Zbigniew Piekarski declares that optimistic prospects for the markets are merely illusions.
"You know the world is going crazy when the best rapper is a white guy, the best golfer is a black guy, the Swiss hold the America's Cup, France is accusing the U.S. of arrogance, and Germany doesn't want to go to war."
- Anonymous
Both the Fed and the ECB have admitted in a roundabout way that the threat of deflation is increasing. The U.S. is exporting deflation through the rapid fall of the dollar and, as a result, the euro has been inflated even more than Jacques Chirac and Silvio Berlusconi combined (both having to stay in power in order to avoid legal prosecution). Yet the various sentiment indicators are expressing degrees of optimism not seen since the March 2000 highs, and we have it on good authority that the end of the bear market is here.
Peter Wuffi, president of UBS, Switzerland's leading bank, pronounced this momentous occasion on CNBC. The detailed analysis upon which he based his conclusion was gleefully repeated by Reuters in a headline: "Hedge funds sniff the end of a bear market." Wuffi stated that he could "smell" that the end of the bear market was upon us. I just wonder whether this was before or after he started to yodel when he caught sight of a naked Julie Andrews dancing in the field.
The current pronouncements made by the Jabberwockies and the extremes of optimism that presently reign are very similar to the situations that existed in 1873, 1907 and 1930 just before sharp breaks to the downside announced the presence of renewed bear markets to a disbelieving public.
For the more mathematically gifted among you, may I draw your attention to the continuing work of Didier Sornette, professor of geophysics at the earth and space sciences department at the University of California, Los Angeles. You may wish to visit his website www.ess.ucla.edu/faculty/sornette. For a general presentation of the underlying concepts, theory, empirical tests and concrete applications, with a discussion of previous predictions, read his book Why Stock Markets Crash, published by Princeton University Press (January 2003).
In collaboration with Wei-Xing Zhou and countless underpaid research assistants, Sornette has developed a general theory of cooperative herding and imitation and applied it to the decay in the Nikkei and the S&P 500 indexes. By analyzing the mathematical structure of changes in herding and imitation behavior, he and his team have developed several mathematical formulae that can be extrapolated in order to provide predictions.
The chart below shows their most recent conclusions of what the S&P 500 index will do, using all the data from Aug. 9, 2000 to May 16, 2003.
I quote: "The continuous line is the fit and its extrapolation using our theory capturing investor herding and crowd behavior. The theory takes into account the competition between positive feedbacks (self-fulfilling sentiment), negative feedback (contrariant behavior and fundamental/value analysis) and inertia (everything takes time to adjust). Technically, we use what we call a 'super-exponential power-law log-periodic function' derived from a first order Landau expansion of the logarithm of the price. The dashed line is the fit and its extrapolation by including in the function a second (log-periodic) harmonic." Wow! Riveting stuff!
According to the three versions of the theory, Sornette expects a continuation of the bear market, punctuated by local rallies, with a strong decline into the first quarter of 2004 after which there should be a rally.
Three key points emerge from the welter of data and mathematical formulae.
The first is that social mood is the motive force behind market movements.
The second is that the behavior of markets is "endogenous in origin" - outside influences and "news" do not affect or alter market behavior. The imputed "events" are merely the rhetoric of the Jabberwockies who have to provide current explanations of a process to a gullible and uncritical audience. Sornette refers to the events of 9/11 in order to illustrate the fact that the market trend was already in a downward spiral when the terrorist act happened, and it merely accelerated an existing trend. The S&P 500 took only 18 days to rebound to the point at which the attack occurred.
Finally, that governments and central banks are helpless in trying to stop what is about to happen.
All three are central tenets of Elliott Wave Theory as is R.R. Prechter's often quoted expression "Bull markets climb a wall of worry; bear markets decline on a slope of hope."
On the WSE: A positive result in the referendum to assist France in the creation of the Sixth Republic and in developing a new economic system should lead to an upward spike. However, the market will "correct" once the realization dawns that most of the euro money will supply additional revenue to the sticky hands of the politicians and bureaucrats and that the import-export equation will alter only slightly.
Stolen German cars will remain the chief import with the addition of abortion on demand and homosexual marriages. The major exports will remain as before: the most gifted and talented of the new generation, amphetamines, duty-free alcohol and cigarettes, car parts for the cars subsequently stolen and pedophile priests.
Remember that the motto of Euro-politics is: If it moves, tax it. If it keeps moving, regulate it. When it stops moving, subsidize it. And don't forget to take a commission for your munificence.
Zbigniew Piekarski is a Warsaw-based portfolio manager. He can be reached at zbigp@bipnet.pl.
