Stock Gurus: Robert Prechter

Written Wednesday, January 27, 2010

Robert Prechter, President of Elliot Wave International, is known for the Elliot Wave Theory, as well as for predicting the 1987 stock market meltdown. He appeared on CNBC on Wednesday, January 27, to issue a new warning: that we were headed into the next bear phase. I always like to listen to the “Gurus” and see how they assess the market, what indicators they look at, etc.

Back in late February, early March 2009, as few as 2% of traders were bullish. At that point, Mr. Prechter believes that the market is coming out of something, and it’s time to look to the upside. They had an upside target of 10,000 on the Down, and that was exceeded.

Today, they’re seeing a lot of signals that are similar to the ones they saw at the top in 2007, as well as in the earlier top in 1999 and 2000. He’s quoted as saying, “this is the last chance to get out of the Dow in quintuple digits”. He characterizes the tops as follows:

- extreme optimism; advisors 3x bulls over bears, biggest ratio since 1987
- extreme valuation, dividend yields as low as 2.8% for Dow
- PE ratio is higher than it’s ever been in last few quarters; even if you adjust for future earnings, still expensive
- downside momentum loss in November, December and January

By the way, he published the second edition of Conquer the Crash in December, to give people time to get out.

Not interested in commodities, that run has already occurred. Expects repeat of 2008, when real estate, stock market and commodities went down together, and safest place is in the dollar. Dollar bottomed in November, has stealth rally and they remain positioned in the dollar.

Mr. Prechter is looking for another wave, so he’s being safe. They’re staying in cash and cash equivalents.

How much weight to put on Mr. Prechter’s comments? I did a little more research to get more information on Mr. Prechter’s point of view. It turns out, he’s quite extreme. He believes that US stocks will fall below their 12-year lows hit in March 2009 and that the S&P will fall below 666. He sees bonds falling to lower levels than the panic of 2008, and gold falling 40% off it’s peak value, especially if deflation sets in.

If you look back, he did call the crash of 2008 and that he did call the bottom in late February 2009, telling traders to exit their shorts when the S&P was near the 770 level. But you’ll also find that Mr. Prechter is a perma-bear. He called for traders to be 200% short in November 2009. He also was very bearish in August 2009, although at that time he admitted that just the reliable part had past, and that he could not time the turn. But the last time he called for traders to be long stocks before 2009 was in 1997, and so he’s missed lots of good stuff. According to the Hulbert Financial Digest, his newsletter is in last among all market timing strategies.

Still, he does have some interested points to consider. Here’s a comparison of the 1987 market and the market on October 19, 2007 from an interview on Bloomberg (available on YouTube):

Markets: 1987 vs. October 19, 2007 - 1987 vs. 2007

DJIA Annual Dividend Yield - 2.6% vs. 2.0%

Price of $1 Dividend - $39 vs. $50

Duration Dividend < in 1929 - 3 mos. vs. 13 years

Price/Book Value - 1.73 vs. 4.04

Advisors Net Bullish (>97%) - 156 weeks vs. 468 weeks

Daily Sentiment - % Bulls vs. Bears - 3x > 90% vs. 51x > 50% in last 13 mos.

The dividend yield measure is interesting, because I think that is a valid indication of a bullish market. Still, one thing to consider today is that a lot of companies eliminated the dividend following the 2008 crash. You could argue the measure is still valid despite that fact.

The third item measures how long it has been since dividend has been less than it was in 1929. The argument is that when people don't want dividends, they think they’ll make it up in capital gains.

“Advisors” refers to newsletter advisors.

You’ll notice though, it’s very hard to use this to time the market – the bullish readings in 2007 lasted a very long time. Mr. Prechter was bearish for the two years leading into the 2007-2008 crash. In this interview on October 19, 2007, he cited the fall in commercial paper and the decline in Asian buying of US Treasuries as the indicators of cracks in the stock market.

In sum, it’s interesting to look at some of his indicators, but it’s hard to make bets based on his perspective. As always, he’s one of many points of view to consider.