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A specter is haunting the world — the specter of gold.  Gold is now the only safe and sensible asset, because only gold will survive apocalyptic scenario that is about to unfold.  Those who thought “this time will be different” are about to be proven right.  Only a few of the most respected authorities of the market predicted elements of the unfolding demise.  As, one after another, these predictions come true, we will see the financial markets gradually unravel.

In August of last year I forecast a target of 800 for the S&P, which is about to be tested.  This was an easy target to establish, since it represented the low of the 2001-2003 bear market.  Last week’s heroic performance – what traders call a “dead cat bounce” - was a temporary respite from the market’s downward spiral.  I now doubt 800 will be the bottom for this bear market.  There may be more dead cat bounces, but there is no support in sight once 800 is decisively broken.  My ultimate target is 400-500 for the S&P (or 4,000-5,000 for the Dow) which will be reached by the end of 2010.  The timing of the 2010 bottom is consistent with what was given by Wharton professors Andrew Abel and Jeremy Siegel in 2001 in their “baby boomer cashing out” scenario discussed below.

My pessimism is based on my belief that neither government actions nor unnatural market mechanisms, such as circuit breakers and banning short sales, are capable of arresting this bear market.  Many believe this bear market will recover quickly, like it did in 1987.  This will not happen.  After the one-day 20% drop in the market in 1987, circuit breakers were introduced to limit daily declines.  But the market has adapted and selling pressure is distributed over longer time intervals, and the net effect is the same.  Regulators could install additional market holidays, like they did in the 1930s, but the market will continue to adapt.

Jeremy Grantham’s Predictions

Earlier this year, Jeremy Grantham of GMO predicted in an interview with Barron’s that the S&P 500 would drop to 1,100 by end of 2010. A lot of people just laughed at him. Was this crazy old man out of his mind? Now, to quote Hamlet, “All the rest is silence.” We always should listen to an old man who experienced the so-called “Nifty Fifty” losing 80% of their market value in 1970s and has extensively studied the Great Depression of the 1930s. He probably regrets now that his 1,100 target was too conservative.

Jeremy derived his 1,100 prediction with a P/E of 11-12 as a norm for a long-term capital market. With a more representative bear market P/E value of 6-7, the forecast comes out in the 600-700 range. At the extreme of this bear market a few years down the road, the S&P 500 might very well overshoot and drop all the way to 4-500. That was the launch pad for last leg of the bull market that followed the recession of the early 1990s. Everything could go back to square one, while 20 years of bull market returns turn out to be in vain.

How long will this bear market last? Well, the Great Depression caused a bear market lasting over two decades, from 1929 to 1952. Only in 1958 did that market come back to the old 1929 peak, nearly three decades later. The 1970s were not much better—the bear market lasted 14-16 years from 1966 or 1968 to 1982. Even though that bear market ended more quickly, it still took until 1992 — 24 years later — to return to the markets’ 1968 peak.

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