Y2k, Stocks & The Economy: The Unavoidable Bear Market of 2000

September 27, 1999

When I first started extensively researching the Year 2000 Problem ("Y2K") in early 1998, the extraordinary magnitude and ramifications of the Y2K challenge to modern society hit me with breathtaking impact. The unavoidable economic consequences of Y2K were far too serious and compelling to ignore. Y2K challenges the very essence of the financial planning industry and yet the industry treats this challenge in ways that confound rationality. The vast majority of financial advisors don't see Y2K as anything more than a minor issue. They don't see the potential effects on investments, companies and pension plans. Subsequently, they advise their clients to "stay the course." The idea that Y2K is an economic Titanic that portends disaster is laughable and shrugged off as absurd, unrealistic and simply not a factor beyond the first week of January 2000. After all, the Dow is hovering near 11,000 and the economy seems "unsinkable." The rest of the world may be floundering but the US economy is solid as a rock and can withstand any global shockwaves.

Since financial planners and advisors are telling their clients not to worry, what is at risk? What is at stake? Millions of consumers have saved and invested over the years and have trusted their nest eggs to advice that states: "Long-term the picture is bright with some bumps along the way. Stay bullish. The markets will be just fine for the foreseeable future. Anyone that tells you different is a gloomer-and-doomer." There are millions of people accruing assets for their retirements, college for their children or saving for that first home. What is wrong with this picture as we enter the remaining months of 1999? If the economy is so invincible now, why bother worrying about Y2K? Won't that be just the proverbial "bump in the road?"

To dismiss Y2K is to dismiss the mountain of evidence that suggests that Y2K will have far-reaching effects for all of us. Although everyone under the sun states that "no one knows what is going to happen," those familiar with Y2K don't ask the question "Will it be bad?" They ask: "How bad will it be?" When you scrutinize the extensive research reports provided by government agencies, corporate sources, international organizations and trade groups and then stand back to see "the big picture," you reach an epiphany when you say: " Good Lord, how can it be anything but a disaster?"

The economist Edward Yardeni has done yeoman work on the potential economic consequences of Y2K. It is widely reported that Yardeni sees a 70% chance of a recession from Y2K. I think he is an optimist. Personally, I believe that a severe recession by Spring 2000 is unavoidable. The data is overwhelming.

I am also an optimist. I have been bullish on the economy and the stock market since 1981. This despite the fact that 1981-82 was the toughest economic period since the severe recession of 1973-74. When the crash of 1987 occurred, I was an optimist and saw it as a buying opportunity for stocks. The relatively mild recession of 1991 was also no reason to change a bullish course. 1991 was also the last official year of existence for the Soviet Union. The fall of this empire had fantastic ripple effects for the US economy. At that point, diminishing defense expenditures at home and pent-up consumer demand abroad started a new growth phase for American companies. A renewed boom was on the way almost immediately.

When the Republicans took control of Congress in 1994 and became a strong counterbalance to Clinton, this "gridlock" became a huge plus for the economy. When Republicans and Democrats are tangling with each other and essentially leaving the economy alone, the economy takes care of itself. After all, politicians can't create a good economy; they can only harm it by interfering. Excessive government intervention is usually bad (and often very bad) for the economy. When people and private organizations are unfettered by excessive taxation and regulation, then economic growth surely follows.

As the 1990s progressed, other factors fueled economic growth and the stunning ascent of the Dow. Productivity increased markedly with boosts from technology and the advent of the Internet. Credit expansion helped the economy to new heights. Many economists hailed economic conditions that seemingly provided endless good times. What was there to worry about?

The 1999-2000 period will be the most treacherous period for the economy in nearly 60 years. There are two basic reasons for this: The Year 2000 Problem ("Y2K") and an economy overextended on debt.

