EXECUTIVE SUMMARY
This essay focuses on current reasoning (logic?) on why in my opinion the Dow Jones Industrial Average (DJIA) currently near 8,000 will decline to less than 6,000 before 2003 ends. However, 2004 will be a DJIA up year due to inflation effects from current deficit spending exceeding $500 billion in 2003 and a 20% dollar devaluation. The essay looks at some Fundamental Analysis, Technical Analysis, and Emotional Analysis reasoning. Eleven governmental policy/practices contributing to a lower DJIA are discussed in Part 2.
I believe in late 2003, U.S. interest rates will begin rising as a result of government attempting to restart inflation (reflation of banks) and to avoid deflation. Interest rates will further rise in response to inflation fears and negative returns on investments. This interest rate rise will:
- Slow the U.S. economic activity by reducing earnings, and increasing unemployment.
- Greatly reduce the purchasing power value of long term (5 years or longer) bonds.
- Cause mortgage foreclosure rates to at least double from 2% rates in 2002.
Should interest rates rise to 12% and has happened before, the $6.4 trillion U.S. debt implies 648 billion/year in federal government interest payments within the 2,200 billion dollar budget. Which U.S. federal government programs will be cut off or reduced? Does additional Federal borrowing put pressure on higher interest rates? It should be noted that 3/4 of the $6.4 trillion U.S. official debt is financed very short term and the average debt maturity for the entire $6.4 trillion is only 5.6 years.
Not all stocks will experience price declines in 2003. The group of precious metal stocks and the group of homeland security related stocks will increase in price.
TECHNICAL ANALYSIS REASONS FOR A DJIA DECLINE
Technical Analysis (TA) looks at graphs of economic numbers with the horizontal axis representing time. From this, attempts are made to infer future numbers. Channels, flags, pennants, waves, gaps, and other unique patterns are sought out. These patterns (sometimes from historical perspectives of previous similar patterns) are then used to infer future numbers which guide investment advice. The drawback is these chart patterns are not 100% fool proof and sometimes are illusions. Past history does not always predict future outcomes in economics from a single variable (usually price) time series chart. Economics involves many inter related variables which do not have simple cause and effect relationships between only two variables. The following are some simple but possibly important technical analysis reasons for a DJIA decline.
January Effect
The January Effect is attributed to the old saying, "As January goes, so goes the year." The January Effect has demonstrated near perfect accuracy in predicting the full year's performance of the Dow in odd numbered years since 1950. The following chart shows the January decline in 2002 and 2003.
In 2002 the January Effect produced a total year decline of 16%. A simple ratio calculation inmolies a 2003 Dow decline of 56%. This would suggest a year end DJIA = (8000)(100% - 56%) = 3520. I doubt that a simple ratio calculation is valid. This material came from the Gold Forum poster "SKI" on Feb 03, 07:55 The financial media is unlikely to mention the January Effect for the remainder of 2003 as this might discourage Joe Six Pack from investing more money into stock markets.
3rd Year Presidential Effect
Proponents argue that every 3rd and 4th year of a presidential cycle since 1937 has resulted in a higher DJIA at the end of the year. Most proponents of higher of DJIA values argue that history will repeat itself in 2003 as well. Most of these proponents have self interest of selling stocks to Joe Six Pack (J6P) and institutional buyers. These proponents ignore the presidential cycle third years in which the DJIA did decline. These years are:
- 1923 - Harding/Coolidge (R) - Teapot Dome scandal, a depression and Dow losses -3.3%
- 1931 - Hoover (R) - Depression, Dow -52.7% and S&P -47.1%
- 1939 - Roosevelt (D) - War Clouds Gather - Dow -2.9% and S&P -5.5%
The DJIA was created in about 1900. Thus analysis of DJIA declines and a third year presidential cycle can not be made prior to 1900.
I disagree with the (very few) proponents of a higher DJIA at the end of 2003. Nearly all of the world economies are in a recession. The world economies including the U.S. have entered the Kondratieff winter. The Kondratieff winter occurs every 55 to 75 years. This cycle is too long for the proponents who have not learned from history.
