An Inefficient Market Hypothesis

According to mainstream economists, greed, in effect, is good. Reigning theory holds that, if individuals and organizations seek to maximize utility and profits, respectively, and there is "perfect" competition, then, as if guided by an invisible hand, market prices and the overall economy will tend toward general equilibrium and maximum happiness for all in the long-run. The reality, however, is that greed is not good, and, in the long-run, it is leading to the collapse of civilization and maximum unhappiness for all. In this sense, reigning economic theory constitutes a dangerous extraordinary popular delusion.

Stemming from pervasive greed and competition, market societies such as our own historically suffer from general disequilibrium in the form of persistent price instability and so-called business cycles. These cycles involve swings between extreme optimism and pessimism in popular mood which, in turn, lead to the formation of irrationally high and low collective beliefs and expectations, respectively. On Wall Street, irrational swings in prevailing expectations are readily observed as general cycles in stock price movements commonly known as "bull" and "bear" markets.

Experienced Wall Street professionals have learned that the general ups and downs in stock prices can be predicted using technical analysis.

One effective approach is based upon a contrarian investment strategy that involves "going against the crowd" (see David Dreman, 'The New Contrarian Investment Strategy', 1982). By paying attention to "psychological indicators" like the put-to-call ratio and polls of investor sentiment, one can determine when extremes of optimism and pessimism are being reached on Wall Street and time tops and bottoms accordingly (see Martin Zweig's 'Winning on Wall Street', 1986).

Irrational extremes in consensus expectations are indirectly reflected in generally overvalued and undervalued stock prices at major tops and bottoms, respectively. Thus, a contrarian investment strategy is also applied using indicators of relative historic valuation like price-to-earnings ratios and dividend yields (see Dreman's book and/or Norman Fosback's 'Stock Market Logic').

With the all-time high above Dow 10,000 in recent years, collective beliefs and expectations reached an unprecedented irrational extreme, something reflected in the highest PE ratios and lowest dividend yields ever seen for U.S. stocks.

In a more general sense, current collective irrationality is reflected in the reigning "Efficient Market" theories of stock price behavior dominating economics and finance. According to the Efficient Market Hypothesis, investors form "rational expectations" of the future in the aggregate using all available information including lessons learned from past mistakes. Assuming the stock market efficiently discounts investors' rational expectations, stock prices reflect an accurate assessment of intrinsic value based upon available, relevant information. Consequently, only new, unexpected information can lead to a price change (a movemement of market equilibrium). Thus, stock market prices are expected to follow a random walk in which only unpredictable, random shocks, i.e., unexpected news, moves prices up and down.

According to the weakest form of the Efficient Market Hypothesis, stock prices fully reflect the information implied by all prior price movements. Price movements, in effect, are totally independent of previous movements, implying the absence of any price patterns with prophetic significance; investors should be unable to profit from studying charts of past prices.

Unfortunately, the Efficient Market Hypothesis, like economic theory in general, is for the most part wrong. While pervasive evidence of irrational swings in investors' expectations mentioned above is sufficient for undermining the key assumption of "rational expectations" in efficient market theory, a straightforward way to falsify the efficient market hypothesis is by making a prediction of the future direction of stock prices based upon historical price patterns in the Dow Jones Industrial Average.

In 1990, the DJIA climbed to the 3000 level for the first time. In mid-July, the Dow closed two days in a row at what was then an all-time high of 2999.75 and subsequently entered a sharp, three-month correction of over twenty percent after Iraq invaded Kuwait precipitating an oil shock and economic recession. The 3000 barrier was subsequently breached in 1991.

The first time the Dow reached the 4000 mark was in January of 1994. Specifically, the DJIA reached an intraday high of 3985 and registered a closing peak at 3978. Following this test of the 4000 barrier, stock prices dropped by ten percent and then struggled with Dow 4000 for about a year after the Federal Reserve initiated a period of tightening credit. (see: "Dow Industrials' Failure to Break 4000 Barrier Stiffens Bears' Doubts" in the Wall Street Journal, 9/19/94, "Once Again, Industrials Close In on 4000 Barrier" in the Wall Street Journal, 2/6/95 or "Rare Planet Alignment Bodes A Bust For Booming Stock Market" in 1/12/94 issue of the Wall St. Journal, P.B1.)

In early 1997, the Dow reversed from the 7000 mark and then the Fed raised interest rates for the first time since 1994 leading to a ten percent market correction.

