The Dent View - Dow 40K and the Double Bubble

Harry S. Dent caught dot-com fever early, published The Great Boom Ahead in 1992, and called the subsequent mania - all at a time when the punditry was largely negative and Prechter was positively Armageddic. He then wrote The Roaring 2000s, and was a bit taken aback by events, but undaunted he wayed in again in 2003 with The Next Great Bubble Boom, predicting a final wave 5 from 2005-2009 that should bring the Dow to between 35K and 40K, and the Nasdaq to 10K-13K. This is nowhere as high as Neely's Dow 100K, but then, Neely gives the market 50 years; Dent gives it 5.

He uses trendlines to make his target predictions. His view is that we finished 82W4 in 2003, and have begun 82W5. (His comes up with the same result if this is 74W5.) Currently we would be in wave 2 down of 82W5, with a very strong wave 3 up soon to come. The trendlines in the Dow are constructed by drawing a line from the bottom in 1982 through the bottom in Oct02/Mar03, then drawing a parallel line through the top in 2000. In the Nasdaq, the trendlines are drawn from the bottom in 1991 through the bottom in Oct02/Mar03, then doing the parallel line through the top in 2000. It is not hard to see how very high numbers result; these analyses essentially assume that the mania will continue through the end of 82W5. Would that the world worked that way! A scathing critique of Dent's views was done by John Mauldin, and expanded on here. 

Dent combines a variety of analyses, including demographics, spending patterns, S-curves and Elliott Wave. More can be found at his website. Once we get past his self-promotion (why else make such an outlandish prediction?), there are some things to extract from his work.

The most interesting is the concept of a Double Bubble: technological innovations tend to spawn two speculative bubbles, not one. It is well known that technologies come into an economy in an S Curve pattern. Dent's S Curve is attached. What is less well known is that investors react to the S Curve with two bubbles: the first Hype Bubble when the technology trend is first recognized by the herd; and the second Growth Bubble when the trend hits 50% of ultimate penetration. The first bubble causes investors to get way ahead of the market, and when the realize this, it corrects; the second bubble comes when they begin to realize that indeed the early promise is being realized, and they jump back in.

We see this in many historical examples. We had several railroad bubbles. The first was in the 1840s in England, and led to serious economic trouble. A smaller example of that happened in the US, but the first really good RR bubble in the US came after the Civil War, and popped loudly in 1873. Many railroads went under, and were later bought for 10c on the Dollar. A second bubble occurred in the 1880s, and some of the same RR's went under a second time, and were later bought for pennies on the Dollar. What is significant about these bubbles is the character of the winning investments changed between the two: the first bubble literally laid the track, and the second exploited the service. The first led to overbuilding of rails, and rates fell. The second exploited these low rates to develop new services on top: Pullman luxury passenger cars; an early version of FedEx; refrigerated cars to haul beef; and perhaps the best example, Sears, bringing all sorts of goods to the vast empty country.

Similarly, with automobiles, we had a first bubble in 1915-1919, the Ford Bubble. The Dow then dropped 72%, but came back in the Roaring '20s in a second auto frenzy, the GM Bubble. Dent makes a lot of this analogy in his most recent book, comparing GM to Intel. The most interesting point however is the pattern: the first bubble led to roads, gas stations, tires and all the infrastructure for an auto nation; the second was based on marketing and fashion, the great GM story of how color and brands beat Henry Ford's 'you can get any color you want, as long as it is black' philosophy.

Now, with the Internet, we have first built it out, and overbuilt it, and as with railroads, rates have plummeted. Now comes the second bubble, to exploit cheap Internet: Vonage (cheap voice), Google (advertising over the Internet), Amazon (the Sears of the Internet), JAMDat (mobile games), and so on and so on. It is clear that this second bubble is happening, and that there is a frenzy of venture capital being moved into these next-generation Internet deals.

But ... will this cause the Nasdaq to go from around 2K to over 10K in five years? If you run the math, as John Mauldin did, only if you believe that companies like Google and Cisco can rise to Trillion Dollar market caps.  Even Microsoft got only half way there during the first bubble, and that was one of the biggest bubbles of all time.  Collectively, he calculates that the Nasdaq would be worth $15T and the S&P $36T, or multiples of our GDP.   Wow!  Now THAT's a bubble!   