Y2K is very bad for the economy in many ways. Information technology specialists and Y2K programmers know what Y2K can do to an unprepared organization. There is no question that an organization that is not fully prepared for Y2K will see devastating results. Y2K preparation is expensive, complicated and time-consuming. For most organizations, Y2K is literally do or die. If Y2K is properly resolved, the cost of assessing, remediating and testing system changes and repairs could be expensive to the point of eliminating profits. The cost of not resolving Y2K could mean bankruptcy. For the economy, however, we must understand the systemic effects and consequences of Y2K.

If 90% of the country's private and public organizations get their systems compliant by Dec '99, we will have a severe recession by the first quarter of 2000. You read that correctly . . . 90%! A 10% failure rate would be a major blow to the economy.

What if only 80% of the country's organizations get compliant by Dec '99? That would be enough to trigger a depression. A 20% failure rate is enough to cause a depression that could last 5-10 years. Y2K compliance is a very serious issue with much at stake. A 20% failure rate would devastate the economy in ways that would rival or exceed the Great Depression. How many businesses would go bankrupt? How many people would lose their jobs? How many 401K plans and IRAs would be devastated? How many financial planners would be sued for bad advice? Indeed, how many financial planners would lose their jobs or businesses?

What if we achieve 100% compliance by Dec '99? Such a feat is not possible , but assuming it was, what would be the result? We would still have a recession in the year 2000 but it would not be in full bloom until Spring 2000. Why is this? Because in spite of our efforts, the rest of the world is lagging 12-24 months behind us. Our trading partners in Europe, Asia and the rest of the world are in terrible shape and will not complete their Y2K efforts until long after January 2000. This will have a terrible impact on us. To truly understand this, you need to refresh your memory regarding the 1973-74 recession.

1973-74 saw a very severe recession that was triggered by a disruption in the flow of oil to our shores. The economic suffering stemmed from the disruption in just that one commodity. Since we imported a significant amount of our oil, we were dependent on sources outside our sphere of control. How many financial advisors in 1999 remember that painful lesson? The noteworthy point to keep in mind is that the imported oil didn't completely stop coming; it simply slowed down. In 1973, imported oil was 34% of our oil capacity. In 1974, it fell to 25%. This drop of only 9% was enough to batter our markets. During this period, the stock market fell 45%. The unemployment rate went from 4.6% in 1973 to 8.5% in 1975. The number of unemployed nearly doubled . . . all from a mere 9% drop in oil imports! How bad would it have been if oil imports were cut in half . . . or fell to zero?

Now fast forward to 1999-2000. We are more dependent than ever before on oil imports. How dependent are we today? By industry estimates, we now import about 55% of our oil. According to the World Bank, the oil-producing countries that we rely on are 18-24 months behind schedule in their Y2K efforts. Countries such as Venezuela and Saudi Arabia have started very late to fix their systems. We forget what it takes to get even one barrel of oil from one part of the globe to another. You need compliant systems to get the oil out of the ground, compliant subsystems working properly in compliant oil refineries. Then you need compliant utilities to power these systems along with compliant telecommunications systems, and you also need compliant banks to process payments for these shipments of oil. Of course, you need compliant ports and compliant tankers. You also need compliant navigational systems and compliant satellite systems. It is truly an amazing, intricate and delicate interdependent tapestry of related systems that is necessary to function adequately for us to get oil.

If we don't get oil for a span of months, it may not be the end of the world . . . BUT . . . it would be the end of the world as we know it. If we can't heat (or cool) our homes, gas up our cars, or get cargo trucks to operate, will our way of life be affected? Absolutely! Y2K poses the grave threat of seriously disrupting oil imports on a scale far greater than the energy crises of the 70s. But we have to realize that this is only the tip of the iceberg. Y2K offers this and much, much more. The disruptions triggered by Y2K affect a wide spectrum of imported goods, services and commodities. There are literally hundreds of thousands of items that would have a great deal of difficulty reaching us because of Y2K-related disruptions. Computer parts and rare metals, pharmaceutical supplies such as insulin and ingredients for many medicines that we take for granted. Food stuffs, textiles, on and on. The list seems endless. Just look at the labels on most items you buy. How many say "Made in America?" How many manufacturers and retailers will survive if they can't get the necessary materials and goods to sell to their customers? If a company can't make the necessary sales to their customers, how long will they stay in business? If a company loses money, how do they pay their employees? If a company suffers declines in sales and earnings, what happens to their common stock? If a company's cashflow suffers, how do they pay their debts? And if their employees lose their jobs, how do they pay their debts?

