4/14/09
STEVEN M. FRENKEL, CFA
Chief Technical Analyst
PatternWatch
6 Maltese Drive
Fair Lawn, NJ 07410
(201) 797-3419
Email: frenkly@verizon.net
TWST: You alluded earlier to a 75-year cycle. Tell us about that.
Mr. Frenkel: Since late 2006, leading up to the top in October 2007, and more importantly since that top, the 75-year cycle has played a predominant role in market analysis and portfolio management, in my opinion, and since it's such a large top and it's such a long cycle, using it or taking account of it in trading and in portfolio construction prior to this period would have been truly meaningless. Using such a large cycle prior to the topping window period would not have given you the extra alpha or separated you from your peers. But only in this turning window period was taking account of it able to provide that separation. Indeed, if you see what the track record of my newsletter PatternWatch has been for these past two years, you see that I was able to separate myself from those who didn't take account of that cycle. This track record is as follows:
You had asked me about PatternWatch. I started PatternWatch in early 2007 in an attempt to transit my previous newsletter, Frenkly Speaking, from a retail environment to an institutional environment. I became involved with a marketing firm StreetBrains.com, which has since run into financial difficulties. They gave me a trial period for the first two months of 2007 and at that time, I was able to forecast that the top that was made in February of 2007 and the steep drop following it. That top was attributed to what was then called the Chinese banking problem. I correctly forecast that the February 2007 drop would be a buying opportunity on the way up to the higher targets I alluded to above. Streetbrains was very impressed by the accuracy of that forecast and signed me up to an exclusive marketing agreement. And so, PatternWatch was born. And I've been with them until very recently. I was and am still the Chief Technical Analyst of PatternWatch, in which capacity I write it, publish it, and do everything except market it.
TWST: What about the methodology? What are the tools that you use to analyze these market cycles?
Mr. Frenkel: As part of the material provided to the prospective subscriber, my methodology was always available on the Streetbrains website, which of course no longer is functional. Rather than hide my methodology, I have always made it available and I encourage people to research it. Specifically, the methodology that I employ is a combination of Elliott Wave Theory, Gann Theory, classic cyclical analysis, classic charting methods, and Wyckoff (volume) analysis. That combination comprises 80% of my methodology. The other 20%, the icing on the cake, so to speak, is proprietary to me alone. Whereas, my preliminary market timing signals are provided by the aforementioned 80% blend, my final timing signals are those that survive a refining and filtering process that makes use of that last 20%, my proprietary methods.
TWST: Tell us about where we stand now in the long-term market cycle?
Mr. Frenkel: We're still in the beginning stages of a super bear market that will not make a major bottom until December of 2012. So I believe we're at a juncture where we will soon finish the first part of the super bear market, at levels slightly lower than those of early March. Then we should have a protracted rally of several months, which always occurs between the first and second halves of great bear markets. I had earlier this year forecast that the first half of the bear market would bottom in late March, but changed this to late April. However, it now appears likely that the bottom may be as late as late June. I believe this because my best analysis of the current market action is that it is a culmination of the up move that started, believe it or not, at the November lows. The whole upward correction from last November's lows is actually a combination of an up move from November until January, a down move from January until March and, finally, a second up move from early March until now. I believe we should peak by Friday this week (April 17) as we speak and then we should head down to as low as S & P 625, Dow 6250, and NASDAQ 1110 into that late June period. At which time we should have the mid-cycle rally.
This mid station rally or the mid-cycle rally always occurs between the two halves of great bear markets. If you go back in history, you'll see that we had it in 1932. We had the first half of that great bear market from September of 1929, through the crash of 1929, and bottoming in November of 1929. Then we had the mid-cycle rally retracing 60% of the decline by late April of 1930. Then we had the second and worst half of that bear market that lasted much longer than the first half. That's pretty typical of these super bear markets. I believe the rally that we get later this year will last into maybe September, and then you'll have the second and worst half of this bear market, which I think will take us down to Dow 3900 and Standard & Poor's 392 by December of 2012, as I already mentioned.
