Zbigniew Piekarski the Illusion of the Central Position

"The committee judges that, on balance, the risk of inflation becoming undesirably low remains the predominant concern for the foreseeable future."

Federal Open Market Committee

Wednesday, October 29, 2003

Once upon a time, the accepted wisdom was that the earth was the centre of the universe and that the sun and planets revolved around it. Then, Nicolaus Koppernigk (1473-1543) concluded that the Aristotelian view did not fit the facts and that the earth and planets actually revolved around the sun. Fearing punishment, he postponed publication of his findings to just before his death.

The standard view was so entrenched that even the telescopic evidence of Galileo (1564-1642) was not enough. Galileo first viewed the four moons of Jupiter on January 7, 1610 but, 22 years later, he was forced to make a public apology for his views and spent the last 10 years of his life under house arrest. A full century after Koppernigk (alias Copernicus) published his revolutionary paper, Galileo, who proved he was correct, was denied respect and recognition.

The Nature of Man has not changed since the time of Adam and powerful leaders still cling to the Illusion of the Central Position, believing that their pronouncements make a significant difference to world economies.

There is a school of thought, started by R.N. Elliott (1871-1948) and developed further by R.R. Prechter, that maintains that human social and economic development occurs in waves of expansion and contraction; that it has an inbuilt self-organising mechanism; that it is powered by changes in the prevailing Social Mood of the masses; and that the actions of groups of men, however powerful, can only delay an outcome that is inevitable. Changes in this social mood are reflected in what is now the most transparent barometer of human collective behaviour, the stock market index and its behaviour forecasts what will happen within the economy.

Cycles of expansion and contraction have occurred throughout history. They have a similar pattern, similar causal factors and identical consequences. Each and every bout of hysterical optimism has been followed by a lengthy and painful "correction" which has purged the excesses of the preceding mania.

At times the mania and the corrections that followed were localized (The Tulip Craze which ruined the Dutch 1634-1637) but most affected all connected economies (The Great Depression after the Crash of 1929). Our immediate future is on par with the corrective process that followed The South Sea Bubble (U.K) and the Mississippi Bubble (France) between 1719 and 1722, both of which were fuelled by the imagined riches of newly discovered lands and resulted in three separate depressions of 1720-40; 1743-47 and 1758-84.

Once a stock-market bubble has been pricked, the initial optimism still persists and results in a retracement of the initial decline. Let us label the decline as Wave 1. The upswing that follows (Wave 2) and the time taken for it to occur are in line with the numerical relationship and ratios discovered by Fibonacci (1117-1250) and have the following characteristics: "There is an environment of euphoria in second waves. At this point, investors are thoroughly convinced that the bull market is back to stay." The rally following the 1929 crash retraced 52.3 percent of the initial decline and stopped two percent shy of a round number (300) before the real bear market set in. This rally may end with the Dow above 10,000.

When optimism reigns supreme, when the Jabberwockies are least prepared, Wave 3 which drives the markets towards new lows will begin. A lack of fear is a precondition for the decline to occur. Investors Intelligence data (www.chartcraft.com) shows that the percentage of bulls has exceeded 50 percent for 26 straight weeks. In its 40-year history, this is the longest running bullish majority on record. Even at its height, the past mania did not get advisors as bullish as they are now.

Under Elliott Wave Theory, Wave 3 (out of 5 Waves in an impulse pattern) is the longest and strongest of waves. Its consequences are dramatic and unstoppable and will produce new lows in 2004. A Wave 4 upswing will follow and then Wave 5 will complete with lower lows.

For those who need reasons as to why the Bear Market has only just started let me provide you with four: debt; dislocation; deflation and distrust.

Historically high levels of debt bedevil consumers and governments alike. In the past debt has been repaid through rises in income and increases in inflation. Now there has been a meaningful breakdown between aggregate demand and employment growth. Jobs are not being created. Businesses are exporting jobs to lower cost environments and this is now affecting even the service sector.

Debts will have to be repaid, refinanced or repudiated. At times of increasing inflation and increasing income levels debts are not a problem. They become a burden when income levels do not rise and when assets fall in value. The Fed's statement that they fear "inflation becoming undesirably low" is another way of saying that deflation is already having an impact.

The final nail in the coffin is beginning to be driven in as investors lose their trust in the providers of financial services. Scandals associated with mutual funds have become public on Wall Street. Putnam Investments, once the fifth largest mutual fund manager in the USA, may no longer exist by the time you read this article.

By the time this Impulse Wave ends all bourses will bottom at the levels reached after the crash of 1987. If you cannot go "short" and profit from these declines then get out of the market. If you want to know more then join us on www.gpmanagement.com

On the WSE: The fate of investors on the WSE will be similar to that which befell Mr Timothy Treadwell. Mr Treadwell, a filmmaker who developed a cult following amongst animal lovers for his willingness to live with and film wild bears, met a predictable outcome. On October 8, an Alaskan newspaper reported that he was eaten by his subjects. Most investors have lost all awareness of the fact that the market is, and has always been, an untamed beast.