ECONOMIC VIEW; Soothsayers huddle around the calendar to locate the big crash

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The Independent Online
Wanna know what is going to happen to Wall Street? Here is the answer.

The Dow Jones is going to carry on its present rise to 6,000, which it will reach this spring. Then, during the week beginning Monday, 20 May, there will be a crash; the market will fall by about 15 per cent. The resulting panic will, however, prove a good buying opportunity in June, for a recovery in prices will take place running up to a peak in the first quarter of 1997. Then the long bull market will be over.

If this forecast seems overly brave in its precision let me say quickly that it is not mine, though I do find it extremely plausible. It comes from Robin Griffiths, head of technical analysis at James Capel, in his recent paper on the US market. For people who are not familiar with the term, technical analysis means chartism. This, for the sceptics, means the black-box art of examining charts for patterns that might have some predictive significance: head and shoulders, double bottoms and the like.

The particular chart which Capels note is the one reproduced on the left here, which shows the extent to which the Dow has deviated from its 12- month moving average. They argue that momentum is such that in the near term the Dow will indeed race on towards 6,000, but that the scale of the deviation is already such that the risks are akin to those of 1986/87. If the index reaches 6,000 before May, the deviation will be the largest ever.

This has always in the past been followed by some kind of crash. But if that crash (or correction, as analysts like to call it) was only 15 per cent the uptrend would still be intact - the Dow would still be above the 12-month moving average. That scale of a correction would obviously be very disruptive, but chartists would argue that since the trend would still be intact, the bull market could continue for a while longer. The period of maximum danger is May-June, with that week of 20 May looking, in Capels' words, "a good moment to panic". I would add that risk-averse investors might consider bailing out a bit earlier on the grounds that it is always better to panic before other people do.

The fun will not, however, be entirely over. James Capel argues that we are now towards the end of the second phase of a conventional three- wave bull market. After the coming crash, there will be the third leg. By the end of June, there should therefore be an opportunity to buy back in and take advantage of the final fling of the bull market.

Charts are a useful tool when the picture they project coincides with fundamentals. The high valuation on US equities has been noted by many investment houses working from fundamental values, rather than from charts: things like price-earnings ratios, or a comparison between equity yields and bond yields. But for a second opinion on the health of the market, let's go to another set of black-box merchants, the editors of The Bank Credit Analyst, a firm of specialist investment advisers based in Montreal.

The BCA team base their advice not on the pictures that the charts make but rather on a series of value indicators, with quite a lot of attention paid to monetary data. They were monetarists long before it came into vogue in the 1980s and have remained monetarists since it went out of fashion too. One of their yardsticks for valuing a market is their speculation index, and the movements of this since 1980 are shown in the right-hand graph.

The point here is obvious. On their reckoning we are also in the danger zone, just as we were in 1986 and 1987. Share prices were, however, also in the "extremely speculative" in 1993 and though there was an adjustment, there was nothing like the 1987 crash. Further, the BCA speculation index has been on red alert since the summer of last year, so following too closely its buy/sell signals would mean one would lose out on a very solid bull market.

BCA has, to its credit, been stressing for some months that although the market is at dangerously high valuations, the bull market is intact and that further rises in share prices are on the cards. It has reckoned that despite this, the risk/reward ratio for investment in US shares is unattractive and has therefore recommended underweight positions.

It takes quite a lot of courage to bail out of bull markets too early. If, however, one takes the very long view of investment it may make sense to do so. The argument here is that it is more important not to lose money in bear markets than it is to catch the maximum gain in bull markets. If you believe this, then following the BCA people is a good long-term common-sense guide to investment.

If I have one hesitation about these dire warnings it is this. Virtually everyone involved in the US market is worried about present levels. Many of the big investment banks are expecting the market to end the year lower than it is now. Others are doing some analysis of the average length of the post-war bear markets to see how long the bad news is likely, on past experience, to last. But the market continues rising, and while it feels exposed, it does not yet have that heady, euphoric, outrageous buzz that would signal a crash was on the cards.

We may feel that buzz by May, and James Capel deserve all the credit for their courage in setting a date when the danger is at its peak. But there is an alternative scenario which is surely just as plausible. This is that the bull market runs on more or less intact through the spring and into the autumn, with maybe a plateau in the summer. Then the final speculative peak comes this autumn rather than next spring. That is a more conventional view - that crashes occur in October - but it is surely just as likely as the sell in May, buy back in June, sell in January 1997 scenario.

What does all this mean for Britain? Historically the UK market has tracked the US one. It would be astounding if a crash there did not result in a similar crash here. But valuations on the UK market, while towards the top end of their historic range, are not at the extreme levels in the US. We have not been so mesmerised by the boom in high-technology stocks, if only because we have far fewer high-technology companies. There is still some value here. So while we should expect to be affected by the fall-out from the US, rationally the crash here need not be as dramatic as the crash there. The trouble with the word "rational", though, is that reason, like goodness, has nothing to do with it. Meanwhile put a ring around 20 May in your calendar.