What people aren't aware of is that the worst fundamentals occur in the second half of super bear markets, such as the fundamentals that occurred between late 1930 and July of 1932. People didn't know they were in a depression until late 1930, or even 1931. Just as the worst fundamentals occurred during the second half of the 1930s bear market, so, too, will the worst fundamentals of the current super bear occur during its second half. This means that we haven't seen them yet. That's what I think people are not aware of. They have no way of recognizing this because they haven't lived through anything like this. However, my work on long-term cycles and the structure and patterns of super bear markets tells me that that's exactly what will happen and that the worst economic damage has not been seen to date! Yet, with the counter-trend rally we have had these past seven weeks, you are hearing people say that “the worst is behind us.” On the contrary, my work tells me that the worst is yet to come.
TWST: How do external factors impact a cycle?
Mr. Frenkel: That was one of the pieces of data that confirmed the overall analysis. Typically, at these 75-year cycle tops, you have an accumulation of 75 years of debt in the banking system. And that's exactly what we had. It takes 75 years for people to forget the mistakes of their grandparents and then repeat them. So after the last depression, people were shunning debt. Debt was the last thing they wanted, because they felt that debt caused the deflation that basically overwhelmed and mowed them down. They were caught up in a debt morass from which there was no escape, so the last thing people wanted to do was to take on debt. But of course, 75 years later, people found themselves going into debt at the drop of a hat. People were encouraged to take loans that they couldn't afford, without any income verification. Who would have heard of that in the 1930s? That would never have happened. So it takes 75 years to go from extreme fear to extreme greed. And that is normal. So the current cycle has been a very normal cycle and all its factors have occurred right on schedule. If we human beings were looking out from another planet, looking over here, we would say, “Well, there they go again. Very typical, what a very consistent, repetitive beast those humans are.”
TWST: So where are we headed? What should investors be wary of now with their assessment?
Mr. Frenkel: I believe that once you had the turn in October of 2007, when the cycle flipped, from that inflection point, you then entered the reverse mode of five-year turning points. Whereas the market would go up for the greater part of five years between the 1950's and 2007 with a series of short-term downward corrections, you are now in a mode of long, five-year declines interrupted by short upward corrections. You see, it's exactly the opposite. Just to give you an example, we had major lows in 1990 with the prelude to the first war in Iraq. Then in 1995, we had a low where technology had a minor problem. It had come too far, too fast and you had the war between Windows and the new Netscape, if you remember that. But that was a five-year low. Then you had another five-year rise between 1995 and 2000. The stock market went up for most of those five years in the great dot.com bubble. And then you had a drop for a year and a half, maybe two years, into 2002 and guess what? How many years were there between the low in 2002 and the final high in 2007? You guessed it, five! Is that a coincidence? No. It's all part of that 75-year cycle.
That trend reversed itself in October 2007. I was aware and am still aware that the first real major low will be five years from 2007 and 2012. That is normal. We are now in a period where the stock market will decline for the most part. You'll have short, sharp, 20+% rallies such as the one we're in now, which will intercede those longer declines. Just the opposite from where we were in the previous 25 years. And also economically, as I said, you have to determine where you are in the overall economic cycle. When these 75-year cycles top, the economy typically contracts, just like we did in the 1930s, for over 10 years. So a normal cycle at this juncture would be the stock market bottoming in 2012 and the economy bottoming in around 2017. People just cannot deal with this mentally. This is something people cannot accept, but, as a matter of fact, I tell you this is normal. So my claim, and I've said this in other interviews, is that for every trillion dollars of government deficit spending, you can add one year to the date at which the economic recovery and the bottom in the economy occur. Thus far, according to my calculations, our Congress and President have appropriated or proposed approximately $6 trillion in deficit spending, if you add up all the programs since October, so this pushes the real bottom and low in the economic cycle out until at least 2020!
TWST: In your newsletters, you give short and intermediate term outlooks for a variety of assets, the stock market, the dollar, the commodity prices, and so forth. Do you want to talk about those?