Four consecutive year effect
Proponents of a DJIA rise in 2003 dismiss a fourth consecutive DJIA decline year because things are different. Things are different. However, human nature seems not to have changed. The years 2000, 2001 and 2002 make for three consecutive years of decline.
The following site shows a DJIA chart of the one historical four consecutive year effect in 1929-1932.
www.gold-eagle.com/bears_lair/29crash.html
Interestingly, the DJIA fell about 50% in the fourth year (1932) from its previous year's close. A 50% DJIA decline in 2003 would put the DJIA at (8000)(50%) = 4000 in December 2003.
The U.S. stock market has been down for 2000, 2001 and 2002. In my opinion, this trend will continue for a fourth year because of many fundamental emotional factors already in place.
EMOTIONAL ANALYSIS REASONS FOR A DJIA DECLINE
Emotional Analysis is tricky. All decisions are ultimately emotional. Emotional Analysis is often based on interpretations of word meanings such as truth, confidence, fear, anxiety, greed, trust, beliefs, faith, a future, and hope. Analysis includes studying current and historical investor attitudes, their emotions, reactions to plausible events, and core beliefs to determine their effects in the market place. Most emotional analysis is of anecdotal nature. It is far from being scientific.
Emotional analysis looks at historical economic psychological economic reactions and manias.
Economic manias are "an individual or group of people who become compulsively obsessed and no longer act rational having excessive or unreasonable enthusiasm of excitement manifested by mental and physical hyperactivity in their decision makings." The Tulip Bulb Bubble is a classic example.
The theory most people accept is that the future exists. The future just hasn't happened yet. The concept of investment is the proof that this theory is widely accepted. Why invest now for a future return if one does not believe in the future?
Projecting Earnings for Investing effect
Barron's financial magazine has recently stated that, "One investor characteristic has been the tendency to sidestep, ignore or explain away consistently unimpressive economic data."
A majority of current investors make major investing decisions based primarily on the rising earnings/share projections. If earnings/share goes up, one can conclude the stock price will go up. I disagree with this conclusion. These projections (models) are sometimes quite complex. However, these models leave out relevant factors affecting earnings. They seldom include all the financial fundamentals and long term (50 to 100+ year) history.
Consumer Confidence Effect
Lower consumer confidence in my opinion usually means Joe Six Pack plans less spending and less investing (including stocks) in the next 12 months from fears of lower income during the next 12 months. This will reduce demand for stocks and cause lower stock prices.
The University of Michigan Consumer Sentiment index in February 2003 dropped more than expected to a new nine-year low 79.2 in February according to the preliminary release. Both components of the index fell though the expectations component suffered the larger decline.
The Disappearing Wealth Effect
The so-called "Wealth Effect" during the technology boom prior to 2000 has become the "Disappearing Wealth Effect." The disappearing wealth effect is "fear of poverty" which slows down consumer spending and therefore economic activity. This in turn increases unemployment which in turn lowers company returns from smaller consumer spending. Economy activity further declines.
Better yet, perhaps we should watch the increase in suicide, divorce and anti-depressant prescription rates for a gauge on the deteriorating economy. Declining consumer spending suggests a very ugly outcome. Crime will increase.
The Herd Mentality effect
Once a investor attitude change begins, there is a psychological term known as the "herd mentality" effect which is sometimes called the "lemming" effect. This effect is described as people do what they see other people doing and consider that activity to be rational and logical. Advertisers and salespersons use this emotional button to increase sales of their product or service. When stockholders see their own stock portfolios declining and hear others such as insiders and foreigners selling now, they too will want to sell their stocks.
Market Watch reports that 94% of all stock mutual funds lost money in 2002 with an average mutual fund loss of 21%. Further stock fund losses is a psychological trigger for further stock selling by many stakeholders in an effort to preserve their capital.
