Special Forecast Update Harr S Dent Publishing Wednesday, October 8, 2008

I hope he is RIGHT!!!

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The markets have continued to fall with no clear resolution to the banking crisis, despite
massive efforts from the government to stimulate the economy and to bring liquidity to the
banking system. Yesterday’s sell-off brought the second 90% downside day in a row, which
alone was likely to see a short term rebound just ahead and this morning the Fed finally
capitulated and lowered rates ½% along with other central banks around the world. Stock
futures rallied strongly at first this morning, but then fell rapidly. Hence, it is not clear what
direction the markets will take today, although the bias should be up after an initial sell-off.
Hence, we could see a bottom today. Our short term oscillators finally got slightly more
oversold than in the July correction yesterday raising the chances that we could see a
credible bottom as early as today. Even if we do ultimately rally more strongly later today,
we may still retest these lows in the next week before a more sustained rally.

This is clearly looking like the depression that we have been forecasting for 20 years – but
obviously coming much quicker and deeper at first than we anticipated from our indicators,
both long term and short term. But there is much more to come by all of our most reliable
longer term fundamental and cyclical indicators! Our cycles would strongly suggest the
worst is to come between late 2009 and late 2010.

The markets were not overvalued coming into the peak in October of 2007, but instead were
undervalued by 30% to 50% vs. earnings and Treasury bond yields from 2001 to 2007.
Every time we have had a short term correction like March or July 2008, the best technical
indicators have said that the markets were more oversold than in late 2002 and due for a
major rebound for months to come. Our long term indicators for demographic and
technology trends are just peaking between late 2008 (technology) and late 2009
(demographic), hence they showed no reason for concern. None of our most reliable cycles
were down in 2008. In fact, the only reason we are not in a very deep recession or depression
at this point is that baby boomers are still spending beyond housing and credit-related
sectors now like autos. Just go to a local mall to verify.

This is the ultimate curve ball that no cyclical or technical indicators warned about –
for us and other credible forecasters. This happens only once every decade or two like
the 1987 crash – and even then there were clear overvaluation indicators, unlike now.
The key is to stand back and react to the most likely scenarios to follow rather than
merely panic. There are always rebounds to major crashes. That is the better time to
get out, rather than selling near panic lows. However, we have given sell signals
recently to protect against this extreme sell-off with the caveat to buy back in near
term when the markets get more clearly oversold and very likely rebound strongly.
That is likely to occur in the next week and possibly occurred yesterday or could
today.

The Economic Guide for Effective Financial Decision Making

Now the public has become extremely bearish in a recent CNN poll that says that 60% of
people think we may be entering a depression like the 1930s. Most people are rarely right
about such things! We got similar indicators in recent months wherein most investors
expected the markets to be down in the next year. The truth is that we are likely entering

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into a more serious recession like 1970 before the greater recession in 1973 – 1975, and the
more minor 1980 recession before the more serious one from 1981 into 1982. This is
precisely because in recent decades the government reacts more strongly to counteract
downturns and crises at first, but only staving off the ultimate downside for a year or so. If
we do see at least a modest recovery into 2009 given the extreme stimulus in 2008 into early
to mid-2009, then most will finally think we have come out of this crisis in mid- to late 2009,
just when the worst is to come into 2010 and likely as late as 2012. So, most people will
think the depression is coming near term, but it will more likely come in the extremes into
2010 – 2012, especially 2010 to early 2011. In fact, instead of a depression in 2009, we will
more likely see a deeper recession that sharply rebounds into an inflationary/commodity
crisis from mid-2009 into as late as mid-2010.

Our most critical cycles that have not pointed down in 2008, clearly suggest that the
worst is to come from mid- to late 2009 into late 2010, likely with major aftershocks
into mid to late 2012. That is the bigger picture beyond the overreaction now to the
banking crisis that no one fully understands. There will be a rebound from this crash,
likely near term well into 2009. Now that this crash has well overreached our
expectations, it is better to look now to play the rebound ahead before making major
changes to your portfolios long term. If you have sold according to our recent
recommendations, look to get back in near term, especially if we retest yesterday’s
lows. If you haven’t sold, look to hold more into March to September of 2009 before
selling long term.

