Private Account Management Services
Newsletter Issued 10-11-02:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw

Position overview . . .

We projected, in the September 11th newsletter, that the DOW would be range-bound between 8,740 and 7,870. This proved to be partially accurate with the monthly intraday high for the DOW being 8,727 and the intraday low being 7,461. Obviously, our expected range low of the DOW 7,870 did not hold, however, it did proceed to our next support level of 7,470. This projection proved to be the most profitable of our analysis of the various markets due to our accurate wave pattern evaluation.

It was stated that we repositioned back into the various US treasury positions and were expecting them to be supported due to the domestic economic uncertainties and continued threats of terrorism. This adjustment proved to be timely as they continued their advance during the course of the month.

Our stock market projections for the third quarter were very accurate and generated profits in all three months. The US treasury projections were most accurate in July & August 2002 where a majority of the third quarters returns were generated. Clients with diversification in the various types of instruments (stock indices, treasuries, and currencies) as offered in our standard trading model outperformed the conservative model of treasuries only. Our private account management services for the third quarter generated a net rate of return (including fees) on investment for the standard model between +31.7% to +64.5%. The conservative model generated a net rate of return for the same period (including fees) of between +18.7% to +38.3%. This brings the cumulative year-to-date (YTD) net performance for the standard model to between +74.1% to +131.4% and the conservative model to between +40.9% to +80.8%.

Looking forward . . .

We are of the school which believes that a series of frequent, strident denials of an event in the economic realm are good evidence that the event will occur. A good example is the devaluation of a nation’s currency. If you hear the Secretary of the Treasury of a country, out of a clear blue sky, announce that its currency will never be devalued, this should raise a suspicion. If this announcement is then repeated several times within a few days in more extreme terms, you can figure that a devaluation is very likely. The reason that one keeps reading that we are not in a housing bubble is that we are in one — and they have to deny that it exists in order to keep it going. A key catalyst to prick the housing bubble could be US treasury bond yields which are positioned to increase over the next year, as discussed further as the main topic of this month’s newsletter. Also, available upon request, are copies of our May 2002 newsletter, which outlines, in great detail, the reasons for the upcoming housing bubble.

We are anticipating, during the month of October 2002, a large trading range between 8,650 and 7,130 for the DOW. This range projects another bear market rally within the DOW and the other major indices. The bearish trend remains in place, but since the DOW met our next levels of support at 7,470 and almost 7,130 yesterday, we feel there could be a countertrend rally. Thus, we are led to suggest to our clients to liquidate all of their US treasury positions within their non-managed retirement fund portfolios, for the reason mentioned below, and allocate between 5% to 10% into low P/E stocks (under 8) or large-cap equity index mutual funds. Those investors uncomfortable with a 5% to 10% allocations into stocks, due to the various domestic and global concerns should simply increase their cash position and look for a more desirable level to repurchase the various US treasury positions over the next year.


The attraction for US treasuries has not been what they are, but what they are not, most particularly equities. On a recent day-to-day basis, US treasuries trade as if they are S&P put options, rallying as stocks tank and selling off when stocks post one of their occasional rebounds. US treasuries also have been attractive for their lack of corporate connections — specifically to bankrupts such as Enron, WorldCom, Global Crossing and other nearly bankrupt telecommunication companies, and/or their lenders. Even corporate credits that preciously were held in reasonably high esteem — i.e., minimal investment grade, triple-B or better by Standard & Poors — become suspect since so many descended into the Hades of the junk market.

Yet, while the risk of not getting paid back in the junk market has been well advertised, the risk of when you will be repaid also has surged. That risk moved into the spotlight when Fannie Mae, the big mortgage agency, announced that its “duration mismatch” had grown to a negative 12 months. Fannie Mae, as well as other financial institutions, tries to match its assets and liabilities. Savings and loans, in the old days, used to take short-term deposits and make long-term home loans. The cost of their liabilities soared, with inflation and deregulation in the late ‘Seventies and early ‘Eighties, while their assets were stuck. Now, Fannie Mae finds herself in the opposite conundrum: Her assets are being paid off faster than expected by homeowners merrily refinancing and locking in cheap mortgages of a little over 6%. The liabilities are maturing more slowly, so Fannie Mae’s profit margin is getting squeezed.

