Michael Belkin, the iconoclastic market strategist who publishes his eponymous Belkin Report for institutional investors from remote and blustery Bainbridge Island, Washington, doesn't really care much if he ruffles feathers. Or upsets comfortable, conventional thought patterns or portfolios. Mike Belkin sees this Fed-fueled rally driving Nasdaq up another 60 percent.
The whole point of his business is helping his clients get positioned right to take advantage of big market moves. Since December that's meant telling skeptical institutions to get ready to party. Mike elaborated on his change of heart for me recently.
-KMW
You are one contrary cuss, Mike. Just when institutional investors were beginning to cotton onto the secular bear market story you've been spinning since 2000, or 1999, really, you call for a monster rally.
I guess that's my lot in life. I do seem to have high targets, in percentage terms, for this rally, higher than pretty much any I've seen out there. It's not because I've suddenly been transformed into a bubble person. It's just that I constantly analyze the situation and what I see now is the potential for a fairly significant market bounce.
"Fairly significant?" I'd say 60 percent more on the Nasdaq would qualify. You are out there on the analytical fringe again.
It is hard to imagine the Nasdaq, which is currently around 1500, going to 2400 any time soon.
Almost as hard as it is to imagine that at the peak of the mania it got up to more than twice that level.
But it's certainly within the realm of probability and possibility. Not this week or this month, but looking out toward the end of the year. Over the next maybe six to nine months, something like that.
Haven't you been listening to the Sage of Omaha? He has been preaching that single-digit stock price appreciation is the best any rational investor should expect.
Yes. I read that and laughed. I was with Salomon Brothers, remember, when [Warren] Buffet came in and sort of reorganized the place-not for the better.
As I recall, he was the white knight called into rescue Solly from the brink.
Yes. He did save the firm. We were able to roll over our commercial paper when he came in, which was an improvement. But that was still the effective death knell of Salomon Brothers. Not that it was Buffet's fault. It was the Treasury trading scandal that brought on the whole sorry chain of events.
Exactly.
But the upshot was that Salomon got acquired by Citigroup. Now the organization doesn't even exist anymore. They retired the Salomon Brothers name. Anyway, back in the late 1980s, it was an interesting place to work.
No kidding. You obviously refined some skills there that are serving you and your clients pretty well.
I spent a lot of time at Salomon applying statistical models to trading strategies and doing a lot of trend analysis. Finding out what works and what doesn't. Out of that experience, I ended up developing the forecasting model that my independent research business is based on. The good news is that my model's indicators are all pointing up very strongly right now, after pointing down for most of the time over the last three years.
You're too modest.
I won't argue. What's a little funny is that the last time we did one of these interviews in your publication, the headline you wrote was "Sell Telecom, Buy Banks." Right now, my advice is almost the exact opposite. I have regional banks listed as one of my better candidates to underperform in terms of industry group rotation in the S&P 500 in terms, maybe not in absolute terms but certainly in relative terms. By contrast, the things all across the board that have fallen the most over the last three years are my outperform candidates. The upshot is that I am looking for a bounce just like a lot of people are. Where I'm a little different is in the extent of the bounce-and in suggesting that the things that could bounce the most are the ones that have fallen the most.
That makes a certain intuitive sense-but flies in the face of Street wisdom that says that the leaders of the last bull market are fated to not be among the best-performers in the next bull. Then again, you don't really think that this is the next big bull market.
No. Although a 60 percent rally in the Nasdaq will certainly feel like a bull market .
Without turning this into a discourse on semantics, I assume the distinction you're making is that even 60 percent would leave the Nasdaq well below its prior bull market peak.
Right. But let's step back for a second to put things in perspective. As you know, what I've developed is a way of looking at long-term trends. Essentially, most financial markets, not just stocks, but industry groups and the ratios of groups to an index, go through deviations from trend-and sometimes extreme deviations from trend, in the case of a bubble-and then they bounce back towards trend. So they're mean-reverting processes. They diverge and then mean-revert. Bubbles are only the extremes at one end of that process.
You're a true believer in reversion to the mean. Never bought the notion that economic and market cycles were passe.