Our Weekly Leading Index now clearly suggests that the economy will continue to weaken
off-and-on into at least May of 2009 and that this recession will be greater than the ones in
1990/1991 and 2001. But remember that the stock markets, like the leading indicators,
look six to nine months forward. They have already discounted a greater recession than in
1990/1991 and 2001. The markets merely need to see that there is some prospect of
recovery by the second half of 2009 to rally near term and some clarity about how bad the
present banking crisis will be. The massive government stimulus would clearly suggest at
least a modest recovery ultimately, but the markets don’t seem to believe that quite yet.
Paradoxically, the best time for the stock markets to rally in this scenario is between when
a recovery is anticipated and when it actually starts to occur – as rising inflation, interest
rates and oil/commodity prices will start to work slowly or quickly against rising stock gains
in the recovery likely into late 2009 or early to mid-2010.

Now that we have violated some very key support levels from 9,700 on the Dow to 16.77 on
the XLF (financials), there is no clear support for the markets, beyond that at 1,750 on the
Nasdaq near term, and we were very close to that at the close yesterday on 10/07 at 1,754.
We are hoping that we hold near that level on any retest of today’s lows in the coming week.
But these violations of strong support clearly make the present scenario much less
predictable and more uncertain as we warned! The next support levels only come at the
2001 lows around 8,000 on the Dow, and ultimately at the 7,200 – 7,400 lows between
October 2002 and March 2003. Will the Dow fall that low? It is clearly possible at this point
if the global banking system continues to melt down. But is it still not very likely given the
extreme panic and near 60 readings on the VIX (volatility index) recently. The markets have
also refused to bottom at most clear support levels in recent down cycles.

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We have given stronger sell signals in the last week. We have advised for months now that
even longer term investors become more flexible, and think more like short term investors
in such a volatile market. One of the greatest reasons not to sell in shorter term downturns
is the impact of taxes on gains. But we are looking at making long term allocations out of
stocks and remaining real estate by sometime in 2009 at the latest. So, the taxes will come
anyway – except for investors that paid the “dreaded” premium for variable annuities that
now will pay big dividends in tax savings as we have advised for years. Hence, hedging more
and making changes more often makes more sense if we can do it at times that our technical
indicators suggest it will be more profitable. But even those indicators are not as reliable as
in many past cycles, now that bad news about events that no one really fully understands
is driving the markets more short term.

Regardless of how low this correction goes near term, there is likely to be a very substantial
“B” wave rally ultimately, or at worst a “4” wave rally. It is best to have sold or lightened your
exposure on recent sell signals and then be patient for a clearer buy opportunity ahead –
either after a clear bottom near term, or after a stronger rally that is more confirmed and
then a pullback after that. Even if we go as low as 7,200-7,400 on the Dow at the very worst,
a normal “B” wave rally could take us back to 11,000 to 12,000. If we bottom closer to 9,400
near term such a rally could take us back to 12,000 to 13,200. Our greater long term targets
for the Dow between late 2010 and mid 2012 are between 7,200 minimum and 3,800
maximum on the downside. So, there is plenty more to come after whatever rally is ahead
from this extreme oversold correction.

A likely scenario near term is that we continue to see the markets bounce from the near
1,750 levels on the Nasdaq and near 9,400 levels on the Dow for a few days and then a final
sell-off and low next week or shortly thereafter. Hopefully such a retest or new low comes
just slightly lower than the lows yesterday and today. We will simply have to judge such
rallies or declines and continue to advise you. We wish we could be clearer in our
predictions, but this correction is the ultimate curve ball, even greater than 1987. Even that
correction could have been anticipated to some degree due to strong overvaluation – just not
the speed or extent. This one had no conventional signs from any level of our indicators –
from overvaluation to fundamental to cyclical to technical. So, it’s best now to stand back
and look at the most likely scenarios, rather than panic too much on the sell or buy side.