Such lurid forecasts make Prechter easy to dismiss. After being accorded guru status on Wall Street in the 'Eighties for being one of the few prognosticators to predict the huge 1982 liftoff in the stock market and to stay aboard for most of the ride until just before the 1987 Crash, Prechter has been dead wrong about the market practically ever since. For he has remained timorously invested mostly in Treasury bills for the past 10 years, blowing better than 200% gains in the Dow and the S&P 500 Index. According to numbers compiled by the Hulbert Financial Digest, the Elliott Wave Theorist timing strategy would have yielded a 12% annual return from the end of 1982 through August 31 of this year, compared with 15.6% for the value-weighted Wilshire 5000 and the 16.6% annual return logged by the S&P. That's a huge underperformance, even taking into account the fact that Prechter's strategy was only half as risky as being fully invested at all times. His rejoinder to such cavils isn't entirely satisfying, least of all to his subscribers, who have canceled in droves over the years. (Circulation to the $233-a-year letter dropped to 4,000 in 1996, from about 20,000 in 1987, before popping to about 6,000 currently.) "Certainly I'm guilty as charged of underestimating both the duration and dimension of the current stock mania," he concedes, "but it's because I see what's coming on the other side. If I'm correct in my forecasts, then my premature exit won't matter, ultimately." Likewise, the scenario he lays out is so outre as to strain the credulity of even the most unregenerate bears. For a while early this fall, he raised the possibility that the Dow might go into a death dive that would take it to support levels of either 3675 or 2365 by the first week of November. The buying panic of the past two weeks that enabled the Dow to retrace more than 1,000 points of its October drop, back to 8500, has led him to push forward his forecast day of reckoning to early next year. In the meantime, investors should regard the current rally as a "golden opportunity" to get out of the market before the deluge, says Prechter.
And that won't be the end of the bear market, according to Prechter. Eventually -- around the year 2003, by his current reckoning -- the Dow could reach a "triple-digit level" bottom of between 1000 and 570, wiping out virtually the entire up move since 1974. "That's the fate of all manias, whether the Gouda Tulip Bulb Craze of 1636, the South Sea Bubble of 1720, the Roaring Twenties bull market, the surge in the Nikkei between 1974 and 1989 or the post-1982 stock market today," Prechter insists. "The only reason the Nikkei has yet to complete a retracement and is only 65% of the way is because it was all alone in a crash mode in the midst of a worldwide stock-market boom. But its decline is far from over." In Prechter's view, no market collapse of this proportion would be complete without the onset of economic depression. His 1995 book, At the Crest of the Tidal Wave, fairly bristles with grim prophesies of economic apocalypse. Deflation will send the prices of all asset classes, from stocks and bonds and collectibles to residential real estate and gold, careering lower. Sales and corporate profits will likewise be sucked down the deflationary vortex. Prices and wages in the service sector will suffer as mightily as those in the goods arena, since services tend to be more discretionary items than necessities. Financial Paralysis Unemployment could soar to 30% or more. Bank failures, moratoriums on mutual-fund redemptions and other calamities could cause the financial system to seize up.
Government policy measures, whether fiscal stimulation or monetary reflation, will prove powerless to keep the economy from augering into the ground. According to Prechter, a depression is in the end a psychological phenomenon not amenable to mechanical policy adjustment. In a depression-induced credit contraction, for example, lenders get too cautious and borrowers and consumers too fearful about the future to behave normally. Only those investors who heed these warnings and ignore today's investment nostrum of "buy and hold" will have a chance of being raptured up to financial heaven, Prechter believes. And then only by taking prudent steps like staying completely in cash, choosing the strongest financial repositories (perhaps outside the U.S. banking system) and selecting the strongest short-term government debt instruments in the safest currencies will investors be able to view the unfolding Great Bear Market "as if floating overhead in a balloon, unaffected, watching a slow-motion earthquake take place below." Or, at least, that's what At the Crest of the Tidal Wave argues. Prechter's current forebodings arise out of his belief in the Elliott Wave Principle, propounded some 60 years ago during the Great Depression by Ralph N. Elliott, a retired Los Angeles accountant. As detailed in two obscure monographs and various market letters in the early 'Forties, Elliott believed that financial markets and, indeed, political, cultural and other social phenomena were governed by recurrent and measurable waves of alternating optimism and pessimism. Man, after all, is a social animal who tends to follow unerringly the ever-changing psychology or, as Elliott put it, "mood" of the crowd.