Right. But remember, reversion to the mean doesn't do you any good at all in short-term trading or in positioning your portfolios. It only works long term; markets are definitely random short-term; filled with a lot of noise. But there are long-term trends. If you look at the history of the DJIA as far back as data goes, you see bull markets typically starting around the 200-week average-that is what I use as an intermediate-term trend. The market goes up for three years or so over the business cycle. It tops out before the next recession; starts going down. Then recession starts and the market bottoms around the 200-week average in the midst of the recession. The cycle starts all over again as the market begins going up before signs of the next economic expansion arrive. That's the ideal pattern of a long-term uptrend, up for three years, down for one. But it could be up five and down two, or any variation on that theme. When you're in an ultra long-term bull market, the difference is that it just keeps going up and you buy all the dips-even the 15 percent declines in the midst of a recession are buying opportunities. The problem is that ultra long-term bull markets tend to climax in a bubble. That's what happened in 1929 in the U.S. and in 1989 in Japan. And again, in early 2000, in the U.S.
It was fun while it lasted-
The problem is that a bubble is an extreme deviation from trend. After which, the market bounces back down to its 200-week average. Then, typically you have a little bounce off of that level, before the market drops back down through it-because you are now in a long-term bear market. Essentially, we've been in a long-term bear market since early-mid-2000. What we've seen is the mirror image of what we saw at the top of the bubble: an extreme deviation downward, away from trend. The trend itself is down, as you can see if you look at the 200-week moving average, which is declining, but we're way below it. We've reached the 200-month average, which is a very rare occurrence. It hasn't happened in decades. We didn't quite go that low on the S&P, but did on the NDX, the DAX, CAC and FTSE-
At least the S&P didn't just evaporate, like the Naz.
The S&P didn't disappear and defensive industry groups, which everyone now is loaded up on – they're the biggest holdings at most institutions – didn't, either. But the Nasdaq has spent seven months now and the European indices, too, basing around their 200- month averages. I've seen this over and over in markets that have gone to bubble extremes. Look at silver in 1982 –
But that was the Hunt brothers' jiggle-
The question isn't why. It's what happened to the price, relative to trend. The Hunt brothers' attempt to corner the market drove the price to $50. After it collapsed, the price of silver crashed down to its 200-month average and then bounced over the course of months back up towards the 200-week average. That was a textbook illustration of a big bear market bounce.
Which is what got you, last October, to predict a mite prematurely that a big bounce was in store?
Right. We were in a similar situation. Nothing's ever exactly like anything else. But now again, after the March retest, we're in a similar position, not just in the Nasdaq, but in the tech stocks and the European stock indexes, to the one the Nikkei was in before it had a huge rally that lasted 9-12 months. We have significant bounce potential.
But if you could say the same thing last fall, and it still has yet to materialize-
Well, I'm always worried about how I could be wrong. Certainly, if you read the newspaper, you're bearish. It looks like the economy is never going to recover and earnings are never going to recover and the S&P price/earnings ratio is at 30. So how can you buy stocks, much less tech stocks that are even more richly priced.
Glad you saved me the trouble of asking.
I'm not arguing. If you just look at that stuff then you don't see a big bounce coming. But if you get the big picture of trend analysis, then you see the potential for a major extended bear market bounce led by technology.
How do you rationalize that?
My fundamental scenario goes like this: The U.S. economy is obviously in malaise, but so was the Japanese economy in 1992. In the U.S. right now, the most important influence on financial markets is the fact that we have negative real interest rates. Right now the fed funds rate is 1.25 percent and the inflation rate is 3 percent.
Makes a dramatic chart.
One that shows we have negative real interest rates of 1.75 percent. That is pretty much unprecedented. You have to go back to before 1981 to find a previous instance of negative real rates-and then they went negative for a little while in a very different circumstance, interest rates were sky high, but the inflation rate was even higher. That was when inflation was soaring in the late 1970s and early '80s, that was the last time. We're in a very different period now. We've had very low inflation for a while. But now it is rising and they've held interest rates artificially low. This is classic post-bubble stuff. If you go back to John Law's Mississippi scheme or the South Sea Bubble, you'll find periods when the central bank affected the price or quantity of credit. This time it's the price of credit.