What does that have to do with US treasuries? Well, the way mortgage investors quickly and cheaply extended their assets’ lives is to buy US government notes. These are the only securities that are completely protected from early redemption’s and have the highest credit quality, even higher than the mortgage pass-throughs issued by Fannie Mae and Freddie Mac. It is estimated that Fannie Mae may need to buy $100 billion of 10-year securities to fix this problem.

We feel most of that buying has already taken place and has caused the ski-slope drop in yields, from 4.13% at the end of August 2002 to 3.64% yesterday. The risk is that all this frantic buying related to mortgage prepayment could be creating a bubble in the US treasury bond market. Corporate bond yields, by contrast, have fallen far less, in part because of credit worries, and from being left out of the duration-extension party.

US treasury yields are out of alignment as measured by just about any criteria you could mention. The 10-year mote provides less than a 2% real return over the 1.8% year-on-year increase in the consumer-price index. The price of gold, oil and other commodities also have been rising. The nation’s external account are deeply in deficit, equal to 5% of GDP, necessitating that the US has to import over $1 billion a day in foreign capital to cover the shortfall.

The surpluses, for the other twin deficit on the budget side, have disappeared. It is estimated the US treasury will be borrowing $150 billion in the next six months, a pace consistent with $200 billion annual shortfalls. We would not be surprised if the US treasury resumes auctioning 30-year bonds. Unfortunately, the main reason to believe that the bond will not come back is the Treasury’s own history of improperly executing its borrowing: It locked in the record high rates of the 1980s, and is not locking in today’s low rates.

The sharp drop in long US treasury yields ironically has made this previous safe haven riskier. The same sort of scenario played out after 1993, when rates fell to previously unheard-of lows, setting off a spree of mortgage prepayments and buying of US treasury notes. When that was unwound in 1994, it made for the worst year in bonds since the ‘Twenties.

The Chairman of the Federal Reserve, Alan Greenspan, claimed he could not see the stock-market bubble building in the late ‘Nineties. Let us hope he is not fooled by the US Treasury bond bubble poised to burst.


Our allocations have changed with the liquidation of the US treasury positions due to their overpriced levels and for the reason discussed above.

We continue to hold the inflation-protection index bond (TIPS), which will be able to generate profits has the bond market declines. Fund managers will change their allocations, out of bonds and into stocks as the stock market performs this bear market rally. Therefore, we are suggesting the following investment allocations:

1) A 0% allocation into 2 to 5 year maturity of US Government bonds;
2) A 0% allocations into 20 to 30 year zero coupon bonds commonly referred to as STRIPS;
3) A 40% allocation into inflation-protection index bonds (TIPS). If the US treasury prices decline, this instrument will effectively generate profits as investors reposition out of bonds and back into stocks. This is far more a conservative investment vehicle than stocks or equity mutual funds and provides an effective 3.5% yield and possible price appreciation as the bond market declines.;
4) 5% to 10% in individual growth stocks or large cap mutual funds during this bear market rally. There is limited upside potential and a majority of stocks provide a low dividend yield with many providing none at all;
5) 30%-35% in cash, Treasury bills, CDs or money market funds with short maturities which will allow investors to rollover these instruments and obtain a higher level of return as interest rates move higher.;
6) 15%-20% in the futures/derivatives markets (Note: This will help provide investors a means to hedge as well a further diversify their investment portfolio during either a bull or bear market as offered in our private account management services).

If there are any questions regarding the information discussed within this newsletter or our private account management services, please call the number provided below or e-mail us and we would be willing to provide further clarification.


John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
E-mail: JOHNTMOIR@aol.com

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