The Contrarian's View is published 11 times per year on a mostly-irregular schedule, and the views expressed are those of the author and editor, Nick Chase. Because nobody can predict the future, results of past suggestions or recommendations are no guarantee of future results. Material in this publication may be freely quoted provided proper attribution is given to its source. Subscription rate: Free on the Internet through the World-Wide Web service at Assumption College. Using your favorite Web-browsing program, Open URL http://www.assumption.edu. Mailed paper subscriptions, one year for $39 to The Contrarian's View, 132 Moreland Street, Worcester, Massachusetts 01609. There is a limit of 50 paid subscribers at one time; please check for availability before sending any money. Sorry, Visa and Mastercard are not available. Overseas subscription rate, U.S. $54. Unsolicited material sent to us by UPS or by courier other than the postal service is refused and returned to sender! Phone: (508) 757-2881
First, the timing: I am not so bold to predict exactly when the current blowoff will top out (though at the moment, the market looks very "toppy"). But from past crashes, we can get a good idea of when a future crash might occur, once it is clear the market is past its peak. In 1929, stocks peaked around Labor Day, and the Crash came at the end of October.... about eight weeks later. In 1987, the Dow peaked in late August, and the Crash came in mid-October.... about eight weeks later. In 1989, the Dow peaked in the first week of October, and the minicrash arrived only a few days later (with "Timer's Trend" barely getting you out in time). If past experience is valid for the future, then a major crash is not likely to occur until we are about two months past the market peak; but minicrashes can occur virtually without warning.
Should the Memorial Day weekend be the current market peak, and if stocks are to crash, then we could expect the crash to arrive around the end of July. If stocks peak in July, then the crash would likely arrive in September. And conversely, if you believe that major crashes occur only in October, then the Dow is not going to reach its ultimate peak until August 1995 (and this is a real possibility!).
Second, the factors affecting a future crash: There are three major factors, I think. The first is portfolio insurance, which, unknown by most, has returned, but keeps a low profile because of the (justifiably) bad PR it got in the 1987 Crash; now it is just lumped into a bigger collection of computer games we call "derivatives". The second is the so-called "circuit breakers", which are designed to unplug the computerized trading when the market moves too far. And the third is the mutual-fund mania.... not that there is anything wrong with mutual funds per se, but when the number of stock funds exceeds the number of issues traded on the NYSE, one can legitimately ask if a good thing has been taken too far.
These factors all reduce to one important one: liquidity, for what is a crash but a sudden drying up of liquidity (everyone wants to sell, nobody wants to buy)? The circuit breakers affect liquidity, first, by "unplugging" those nasty program-trading computers if the market declines too far, which may actually be helpful.... until the day stocks continue to decline even with the computers turned off.... and second, by closing the markets on a 500-point Dow downmove. Now when the "collars" were designed after the 1987 Crash, 500 Dow points were a big deal; but at today's elevated stock prices, 500 points would be only a 7% move. (For comparison, the 1989 minicrash was an 8% move.)
But the most important factor affecting liquidity is the plethora of mutual funds, which have literally wired themselves for trouble. The managers of these funds tend to forget that they do not own the money they manage when, in fact, that money can be taken away from them almost instantaneously, in many cases by automated telephone or computer transfer (no human intervention!). To protect themselves against such a "run on the bank", the mutual fund companies have also arranged to make themselves illiquid on command.... first, by suspending redemptions when market trading is suspended or, if that fails, simply by suspending redemptions when stocks can't be sold quickly enough to meet them.
So, with this knowledge in hand, let us take a hypothetical trip into the future. For the sake of tradition, let us assume that a 1995 crash will occur in October, placing the market peak in August (this is not a prediction!):
August 25, 1995: Today the Dow closed at 4636, after having climbed steadily since March, with only a brief June correction of a few percent to mar its extraordinary performance. The bearish analysts who had been warning of the extremely high risk of the stock market and were occasionally found muttering words like "tulipmania", have been completely discredited because none of their dire predictions have come to pass. Rather, prominent analysts (which is to say, those connected to brokerage firms dedicated to sucking your money out of you at high prices) aver that stocks have been climbing a "wall of worry", and that with so much "worry" about, stocks have nowhere to go but up.... 5000 by year-end, or certainly in early 1995.
As in past market feeding frenzies, there really was no lack of experienced advisors warning of the danger ahead; it's just that few chose to listen. And this is the top.
September 5, 1995: "Timer's Trend" gave a sell signal, during a weak trading day (unusual for the day after Labor Day); by tomorrow, subscribers to The Contrarian's View who have been following the indicator (mostly young folk) will have safely bailed out.
September 7, 1995: A downdraft hit, more severe than the 80-pointer of last May. Stocks tumbled all day, with the Dow down 163.49 points for the day, and with the "circuit breakers" unplugging the computers three times during the day's volatile trading. The pundits advised that a "healthy and much-needed" correction had set in, but the bull market was still intact.
