As you are probably aware, Robert Prechter of ElliotWave International came on CNBC yesterday and talked about the Dow eventually hitting 1,000 before this was all said and done. For disclosure purposes, I subscribe to his newsletter, as I do many others in both the bull and bear camp. I like to keep my finger on the pulse of what each camp is thinking. If you haven't seen the call yet, take a look here.
This call, though, seems to be one set on selling more subscriptions, having less to do with reality. Dow 1,000 is a headline grabber and sure to put some people on edge. What if? What if we did see 1,000 on the Dow? I have talked to a prospect recently who is scared to invest any money with our firm, even though he agrees with the way we invest, because of Prechter's call the past few months of 1,000. I wonder how many others are staying on the sidelines in cash awaiting the potential end of the US market as we know it. While I agree with a more cautious stance at the moment, 1,000 is out of the realm of possibilities based on my research. Let's take a look.
First, 1,000 on the Dow will literally wipe out 90% of the market cap of the greatest businesses in America, and arguably the world. Let's look at Coca-Cola (NYSE:KO) for example. Currently Coke has a market cap of $135 billion. If we wipe out 90% of that market cap, at the Prechter bottom, the entire franchise will sell at a market cap of about $13.5 billion. Coke made $6 billion in free cash flow last year. If their business stayed flat - they would be making 50% returns per year on their Prechter bottom market cap. Does Prechter think the world will be drinking 90% less Coke as well?
Here is another thought: Coke currently has $9 billion in cash and short term investments (cash equivalents), along with $5 billion in long term debt. Berkshire Hathaway (NYSE:BRK.A) has $27 billion in cash. At the Prechter low, Warren Buffett's company can buy Coca-Cola for $13.5 billion, take the $7 billion of Coke's cash to pay off the long term debt, have $2 billion of cash left over in Coke, thus bringing the net purchase price to only $11.5 billion. Not a bad deal. Berkshire would now have $15.5 billion in cash left after buying 100% of Coke at the Prechter bottom. They could now focus their attention on buying 100% of Intel (NASDAQ:INTC), because Intel would only have a market cap of $11 billion, down from $110 billion. Intel, with only $ 2 billion in long term debt and $14 billion in cash, would basically be free to Mr. Buffett! As a matter of fact, he could get paid to buy the company, thus not risking any of Berkshire's capital. Warren could buy the company for $11 billion, use the $14 billion in cash he gets with the company to pay off the $2 billion in debt, pay himself back his $11 billion from the cash that came with Intel, and walk away with a $1 billion more in cash than he brought to the deal. Oh yeah, and he gets the microchip business for free. (Numbers are before the announced take-overs.)
Now that is a deal.
These types of deals would pretty much be available for all 30 Dow components. Hopefully, you can see the absurdity of this Dow 1,000 call.
What is more likely to happen?
If (and it's a big if) the Dow were to reach 1,000, it would get there in real terms from the proliferate printing of Ben Bernanke and the Federal Reserve, not in nominal terms.
We are seeing this happen already. Here is a chart of the Dow in nominal terms (click to enlarge images):
As you can see from the March 2009 lows, the Dow is up about 64%. Seems like a nice little "gain" in wealth for those who were lucky enough to buy in March of 2009. Due to the theft of middle class investors through the printing press, here is the Dow priced in a basket of 17 commodities that are used by most humans:
In "reality", stocks have only gained about 8.8% from the March 2009 lows. That is to say, stocks have barely beat inflating prices since the depths of the crisis over a year ago. Ben has done a great Houdini act in making things appear like they have gotten better.
The Dow priced in honest money, Gold is even more worrisome when viewed over the the last decade:
The Dow in real money (gold) terms, is about 82% lower since 1999 before the tech bubble burst. It is up 19% from the March 2009 lows in real terms. In nominal terms, it seems like the Dow is "only" about 24% below its all time highs, but in real money terms (gold), the Dow is already almost 90% lower than it was a decade ago. Will we drop another 90% from here, or is Prechter's 90% drop almost complete in real terms over the past decade?
While I still think there is some pain to be had in the markets, and believe investors should do some very focused things to protect themselves from a Japan-style lost two decades, Dow 1,000, in nominal terms, is absurd in my opinion. Deflation, if it does take hold, would drive the value of the dollar to extreme highs from here. I am not saying this is not possible, but if the companies above, like Intel, have balance sheets stocked full of cash which is becoming ever more valuable in deflation, is it sane to think the market caps of these companies will ever trade below the cash they have in the bank? At Dow 1,000, they would have to. Japan has a number of companies that meet this profile, so maybe Prechter will ultimately be proven right. Based on the performance of the Dow in real and nominal terms though, my guess is that a 90% drop will come about in such a way that will hurt everyone, including him. Since he and his followers are in mostly cash, the market will try to hurt them by hitting that 90% drop though real, not nominal terms, thus depleting the value of that cash over time, without them even noticing it is happening:
Caution makes sense at the moment, but hiding in a bunker waiting for Dow 1,000 in cash is about as risky as the other option, being long 100% in equities. If the drop happens in real terms and not nominal, holders of "cash only" could stand to lose yet another 50%+ of their purchasing power over the next decade like they would have over the recent past decade, even while stocks lost money.