To be a true optimist about share prices this summer then you have to hold that last December was the bear market bottom, and that the rally since then still has further to go. Both assumptions can easily be challenged.
If you turn to the conclusions of the classic ?Anatomy of the Bear: Lessons from Wall Street?s four Great Bottoms? by Russell Napier then it is fairly clear that last autumn was not a bottom, even if we take this bear market back to 2000 and the dot-com bust.
Bear market cycles
Nine years is short for a bear market as these cycles can last up to 14 years. When Napier wrote his book in 2005 he said we would need to see four things before a true market bottom emerged: a bond market crash, a recession, lower interest rates and a general price disturbance (inflation or deflation) leading to a final bottom in share prices.
Given that in the past four years we have only seen two out of these four factors ? recession and low interest rates ? at least two more things still have still to happen based on the historical precedents of the 1921, 1932, 1949 and 1982 stock market bottoms.
?Equities will have to fall below fair value and the likely catalyst will be a bout of deflation or, more likely, inflation. There will have to be a bear market in bonds and a recession,? concluded Napier.
?Before the bear market is over, the DJIA is likely to decline by at least 60 per cent ? perhaps something more than 80 per cent (given the current level of earnings and replacement value of assets.?
Hyperinflation scenario
That would take the Dow down to 2,800-5,600 points, sometime between 2009-2014, according to Napier. Recently the hyperinflationists like Dr Marc Faber and Jim Rogers have suggested that inflation is likely to come to the rescue of share prices and support the Dow in an economic recession.
Share prices would therefore be supported in nominal if not real value terms. Yet there is nothing from the experience of the 1970s to support this theory. You have to look at the Weimar Republic or Zimbabwe for a precedent.
It could be that the US economy deteriorates to such a degree but surely we would first see a re-run of the 1970s? And that would allow time for Napier?s bottom to be formed in US markets. Unless you think it is different this time, Napier will be right. History is always a good precedent.
And a final reason to believe the market has not seen the bottom yet: share trading volumes are far too high. You need to see a widespread aversion to share ownership before a real bottom can be called. People are still far too keen on equities.
Written by Peter Cooper
July 5, 2009
