock investors will be devastated in a crash much worse than the declines of 2008 and early 2009 or the worst years of the Great Depression or the Panic of 1873, he predicted.

For a rough parallel, he said, go all the way back to England and the collapse of the South Sea Bubble in 1720, a crash that deterred people “from buying stocks for 100 years,” he said. This time, he said, “If I’m right, it will be such a shock that people will be telling their grandkids many years from now, ‘Don’t touch stocks.’ ”

The Dow, which now stands at 9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end, he said. That unraveling, combined with a depression and deflation, will make anyone holding cash “extremely grateful for their prudence.”

Mr. Prechter is hardly the only market hand to advocate prudence now, but nearly everyone else foresees a much rosier future, once current difficulties are past.

For example, Ralph J. Acampora, a market analyst with more than 40 years of experience, said he moved entirely out of stocks and into cash late last month. Now a partner at Alverita, a wealth management firm in New York, he said recent setbacks suggested that the market would drop another 10 or 15 percent, probably until September or October, before resuming another “meaningful rally.”

Over the next several years Mr. Acampora expects an “old normal market,” characterized by relatively short-lived swings that will provide many opportunities for smart investors — one that resembles the markets of the 1960s and 70s. “I’ve lived through it,” he said.

Like Mr. Prechter, he is a past president of the Market Technicians Association, the leading organization of technical market analysts, and he said that his colleague has done “some very good work.” But Mr. Acampora doesn’t agree with Mr. Prechter’s long-term theories, either intellectually or emotionally.

The “mathematics don’t work,” Mr. Acampora said, because such a big decline would imply that individual stocks would need to trade at unrealistically low levels. Furthermore, he said, “I don’t want to agree with him, because if he’s right, we’ve basically got to go to the mountains with a gun and some soup cans, because it’s all over.”

In 2002, he (Prechter) published “Conquer the Crash,” which predicted misery ahead. Even so, he said in 2008 that the market would soon rally sharply — then said late last year that stocks were about to fall and that the great decline would resume.

Since 1980, the advice in his investing newsletters, when converted into a portfolio, has slightly underperformed the overall stock market but has been much less risky, losing money in only one calendar year, according to calculations by The Hulbert Financial Digest. Mr. Prechter said he disagreed with the methodology used in these measurements, but offered none of his own.

For his part, Mr. Acampora says that the Elliott Wave has some validity as an indicator but that “it’s only part of the story” of technical market analysis, which also needs to be buttressed by economic and fundamental research.

While I appreciate Prechter’s attempt of forecasting and his good work with the EW Theory, I am not as bearish as he is. Personally, I think that the U.S. markets have a good chance of following the way of Japan (Nikkei) given that nothing was learned from their deflationary circumstances (and attempted solutions to reverse course) during the past 20 years.

While a bear market is pretty much a sure thing, it is also fairly certain that major downswings will be interrupted by sharp market rallies, such as this week’s. I agree with Bob Prechter in that buy-and-holders will absolutely get slaughtered over the next few years, just as they did in 2001 and 2008.

More so, as I have repeatedly said, we’re in unchartered territory in regards to the busted real-estate/credit bubble where potential outcomes have no real historic precedent.

It is therefore important that you are disciplined with your investments, stand aside when trend reversals tell you to do so and live with the occasional whip-saw. Try to look at the big picture and don’t sweat the small stuff.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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