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Dow's Worst Plunge In 45 Years Dares Investors to Just Say No to Stocks

February 29, 2000

Thursday’s Wall Street Journal was filled with articles about how risky the stock market is and about how Alan Greenspan is stubbornly holding onto his desire to gently prick what he perceives as a stock market bubble. Friday, the Dow Industrial Average plunged below 10,000 for the first time since last April.

Of course, Mr. Greenspan’s rhetoric is not to be classified as mere unfounded opinion. Neither are the risk indicators that filled up Thursday’s Wall Street Journal. One such indicator was devised by our friends at the respectable Ned Davis Research firm.

In fact, with the Dow now 16% off its record high set only five weeks ago, Alan Greenspan increasing his rhetoric to keep raising interest rates until the air comes out of the stock market, and with tech stock investors turning a deaf ear to both events, one must wonder how heavy the Dow or S&P must get in order to finally pull the NASDAQ down with it. The benchmark S&P 500 Index traded again at new lows for the year Thursday as the Dow plunged below 10,000. The Dow Transportation Average, which peaked last May in a pattern of classic divergence with the Industrials (the DJTA typically peaks ahead of the DJ Industrials), is now down a hefty 39% in only nine months. The Dow Utility Average also failed to confirm the DJIA’s January 14 record high of 11,750. If you’re a trader of Dow stocks, the DJTA and DJUA pattern of non-confirmation signaled the DJIA’s 16%, five-week plunge, the steepest dive straight from a record high in 45 years.

In the process, a full ¼ of the New York Stock Exchange consistently moves to new 52-week lows, often in consecutive weeks, illustrating the true nature of the bear market in stocks that began in April 1998 when the so-called internal market peaked. At one point during the S&P 500’s Year 2000 decline, a full 24% of the S&P was setting new 52-week lows. It’s enough to make your hair stand up on end.

But the hair on nervous investor and worried Fed chairman heads is not the only thing up. The NASDAQ is now involved in its most extreme divergence with the S&P 500 and other benchmarks in history. Never has the NASDAQ moved 4 standard deviations above its 200-day moving average, let alone moved up so much while the other important benchmarks move down. This, it seems, is a result of a situation in which tech stock speculators after the high returns some of the NASDAQ stocks have produced are rationalizing their rampant buying by saying “it’s a new economy,” and in that new economy, they say, tech stocks will not be affected by rising interest rates, soaring trade deficits, and the dreaded inverted yield curve (short-term Treasuries yielding higher than long-term Treasuries).

We beg to differ. And so does history.

Now, granted, this is the very New World our annual forecast reports of the past decade had prognosticated. We didn’t’ jump on the bandwagon late by any means, for we have been prognosticating such a new world for a large majority of our 12+ years publishing market research. That new world is now here, and the stock market did, stage the raging bull market our February 1991 issue of The Global Market Strategist® had forecast. And, boy did the bull rage—so much so that its movement through long-term resistance levels three times this decade prompted us to raise our forecasts.

I bring all this up not to illuminate our past record (do we really need to acknowledge again that we are not right every time?), but for a good reason: we don’t wish to be misinterpreted as negative, or as underestimating the boon to the domestic and world economy that today’s Internet and technological advances allow us. Our annual forecast reports observed as early as 1992 that the huge increase in U.S. productivity that year signaled that, once again, it will be technology that pulls the economies of the world out of recession or depression.

That said, let’s make sure we distinguish between an observation which says that the NASDAQ and tech sector is too risky to buy, and that investors should consider the dreaded “D word”: Diversify, even some of your capital into alternative investments or into boring U.S. Treasury Notes or Bonds. Compared to the NASDAQ casino, you’ll be sure to fall asleep following your Treasury investments. But it beats lying awake at night as soon as that huge risk hits the NASDAQ-heavy portfolios investors seem to have accumulated while ignoring the Fed, the inverted yield curve, and the leading indicators of a stock market top.

Yet, the bear market in 80% of the stock market, and the research and market indicators that we have observed in our research products, and that Ned Davis has now devised, scream high risk even to tech stocks that are a proxy on the future. Davis’s firm, the Wall Street Journal reported, has found a great way to help confirm suspicions that today’s market is more like the 1972-1973 market environment, not 1929 or 1987. The market did not crash in 1999, and that told us a lot: that the bull market is likely to begin a slow bleed that accelerates increasingly until our dominant 39-month cycle bottoms in the fall of 2000. The 1972-1973 market, in fact, performed the same way and yielded to a steep sell-off in the averages into 1974. So, crash or not, we wouldn’t advise ignoring such an important market cycle even if you’re not a “cycle person,” for this cycle has been responsible for some of the worst stock market damage in modern history. It ushered in the declines of 1974, 1981, 1984, 1987 (the crash bottomed right on the 39-month), 1990/1991, 1994, and 1997. Now, that cycle looms ahead to greet the new millennium, and the stock market is in a rather vulnerable position with so many stocks in bear markets.

Back to Ned Davis’ indicator. They found that today’s market is like the “Nifty Fifty” era of 1972/1973, the last time the Advance/Decline Line acted like it has the past couple of years, and the last time the tech stock sector was rising. In the wake of that era came a 23-month-long bear market, which culminated in that devastating stock market decline of 45% in the averages and up to 80% in many stocks by the time the dust settled in 1974.

Ned Davis Research found that, in 1972, the most expensive 20% of the S&P 500 Index “commanded a median price-earnings ratio that was 3.0 times the median P/E/ multiple for the remaining 80%,” as the WSJ reports. Those were the days of excess valuations, but today the market has managed to blow the top off even that extreme, the top 20% of the S&P commanding a P/E/ multiple of a whopping 4.8 times the P/E ratio of the rest of the market.

So, the 1990s bull market pushed the envelope of historic extremes, exceeding by many measures that of the rampant speculation of the late 1920s, and of the late 1960s and early 1970s. Did the bear market following those periods mean that the technology of the day – radio and automobiles and mainframe computers and semiconductors—was not good for the domestic and global economy? By no means did it imply that the technology was not good….just that stocks were pushed too high and it was time for a correction.

Does the bear market in 80% of U.S. stocks now signal that the Internet or our modern-day technology is going to fail for the first time in history to bring the economy into a new era of prosperity? It is technology, we wrote in our annual forecast reports of the early 1990s, that will bring us out of the 1990/1991 recession and into the New World, as we dubbed it before it became an every-day buzzword. The answer, of course, is no—it will not fail to produce the kind of global prosperity in the 2000s that we envision and hope for.

But what the stock market is telling us, once again, is that one cannot ignore interest rates, and that the new economy still needs the goods and services produced by the old economy. Technology companies alone will not save the world, if you will. They will help bring on the new prosperity, but they won’t solve the problems of high interest rates, soaring fuel costs, the global business cycle of expansion and contraction, and of the chronic problems our global monetary system presents. That monetary system, which has the world dependent on the state of the U.S. dollar as the reserve currency and as a fiat currency not backed by gold but in which much of the world still denominates their debt. A high dollar does not help the distressed economies of the world, and the faster the U.S. economy chugs along and the higher interest rates go, the more it becomes evident of something we observed in our Forecast ’99: Investing During The Void report last year: that the global economy must be considered one large unit comprised of individual component economies, and that one part of that unit cannot ignore the other. If that occurs, that sector becomes out of balance with the other sectors, and problems develop. The good U.S. economy the past year illustrates that perfectly, and again poses the question that, if the economy is so good, then why is the stock market plunging in its worst decline since 1974?

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