Corporate Accounting Scandal Effects
Corporations are not free of accounting scandals. More scandals will be revealed as more and more companies go into bankruptcies in 2003. An equal number of major accounting scandals will be revealed in foreign countries. Most of these scandals will be ignored by the media, but will cause increase investor uncertainty and fear where greed and confidence was once the order of the day. Investors are likely to sell stocks and/or put their capital into other markets such as mortgages in 2003 which in their view have lower risks and greater returns. It is my opinion the U.S. 2003 business bankruptcy totals will exceed the 2002 record totals of 368 billion by another 20%. Many corporate executives are still focusing more on lining their own pockets while stiffing stockholders, employees, and pension funds.
Corporate Scandals and Low Investor Confidence Effects
More corporate scandals will contribute to a low investor confidence. Low confidence results in market stakeholders becoming more risk adverse (taking fewer risks) from a great deal of uncertainty in the predictability of an outcome. As confidence declines from high to low, economic activity declines.
The term "Con" or "Con Job" is defined for this essay as meaning "using something such as a ruse or deceptive practices to deceptively to gain another's confidence." The "Con Job" is sometimes known as a confidence game to swindle another.
Attributes associate with "Low Confidence" include:
- "half truths",
- "questionable believability, credibility, ethics, and morality standards"
- "a stakeholders willingness to compromise core beliefs.
- "use of fuzzy communication"
- "information that is incomplete and or inaccurate.
- "information that has been spin doctored"
- "questions as to logical and methodology for decision making.
- "appeals to emotion are being made"
Con Jobs are still minefields in the business world and the stock markets. Attributes of "Con Jobs" are mostly listed under the "Low Confidence" definitions. Other attributes include:
- "Belief in the Greater Fool Theory"
- "Belief in pro forma accounting"
- "Belief in Ponzi Schemes which always fail."
- "Belief in Good Will asset valuations"
- "Belief in that all market stakeholders act in your best interest at all times."
- "Use of lies and half truths in communication with other market stakeholders."
The following important lesson is being learned by many investors. When a financial planner/analyst advises purchase of a stock consider the following.
- Your first reaction should be, "I am sure going to avoid that one, because if it was any good he/she wouldn't have to be pumping it."
- Your second reaction should be "if it is so good, why doesn't he/she keep it secret so he/she can make money like mad buying it?"
- Your third reaction should be "maybe he/she has already bought a lot, and now he is recommending it so it will go up and he/she can sell out." This is called "pump and dump".
- But your MATURE reaction should be: "Well, maybe this individual has a point, but I am going to study the hell out of this before I buy any!"
FUNDAMENTAL ANALYSIS REASONS FOR A DJIA DECLINE
Fundamental Analysis focuses on analysis of financial accounting sheets. Typically, financial ratios of various types are computed and compared to similar ratios in other companies and sometimes historical ratios. Changes to accounting procedures are particularly of importance. Changes may include write downs, re-evaluations of assets for depreciation, sales and/or purchases of fixed assets, changes in stock distribution, issuances of stock options, and bond issuances. A good analysis includes a sharp look out for creative accounting.
Financial Fundamentals
In earlier decades, a financial analyst considered the following ratios very important in investment decisions. Current ratios are considered by historical standards of the 20th century. The 2003 February 10th issue of Barrons provided the following numbers for the DJIA.
By simple ratios, the following calculations are made to predict a DJIA low in 2003 or 2004.
- By historical standards of the 20th century, a P/E ratio of 10 is near the low. Therefore DJIA low would be (7,864)(10)/(20.9) = 3762
- By historical standards, a Market/Book ratio of 1.5 is near the low. Therefore DJIA ratio low would be (7864)(1.5)/(3.19) = 3698
- By historical standards a dividend yield of 5% is near the low. Therefore DJIA ratio low would be (7864)(2.48)/(5.00) = 3900
I do not believe the DJIA low will be reached until sometime in 2004.
