An amazing prediction for us to check a year or two from now

Here is a reputable person in a very reputable magazine making an amazing, unequivocal prediction about the stock market:

Recipe for a meltdown by Shawn Tully in Fortune Magazine

Here are two quotes that summarize Tully’s prediction (boldface is mine):

There’s just one way for equities to get their lustre back — their prices have to fall substantially so that investors can harvest attractive returns from the modest profit growth that’s in the cards. Like the biblical sheik who hastens to Samarra to escape death, only to find death waiting for him there, stocks have an inescapable appointment with a withering fate.

Investors can’t get fat returns from profit growth. But they can get good returns from a combination of far higher dividend yields plus modest profit growth. And for dividend yields to rise, prices have to drop. That’s the inexorable math we now see playing out. Forget the chatter, ignore the headlines, and follow the math. Prices will get a lot more attractive. The process is underway. All investors have to do is wait.

The article was published on the morning of November 28, 2007. For the record, the Dow Jones Industrial average closed at 12,743 on November 26 and closed at 12,956 on November 27. So if we beleive Tully’s prediction, the market is going to go down - in his words there will be a “massive, irreversible revaluation of stocks” - from here.

The last time we saw a big “revaluation” like this, the Dow fell from a high of 11,750 in January, 2000 to a low of 7,197 in October of 2002. In other words, it fell 4,552 points, or 38%. [Note that the NASDAQ was even worse. It fell from 5,132 in March of 2000 to a low of 1,108 in October of 2002, or 78%] And in Tully’s opinion, 38% wasn’t enough. He says, “The problem with equities is that the repricing following the bubble of the late 1990s never fully played out.”

Therefore, Tully must believe that the Dow is going to fall below 7,000. That would be a 50% drop from the Dow’s peak last month of 14,198. And he must also believe that the NASDAQ will fall below 1,100, or 60% below its peak of 2,861 last month.

That, in a nutshell, is Tully’s Prediction.

Now, here is reason for taking the time to call out Tully’s Prediction. I think that Fortune magazine is being completely irresponsible when it publishes a piece like this. Here’s why.

First, if you read the entire article, you will see that Tully never states how far the market will fall. And he never states when it will get there. His is a completely nebulous prediction, and therefore Tully is completely unaccountable. The editors at Fortune should have said to him: quantify your prediction, and justify it. Tully should have been forced to say something concrete like, “The Dow will fall below 7,000 by October of 2009, and the NASDAQ will be at 1,000.” There is no reason why the editors should have allowed him to be totally nebulous.

Second, the editors should have asked Tully to put his money where his mouth is. If Tully believes what he is saying, Tully’s portfolio should reflect that. He should be completely in shorts or long term put options right now. If his prediction is true, he is going to make a massive amount of money that way. Based on his prediction, what is Tully doing with his money? If he is not doing anything with his personal money, then that means his prediction is crap and it should not have been published. If he has acted on his convictions in his personal portfolio, with all of his money, then we know that Tully will be punished if he is wrong.

Third, Fortune has some obligation to tell the rest of us what to do. Fortune’s editors must believe this prediction is valid. If not, they shouldn’t have published it (or it should be published with a disclaimer). I trust Fortune magazine, and Tully is speaking unequivocally. He does not say, “based on the data, there is a 75% chance that the market will go down.” He says:

That’s the inexorable math we now see playing out. Forget the chatter, ignore the headlines, and follow the math. Prices will get a lot more attractive.

“Prices will get a lot more attractive” - What an amazing euphemism for a disaster. If the market really is going to fall 50% (or more) as Tully seems to believe, that means that millions of American families who have their retirement savings and college funds in stocks should absolutely get out of the market. Tully should be required to say that. Tully’s article should say in no uncertain terms: “If you have money in stocks right now, you should take all of it out of the market because you will lose 50% over the next two years.” Or something along those lines.

Why? Imagine that a scientist stood up and said, “That’s the inexorable math we now see playing out. Forget the chatter, ignore the headlines, and follow the math. There will be a tsunami that wipes out half of Los Angeles in the next 12 months.” If the math is inexorable, then other scientists would agree and we should take action. Shouldn’t we start the process of evacuating Los Angeles right now? Shouldn’t we declare a national emergency? Millions will lose their houses and the insurance industry will collapse - don’t we have some obligation to address that?

If the stock market falls 50%, it means that the NY Stock Exchange (”with a total market capitalization of over 12 trillion dollars” [ref]) is going to lose $6 trillion. So we should act, and Fortune should lead the way.

Fortune could actually do these things now. The magazine could post a follow-up that includes:
1) Tully’s concrete prediction about how far the market will fall and when. The math is inexorable, so please do the math and publish it.
2) A statement of Tully’s actions in his personal portfolio to show that he has put his own money on the line in concert with his prediction.
3) An action plan for American families so that they are not financially ruined by the imminent collapse of the American markets.

Let’s see what Fortune does.