Mr. Frenkel: Yes. I think it's very typical that the commodity and gold markets peak several months after the stock market historically, and that's exactly what they did this time. Gold peaked in March 2008 - actually gold had a double top in March of 2008 and February of 2009 of just over a $1,000/oz., and the commodity index usually peaks several months after gold. Commodities, as measured by the old Commodity Research Bureau Index, now called the Continuous Commodity Index (CCI), peaked in early July 2008 at 615 and it's clear that that was a classic peak several months after gold and several months more after the stock market peak. These peaks were classic in terms of the long cycles. One thing I note is that since that time in early July of last year, you had a crash in the price of oil -- and I would call going from $147/barrel in July 2008 down to $34 in February 2009 a crash; and the continuous commodity index crashed from 615 in early July of last year to 322 in early December, an almost 50% drop! However, my work tells me that this is just the prelude of a great deflation. And we are now midway into that. We're in the sideways to up recovery phase from the first decline, and this upward correction is about to end. And then the commodity prices, gold, and oil should all have another leg down later this year and eventually break their lows of early 2001. These lows were 186 for the CCI index, $246/oz. for gold, and $19/barrel for oil. I believe these markets will break those lows late this year. My targets would be CCI 140-165, gold $200/oz., and oil $17/barrel.
I believe these dramatic declines will be caused by a deflationary black hole, as I like to call it. This is the message I obtain by interpreting their charts. And this message is very typical of these long-term cycles because both the gold chart and the CCI or continuous commodity index chart confirm this to me. It is important that your readers be reminded that I do not speak for myself; I speak for the markets, from my analysis of the markets. I'm not uttering my own personal opinions, but rather my analysis of the long-term charts of the commodities and gold. They tell me that what we are entering is a normal deflationary black hole of which the vast majority of people are unaware. Conventional wisdom states that the Fed will step in and reliquify the economy. This is the word that is used. With quantitative easing, the Fed will succeed in reliquifying the banking system and the economy and preventing a deflationary collapse. But the charts tell me that is just not the case, that, on the contrary, the Fed will not succeed.
TWST: That's the printing of more money?
Mr. Frenkel: Right, and my feeling is that in this case they won't. Let's say they do print, and now they are up to a little over $2 trillion. Let's say they print $3 trillion. That amount will be overwhelmed by the meltdown of both the global economy and global demand for goods and services and by the multi-trillion dollar write-offs of many of the loan derivatives made during the past boom. I like to say that the Fed trying to re-flate the global economy is akin to melting an iceberg with a teakettle! It just won't happen. This opinion is most certainly not conventional wisdom. If you talk to the average trader, the average portfolio manager or sophisticated investor, they all feel that the current economic down turn will be like the last recession, where all the Fed had to do was re-flate the system by increasing the money supply and monetizing debt. They think the difference this time is that the Fed has to go to a quantitative step or quantitative degree not seen previously, but once that is done, it will have the same success as past federal reserves have had in the past 75 years. My read of the charts tells me that the Fed will not meet success.
TWST: What about the housing and real estate?
Mr. Frenkel: Real estate has an 18-year cycle. So let's say you picked the top as 2006 for real estate. And, let's say we use the Case-Shiller price index of real estate. If that index peaked in 2006, a normal real estate cycle of 18 years would indicate that the next top would be in 18 years, and the next bottom would be 9 years from 2006, or 2015! That would be a normal real-estate cycle. Again, we had these cycles in the past 75 years. In a bull market the lows were higher lows. But now that's turned upside-down and the lows will be lower lows. So the low before you get a realistic bounce in real estate prices will be 9 plus 2006 or 2015. Again, this is not something people want to hear, and not something they can easily deal with.
TWST: What other areas do you want to discuss that we didn't touch on?
Mr. Frenkel: I want to discuss what this deflation means or will mean to the wage structure. One of the great myths that is now being exploded is that we have a new paradigm in the United States of a service economy. History tells me there is no such thing as a service economy. So that's been exploded, and therefore, one has to look at a floor for wages before any meaningful recovery can take place here, which is again consistent with the fact that the Fed will not be able to achieve what they would want to achieve, which is maintain the status quo in wages and prices.