Corporate Write Down of Asset Effects
The current write down of assets to reflect more accurate the real world will cause lower corporate earnings. There were more than $750 billion dollars in Corporate write downs in 2002. An additional $250 billion in writedowns is expected in 2003. The combined total of these is 10% of the stock market capitalization. The Time-Warner-AOL largest write down of over 90 billion dollars (much in intangible assets) in 2003 is just the tip of a wave in write downs. When assets decline by these writedowns, the stock value usually declines. Most corporations due to bankruptcies by Joe Six Pack and Corporate customers will have to write off additional hundreds of billions of dollars in accounts receivables (credit accounts). This in turn will add to more companies going into bankruptcy or increased layoffs (unemployment).
The year 2002 record number of 1.6 million Joe Six Pack bankruptcies will be exceeded in 2003
Corporate Pension Debt Bomb Effects
Major corporations are having to deal with a Pension Debt Bomb. Large Corporations such as Bethlehem Steel and General Motors are upside down in their pension plans. The pension funds are under funded in assets for obligations promised. Corporations are being forced to divert earnings to these pension plans increasingly leaving fewer rewards for the stockholder.
The Wall Street Journal has reported the following: In 1998, pension plan assets of all companies in the S&P 500 totaled $1,150 billion; obligations totaled $897 billion, for a surplus of $253 billion. Today, assets are $904 billion, obligations are $1,150 billion. Pension funds are now $243 billion in the hole. $500 billion has vanished from pension fund reserves in just 4 years. Pension funds will require more company input thus lowering projected company earnings. Lower projected earnings suggest lower stock prices.
Higher Energy Costs Effects
Higher energy costs from oil prices and natural gas will reduce corporate earnings since energy usage is not easily be controlled. Similarly the higher gasoline prices will reduce motorist demand reducing somewhat their money for investing including stocks. The U.S. consumes about 10 million barrels a day from U.S. oil wells and about 10 billion barrels a day from foreign oil. Thus the U.S. spends (365 days/year)(20 million barrels/day)($35/barrel) = $255 billion/year on oil. Natural gas prices have doubled from $2 to near $5 per million BTU of energy. There are reports of inadequate natural gas supplies.
Joe Six Pack 's Personal Consumer Debt Bomb Effects
The U.S. Joe Six Pack is being effected by the personal consumer debt bomb which now totals over $1,700 billion. ($1,700 billion/80 million workers = $2,175/ average worker). Much of this requires interest payments of 16% to 20% on the unpaid balances. An annual average 12% interest payment (12%)(1,700 billions) = $204 billion (or $260/ average worker).
Many Joe Six Packs are now borrowing money by making home equity loans to maintain their affluence. Others are paying down debts. The majority of Joe Six Packs are out of borrowing power. That is to say, Joe Six Pack cannot borrow to invest in the stock market. The year 2003 may see Joe Six Pack having net negative savings.
Joe Six Pack and the War on Terrorism Effects
This expanding "War on Terrorism" program and tax increases is causing a small but growing underground economy. Joe Six Pack in order to survive and protect his earnings begins to work off-book (paying in cash, precious metals, or other portable physical assets) like in Argentina. This reduces government revenue. Joe Six Pack in seeking to be less visible to the tax collector will no longer put some of these earnings into stock market investments. Increasing numbers of honest Joe Six Packs will increasingly believe they are really being terrorized by the governments.
A Declining Economic Activity Spiral Effects
declining economic activity spiral is a feedback which causes further economic activity declines.
Increasing unemployment lowers consumer demand for goods and services since more and more Joe Six Packs have less to spend for spending or investing. This causes business to lay off more Joe Six Packs because of less demand for goods and services from business. Lower demand results in lower earnings/share. Lower earnings often means corporate mergers to lower costs. Corporate mergers increases unemployment.
Unemployment causes Joe Six Packs to sell stocks and other investments to maintain his affluence which lowers stock prices. This feedback again repeats from the beginning in a more serious manner. At some point in time, which I don't know, the spiral feedback will end.
Wally Bently
All flames and comments are appreciated. I reply to most e-mail.
Reply to wallybently2@aol.com
DISCLAIMER: The above information is not a recommendation to buy or sell anything. Do your own Due Diligence!
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