An Interview with Prechter
11/26/2004 12:00 am EST
Forbes editor John Dobosz recently interviewed Robert Prechter, who is well-known for his extremely bearish posture and his expectations for deflation. While many disagree with his controversial outlook, all will benefit from listening to his reasoning.
"Prechter uses a method of technical analysis developed in the 1930s by Ralph Nelson Elliott. Elliott wrote in his 1938 book The Wave Principle : 'Practically all developments which result from our social-economic processes follow a law that causes them to repeat themselves in similar and constantly recurring serials of waves or impulses of definite number and pattern.... The stock market illustrates the wave impulse common to social-economic activity.’ In the early 1970s, while working in New York City as a technical analyst at Merrill Lynch under Bob Farrell, Prechter became acquainted with Elliott's work and applied it to a wide range of financial markets.
"Prechter began publishing the Elliott Wave Theorist in 1979, and in 2002 he wrote his tenth book, Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression. In the book, Prechter outlines his case for why the US is heading into a deflationary meltdown and economic depression. Prechter still says the market's going to tank as deflation takes hold. We asked him why.
Forbes: Do you still view the long-term economic environment
in the same way you did in 2002 when you wrote Conquer
Prechter: It's changed a bit. In 2002, I was less bearish than in 2000 because the market had moved toward my ultimate downside expectations. In 2004, I'm more bearish than in 2002, as the rally has left that much more room for the market to fall.
Prechter: Yes, definitely. By the way, deflation does not mean that all bonds are safe. Every bond whose issuer could be in danger of default is going to fall in price. Many will become wallpaper when the issuers go under. Municipal and corporate bonds in particular are extremely vulnerable to a depression.
Forbes: Ten-year Treasury notes yield less than 4% again. Who would have thought that in June?
Prechter: Not many people. Everyone was betting on higher bond yields because everyone was betting on continuing inflation.
Forbes: Why do you think the bond market only demands a 3.99%
yield for ten-year money?
Prechter: The bond market must be of the opinion that credit inflation is reaching its limit. That's what I think, too.
Prechter: Credit inflation is an expansion in the credit supply. For every creditor, there is a debtor. When debt loads become too heavy for the economy to carry, the outcome is a contraction in credit/debt, which is deflation. The Fed can only facilitate credit inflation; it can't create it. When people are unable or unwilling to borrow any more, the credit inflation stops, and the trend reverses to debt retirement. I think we have reached that point.
The Fed is passionately dedicated to inflation, just as it has been for 71 years, and it will stay that way. But it has no ammunition left. It can't reduce the bank reserve requirements any further because they are already effectively at zero. It can't lower interest rates meaningfully anymore because they are already at bottom. It can't go on a wild printing spree because that would kill the government bond market. In my book I also ask, 'Can the Fed stop deflation?' The answer is 'no, it can't.' Neither could the Bank of Japan.
Forbes: Stocks made a nice recovery in 2003 but are flat to lower on the year. Are we in a 1966-1982 base, or set for a bigger drop?
Prechter: No way it's a base. All of our indicators show unequivocally that optimism has reigned throughout the past five years despite lower prices. This is not the way markets base out. On the contrary, the market has been building the biggest top of all time.
Forbes: Small stocks are at new highs. Can they keep bucking the trend in larger caps?
Forbes: What about residential real estate? Will the bubble be a slow leak or a burst, or will it continue to inflate?
Housing is peaking in a bubble, just as the NASDAQ did in 2000. The decline in
property prices could be slow or fast, but it will be relentless. Stocks and
property are both vulnerable to a 90% decline.
Prechter: One must be careful to distinguish between leading, coincident, and lagging indicators of inflation. Yes, there has been substantial credit inflation for 71 years, including the last four, which is why the dollar has lost purchasing power. But that fact has no predictive value at all. It tells you nothing about future inflation, only about past inflation.
Leading indicators such as the rate of change of the PPI and the CPI, the rate of lending to corporations, the volume of venture capital, the political attacks on lending institutions such as Fannie Mae, the slowing upside rate of change in the commodity indexes, and so forth indicate deflation ahead.
Forbes: It seems like most physical commodities have become more expensive: steel, timber, coal, oil, natural gas, orange juice, and, of course, precious metals.
Prechter: Only some commodities are more expensive. Did you know that cotton, lumber, soybeans, corn, and wheat are down 30% to 50% from their 2003-2004 highs? No one mentions this fact. The media write only about the commodities that are up, such as oil. If this were a runaway inflation, everything would be up. If this were a runaway inflation, car prices would not have been going down for the past three years. If this were a runaway inflation, bonds would not be near their highs. If the housing boom had lots more to go, lumber would not have fallen so hard.
Oil is just a lagging beneficiary of the reflation bubble of the past two years. The bullish sentiment on oil is so extreme and widespread that I expect a major downside reversal and collapse in the price of oil any time now. In a few years, it will be a lot lower than it is today. People betting on higher oil prices today are the same ones who bet on higher stock prices in 2000. They love markets at tops; it's human nature.
Forbes: Do you think the commodity markets have reversed trend and will be moving downward for a period of several years?
Prechter: I think the overall commodity market is in the process of reversing from an uptrend to a downtrend. Some individual commodities are leading the turn; others are lagging.
Forbes: Don't securities sometimes correct 50% of an up-move
within a larger bull market?
Prechter: If you view the past 200 years as one bull market (which I do), then sure, but that's not very informative. Sometimes markets correct 10%, sometimes 50%, sometimes 90%. Many stocks go to zero, so you can't call them corrections. The idea is to avoid those declines if possible.
Prechter: You're asking all the right questions. This seems like a mystery to people, but it is not a mystery if the market senses that deflation is imminent.
Forbes: Sounds like you think commodities are going to come crashing down. What about gold? Isn't it the antidote to currency flux?
Prechter: Commodities should fall. Since gold is freely traded and not fixed by fiat, I think it is likely to fall as well. But I am less certain about that than I am about the developing monetary trend. Gold is not an antidote to flux; it fluctuates, too. I sent out a bullish special report on gold in February 2001 when it was about $250 an ounce. I'm no longer bullish on it.
Forbes: Which funds or stocks do you buy for this kind of environment?
Prechter: There are index mutual funds that are short the S&P, such as Rydex Ursa (RYURX) or ProFunds Bear (BRPIX), or funds that short the NASDAQ such as Rydex Arktos (RYAIX)."