Why the Stock Market Will Drop 60% in the Next Decade

In recent years, the great economies of the world have been rocked by crises the likes of which have not occurred for generations. The severity of these events was matched by their unexpectedness.

In recent years, the great economies of the world have been rocked by crises the likes of which have not occurred for generations. The severity of these events was matched by their unexpectedness. World leaders, economists and great banking firms - not to mention millions of ordinary citizens - were taken completely by surprise. Could the stock market crash of 2008 - 2009 have been foreseen ahead of time? And, more importantly, is there a way to accurately predict the major market trends that are likely to occur in the near future? I believe there is.

When we examine the long term pattern of the stock market from 1870 to present notice how it always regresses from upward "bull" and downward "bear" periods back to the historical average or "trend" line. Whenever it reaches great heights it inevitable falls back to the trend line and then further into recession or depression. From there the cycle repeats itself. As you can see on the chart, the last great stock market peak occurred in 2000. That was the final year of the unprecedented bull market that began in 1982.

Since 2000, the stock market has switched from a long term bull to a long term bear. What happened? One explanation is demographics. Middle aged individuals are in their prime earning years and the group most likely to be purchasing stocks for wealth accumulation and eventual retirement. Their buying causes upward pressure on stock prices. Older individuals are more likely to cease buying and switch to selling or holding their stocks as they enter retirement. The population of middle aged baby boomers grew during the 1980's, peaked in 2000 and has been falling ever since. The baby boomers who drove the stock market to new heights during the 1980's and 1990's by massively buying stocks are transforming into stock selling or stock holding investors causing downward pressure on stock prices and the market as a whole.

But there's another more fundamental explanation. By 2000, the stock market was wildly out of equilibrium and what goes up must come down. Despite the oracular pronouncements of Alan Greenspan and others that we were in a "new economy" and "this time it's different" nothing of the sort was true. The stock market had just experienced a classic financial "bubble" that had to pop as all bubbles eventually must. Since 2000, it is almost as if the stock market is being gravitationally pulled back into equilibrium according to historical patterns.

This event is actually very simple to understand. Just as the long term 140 year pattern of the stock market has an average trend line, so does the bear market from 2000 to today. The stock market is currently above both its 140 year long term trend lines for the bear market since 2000. In other words, the market is doubly top heavy and so that much more likely to be pulled back into balance by a sharp correction in the near future. Fed Chair Ben Bernanke can only feed the market so many cans of QE Red Bull before it eventually crashes. What goes up must come down, it always does. Add to that any number of likely events that could exacerbate the correction: An Israeli - Iran - U.S. conflict with $200 oil, the next chapter in the Euro-crisis, etc.

And what of the recent crash? Was it really such an outlying "black swan" event? If you trace the short term trend line along its downward path and compare it to the up and down gyrations of the stock market from 2000 to present you can see that both the timing and the severity of the 2008 - 2009 correction are really not that surprising.

Now for the most important question: What could the future hold? Again, we can turn to the historical charts for some insight. Notice that all three previous bear markets beginning in 1901, 1929 and 1965 followed their trend lines down to the same level at the green line before rebounding. If we extend our current bear market trend, we arrive at a very conservative end point for the current bear in 2022 - 2024 with the S&P at approximately 540, a 62 % drop in value from it is today. And that, for a variety of technical reasons, could actually be a conservative scenario.

What of the near term?

Upon close examination of the charts, one can see that during past bear markets there was always a small dip below the 140 year trend line immediately preceding a sharp decline. After these downward dips there was a brief rise in the market followed by a precipitous drop. I believe this phenomenon was recently repeated by the 2008 - 2009 crash and 2009 - 2012 bull market. If this event replays as it has in bears past, the S&P could experience a near term correction in late 2012 - 2013 to 580, a 59 % decline in its current value. The S&P would then likely rebound to straddle the bear market trend line to its end in 2022 - 2024, as previously discussed.

The charts point to several long and short term scenarios for the stock market that have a very high probability of coming to pass. Statistically, it is extremely unlikely that the mathematical patterns discussed here are simply due to random chance. Maybe all of these predictions are completely wrong and for the first time in history, "This time it is different."

Or, maybe not.

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