My feeling is, you will get an economic recovery in the United States only when manufacturing returns to the United States economy. Manufacturing will return only when wages here are equal -- and let me underline equal -- to those in India and China! So we've got a long way for our wages and prices to decline. And I'm not saying it will take very long, but it will decline a long way in terms of price, in terms of dollars. But that's what I expect before the economy can recover. Again, this is not common knowledge and people don't think that this can happen. That's what I mean by a deflationary black hole and that will be normal. It will bring our wages down to where we can have a meaningful manufacturing economy once again.
TWST: So a deflationary environment rather than an inflationary?
Mr. Frenkel: Right. And one more reason, Paul, why I think this is that - and I have said this in other proceedings, which really got people thinking and turned some heads -- this is not a typical 75-year cycle like the 1930s depression. This is a fifth 75-year cycle, with the fifth one being the worst. So every fifth 75-year cycle is the megacycle. This is where we are, so therefore, we can look at the deflation brought about in this time period as a degree of magnitude worse than that that occurred in the 1930s. People have no concept for understanding that or perceiving that and that's part of the work too. If you didn't have the 75-year cycle that was not confirmed in the charts and all my other work, I would not look to a 375-year cycle, it wouldn't be relevant, but since one is confirmed, you have to look and say, “Well, what 75-year cycle have we just peaked, which one has peaked?” And yes, you conclude that it is indeed the fifth one or the granddaddy, the mega one. Therefore, I do expect this deflation to be worse this time than the 1930s. Finally, when I examine the long-term charts of the price of wheat as a proxy for global inflation going back to the medieval period, or dark ages, when they first started keeping track of the price of wheat, I can see that we needed one more top in the pattern from about the year 1000 to the present in order to complete the pattern in inflation from the dark ages. I now believe that the top made in July of 2008 constitutes that final top. Thus, I believe that we are, in the next several years, about to undo all of the inflation that occurred since 1000, since William the Conqueror. The fact that we have now completed the pattern is very, very significant.
TWST: That's a fascinating study that you do that goes right back in history. So you think that these glimmers of hope or shoots of green just indicate a small spike rally?
Mr. Frenkel: Yes, I think they are normal human responses, wishful thinking, denial, whatever you want to call them, that always occur in the periods between contractions of a down cycle such as we're in now.
TWST: Is there anything you'd like to add?
Mr. Frenkel: All is not lost because in times like this you must be a trader to survive. If there were one thing I would recommend, one portfolio or asset allocation strategy, if you had to do one, it would be short and hold, because just understand that if you applied buy and hold between 1932 and 2007, you would have done quite nicely. The market would have bailed you out every time. Well, now it's the reverse, so you have to look at short and hold. But if you can't do that, there are many vehicles we have now with the ETFs out there that are ideal vehicles for trading. Those should and must be used to survive the next several years. And that's how I see that you can survive and prosper during these times ahead from now until 2012. But if you want to do business as usual, in the same manner you did business between the 1980s and 2007, you'll be overwhelmed and destroyed. I like to say business as usual is death, and I mean that. You can trade your way through this, but you need the services of somebody like myself (or others like me) who can navigate the up rally such as the one we are in now and then the longer down periods and can advise you when to exit one trade and enter another. If you trade in this manner, you will have liquidity when the deflation wipes out liquidity from the global financial system. Most people will not have liquidity or cash; you'll be one of those that does and you'll be basically in a royal position. So I believe that's what you have to do.
Let me not fail to mention what's going to happen to the banking system and global non asset-backed or fiat currencies. Basically, they will fail. The banking system will fail and 95% of banks will fail and the currency system as we know it with the dollar as the reserve currency and the Euro and a few others will also fail. And after 2012 or maybe even sooner, human beings will survive, but we will have to have a new monetary system based on gold or backed by some other asset. The fiat currency experiment that lasted for the last 75 years will be proved a failure. Mankind will start the global financial system all over again based on a currency that is sound, like the soundness of gold, and that will be backed by gold or silver or some other asset. There will be no more paper currencies, fiat currencies that are backed by nothing, because they will have failed. So people should be aware that this period will not end and the economy will not turn around before the current currency and banking systems are no more. That's all part of this mega cycle. So people must take appropriate measures to guard against those developments.
TWST: Thank you. (PS)