September 21, 1995: After two weeks of steady erosion in stock prices.... during which the Dow treaded water, but most stocks drifted lower.... the Dow took another plunge, dropping 221.06 points to 3905.15. (During the day, it had been as much as 265 points lower.) The decline to date has essentially wiped out all of 1995's gain, except for the meager 2.6% dividend yield. More analysts have joined the bearish camp; skepticism about the "bull" market abounds.
September 22, 1995: Surprise!.... a rally. The Dow soared 195 points, recovering almost all of the prior day's decline. "See, we told you so," the pundits declared; "we're still in a bull market.... occasional corrections are normal and healthy and should be expected".
October 17, 1995: After a two-week mild rally followed by a week of stock prices drifting lower, stocks tumbled again. The Dow dropped 172.89 points for the day, closing at its daily low. Another "healthy correction", the pundits decared; but the public was beginning to wonder if maybe too much "health" was a bad thing.
October 18 and 19, 1995: Both days the market dropped lower, 15 and 85 points per day; the Dow was now at 3895.94, and the year 1995 was lookong more and more like a washout.
Friday, October 20, 1995: Persistent selling, punctuated by volatile trading as the "circuit breakers" cut the computers in and out, marked this trading day. At day's end, the Dow had dropped 341.03 points, closing at 3644.91, its low for the day; and in after-hours electronic trading, prices went lower.
The similarity to the situation in 1987 could not be ignored.... you will recall, in 1987 "Black Monday" was preceded by a dismal Friday, during which the wholesale dumping of stocks had actually begun, and investors had all weekend to decide whether or not to bail out of stocks on Monday.
"But this time is different," the experts assured us, because the "circuit breakers" made a crash impossible. Frank Cappiello will be remembered for his appearance on Wall $treet Week in 1987, when he clearly stated (contrary to the conventional wisdom) that stocks would crash on Monday. So naturally, Wall $treet Week invited him for a return visit after this awful market day, and Cappiello opined that indeed this time was different, and that while we were certainly now in a bear market, the "circuit breakers" would cause the decline to be gradual and orderly.
Investors also remembered that those who bailed out of mutual funds on "Black Monday" 1987 actually bailed out at the bottom of the Crash, and nobody wanted to repeat that mistake. (Actually, not true; the ultimate bottom for the unweighted averages was on December 4, 1987.)
Ultimately, mutual-fund investors decided to take advantage of the "protection" the "circuit breakers" provided. If this indeed was a bear market, and if the decline were indeed programmed to be orderly, then it made sense to sell on Monday, wait for the bear-market bottom, then buy in again at low prices. Furthermore, more than half the money thrown at stocks, and probably more than half the investors buying in, had arrived when the Dow was above 3200, and even if Monday were a bad day, at least many of them would break even or escape with a small profit.
So all weekend long, the automated-telephone and computerized redemption (switch to money-market fund) orders piled up in the computers of the mutual-fund companies.
Monday, October 23, 1995: The Dow opened 153 points lower, and sank like a stone at the rate of about 100 points per hour.... even with the program-trading computers "unplugged".... until, at 2:17 P.M. the "magic 500" number was hit, and the markets were closed. With redemption orders continuing to pile up at the mutual-fund houses, it did not reopen that day, and Dow 3140.39 was the day's closing price. Stocks had crashed after all.... and, with trading suspended at day's end, mutual-fund redemptions were also suspended, and investors could not get out of stocks.
October 24, 1995: After frenzied meetings at which the midnight oil was burned, the presidents of the various exchanges, in conjunction with the Federal Reserve (and, no doubt, with a nudge from the White House) decided to keep the exchanges closed for the day as a "cooling-off" period. In addition, nearly all of the mutual-fund companies announced that all fund redemptions (including money-market funds) would be suspended until calm returned to the markets. But mutual-fund owners were not pleased that, not only could they not bail out of stocks, but that checks written on their money-market funds might bounce; and the telephone redemption orders continued to pile up.... if you could get past the busy signals.... along with redemption orders sent by snail mail.
October 25, 1995: The stock markets finally reopened, with the opening Dow at 2815. With mutual-fund investors still unable to redeem their holdings, the selling pressure abated somewhat, but it was still an off day; the Dow closed at 2772.67.
October 26 and 27, 1995: An uneventful two days; the Dow rallied 20.82 points for the period.... but mutual-fund investors still could not get out of their damn stocks. The mutual-fund companies promised to restore redemption privileges the following Monday.
