Last year in his private newsletter Yelnick outlined three options for the new year. How did they turn out?
1) Prechter's meltdown. Didn't happen. Yelnick thought it least likely: "The STU crew was soooo convinced of Big Debacle last October, which ended short, that they have been overly anxious to see the drop recommence ever since."
2) Cycles rule. Did happen. Yelnick thought this most likely: "Historical analysis would predict the next up cycle as 9 months and the down as one year to 15 months, meaning generally up or flat through the first half of 2003, with a drop in the 2d half that extends into the last half of 2004 to end this cycle down."
3) The Bull is Back. Could happen. Yelnick still thinks unlikely: "Current worries are over the uncertainties of war, but a war in Iraq would be much less costly to us than real dip in the economy or another 9/11 event. These uncertainties should be behind us by 2Q03, as a war in Iraq if it occurs seems timed to commence in Feb/Mar. The market tends to anticipate the end of a recession by 6 months - which means the Oct bottom predicts we begin to grow again in 2Q03."
So, not bad in predictions. The cycle prediction expected a downturn in late 2003 which has not yet happened; mid-year Yelnick modified that prediction to target Mar/Apr 2004 as the turning point. This is still the preferred view. If we pass by that turn period, however, the third prediction becomes interesting. What about the return of the Bull?
The case for the Bull is straightforward: bear markets seldom last this long, the economy never really went through a '30s or '70s debacle and seems to be growing again, interest rates are low, and there is a lot of investment capital looking for someplace to invest in the Global Scramble for Yield. Further, the jobless recovery can be explained as due to the rapid increase in productivity from the Internet. The mania simply got ahead of itself; the predicted value of all those dot-com stories is steadily being realized by the survivors.
All of this sounds comforting until you measure it against the still stunning P/E ratios - the market went so high in the mania, it has a long way to drop to get into historical ranges. Unless, unless ...
Unless you buy into the Dow36000 theory, that the preference for predictable bonds over risky stocks has been shifting for 100 years to the point that the risk premium for stocks is barely above that for bonds. For those not familiar with this argument, the risk premium for stocks at the turn of the century was 8% more than bonds, which made stocks the equivalent of junk bonds today. Stocks had to return 14% when bonds were paying 6%. Hard to do! Smart money bought RR bonds, not RR stocks. This premium shrunk to 6% in the 60s, and to 4% in the 80s, and may have gone closer to 2% in the 90s. At low interest rates on bonds, the PE multiple for stocks is in effect the reciprocal of the premium, so an 8% premium means a 12x PE ratio, while a 2% premium means a PE of 50! A Dow of 9000 at an 8% premium would be Dow36000 at 2%. So maybe the 'stunning' PE ratios reflect the rise of the Investor Class, a preference for stocks over bonds, and the shrinking of the premium.
The Dow 36K argument sounded great in 1999, does anyone believe it today? Manias always have shills to justify the foolishness with multisyllabic profundities and complex mathematics. Yet some very serious people are pushing a kinder, gentler version of that argument. Abby Cohen at Goldman Sachs has been making a similar case for the Bull, that PE ratios should be higher in a low interest environment. The CSFB economists behoind the Global Scramble for Yield viewpoint would implicitly agree. If returns are too light in safer investments, hot money will seek riskier returns elsewhere.
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