A Prophet of Doom Speaks – Should We Listen?
The New York Times hit pay dirt last week with its article "A Market Forecast That Says 'Take Cover'" – the top emailed article over the next few days. With investors already rattled by market declines in May and June, the article found fertile ground for a doomsday prediction by market forecaster Robert Prechter:

Mr. Prechter is convinced that we have entered a market decline of staggering proportions – perhaps the biggest of the last 300 years. . . . His advice: individual investors should move completely out of the market and hold cash and cash equivalents, like Treasury bills, for years to come.¹

The article noted further:

For a rough parallel, [Mr. Prechter] said, go all the way back to England and the collapse of the South Sea Bubble in 1720, a crash that deterred people "from buying stocks for 100 years." This time, he said, "If I'm right, it will be such a shock that people will be telling their grandkids many years from now, 'Don't touch stocks.'"

Whew! That must have added a jolt to the morning coffee. But who is Robert Prechter and should we heed him?

Mr. Prechter is a technical analyst who has published an investment newsletter for more than thirty years. He gained a following in the early 1980's by predicting the start of the bull market in 1982 and, by some accounts, the crash in 1987. At the time, even People Magazine saw fit to profile him.²

Technicians such as Mr. Prechter look for patterns in stock-price movements to reveal where the market is headed. Sometimes called "chartists," they typically speak in visual terms such as "head-and-shoulders" or "double-bottoms" based on the designs they see in their charts.

Mr. Prechter employs a system known as the Elliot Wave Theory, developed by an accountant Ralph Nelson Elliot, who studied market patterns in the 1930's. According to EWT, markets move in predictable patterns, first in one direction, then the other, based on investor psychology and waves of optimism and pessimism. These waves, moreover, are fractal in nature, built from similar patterns on larger and smaller scales and thus offering predictive insights.

The father of fractal geometry Benoit Mandelbrot was skeptical, however, of the Elliot Wave Theory, noting that it was "a very uncertain business" and "an art to which the subjective judgment of the chartist matters more than the objective, replicable verdict of the numbers."³

A competing technician David Aronson offers a less charitable view:

The Elliott Wave Principle, as popularly practiced, is not a legitimate theory, but a story, and a compelling one that is eloquently told by Robert Prechter. The account is especially persuasive because EWP has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations. I contend this is made possible by the method's loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude. This gives the Elliott analyst the same freedom and flexibility that allowed pre-Copernican astronomers to explain all observed planet movements even though their underlying theory of an Earth-centered universe was wrong.⁴

Last year, syndicated journalist Eric Tyson examined the performance of Mr. Prechter's investment advice. Using data gathered by newsletter-tracker The Hulbert Financial Digest, Mr. Tyson looked at the twenty-five years from January 1985 through May 2009. Here are the results, with U.S. market performance in blue and Mr. Prechter in red:

As Mr. Tyson stated, "Prechter has underperformed the broad U.S. stock market Wilshire 5000 index by a whopping 25 percent per year!" In other words, if you had invested $100,000 in the Wilshire 5000 over this period, you would have accumulated $957,000. With Mr. Prechter's advice, you'd have $1,700.⁵

Just about all of Mr. Prechter's underperformance was caused by his permanently bearish stance during the 1990's. In fact, he was making the same market predictions then that he made last Friday. Here he is in a 1994 New York Times article, "Is This Bubble Really Puncture-Proof?":

The high valuations that have been built into U.S. share prices have, for obvious reasons, alarmed many an analyst. Robert Prechter, who publishes the Global Market Perspective, writes that "current market risk is unprecedented in U.S. history. In fact, it's probably not much less than what existed in 1720 at the top of the investment manias that occurred then in England and France."⁶

You can find similar quotes in subsequent years across various publications. See, e.g., "Bracing For a Market Apocalypse," BusinessWeek, November 18, 1996 ("According to [Prechter's] calculations . . . the coming crash will take the economy with it. His recommendation: 'Invest in the shortest-term interest-bearing instruments.'")

Perhaps Prechter's consistently bearish calls were merely early. After all, didn't the markets eventually suffer devastating declines at the beginning and end of the last decade? Yes, but at some point one must concede that being too early amounts simply to being wrong. As Peter Lynch once said, "More money has probably been lost trying to avoid bear markets than in bear markets."

There is, I'll admit, something appealing about Mr. Prechter's consistency and conviction over the years. In a world of ever-present uncertainties and surprises as varied as the BP oil disaster and Spain's arrival in the World Cup final, a little consistency can be a big comfort.

But such consistency has not made any "Prechter millionaires" - apart from Mr. Prechter's newsletter earnings. And Mr. Prechter does not play bridge with Warren Buffet and Bill Gates. So while his prognostications may make for a colorful morning read, when it comes to your investment strategy, you'd be well advised: turn the page.

Thank you for reading. Please look for our next newsletter in September.

Best regards,

Milo Benningfield




¹ "A Market Forecast That Says 'Take Cover,'" The New York Times, July 2, 2010.

² "Ace Analyst Robert Prechter Says When Skirts Rise, So Does the Stock Market - No Bull," People Magazine, May 11, 1987.

³ The (Mis) Behavior of Markets, Benoit Mandelbrot, (Basic Books 2004), p. 245.

⁴ Wikipedia, quoting Aronson, David R. (2006). Evidence-Based Technical Analysis, Hoboken, New Jersey: John Wiley and Sons, p. 61.

⁵ "Prechter Predicts New Stock Market Lows and U.S. to Lose AAA Credit Rating," Eric Tyson, June 16, 2009.

⁶ "Is This Bubble Really Puncture-Proof," The New York Times, January 29, 1994.