Oh well, it is nice to fantasize ... maybe if we clap our hands and really believe, it will come true. You do believe in Santa Claus and the tooth fairy?

We should note that there is something different about a technology bubble from the type of credit-fueled speculative bubble we just lived through. Yes, there will be great opportunities in tech stocks in the next five years, and sectors will have bubblicious valuations for a while, but without the overarching speculative frenzy that we just experienced, nothing like the '90s can be expected to happen again in our lifetime. 

Comments

[Rich Melmon]

I have a dear college friend from almost 50 years ago I saw most recently last week. We’ve stayed close. He’s one of these fellows who likes to take the position that the US is not as great as some of us think it is. He did it 50 years ago, and he does it today. And he always argues his point with great eloquence. Over the 50 years, he has with great facility shaped the particular events of the day to make his case. I love this guy, and so it is easy for me not to get involved in the debate so much as to see the Platonic form at work within him, and watch with fascination as he shapes the material of the day to it. Facts don’t bother him. He has his own. They serve him well. For out of his inner makeup, a particular Platonic form that says the US is not so good must be served. He needs that to savor his life.
I think it safe to say most of us have our own versions of Plato’s forms in us. And it is damn hard, if not impossible, to go very far from them when forming our views on any subject that has any amount of complexity to it—that is, any subject even worth forming a view on.
Predicting stock market closes for tomorrow is impossible. Predicting stock market closes 50 years from now truly absurd. Nonetheless, people far more clever than I can somehow find ways to be paid to do it. And paid well. So they do it. And they, like the diet pill peddlers, use fascinating bits of logic to make their money seemed earned. Or their views seem sociality important. The form their particular versions of this logic take are of course shaped to the particular Platonic structures that inhabit their unique brains. Facts about actual market performance will not in any way dent those Platonic structures. The facts will always be easily shaped to conform to the form.
This is not to say the logic used to support these predictions is completely without merit. There are varying degrees of interesting speculations that come out of the Dow 100000 or Dow 400 debates. Population explosions. Population crashes. Exploiting the natural resources of the planet. Running out of the resources. There are drivers in the world’s economy, like these, that will determine our fate. Some of them can be discussed with insight. But how these drivers will interact with each other, and with the cultures and political structures of the world is not knowable. The discussion reveals only Platonic forms. And there are only two—optimistic and pessimistic. Optimists see man as ascendant. Pessimists don’t. I’m more inclined than ever to think any one strongly in either camp is an idiot.
There are really good people who work very hard on real things that can have a big impact on our future. For example, people who have perfected the hybrid car. Or the next generation of nuclear generation technology. Or sincere efforts to build health care schemes that admit we can’t afford to save everyone every time forever. Apologists for technology, thinking it capable of solving all our problems, are silly. Our market economy is not at all effective in sending us the complex signals we need to do this right. While no better economy has yet been devised, I’m inclined to think we will survive in spite of our belief in markets, not because of this belief.
Market signals notwithstanding, some people still try to spend their energies making good judgments about things that could really impact our grandchildren’s futures. Some people don’t.

[Nate Kendrick]

A simple criticism, maybe, but looking at the Dow Jones charts on the Dow Jones website, I can't see much that resembles a bubble from 1915 to 1919, and nothing that looks like a 72% drop... Am I missing something?

[yelnick]

The scale of charts can mislead. The data show that the Dow had a nice run until 1919, then fell 72% over the next 3 years. The run up was driven by Ford and the promise of mass production. Surrounding it a lot of auto infrastructure got built - paved roads, gas stations, tires, parts stores, and so forth. No where near the bubble of 1929 or 1999, but for the time it was a nice little bubblet, and the auot promise caused a lot of surrounding investments to be made, not all of which were showcased by the Dow index. The Dow had been in an extended trading range, something like now, bouncing against 100, and the Ford phenomenon drove it up, then it collapsed post WW1 amidst double digit inflation, high interest rates, and similar.