Elliott believed in fundamental human progress. Yet it never came in a straight line, advancing instead in waves of growth punctuated by phases of "non-growth" or correction. The inherent pattern or sequence in all financial markets is "three steps forward, two steps back." In a bull market this process plays out as a rising, three-step, five-wave pattern-up, down, up, down, up-followed by a corrective, two-step, three-wave retracement-down, up, down. According to Elliott, this identical pattern can be seen over differing time spans, from less than an hour to market periods as long as several centuries. What has Prechter and fellow Elliott Wave adepts in a state of millennarian fever these days is their conviction that the July high in the Dow Jones Industrials may have marked incontrovertibly the concluding fifth wave not only of a bull market dating back to 1974 but, indeed, the Elliott Wave "supercycle" tracing back to the 1932 depth of the Great Depression. If true, under Elliott Wave theory one would expect a bone-shattering correction akin to that suffered from 1720 to 1722 in the British stock market with the bursting of the South Sea Bubble. The average stock lost more than 90% of its value in two years. The damage was even more grievous, though, if one also takes into account the dozens of companies that ceased to do business. The 12-fold increase in U.S. stocks since 1982, in fact, exceeds that of past stock manias by a goodly measure. Stocks rose but six-fold in the Roaring Twenties, for example. To Elliott Wavers, the bigger they come, the harder they fall. Many on Wall Street consider the Elliott Wave Principle to be voodoo. Detractors never tire of asserting that Elliott died both broke and insane, points that Prechter disputes. Critics are likewise put off by the theory's quasi-religious pretensions. Wave analysis in Elliott jargon becomes "interpretation." Fierce sectarian battles frequently flare among Elliott disciples over current wave count, though rulings by Prechter, given his stature in the field, are usually accepted as canonical. And as even Prechter will concede, Elliott Wave theory often proves wanting in the timing of major market moves. He should know, having been waiting fruitlessly for the Big Kahuna for the past 10 years. Yet one can't ignore Prechter's many forecasting coups over the years. He achieved cult status in the 'Eighties when he not only predicted the coming of a huge bull market but got his subscribers out of stocks just days before the 1987 crash. That year he was the subject of flattering profiles in The Wall Street Journal, Fortune and People magazine, among other publications. He first made his call of an impending bull market in a 1978 book on the Elliott Wave for which he was the co-author. The prediction was greeted with near universal derision. At the time, inflation and interest rates were soaring out of control. Stagflation reigned. A second gasoline crisis hit. President Jimmy Carter worried about a crippling "national malaise." Each stock-market assault on 1000 in the Dow seemed to end in what was called at the time a "massacre." In a famous 1979 cover story, Business Week declared "The Death of Equities." But Prechter hung tough and was ultimately vindicated. He feels similarly confident about his current bearish stance. The scorn and derision being heaped upon him yet again are, in Prechter's view, telling signs of the top-of-the-market euphoria that will soon be dashed. Likewise, Prechter has built a thriving business with some 70 employees in Gainesville, Georgia, offering a dozen printed and online publications applying Elliott Wave analysis to currencies, commodities and global stocks in addition to the U.S. equities market. His company also boasts a number of institutional clients that take his advisory service mainly for shorter-term market calls. He nailed the recent high in the dollar, for example. Clearly, at least some customers deem his work to be of value. With each passing month, Prechter sees more signs of the coming apocalypse. Back in 1995, he warned in At the Crest of the Tidal Wave that deflation was the menace and not the inflation that was the media's and Wall Street's continuing obsession. Now suddenly, economists and other pundits are joining his camp in droves. In the book, he also prophesied an epic global credit crunch with soaring risk premiums on all but the most blue-chip debt, defaults by foreign governments, a stampede to quality and an eventual seizing up in the global credit system. Just such a scenario has started to unfold with the Asian economic crisis, the Russian debt default last month and the widespread damage wreaked on fixed-income markets of late by Long-Term Capital Management and other overleveraged hedge funds. Finally, the CRB commodity index, gold, junk bonds and several other markets that he sounded a bearish note on in 1995 have continued to take gas. He even adopted a biblical cadence in his recent newsletter, observing that these and other forecasts "have now come to pass." To Prechter, market and economic fundamentals are mere reflections of the shifts in social-psychological moods rather than causative factors. It's the collective unconscious that dictates events, not the opposite. Yet he ascribes much moment to the fact that the economic fundamentals that undergirded the economic and stock market expansions from World War II to 1966 were so much stronger than those underpinning the economic expansion and stock market surge since 1982. The numbers bear out his contention.
Annual real growth in gross domestic product during the earlier period averaged 4.3% a year, compared with just 2.8% a year since 1974. Similarly, industrial production enjoyed a 5.5% annual gain from 1949 to 1966, while from 1982 to 1998 it grew only 3.2% a year. Likewise, the monthly unemployment rate from 1949 to 1966 averaged 4.9%, besting the 6.7% of the 1982-1998 period. Measures of debt and liquidity are also skewed in favor of the earlier period. At the end of 1966, for example, household liquid assets stood at 161% of liabilities, according to Prechter. Today households have less cash on hand than their total liabilities. Total debt as a percentage of GDP stands at 258% as of mid-1998, compared with 148% as the bull market peaked in 1966. Huge current-account trade deficits during the 'Eighties and 'Nineties have transformed the U.S. from net creditor to net debtor nation. One can argue that some of these measures, such as the current U.S. debtor status, ultimately don't much matter. But Prechter contends that the discrepancy in the vitality of the U.S. economy between the two periods is important in several respects. For one, it exposes the manic characteristics present in the post-1982 market surge. Stock prices managed far greater gains on far less salubrious economic fundamentals than in the first two decades after World War II. As a result of this obvious speculative froth, investors' expectations are fated to be cruelly dashed. Extreme disillusionment is the stuff of ugly bear markets and complete retracements, according to Prechter. One More Year, Michael Much of the fun in Prechter's musings comes from his tying cultural, political and social developments to the Elliott Wave periods. Bull markets, in his view, are invariably accompanied by higher hemlines, comity in domestic politics and foreign relations, happy, upbeat music and movies, strong attendance at sporting events and the like. Bear markets spawn the opposite. So far Prechter sees little in the zeitgeist to substantiate his conviction that the tide has turned for the economy and the market. Music groups like Hanson and the Spice Girls continue to top the charts with the same kind of happy, bubble-gum music that flourished in the 'Fifties and 'Sixties. Even country music these days remains more upbeat and pop-like in its themes than traditionally. Yet the dark side may be impending, according to Prechter. NBA basketball, the supreme symbol of the feel-good 'Nineties sports scene, is now threatened by the possible breakup of the heroic Chicago Bulls and the scrapping of the current season. One can only hope that Michael Jordan plays yet another season and a labor settlement is quickly reached. For the very health of the U.S. stock market and economy may be at stake.
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