Even the heartiest optimists concede that the international situation looks negative. They just don't seem to grasp the idea that the United States will be seriously impacted. This defies logic, empirical evidence and past experience. At what point does the light bulb go on? At what point does Y2K denial become Y2K reality?

Keep in mind that we in the US still have a long way to go before we can brag about our readiness. There are far too many government agencies and companies that are lagging behind schedule. The studies done by the Gartner Group, Cap Gemini, Weiss Research and other organizations that monitor Y2K show conclusively that many organizations will simply not make it in time. Anywhere from 22% to 40% of the Fortune 1000 will fall short of the immutable deadline. How does this impact the markets? How about personal financial planning?

The ramifications for financial planning are obvious once you grasp the entire picture. If you knew that the company you just bought stock in was in danger of bankruptcy because of Y2K problems, what would you do? What would happen if you or a family member were employed by such a company? If your pension plan is totally invested in Fortune 500 stocks and you know that 22% to 40% of them will suffer losses from Y2K, what would you do? It's obvious that you would switch out of vulnerable investments into safer vehicles such as high-grade bonds or US Treasury securities (preferably).

In the Y2K environment, land mines are everywhere. Losses across our economic landscape will be impossible to avoid. The cascading effects of Y2K disruptions will cause an endless myriad of negative possibilities. What happens if company A is compliant and totally ready for Y2K but their main supplier or main customer isn't? What happens to General Motors if only 1% of its critical suppliers have Y2K-related failures? Or what if General Motors doesn't finish repairing its systems and sees its operations disrupted. How will that affect its suppliers, vendors and customers? When you logically play out the cause and effect aspects of Y2K, you can easily see the compelling picture of the very real possibilities. Many, if not most, of these possibilities are at this point unavoidable.

The Y2K problems, both direct and indirect, put every industry at great risk. Investments in these industries are then at risk. People and organizations that hold these investments are at risk. The stakes are very high and planners and their clients need to ask themselves some hard questions and assess their financial situations from a risk management perspective. I have told my clients and students to factor in Y2K in their financial planning because it is the prudent thing to do. Indeed, it is essential.

People ask me . . . "What if you are wrong about the severity of Y2K?" First of all, I tell them that being wrong is what I hope for. What rational person hopes to be right about a disaster? The important point I make is that planning for problems is a low-cost, low-risk strategy. If my clients sell their stock now, they have locked in their gains. No one ever lost money taking a profit. It's better to incur a capital gains tax now than to suffer a heavy capital loss later. If Y2K blows over with minimum effects, then investors can breathe a sigh of relief and re-focus on growth and stock market investments.

Diminish your exposure in the stock market. Use the current environment to consider selling off stock to lock in profits. I know I will be accused by some of creating panic with this suggestion. But isn't it time that public figures-- and financial planners and advisors-- began being honest with their readers and clients? The panic will come. It may happen in late 1999 or early 2000. This is inevitable. So by suggesting an "orderly pullout" now, I am mitigating the severity of that panic later. Isn't that the responsible and honest thing to do? If I don't do this, what do I say to my clients after they have lost 50% of their life-long savings when the market falls? That I didn't tell them the truth because I didn't want them to panic?? The American people are a lot smarter and a lot more levelheaded then we sometimes give them credit for, so long as we don't force them into a corner-- as the Y2K nay sayers are doing.

