Successful Wall Street contrarian bets on another great depression

By Harriet Johnson Brackey
Knight Ridder News Service

Three years ago, when Michael O'Higgins was out of stocks and into zero-coupon Treasury bonds — when he was predicting stocks would lose half their worth — some didn't believe him.

If you listen to O'Higgins now, you won't want to believe him either: He's predicting another depression.

But you might want to pay close attention, because it's possible he's on target. Again.

O'Higgins, for whom the term "contrarian" is much too mild, has a record of being right when most of us are wrong. And of making money while we're losing it.

Since our last conversation in March 2000, zero-coupon Treasuries are up 43.5 percent. The S&P 500 index is down 41 percent. O'Higgins said long-term Treasury bond yields would drop from 6.15 percent to 4.6 percent. They are now paying about 4.7 percent.

O'Higgins manages $200 million at his boutique investment firm in Miami Beach that caters to clients with assets of at least $1 million. He's been a top money manager for more than 20 years and written best-selling investment books "Beating the Dow" and "Beating the Dow with Bonds." He's best known for his "Dogs of the Dow" theory, which worked quite well when the market was going up.

Today, O'Higgins won't touch a Dow stock, or almost any other stock at current prices.

He is looking for a depression to begin soon or be in progress. "Perhaps the greatest deflation and depression of all time," he said, "following the greatest speculative boom in stocks of all time."

It will begin as baby boomers wake up and realize the stock market's downturn in the last three years has wiped out almost half their nest eggs.

"When you say it can't be like 1929 through 1931, when stocks lost 89 percent of their value, you're right. It could be worse," he said.

Boomers and consumers will begin to save more money when they realize the bull market is over. Stock gains in the future will not bail out an investor if he has put too little money away.

Debt levels are higher today — for consumers, government and corporations as a percent of gross domestic product — than at any time since 1929, he noted.

The depression will not end until that debt is liquidated. When consumers decide to save more, they'll stop spending. Then the economy's main support will collapse.

After that, you can wait and watch for the Dow Jones industrial average, currently at 7,859.71, to sink deeply to 6,000. That's O'Higgins' best-case scenario.

It could go as low as 3,100 if the stock market goes back to its normal range through the last century for the dividend yield, the figure you get if you divide a stock's dividend by its price.

Right now, O'Higgins is interested only in gold, which he sees as undervalued and heading up because of deflation — "because it's real money, because it has held its value for thousands of years, because it's not subject to the manipulations of government or central banks or dishonest corporate executives."

A gold stock, Newmont Mining, is the only one he owns, and he's betting against the rest of the market. His strategy is risky, not diversified and, well, daring.

"He's made some great calls over the years," said Joseph McGraw, a hedge-fund manager and president of Yankee Advisors in Waltham, Mass. "Mike likes to be emphatic, but I'm pretty negative, too. I'm concerned about deflation coming out of China. I'm concerned about the U.S. consumer totally retrenching and freezing."

"Fundamentally, I think he's correct," said money manager John N. McVeigh of Upland Capital management in Ridgefield, Conn. "I think we're in a secular bear market; those typically run 10 years or more. That takes us out, from ... 2000, to 2010."

This isn't the mainstream view. Bloomberg News finds the average Wall Street market strategist thinks you should put 68 percent of your portfolio in stocks.

The Wall Street crowd has been largely wrong throughout this bear market that began in March 2000. Meanwhile, the O'Higgins Fund of Funds in 2000 soared 71.32 percent while the Dow dropped more than 6 percent, and rose 4.76 percent in 2001 when the Dow was down more than 7 percent. Last year, as he moved out of bonds and into gold, O'Higgins' fund rose 19 percent when the Dow dropped 17 percent.

Certainly, he has not always been on target. He moved out of stocks too early and missed the 86 percent gain on the Nasdaq in 1999, when his fund rose just 48 percent.

"I'm only dealing with probabilities," he said. "I don't have any illusions that I have a crystal ball.

I just know financial history."