Bill Fleckenstein

Contrarian Chronicles5/7/2007 12:01 AM ET

The Dow's dangerous winning streak

The market's recent performance mirrors the strong runs that led up to the crashes of the Nikkei in 1989 and the Dow in 1929. Coincidence? Or warning?

By Bill Fleckenstein

Folks can be forgiven for rolling their eyes at general statements that begin: "The historical data suggest that . . ." But apply this to potential stock-market gains and losses, and people's attention usually perks up.

Recently, I decided to revisit a chart of Japan's Nikkei index from 1989. What prompted me were comments by GMO Chairman Jeremy Grantham that, for America's current stock bubble to burst, it may need to go parabolic, a la Tokyo 1989.

When I read that, I thought: Wait, the Nikkei did not go parabolic at the end in 1989. I was short that market in 1989 and held long-dated put warrants, so I followed it quite closely. In the final five months before its crash, the Nikkei was almost orderly, rallying about 20%. By contrast, the Nasdaq Composite Index ($COMPX) nearly doubled in the last five months before the 2000 crash.

Mr. Dow's hitting streak and history

In any case, after a little checking, I did find an amazing similarity between the last month or so of the rise in Japan that ended on Dec. 29, 1989, and the current advance in the Dow Jones Industrial Average ($INDU) (through April 27): Specifically, the last 32 out of 38 trading days in Tokyo were on the upside, with an initial run with a higher close on 19 out of 21 days, followed by seven out of 11, followed by six for six before about a 40% drop in the course of nine months took place. Recently, from the lows of March 5, the Dow closed higher in four out of six sessions, followed by seven out of 11, followed by 20 out of 22 -- for a grand total of 31 out of 39 days.

Now, I am not a big believer in analogs, but if the mind-set in Tokyo back in those days was similar to the mind-set that we're witnessing here today, which, by my reckoning, it is, I guess it's not impossible for that similarity to have some predictive power.

(Another interesting parallel to note, by way of Justin Goepfert at the ever-valuable The last time the Dow had a run of 19 out of 21 days was in July 1929 -- not exactly a great time to buy stocks.)

I'm not putting up any money on the back of this idea just yet. But I thought it was so interesting, I wanted to have it on my radar screen, and I assumed others would, as well.

Getting liquid to fight leverage

Meanwhile, despite what history tells us about the ultimate outcome of market euphoria, the bulls are having no part of it, as they enjoy the current incredible rip to the upside. Against that backdrop, I cannot shake this nagging feeling that the most important idea for folks to consider before the coming dislocation hits, whenever it hits, is that it will be necessary to have some liquidity, even if that liquidity is held in a crummy currency like the dollar. I am more convinced than ever that the amount of leverage being held at the institutional, hedge-fund, individual and corporate levels is, while not directly ascertainable, extremely high. In fact, I think the overall financial risks are far higher than I ever imagined they could be.

Consequently, I no longer believe it's possible to determine in advance just what asset classes might be safe in a financial dislocation, as so many of them have become so intertwined, while at the same time we can't know how leveraged any of the underlying positions may be. Thus, when liquidation occurs one of these days, absurd developments may unfold that you might like to take advantage of. But one must have some flexibility -- liquidity -- to do that.

So, as I did by recently in selling my Newmont Mining (NEM, news, msgs) position, I intend to find ways to increase my own liquidity (even though I intend to increase my short positions one of these days), while still trying to protect myself against the fact that the dollar is sure to decline in value. I encourage others to give this subject some careful consideration.

At the time of publication, Bill Fleckenstein did not own or control shares of companies mentioned in this column.

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