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Hochberg: The Bearish Case

03/18/2005 12:00 am EST


Steven Hochberg

Chief Market Analyst, Elliott Wave International

No matter how bullish one may be, it is in all investors' interest to understand the opinions of those with differing views. Here, we feature Elliott Wave expert, Steve Hochberg, who holds an extremely bearish long-term view of the US market, real estate, and the economy.

"March should finish the topping process in the Dow and S&P, which started in December. The NASDAQ is leading the way and should set the pace through the next leg of the bear market. The NASDAQ has lagged since January 3; the under performance of this high-beta index suggests that investors’ speculative fervor is on the wane. This assessment is supported by the rally’s shift toward a focus on oil stocks and utilities. Historically, these sectors take the lead when the overall market’s advance is ending or over. At the same time, the financials, which tend to lead developing declines, are falling. The daily trading volume for the S&P Spiders, the exchange-traded fund that tracks the S&P 500, shows contracting volume during rallies and the largest volume spikes on down days. This is a classic sign of a distribution phase, in which shares pass from strong hands to weak.

"Meanwhile, from Fannie Mae's accounting irregularities to new revelations about conflicts of interest in the investment banking industry, the scandal mills are heating up. We see this as only a preview of coming attractions. Meanwhile, the average CEO bonus rose to a new high of $1.14 million last year, representing a 46% increase from 2003. Based on CEO compensation, the bear market has yet to begin. We’d add that Martha Stewart’s smiling visage on the cover of the March 7 Newsweek suggests that another peak is near. A similarly beaming Martha appeared on a January 2000 cover of Business Week, just as the Dow was topping.

"From a psychological standing the waning interest in financial affairs is also manifest in CNBC's viewership ratings, which continue to plunge. According to Nielsen Media Research, CNBC's daytime viewership fell 21% in 2004. Since 2000, it is down 61%. Another important nuance of sentiment seen at the all-time high in 2000 was the rejection of more experienced market voices for novices and man-on-the-street opinions. In 2000, the papers were filled with stories about the investment prowess of baseball players, plumbers, and a wide assortment of young stock market mavens.

"While the NASDAQ is down 60% over the last five years, a similar situation today suggests that the bear market’s mission is far from complete. A recent newspaper ad promotes a 12-year-old who 'can make 355% in six months.' Another recent article offers investment advice from New York Giants quarterback Kurt Warner who says, ‘I had money in the stock market, but the market always seemed to be going down. I decided to take that money out and invest it in real estate.’ We would say he is moving money from the frying pan to the fire, as houses are far less liquid than stocks, and thus a more perfect final resting place for many investors’ mania-era ambitions.

"Indeed, real estate is now the focus of investment clubs, a Chicago Mercantile futures instrument, full page ads in newspapers, and best-selling books. This optimism suggests that real estate is near a Grand Supercycle bull market peak. Since the NASDAQ's March 10, 2000, peak, investors have turned from stocks to property. Since that time, the S&P 500 Homebuilding Index has soared more than 700%, which resembles the NASDAQ's October 1998-March 2000 ascent. According to the National Association of Realtors, a stunning 25% of the 7.7 million homes sold in 2004 were purchased strictly as investments. In a throwback to the final moments of the NASDAQ's bull market, the man on the street is now captivated by the concept of easy wealth through real estate.

"January brought the first wave of housing mark-downs. The median sale price on new US homes plunged 13%. The decline is the largest one-month fall in the history of the data, which goes back to 1963. The five-wave pattern from 1990 says that the January drop in home sales is the beginning of a much steeper long-term decline. The potential for a serious unraveling of the housing market is confirmed by the stock of the major sub-prime lenders. As the most aggressive dispensers of credit to the housing industry, these firms are on the front edge of the debt and housing bubble. Back in the 1990s, we designated Japan’s developing deflation as the best available model for the US. As the next phase of the bear market digs in, the Japanese real estate experience will be replayed in the US.

"From a geopolitical view, we'd note that for the first time, signs of a potential split in the 50-year alliance between the US and all of Europe appeared when President Bush refused to negotiate with Iran regarding its nuclear capabilities and the US house voted 411-2 to warn the EU that it must not lift its arms embargo with China. As one political observer noted, ‘Imagine a world where Russia and the European Union, and Russia and China, and the EU and China, all find more in common with each other than with the United States.’ In our view, the seeds of an anti-US entente have already been planted and in a downturn in economic and social moods, these seeds will easily sprout into serious conflict. Our outlook implies that the US economy will start moving toward another period of contraction. Japan and Germany, two of the largest G7 economies, are already in recession, and Italy is one quarter away from joining the list. The US may not be far behind."

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