The Crash

THE first time I met Robert Prechter was at a meeting of the Market Technicians' association in New York in the early 1970s. Over time we became good friends and a few years ago he invited me to speak at one of his seminars in the United States.

I have to confess that when I first met Robert, I had not heard of the works of Ralph Nelson Elliott which form the basis of the Elliott Wave Principle.

However, I subsequently became interested in the subject and when Robert Prechter, together with Alfred Frost, published the Elliott Wave Principle in 1978, I read it with great interest and, also, a lot of scepticism.

Today, it is hard to believe how pessimistic investors had become in the late 1970s about the outlook for stock prices. Inflation was accelerating, oil prices were shooting up, and the Cold War was in full swing. Gold and silver prices were soaring while financial markets were in disarray. The whole world was speculating in gold 24 hours a day. Investors flocked to gold seminars at which the gold bugs predicted it would rise to US$ 3,000 (S$ 4,230) while stocks and the US dollar would tumble.

The Dow Jones hovered around 800 points after having exceeded 1,000 for the first time in 1966 -12 years earlier. I can assure you that in 1978, not many people believed that stocks "always go up in the long term".

After all, mutual funds had suffered net redemption since 1971 and many US brokerage firms had to close their doors or merge because of low volume -in 1978 the average daily NYSE volume was 28 million shares -as well as negotiated commissions.
Investor sentiment was then so bearish that hardly anyone gave much weight to Mr. Prechter's forecast, based on the Elliott Wave, of the Dow Jones rising to 2500-3000. In the 1983 edition, this target was revised to 3500-4000, a prediction which was then taken with equal disbelief.

Today, the mood is obviously quite different. Investors believe that stocks will always go up and outperform cash and bonds, while gold is totally out of favour. Confidence in equities is so high that, for 58 consecutive months, US equity mutual funds had net inflows.

At the same time, the public has become accustomed to the idea that any decline is a great buying opportunity -as was provided by the October 1987 crash, or the 1990 Gulf War. Communism is dead, capitalism and market-based economies with financial markets are in fashion, the global economic outlook is perceived to be bright, and renowned strategists talk about a "perfect world" for equities.

Thus, it should come as no surprise that Mr Prechter's latest book - At the Crest of the Tidal Wave -A Forecast for the Great Bear Market - will meet with total incredulity among the investing public.

People will read it and find it "very interesting". But since everybody believes that stocks will rise further -even Mr Prechter concedes that the Dow Jones could still rise to the 5200-5500 range within the next few months -not many will act upon his predictions. Many "experts" will likely dismiss it as "ridiculous".

In Forecast for the Great Bear Market, Mr Prechter, based on his interpretation of the Elliott Wave Principle, expects "almost everything" to decline massively in value over the next few years. This includes stocks, bonds, gold, real estate and collectibles, but not the US dollar, which will rise because of a credit contraction.

The Elliott Wave stipulates, based on complex wave counts and Fibonacci numbers, that the US stock market is at present "at the crest" of the fifth wave which will be followed by a "Grand Supercycle degree bear market" which will carry the Dow Jones "to its expected target within the range of the previous Supercycle fourth wave, between 41 and 381 on the Dow".

And since no "Supercycle degree decline in stock prices on record has failed to produce a depression", Mr Prechter argues that the coming deflationary depression will also wreak havoc in the real estate and commodities markets.

But the bad news does not stop there. While a deflationary depression should, under normal conditions, be favourable for bonds, Mr Prechter's Elliott Wave counts suggest that bonds will not escape the coming collapse. This he attributes to massive defaults, including the one by governments.

According to Mr Prechter, "rising interest rates in a deteriorating economy will be a total mystery to most investors".

In a strongly deflationary environment, gold is not expected to perform well either. The wave principle has an ideal price target for gold of between US$ 112 and US$ 182.

In the case of gold and silver, however, Mr Prechter allows for an alternate wave count which suggests that the precious metals will not fall to new lows before rallying. "With silver having fallen 93 per cent, this possibility must be entertained."

And what should we think of his apocalyptic forecasts?

As indicated earlier, Mr Prechter's forecasts sound as far-fetched today as his prediction of the Dow Jones in 1978. All I can say is that Robert Prechter is no lunatic and, most certainly, not a doomsayer.

He is one of the most thorough observers of stock, commodities and currency markets I have ever met, and has an enviable forecasting track record.

In the early 1980s, he recognised the disinflationary environment to come which would propel stocks sharply higher at a time investors had lost faith in equities. Then, in August 1987, he advised his clients to liquidate their stocks -not a bad call considering the global stock market crash that occured two months later. And while the Elliott Waves are open to a number of different interpretations and alternate counts, they cannot be dismissed as hogwash.

Personally, I agree with Mr Prechter that the next bear market will be devastating and will bring about a very nasty global recession. It will also shake an entire generation's confidence in the cult of equities and mutual funds, as well as other financial assets.

But I have my doubts whether some of his price targets will be fulfilled. I rather believe that in the next recession, governments will immediately reflate massively, which will quickly lead to rising inflation rates and, eventually, hyperinflation. As a result, I doubt that the Dow Jones could fall much below 1000 -the level from which the bull market started in the early 1980s -and, according to Mr Prechter, a strong support level.

At the Crest of the Tidal Wave is a well-written, highly interesting, book full of insights into many different markets.

Regardless of whether you agree with Mr Prechter's views or not, much can be learnt from this book with its many historical graphs. I cannot imagine anyone regretting a purchase. I have little doubt that At the Crest of the Tidal Wave will become a classic in financial literature and many future generations will talk about the fact that Mr Prechter's warnings were almost totally ignored by the investing public in 1995.

At the Crest of the Tidal Wave- A Forecast for the Great Bear Market. By Robert Prechter, Jr.; 465 pages.; New Classics Library. July, 1995.