Will 2005 be a year of losses for all asset classes?

So we have back to back years during which 'everything' went up - that is with the exception of the US dollar, which continued in 2004 the decline it began in 2001.

In particular, the S&P 500 finished the year on a high note with bullish sentiment at an extremely high level. Peter Eliades at Stock Market Cycles (www.Stockmarketcycles.com) points out that, 'It appears that 2004 will mark only the second time in the sentiment history of Investors Intelligence going back to the early 1960s when two consecutive calendar years have passed without a single weekly sentiment reading showing a plurality of bears over bulls.

It is a simplistic method of measuring the lopsided bullishness permeating the investment atmosphere and it is almost impossible to believe it will lead to anything but a punishing bear market. The first leg of that bear market was seen after the phenomenon was witnessed the first time in 1999-2000.

The fact that we have once again gone two consecutive years without the kind of market decline that would cause one weekly reading of more bears than bulls bespeaks of a sentiment phenomenon that has never before been witnessed, namely four years out of a six year period without one weekly plurality of bears over bulls. I may point out that such high bullish readings as we just had in late 2004 usually lead to market corrections of at least 10%.

In addition, everybody bought into the late 2004 stock market rally because of a myth that is flying around the investment community, which says that years ending in 5 (such as 1985, 1995, 2005) are 80% of the time 'up years'. However, the period under observation is too short to be statistically relevant and the fact that years ending in five have produced positive returns could be entirely accidental.

More important, in my opinion, is the fact that in 2004, and in particular toward the end of the year 'Insiders' (corporate executives, directors, etc) stepped up their stock sales. In 2004, insider selling rose by 20% to US$ 51.3 billion whereas insider buying rose by 13% to just US$ 2.11 billion! (Insider selling was at its highest since 2000, when insiders sold US$ 80 billion worth of shares.)

There is another reason for caution about equities. Since 1982, and until 2000, we have been in a roaring bull market for stocks in the stock markets of western industrialized countries. During this time we had very few down years (even the 1987 crash year) was an up year and so the average investor simply believes that the 2000 to 2002 bear market was nothing else than a bad dream in an otherwise ongoing eternal equity bull market.

However, Jim Stack, proprietor of the InvesTech newsletter, who has an excellent stock market track record, points out that a typical bull market tends to last 2.6 years and is then followed by a more serious correction.

The 1982-1987, 1990-2000, and the 1949-1956 bull markets were unusual. In the case of the 1949-1956 and 1982-1987 bull market the starting point was from an extremely depressed level. (In 1949 stocks were still down about 50% from their 1929 highs and stocks had a higher dividend yield than bond yields, and in 1982, stocks were no higher than in 1964 and down 70% inflation adjusted.

In the 1990s, stocks had the benefit of a Fed chairman who increased the money supply considerably and allowed history's greatest credit expansion to occur. (In the 1990s, we also had the benefit of declining commodity prices and interest rates.)

So, I must admit that I do not share the widespread optimism about US equities - nor for that matter about emerging markets. The years 2002 to the very present witnessed an increasing appetite for risk and excessive speculation across all kinds of relatively illiquid asset classes including lower quality bonds, and emerging market equities. For example, look at the Ukraine Stock Exchange Index, which rose four-fold in 2004.

Now, I have no doubt that much has improved in Ukraine over the last few years and that like Bulgaria, Romania, the Czech Republic, Poland, etc the inclusion into the EU or closer ties to the EU will have lasting benefits for most Eastern European countries. Still, the Ukraine stock market may have risen ahead of itself, the same way numerous industrial commodity prices seem to have overshot on the up-side.

In fact, what I find interesting is that in the first two trading days of 2005, numerous asset classes - in particular stocks, commodities and foreign currencies - have given back most of the gains they achieved in the month of December 2004. Aluminum declined by almost 7% on January 4, and is no higher than in October!

Or take copper, which displayed unusual strength until just recently. On January 4, 2005, it also declined by almost 9% to below the October high (it is also lower than at it March 2004 peak), while Nickel collapsed by 7%. US equities also had a very bad start in the new year and since they closed the first five days of 2005 with a net loss, it is a bad omen for the rest of the year.

My point is this: In 2003 and 2004, all asset classes rose in value while the US dollar sold off. Would it be possible that in 2005, all asset classes perform poorly while the US dollar strengthens?

Only time will tell but for now, I would stay aside from equities, commodities (including gold and silver), and bonds and only hold the US dollar, which may have more of a rebound potential than is generally expected. As a trade, I would consider shorting the South African Rand or British Pound against the US dollar since the British price level is now so much higher than the one in the US.