Taking my point of view means you may pass up on some further growth in this currently over-valued, over-heated market. However, you also shield yourself against potentially massive losses. In the Spring of 2000, one can re-assess the situation and invest accordingly. Planning for potential affects of Y2K is a temporary strategy that does no harm. However, taking the point of view that Y2K is a non-issue needlessly exposes one to great risks. If Y2K is even 25% as bad as the research indicates, then many investors will suffer. The next nine months will be very volatile and the dangers of Y2K will become more evident as more data comes in during the upcoming months. Keep in mind that Y2K is not the only issue plaguing our economy. Despite the robust facade of seemingly endless economic growth and sky-rocketing stock indexes, the underlying fundamentals in the economy are serious harbingers of decline.

Think about what is going on in the economy as this article is being written . . .

  • Record personal bankruptcies. 1999 will be the third year in a row of over one million personal bankruptcies.
  • Record corporate bankruptcies.
  • Consumer debt is at an all-time high.
  • Mortgage debt levels are at an all-time high.
  • The loan-to-value ratios of many of these mortgages are also alarming. For the first time in my career I have seen mortgages at 125% of market value. The dangers are obvious.
  • Margin borrowing is at an all-time high. More investors than ever before are leveraging their investments by borrowing against their stocks by loans from their brokers. A market correction would mean many investors would get those dreaded margin calls from their brokers. This in turn would trigger more selling that could in turn exert more downward pressure on the stock market.
  • The consumer savings rate is a negative number for the first time ever. Consumers are putting less money in savings accounts as they funnel the bulk of their money into the stock market.
  • According to the Wall Street Journal, corporate debt levels have tripled since the beginning of the decade. As deflationary pressures keep prices low, debt levels remain high. Current research suggests that corporations are currently seeking even more credit to pay for mounting Y2K remediation expenses and to also have a cash cushion in their year-end contingency planning.
  • The price/earnings ratio for the Dow Jones index stocks is at 29. This is twice as high as its average during the 80s and early 90s. Even the cautious Greenspan is concerned about high stock prices that are not sustainable.
  • The price/ earnings ratio for the S&P 500 is over 30. 10 years ago, stocks that had P/E ratios of 20 were considered risky.
  • The price/earnings levels for Internet stocks are outrageous by any rational standard. There are companies with P/E ratios of 400, 500 and over 1,000! Many Internet companies like Amazon.com have losses year after year and yet see their stock share prices at dizzying heights.
  • The international situation has not markedly improved. Most countries still have languishing economies that are not out of the woods. The currency and debt crises of recent years have not appreciably abated. Russia and Brazil have weak economies that are in danger of stumbling further into the abyss.

Even if Y2K was not an issue, the above points alone make the next 6-9 months a treacherous path for the economy. Y2K adds tremendous financial pressure to an already weakening economy. The budgets for Y2K planning, remediation and testing have continued to balloon. Peter Lynch regularly points out that "earnings drive stock prices." What happens to earnings as 1999's deflationary environment keeps revenues low and Y2K drives costs up? Companies that are already over-extended on debt will be squeezed even more. Earnings will decrease which will have a downward effect on stock prices. For companies dealing with Y2K, their choice in the coming months will be a tough one: either spend the money on Y2K or go out of business. The ripple effects from companies that see earnings drop, suffer losses or go bankrupt would be a tidal wave. Noncompliant companies will sink and drag down their compliant customers and vendors with them. The stakes are indeed very high.

When I mention Y2K to other financial planners, they usually scoff at it and respond flippantly with "they'll take care of it." I ask them "what 'they' are you talking about? The 'they' that I speak to is either very worried about Y2K or downright terrified by it. Maybe your 'they' should speak to my 'they' so that 'they' can come to a consensus about Y2K."

I spoke to an insurance broker about Y2K and he told me he wasn't worried about it. Not in the least! This insurance professional disregards the risks of Y2K and then goes about his business. What does he then do? He goes to his clients and sells them . . . insurance! How does he justify the idea of selling insurance? "You need insurance . . . just in case . . . because you don't know what tomorrow will bring! You have to protect yourself against the risks to your life, property and business!" Billions of dollars of insurance coverage is sold with this basic idea. Insurance is a vital part of the financial picture for most people. No matter how remote the possibilities, you must guard yourself against potential disasters. He pooh-poohs Y2K and yet has this position on insurance. Preparing for Y2K is another form of insurance. Can you see what I mean? He can't.