Negative interest rates aren't exactly an incentive to save.
Right. You're losing money.
Unless you think serious deflation is just around the bend-
Which as you know, I don't see. My work has switched me from being worried about the risk of deflation to worrying about the risk of inflation over the last three-six months. We came to a decisive point in this economic downturn where we were going to turn one way or the other. We either were going to become like Japan and sink into a deflationary morass, or we were going to do what they did in the 1930s in the U.S.-put the pedal to the floor and go in the other direction. Actually, what happened is more likely to produce an Argentina-like outcome than anything else: a continuing but more palatable economic downturn in which interest rates soar and inflation soars. So my longer-term scenario certainly isn't positive.
Not when you're comparing our prospects to Argentina's.
Well, it won't be exactly like Argentina but we're more likely to follow that model than the Japanese deflationary model that everyone seems to be so worried about now. The good news is that this does imply that this bounce should be very impressive. Basically, when you have negative real interest rates you can get the fires going. You can get speculation going. That's basically what the Fed is doing.
Which is why the Fed has been trying to light a fire under stocks.
That is basically what I expect-not a long-lasting fundamental economic recovery but the sort of situation where stocks lead confidence higher, leading to some sort of rebound in the economy that people can use as a theme to ram tech stocks higher.
Why tech stocks?
Basically, because they are the highest-beta lottery tickets out there. The senior techs, the large-cap Nasdaq leaders, look like they have the biggest bounce potential in terms of indexes. The NDX is currently around 1160. Its 200-week average, which is my target for this rally is around 2130, which is up 84 percent from here. To put that in perspective for the S&P 500, it's currently around 945. It's 200-week average upside target is 1193, call it 1200; that's only up 27 percent, well, "only."
That sounds awfully good, next to the negative numbers a lot of folks have been seeing for the last several years.
Definitely. But my point is that the techs could bounce basically three times as high as the S&P 500.
You're urging clients to take advantage of what you see developing into a big bounce in many of the speculative darlings of yesteryear?
The tremendous irony is that this is only happening now that most of the erstwhile big institutional heavyweights in tech have finally sought cover elsewhere.
Because the defensive stocks they've taken shelter in won't participate?
Exactly, or they'll underperform. And the big mutual funds are basically as overweight now in the conservative stuff as they were in the techs in March of 2000. So as the market rebounds, they'll underperform again. That is what has happened to a lot of institutional investors. They've been punished by the bear market. So they've spent the last three years selling techs, which used to be almost 30 percent of the index by weighting, and going and buying banks and all this other conservative stuff. The upshot is that tech now has a low weighting in the S&P and defensives are overweighted. And the institutions are underperforming, again, because the Nasdaq is going up more than the S&P 500. So at the margin, the order flow from big institutions is likely to be to sell all these defensive stocks that they've been hiding out in, and to buy the likes of Cisco (CSCO), Microsoft (MSFT), Intel (INTC), and then all of the mid-tier companies like EMC (EMC)-things that don't have share prices below $5. Then they'll even migrate into the stuff that has cratered by 90 percent to 95 percent. Stocks like Ciena (CIEN) and JDS Uniphase (JDSU), all the way down, even, to a Lucent (LU). These things have already started to go up even more than the market in percentage terms; of course, they're the most highly speculative and who knows if some of these companies will even be around a year or two hence. Nevertheless, at the margin, the selling of the defensive issues and the buying of this sort of more aggressive stuff is a theme that is here to stay for the rest of the year.
How long do you reckon it'll take those moves to unfold?
That's a good question, if for no other reason that these indices' 200-week averages-which are my upside targets-are declining. Not by a lot, but by about 1 percent a month. Which means that if the bounce takes, say, six months to play out, my targets will actually be 5-6 percentage points lower.
Thanks, Michael.
Kathryn M. Welling is the editor and publisher of welling@weeden, an independent research service of Weeden & Co. L.P., Greenwich, Conn. http://welling.weedenco.com
