40%-50% Chance Stocks Will Crash To New Low, Says Gary Shilling

Last summer, our guest Gary Shilling of A. Gary Shilling & Co. predicted that stocks would fall 30%.  That hasn’t happened yet, but the extraordinary bull run that made idiots out of many of Wall Street’s greatest gurus last year has now finally reversed, and Gary is sticking by his bearish guns.

At Dow 10,000, Gary says, stocks are still priced to reflect a strong economic recovery throughout 2010 and 2011.  And that’s not going to happen.  Consumers still account for more than 70% of the spending in the U.S. economy, and consumers are retrenching.  The value of their assets has plummeted, so they’re finally saving again.  They’re unemployed.  They’re tapped out.  Put all that together, and consumer spending will continue to be weak, and the overall economy will only grow 2% a year.

When the market finally realizes that its dream of a v-shaped recovery is too optimistic, stocks will go lower–perhaps much lower.  In fact, Gary thinks there’s a 40%-50% chance they’ll crash right through the bear-market lows set last spring.

So what’s an investor to do?

Buy Treasury bonds, Gary says.  Contrary to the concerns of they hyper-inflation crowd, the world is awash in excess capacity.  We have too much production capacity, too many houses, too much labor.  Overcapacity leads to deflation, not inflation.  So today’s 4.5% long-term Treasury yield will go to 3%, making bondholders 25% in the process.

And buy the dollar.  At the end of last year, everyone agreed that the dollar was going to continue to collapse.  That was your queue to get the heck out.  It’s not that we don’t have serious problems with deficits and debt in the U.S., Gary says–it’s that our problems are less bad than the problems facing the Euro.  Gary thinks the dollar will rise back to parity with the Euro, a major move from the ~$1.35 it takes to buy a Euro today.

And sell commodities.  China is overheating, and as it corrects, it will take global commodity demand down with it.

In short, Gary says, do exactly the opposite of what everyone was telling you to do at the end of last year.

Barry Ritholtz says, A Bad Economy Could Spell Good News on Wall Street for Years to Come

The economic recovery isn’t as strong as first thought. Revised GDP figures released this morning show the economy grew at a 2.8% annualized pace in the third quarter, less than the 3.5% initially reported. The revision was in-line with expectations but shows the economy didn’t have as much momentum heading into the fourth quarter as previously believed.Unlike Wall Street traders, consumers seem to know the recovery is “anemic,” as Barry Ritholtz, CEO of Fusion IQ, describes it. The Conference Board’s latest confident survey shows Americans feel worse about the current economic situation than they did in March, when the stock market was making new lows. (Thanks to Dan Greenhaus of Miller Tabak for pointing this out this last fact.)Yet, stocks are still near their highs of the year. Going into the final hours of trading Tuesday, stocks were in the red but well off the lows of the day. What’s driving the disconnect between Wall Street and Main Street?Ritholtz says it’s a classic example of bad news being good news on Wall Street. “We’re in a cycle that’s not based on profitability, not based on expanding economy but based on all sorts of government supports,” he says. “Bad news is going to be good news for the next couple of quarters probably.”That’s because low interest rates and liquidity provided by the Federal Reserve, coupled with government stimulus are enticing traders to buy into the market. “Cash is trash,” says Rithotlz, who remains bullish on stocks.Ritholtz is confident that eventually fundamentals will prevail and thinks the market will take a hit once the economy shows signs of improvement, meaning the “extraordinary” stimuli can be removed. But predicting the timing is anyone’s guess. “You could have this disconnect that goes on for not days, weeks or months but years and years,” he says. So, in the meantime, Ritholtz – who correctly predicted the 2008 crash and told Tech Ticker’s audience “the mother of all bear market rallies,” was upon us in March – is still long stocks and likes commodities (thanks to a weak dollar) and emerging markets.

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Bob Prechter “Quite Sure” Next Wave Down Will Be Bigger and March Lows Will Break

Yes, the late 2007-early 2009 market debacle was just a warm-up to what Prechter believes will be the bear market’s main attraction. In this regard, he says the current cycle will echo past post-bubble periods such as America in the 1930s and England in the 1720s, after the bursting of the South Sea bubble.The 2000 market peak market a “major trend change” for the market from a very long-term cycle perspective, and the downside is going to continue to be painful well into the next decade, Prechter says. “The extreme overvaluation, the manic buying and bubbles in the late 1990s [and] mid-2000s are for the history books – they’re very large,” he says. “The bear market is going to have balance that out with some sort of significant retrenchment.”

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Robert Prechter Says Dollar’s Hit a “Major Bottom”

Forget all the talk about the dollar being in terminal decline. The recent rally in the greenback is for real, says Robert Prechter, president of Elliott Wave International. The man who correctly predicted the 1987 crash and last year’s peak in oil prices now says we’re “going to be up for a year or two in the dollar.”Reuters and other mainstream news outlets attribute the recent uptick in the dollar versus other major currencies to an improving economy signaled by Friday’s “stronger-than-expected U.S. jobs numbers.” Prechter, ever the contrarian, says the U.S. dollar has put in a major bottom but not for the reasons everyone else is pointing to.

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Inflation Not a Problem “Deflationary Depression” in Our Future

Elliott Wave International founder, Bob Prechter thinks Krugman and Bernanke are premature in declaring victory over the credit crunch. Prechter, who famously predicted the 1987 stock market crash, tells Tech Ticker “the march towards depression, which is being fueled by deflationary trend, is pretty well intact.”So forget all you’ve heard about recovery and inflation, “we’ve only seen the first phase,” of the downturn according to Prechter. Next to come, is “a credit implosion” that will once again destroy the value of stocks, commodities and especially real estate. “The biggest area of overvaluation because of credit extension is the real estate area,” he says. “And if you’ll notice that’s the area that’s had the weakest of any kind of attempt at a recovery.”When this next phase of “deflationary depression” happens the only investment advice he can give is: safety first. “Make sure as an individual you’re in the safest possible investments so you can ride this out.” And as discussed in a previous segment, that means investing in dollars or dollar equivalent assets.