In August of 1997, the DJIA broke above 8000 for the first time in history and then reversed sharply. In October of 1997 the DJIA reversed from Dow 8000 in the form of a mini-crash triggered by an Asian financial panic that received international attention.

Finally, in 1999 the DJIA climbed above the psychologically critical 10,000 mark and bounced around above this benchmark for a couple of years. On September 6th of 2001, the DJIA closed decisively below the 10,000 mark and entered a sharp drop. Then, on September 11th, terrorists hijacked U.S. jetliners and drove them into the World Trade Center and Pentagon. The Twin Towers collapsed, the Pentagon burned and thousands of Americans perished. In response to the 9/11 terror and its potential impact on the U.S. economy, stock prices dove to just above Dow 8000, almost 20% below the psychologically important 10,000 mark.

Following the September 11th terrorist attacks against the United States and associated reversal in the DJIA from 10,000, the stock market recovered from its October 2001 lows and climbed back above 10,000 into the Spring of 2002. Stock prices then entered a sharp decline to new lows into October of 2002. Then the DJIA entered a major recovery until now where the DJIA is again retesting the magical 10,000 barrier.

At the current juncture the DJIA is poised to reverse from the psychologically important 10,000 mark that was violated in September of 2001 in association with the horrible events of that month. If history repeats as normal with a reversal below this critical thousand mark in the Dow, then one should expect at least a thirty percent drop in stock prices, possibly in association with negative world events.

The Elliott Wave Principle holds that stock prices move in repeating, fractal-based wave patterns. Based upon these patterns, Robert Prechter, the 'Elliott Wave Theorist', predicted in the late-1970's and early-1980's that a major bull market in stocks was due that would carry the DJIA to a "Grand Supercycle" top which has been at least 200 years in the making. Following the final peak, Prechter warned the 'worst crash in U.S. history' would occur and ultimately the DJIA could bottom below the 400 mark (that's correctly read as four HUNDRED not four THOUSAND).

Even though the bull market has lasted longer than Prechter expected and the DJIA has gone higher than first projected, the indication is that the final top was reached above the key Dow 10,000 mark.

One of the main reasons to believe the Grand Supercycle peak has been reached above Dow 10,000 is because the recent high point in stock prices coincided with a major planetary alignment on May 5th of 2000. Each of the Elliott Wave turning points of the 'Supercycle' upswing from the 1932 Great Depression low, i.e., in 1937, 1942, 1966, 1974 and 1982, occurred around the time of rare planetary alignments. This pattern repeated in the spring of 2000 when the DJIA peaked above 11,000 and the Nasdaq Composite topped out above the 5000 mark around the time of one of the most significant planetary alignments in human history.

If, indeed, we reached the Grand Supercycle peak in stock prices above Dow 10,000 in recent years, then an historically unprecedented collapse is near. Given the scale of the relevant historical wave patterns, this collapse could last upwards of a century and involve upwards of a 99% decline in the DJIA.

As explained in my other writings, this collapse could ultimately involve apocalyptic world events and the fall of Western Civilization. Indeed, with a reversal from Dow 10,000, historical events could take the form of what I've been warning the world about since February of 1991, i.e., Saddam's Revenge in the form of a SCUD missile attack against Israel involving weapons of mass destruction by Iraq and/or Syria that, in turn, will trigger an Arab/Israeli war and ultimately an all-out, nuclear East/West conflict.

If the expected collapse occurs, then this will significantly falsify the Efficient Market Hypothesis and undermine reigning economic theory. Furthermore, the collapse will demonstrate the inefficiency of allowing greed and competition to run its inevitable course such that the worst of all possible worlds comes to pass in the long-run. In other words, the faith of secular society in some imaginary invisible hand is a catastrophic mistake.

While the anticipated collapse will upset the worldview of economists and those who believe greed is good, it also implies an upset of prevailing popular opinions. Indeed, since general swings in stock prices reflect swings in mass mood between irrationally optimistic and pessimistic collective beliefs and expectations, the unprecedented Grand Supercycle peak of recent years likely involves the worst popular delusions imaginable. Indeed, one such delusion is that a "New World Order" of East/West peace, friendship and cooperation is at hand, when, in fact, I have foreseen a new world disorder and global war . While the approaching world war will upset popular expectations and surprise the modern "secular" world, it shall fulfill biblical prophecy and thereby verify religious truth and the wisdom of faith in God.