View From His Lair: Dow 3500

In our profile of David Tice (Bear Market Insurance, May 2008), the long-time pessimist predicted that the credit bubble would burst, hobbling the economy and the stock market for years. For now, his forecast has turned out to be uncannily accurate, and his fund, now called Federated Prudent Bear (symbol BEARX), has performed spectacularly. Over the past year through March 6, Prudent Bear returned 36%, while Standard & Poor's 500-stock index has plunged 46%. Tice sold the fund to Federated Investors in December and is now the firm's chief portfolio strategist for bear markets. We checked in with Tice to get his current thinking on the market and the economy.

KIPLINGER'S: Have you been surprised at the way things have played out?

TICE: I'm a little surprised that the European banks got in so deep in Eastern Europe and in emerging markets. So I'm a little bit surprised at how deeply global the problem is.

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Could Eastern Europe melt down the same way Asia did a decade ago?

Yes, it really could. Retail sales and gross domestic product declines have been extremely large. It's just very, very ugly.

What should investors do now?

My advice is still the same: Sell stocks short and hold precious metals.

How far could the stock market fall?

It could fall to book value [assets minus liabilities]. That would be 3500 on the Dow industrials.

The Dow is at about 7000 as we speak, so you're suggesting it could fall another 50%. That's hard to believe.

People think we're near a bottom because President Obama is throwing money at the problems, the market's down 50% from the peak, and we can't stomach much more pain; therefore, stocks have to go up. Well, it doesn't work that way. Markets hit bottom not based on how bad the earlier pain was, but based on where markets should be relative to fundamentals.

And the key fundamentals are?

Earnings for S&P 500 stocks were far down in 2008, and 2009 earnings aren't going to be any better. S&P earnings will probably be below $40 per share this year [versus $65 in 2008 and $83 in 2007]. So the market's price-earnings ratio, based on 2009 estimates, is 20. That's still high, so how can you think the market is near a bottom?

What will it take for the market to bottom?

It depends on whether the stimulus package gets teeth, it depends on the dollar, it depends on what the Chinese decide to do. There are many moving parts here.

What do you mean by the stimulus getting teeth?

A strong stimulus package could mean the economy picks up a little bit in the short term, but I don't think it will work longer term. The Italian finance minister recently said, "When the problem is too much debt, you can't fix the problem by adding more debt." The problem is we have an output gap. We have too much capacity for existing consumer demand, and, therefore, manufacturing, retailing and other sectors will have to downsize.

Is restructuring the financial sector necessary to get our economic house in order?

Yes, it's necessary. We'll probably have to nationalize some banks -- maybe a lot of banks.

Do we really need to take such drastic action?

Politicians like to avoid any pain. But you have to cleanse the system, and that will be painful. Some bank shareholders will be wiped out. The rest of the country won't look kindly at bailing out banks and letting shareholders remain with very much.