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Jeremy Grantham – Wild Stock Ride Ahead

Jeremy GranthamA large rally here is far more likely to prove a last hurrah … a codicil on the great bullishness we have had since the early 90s or, even in some respects, since the early 80s.  The rally, if it occurs, will set us up for a long, drawn-out disappointment not only in the economy, but also in the stock markets of the developed world.

From The Business Insider, May 7, 2009:

Jeremy Grantham was one of the few forecasters to call the crash, He was also one of the few to call the bottom two months ago–publishing “Reinvesting While Terrified” on the exact day the market bottomed.

And now, in his quarterly letter, the great Grantham has a surprise for those expecting a return to unremitting gloom: He’s (mostly) bullish!

Yes, stocks have once again reached fair value, which means there’s no enticing valuation opportunity.  But what the bears are missing, Grantham says, is that the entire world is now pumping more stimulus into the system than the entire world has ever seen.  And stimulus has a much bigger impact on stocks than it does on economies, Grantham says.

Alas, all is not champagne and roses.  After the market enjoys its little rocket ride through the end of the year, when everyone is finally certain that it’s not a sucker’s rally but a great glorious new multi-year bull market, stocks will crash and stay in the dumps for the better part of the decade.  So enjoy the ride while you can.

Excerpt from Grantham’s Q1 letter here.  Full letter from GMO.com embedded below.

Just bear our two principles in mind.  If the stock market is many times more sensitive to financial stimulus in the short term than the economy is [Grantham’s data suggests it is], then we could easily get a prodigious response to the greatest monetary and fiscal stimulus by far in U.S. history.

Second, if you don’t think there is a special, one-off, super colossal dose of moral hazard out there today, you are sadly uninformed.  The moral hazard in play today is of a massively larger order than any we have ever seen.  (But given how strangely selective the moral hazard or bailouts have been, it is enough to make those susceptible to conspiracy theories think in terms of a financial mafia led by You-Know-Who.  Too much seems to depend on which friends you have.)

So by analogy to the normal Presidential Cycle effect, driven by stimulus and moral hazard, we are likely to have a remarkable stock rally, far in excess of anything justified by either long-term or short-term economic fundamentals.

My guess is that the S&P 500 is quite likely to run for a while, way beyond fair value (880 on our revised data), to the 1000-1100 level or so before the end of the year. (For the record, I presented this case six weeks ago in Europe at 725 on the S&P, but was sadly distracted in my quarterly letter writing by a trip to Bhutan.  Poor thing.  I won’t complain, though, since my “Reinvesting When Terrified” was posted on the day the market hit its low.  You win some and you lose some.)

The market always anticipates an economic recovery and, sometimes, it must be admitted, there are several false moves (“suckers’ rallies”) before the recovery takes place. The current stimulus is so extensive globally that surely it will kick up the economies of at least some of the larger countries, including the U.S. and China, by late this year or early next year.  (This seems about 80% probable to me, anyway.)

Anticipating this, we should expect a stock market recovery – which normally leads economic recovery by six months, plus or minus two – sometime between two months ago and, say, August, which the astute reader will realize implies that this rally may already be it.

This was part of the logic behind my March posting, “Reinvesting When Terrifi ed”:  the uncertainties of the economy are so great that when the uncertainties of the stock market’s anticipation are laid on top of them, you simply must have big ranges of outcomes and hedge your bets.  Unless you have extreme luck or divine guidance, you will never catch the low.

Alternatively, there is still time – just – for another freefall leg, but time is running out.  Investor confidence is still fragile, and should we get a series of particularly shocking data points, which, in the unique position we fi nd ourselves is quite possible (say, one out of three), then confidence could crack one more time and the market could go to a new low before the major anticipatory rally I’m describing.  (This would make the current rally a short-term head fake.)

In a rally to 1000 or so, the normal commercial bullish bias of the market will of course reassert itself, and everyone and his dog will be claiming it as the next major multi-year bull market.  But such an event – a true lasting bull market – is most unlikely.

A large rally here is far more likely to prove a last hurrah … a codicil on the great bullishness we have had since the early 90s or, even in some respects, since the early 80s.  The rally, if it occurs, will set us up for a long, drawn-out disappointment not only in the economy, but also in the stock markets of the developed world.

For the full post including the May 2009 report, click here.

Money Fleeing the Market at Rate Typical of Bottoms

Posted Oct 22, 2008 12:47pm EDT by Aaron Task in Investing, Recession

As the market struggles to find its footing, debate is raging over whether the kind of panic typically associated with market bottoms has occurred in recent weeks.

It’s too soon to judge whether a sustainable bottom has occurred, “but there is a bit of capitulation going on,” says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co.

According to Sonders, outflows from mutual funds in the first two weeks of October exceeded the record $75 billion of redemptions set for the entire month of September.

Breaking things down further, the most dramatic outflows have come from assets tied to commodities like oil and gold, as well as emerging markets, which have suffered even more dramatic declines than the Dow and S&P.

That level of “I give up, get me out”-type activity — which is also evident in massive redemptions from hedge funds – is typically associated with market bottoms. Conversely, mutual fund investors were most bullish at the market’s peak in early 2000.

To be clear, Sonders isn’t a market timer or declaring the bottom has been established. Her message remains unchanged: have a plan, stick to it, stay diversified and periodically rebalance. But when panic – or even just fear — is in the air, it’s probably too late to go to cash, which may feel “safe” but typically proves to be a long-term loser after adjusting for inflation, she notes.