October 30, 1995: You can bet that every official financial organization had prepared the whole weekend for the onslaught of sell orders from the hapless owners of mutual funds. The Dow opened 225 points lower, and continued to sink until 1:33 P.M when it touched 2431.74, which was the ultimate (short-term) bottom; thereafter, stocks rallied sharply, closing for the day at 2803.33, and allowing most of the panicked mutual-fund owners to escape without further losses. But once again, the small investor had been taken to the cleaners; and mutual funds began to wither away....
If the current miniscule 2.6% yield were to persist for the next five years, or if we were again at that level five years from now, and the 6% dividend-growth rate were to prevail, then at this time in the year 2000 the Dow would be at.... 5925! That's only about one-third higher than current levels, with a return no greater than that currently available from money-market funds at much, much less risk.
You can see that under even the most optimistic of assumptions, large-capitalization stocks are unlikely to outperform a simple buy-and-hold of a money-market fund for the next few years. That doesn't leave much room for disappointment.... like, say, rising interest rates, a sinking dollar, or a recession. You can also see that it's quite possible to have a reasonably robust economy for the next few years and still have a bear market.... just as we did in the 1970s.
This is why I say that current stock-market risk is extremely high.... the odds that stocks will creep along, behaving like a money-market fund, with no intervening bouts of bearishness, are slim. You can take your pick whether we will suffer a long, drawn-out, 1970s-style bear (odds currently about 55%), or whether the market will collapse in some sort of spectacular flameout (odds currently about 45%), after which the lemmings can partake of a new bullish cycle.... but (the return of) a bear market from recent high levels is virtually guaranteed.
Whenever the major averages "blow off" as they've been doing lately, I always do a "reality check" by looking at the stocks in my own portfolio. But now I've sold so many stocks that there aren't enough left to give me an accurate feel for the true condition of "the market" when I do my checking..... so I've been asking friends how their stocks have been doing. Their experiences seem to mirror mine.... their stocks dipped in 1994, and have been mostly asleep since, and they wonder why their portfolios aren't doing so well when the Dow is hitting new highs. (Mutual-fund owners, who by definition track what the hotshot fund managers are doing, are happy as clams, of course.)
Even though the current odds for a stock-market crash are less than half.... if we are, indeed, just past the market peak (which looks increasingly more likely, even as I write these words), does that mean a crash is not likely? Not necessarily.... the odds can change dependent on the nature of the subsequent decline. Keep in touch with the "computer warmline" during turbulent periods.
Notice to Internet readers: To date, there is no adequate Macintosh software tool available that will allow me to "convert" the portfolios printed in the paper version of The Contrarian's View (which are actually spreadsheet tables in a word processor) into something that can be viewed by a World Wide Web browser. Consequently, they are omitted here; just the summaries and commentary follow.
A. "Hedger's Delight" - real portfolio, includes commissions:
SUMMARY - "Hedger's Delight" :
Original cost: $10,455.77
Present value: $ 5,454.84
Increase: $-5,000.93 [-47.83%]
Yield: $ 22.00 [0.21%]
The performance of this portfolio from January 1987 to the present (adjusted for the dilutive effect of added cash) is -46.46%, for a compound annual rate of return of -7.16%.
B. "Present and Future Income" - real portfolio, includes commissions:
SUMMARY - "Present and Future Income" :
Original cost: $ 9,548.98
Present value: $12,379.63
Increase: $ 2,830.65 [29.64%]
Yield $ 133.30 [1.34%]
The performance of this portfolio from January 1987 to the present (adjusted for the dilutive effect of added cash) is +45.07%, for a compound annual rate of return of 4.53%.
C. "Crapshooter's Folly" - real portfolio, includes commissions:
SUMMARY - "Crapshooter's Folly" :
Original cost: $10,817.13
Present value: $16,691.71
Increase: $ 5,874.58 [54.31%]
Yield $ .00 [0.00%]
The performance of this portfolio from January 1987 to the present (adjusted for the dilutive effect of added cash) is +70.03%, for a compound annual rate of return of 6.53%.
This is the closest to all-cash this portfolio has ever been.... not even
before the 1987 Crash was I so heavily in cash. Obviously, I feel that overall
market risk is so high that one should not engage in any bargain-hunting
(except maybe in the precious-metals stocks, which I do in "Hedger's
Delight").
D. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG" :
Original cost: $ 2,988.00
Present value: $ 3,255.25
Increase: 267.25 [8.94%]
COMMENT on "PIG" : There is no change from the April issue.
Original (1983-86) cost: $ 8,326.19
Present value: $19,250.54
Increase: $10,924.35 [131.20%]
Current yield: $ 886.19 [4.49%]
The performance of this portfolio (including its predecessors) from January 1, 1987 to the present is +75.53%, for a compound annual rate of return of 6.93%.