The threat of Y2K is real and it grows closer with each passing day. Ignoring Y2K will be the biggest blunder we can ever make. The tragedy will be that millions of consumers who rely on these financial advisors will be needlessly put at risk. For those who are concerned about Y2K, some low-risk precautions will help you minimize the risks:

  • Everyone tells you to keep good paper records. Do it! It is something you should be doing anyway.
  • Find out about the Y2K status of the companies you invest in. The most reliable way is to check their SEC filings. Look at the companies' most recent 10K & 10Q reports. Go to the Edgar database at www.sec.gov.
  • If you are not sure about selling stock, at the very least put stop-loss orders in place on all your stocks through your broker. Stop-loss orders make sense in any market. They are a sensible way to avoid major losses. For example, let's say you own XYZ stock which is currently priced at $100 per share. Call your broker and put in a stop-loss order at $90. Your upside potential remains intact and it protects the bulk of your investment from downside risk. I have recommended stop-loss orders since I did my first investing seminar in 1986.
  • Consider US Treasury securities for maximum safety. Treasury money market funds and US Savings Bonds are excellent vehicles for jittery Y2K investors. Also consider medium term and long term investments using Treasury notes and Bonds. Treasury bond funds also make sense. Speak to a financial planner that is not in "Y2K denial."
  • Consider re-allocating the investments in your 401K plan or IRA to more secure investments such as mutual funds that specialize in Treasury securities and other safer/ less volatile investment vehicles.
  • Inform yourself about Y2K. Don't take any one source --including this one-- as gospel about Y2K. Get the "Big Picture." Use the Internet and get as much information as possible. Some great sites are...
  • www.y2ktimebomb.com
  • www.year2000.com
  • www.y2ktoday.com
  • www.garynorth.com
  • www.y2knewswire.com
  • www.y2kreview.com
  • www.y2k.gov

I have put myself on the line and have forecast a severe recession to start no later than the second quarter of 2000. My research indicates that a bear market within the next 12 months is a virtual certainty. I believe that the unemployment rate will be in double digits by mid-year. I expect the Dow will fall to 5,000 during the first half of 2000.

What if I am wrong? What if the overwhelming evidence is wrong or inaccurate? Being wrong is something I would welcome, but keep in mind that when the coast is clear you can switch back to the stock market and know that all you really lost was a few months of modest growth. You kept your assets intact through an uncertain period.

As I stated earlier, I am an optimist. I am not into doom-and-gloom. Panic is not suggested. Keep in mind that "doom" and "panic" are not the real issue. The issues are economic fundamentals and a very real and potentially disastrous computer problem. The evidence suggests that we must act prudently, responsibly, but without waiting much longer. I have said it many times to my students: "If you prepare for a problem and it doesn't show up, then no problem! Enjoy yourself and go on with your life. But what if you don't prepare for a problem and it shows up? At that point, what was an avoidable problem is now far worse because you didn't prepare. It is a risk-free strategy.

The burden is not on my point of view. It falls squarely on those that dismiss Y2K. The point is . . . what if THEY are wrong? The price for being wrong about Y2K ranges from significant loss to outright devastation. Why take that risk?

Alan Greenspan is being cautious about the market. Why not you? According to the SEC, many insiders at many companies are selling their stock in record numbers. What do they know that you don't? Isn't it time to join the ranks of the professionals?

The comparison of Y2K to the Titanic is a fair one and accurately summarizes the troubled waters that lie ahead. Be among the first to orderly head for the lifeboats. If nothing happens, you can always return to the ballroom later on. In the meanwhile, better safe than sorry. But don't wait too long. Time is running out. Good luck.

A one-ounce gold nugget is rarer than a five-carat diamond.

Gold Eagle twitter                Like Gold Eagle on Facebook