Rumors of the 2003 market rally's imminent death have been greatly exaggerated in recent months. But according to one analyst with an enviable track record, the end days are finally here, and it's time to prepare for a sickening plunge into December and beyond.
The doomsayer is Michael Belkin, one of the few investment analysts who has emerged from the recent boom, bust and reboom with his reputation not just intact, but aglow.
Most independent researchers build careers as all-bull or all-bear, but not this guy. Operating out of a home office on Bainbridge Island in the Puget Sound near Seattle, Belkin writes a $36,000-per-year weekly report on equities, bonds and commodities for leading managers of mutual funds, pension funds and hedge funds worldwide. The report rises above the straitjacket of specialization to treat the global landscape holistically as an interlocking economic, political and social system.
Two weeks ago, Belkin abandoned his yearlong (and initially very lonely) bullish posture and put on the fur. He expects the broad market indices to sink significantly through the end of the year, led by cyclical industrial stocks, and does not see much of a recovery on the horizon for 2004.
Belkin's Street Cred
Why take him seriously? He's been right about the last few major swings.
In mid-1999, he advised clients to buy into the Nasdaq bubble through the first quarter of 2000, noting that the Federal Reserve had printed so many billions of dollars to battle a nonexistent Y2K problem that money would spill into stocks and fuel a boom.
On March 2, 2000, he turned around and advised clients to bail out of tech stocks and buy U.S. government bonds, contending big market indices could get cut in half.
A month later, after the Nasdaq had plunged 1,000 points from its March 20 peak, he stunned clients who thought the worst damage had already been done by proclaiming the tech-heavy index would sink at least another 65%.
In November 2002, with the Nasdaq having fallen about 70%, he turned full circle and advised clients to aggressively buy the most-volatile tech and gold stocks and sell low-volatility defensive stocks and bonds.
In an interview last week, Belkin said everything that made him bullish last November now makes him bearish. His forecasting model, which consists of a nonlinear set of probability distributions, shows equity markets in every developed country around the world "wanting to turn down." At the same time, he sees emerging markets such as Brazil, Chile and China "turning up in parabolic fashion."
The way Belkin sees it, we're "at the end of a liquidity bubble." Liquidity is analyst-speak for money, particularly dollars that the Federal Reserve prints and pushes into banks in a variety of ways for a variety of economic, political and social purposes. ("When the Fed makes new money, it's like counterfeiting, only it's legal," he quips.) He learned long ago that it made sense to buy into a liquidity bubble while it's happening, but that you needed to be able to identify its final days and get out a little early.
Belkin's Bearish Case
He defines major bubbles as excessive deviations from stocks' 200-week trend, while major crashes entail reversion to their 200-month trend. That's not information you can use to daytrade, but it helps with the big picture. And the big picture, in his view, amounts to this:
In March 2000, his prediction for a 65% decline for the Nasdaq was predicated on a belief that it would sink to its 200-month (or 16.5-year) average.
In October 2002, the Nasdaq rebounded off that level, which was around 1180.
In November 2002, his belief in a Nasdaq rally to 2280 was predicated on a belief that it would rise to its 200-week moving average at that level amid a business-cycle bounce.
Now he thinks the index will fall short of his predicted move because private-sector credit growth is declining sharply despite the Federal Reserve's neutral-to-slightly-stimulative stance.
What's with the number 200? Nothing magical, he says, except that it has worked to define levels of support and resistance in every major bubble and crash he has studied over the last 100 years. A bear market bounce in a stock index or commodity from its 200-month average to its 200-week average, he says, is relentless, takes about a year and ends with low volatility -- all characteristic of the recent U.S. rally.
Belkin abandoned his Nasdaq 2280 target because he noticed that money-supply growth had begun to contract as credit markets froze up -- an event that, in his words, has "drained the economy of bubble fuel."
In July, the three-month annualized rate of growth of money had reached a peak of 14%. But money-supply growth two weeks ago had fallen to 1%, and last week, according to Federal Reserve data, it actually turned negative.
Fed data show that banks are dumping their holdings of government bonds right and left; their Treasury holdings have dropped $100 billion since July.
Commercial lending has gone nowhere since July, and real estate lending has slowed dramatically. (A newsworthy example of the latter was a report last week that
The New York Times
had put off building its new headquarters tower in Manhattan for a couple of years because its development partner was unable to obtain financing.)
Belkin believes that the Bush administration essentially "rented the 2003 recovery from
" by cutting taxes and mailing out rebate checks, and now faces an "involuntary deleveraging process" that will feed into weaker corporate results, softer economic statistics, worsening unemployment and, eventually, a sharp decline in real estate values.
In his Oct. 12 report to clients, he warned that "deleveragings are not low-volatility events -- a financial market dislocation in the fourth quarter is likely." And in his Oct. 19 report he upped the ante, saying that "the contrast between bullish equity-market psychology and deteriorating private-sector credit conditions is bizarre," concluding: "The point of a bear-market rally is to make everyone bullish again just before the market does its next swan dive."
Control the Damage With 'Chicken Longs'
How will you know if he's right and not just another dour crank? Until now, every 5% decline in the broad averages this year has been met with buying at some identifiable level of support.
Back in August, it was the 960 area for the
, while in September it was the 1000 area. The next time the market sinks below an area of supposed support -- e.g., the 1015 area for the S&P 500 -- and stays below it for more than a couple of days, it could be lights out for the buy-the-dips crowd. And then a real liquidation could ensue.
It's worth noting for the record that while the Nasdaq hasn't reached its 200-week moving average quite yet, other indices and stocks are very close: For the
Dow Jones Industrial Average
, the 200-week moving average is at 9789; for chip giant
it's at $32.81; for
it's at $38.44.
Meanwhile, stocks that are the most extended above their 200-week moving averages after a year of rally -- and thus most ripe for a reversion to the mean -- are all the major homebuilders, such as
; gold miners such as
; casino supplier
International Game Tech
; and security-software maker
In his latest report, Belkin told clients to shift from buying dips to selling strength to "avoid having egg on their faces during a fourth-quarter downturn." For mutual fund managers obligated to be long, he recommended they overweight defensive consumer stocks such as
Procter & Gamble
. He calls these "chicken longs" because he believes they will fall less than market benchmarks in a broad downturn -- although they probably won't provide positive returns.
Among his top shorts are the homebuilders, which he called "so overowned, overvalued and undershorted they're like
at the top, but with fundamentals that are deteriorating every second under your eyes." Others on his list for short-sellers are cyclicals such as machinery makers
; chemical makers
; Internet service or hardware providers such as
; and retailers such as
Naturally, one hopes Belkin has it wrong this time. But you have to admit that he does have the hot hand. I'll check in with him later this year as we learn whether his guidance was right, wrong or perhaps just early.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at
email@example.com. At the time of publication, Markman owned or controlled shares in none of the equities mentioned in this column.