F. CREF Pension plan; I switch between indexed stock/bond/money funds:
Date Sold Bought
13Mar92 stock @ 56.65 MM @ 13.41
29Apr92 MM @ 13.48 bond @ 31.19
19Jun92 bond @ 32.14 MM @ 13.55
29Jun92 MM @ 13.57 stock @ 56.74
24Jul92 stock @ 56.76 MM @ 13.61
29Oct92 MM @ 13.72 stock @ 58.61
23Dec92 stock @ 61.48 MM @ 13.78
16Jan95 MM @ 14.83 equity-index @ 26.44
20Jan95 eq-index @ 26.19 MM @ 14.84
Values, 26May95: stock, 78.52; MM, 15.16
Gain, 1988: 18.91%; 1989: 14.48%; 1990: 8.28%; 1991: 27.93%; 1992: 10.20%; 1993: 3.08%; 1994: 4.07%
Gain, January 1 through March 31, 1995: 0.48%
Total gain since January 1, 1988 (7.25 years): 124.01%
Compound annual rate of return: 11.77% (My long-term target: in excess of 15%)
Gain shown excludes the impact of additional monthly cash contributions.
Buying CREF stock on January 1, 1988 and holding it gained 138.24%, for a compound annual rate of return of 12.72%.
COMMENT on "Timer's Trend" :
We're still on the March 14 buy signal.... but it's
weakening fast.
{, } = "Timer's Trend" (4% and 10% exponential) SELL ({) or BUY (}) signal
=============================TIMER'S TREND===========================
Mon 27 Mar 95 . | . # | 4157.34 | .+ *
Tue 28 Mar 95 . | .# | 4151.81 | .+ *
Wed 29 Mar 95 . | .# | 4160.80 | . + *
Thu 30 Mar 95 . | . # | 4172.56 | . + *
Fri 31 Mar 95 . | #. | 4157.69 | . + *
Mon 3 Apr 95 . | .# | 4168.41 | . + *
Tue 4 Apr 95 . | . # | 4201.61 |~.~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Wed 5 Apr 95 . |# . | 4200.57 | .+ *
Thu 6 Apr 95 . | .# | 4205.41 | .+ *
Fri 7 Apr 95 . | # | 4192.62 | .+ *
Mon 10 Apr 95 . | .# | 4198.15 | .+ *
Tue 11 Apr 95 . | # | 4187.08 | .+ *
Wed 12 Apr 95 . | . # | 4197.81 | .+ *
Thu 13 Apr 95 . | .# | 4208.18 | .+ *
Mon 17 Apr 95 . | # | 4195.38 | .+ *
Tue 18 Apr 95 . | #. | 4179.13 | .+ *
Wed 19 Apr 95 . |# . | 4207.49 | .+ *
Thu 20 Apr 95 . | # | 4230.66 | + *
Fri 21 Apr 95 . | . # | 4270.09 |~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 24 Apr 95 . | . # | 4303.98 | .+ *
Tue 25 Apr 95 . | .# | 4300.17 | . + *
Wed 26 Apr 95 . | .# | 4299.83 | . + *
Thu 27 Apr 95 . | # | 4314.70 | . + *
Fri 28 Apr 95 . | .# | 4321.27 |~.~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 1 May 95 . | .# | 4316.08 | .+ *
Tue 2 May 95 . | .# | 4328.88 | .+ *
Wed 3 May 95 . | . # | 4373.15 |~.~+~~~~~~~~~~~~~~~~~~~~~~~~~~~*
Thu 4 May 95 . | .# | 4359.66 | . + *
Fri 5 May 95 . | .# | 4343.40 | . + *
Mon 8 May 95 . | . # | 4383.87 | . + *
Tue 9 May 95 . | . # | 4390.78 | . + *
Wed 10 May 95 . | . # | 4404.62 | . + *
Thu 11 May 95 . | . # | 4411.19 | . + *
Fri 12 May 95 . | . # | 4430.56 |~.~~+~~~~~~~~~~~~~~~~~~~~~~~~~~*
Mon 15 May 95 . | . # | 4437.47 | . + *
Tue 16 May 95 . | . # | 4435.05 | . + *
Wed 17 May 95 . | .# | 4422.60 | . + *
Thu 18 May 95 . # . | 4340.64 |~.~*~~~~~~~~~~~~~~~~~~~~~~~~~
Fri 19 May 95 . # . | 4341.33 | .+ *
Mon 22 May 95 . | . # | 4395.63 | + *
Tue 23 May 95 . | . # | 4436.44 | .+ *
Wed 24 May 95 . | . # | 4438.16 | .+ *
Thu 25 May 95 . | .# | 4412.23 | . + *
Fri 26 May 95 . |# . | 4369.00 | . + *
=====================================================================
[, ] = 4% exponential change unconfirmed by 10% exponential (not a signal).
@ = market overbought or oversold. I or & (on baseline) = 10% exponential SELL.