WAVETECH ENTERPRISES, LLC
Private Account Management Services
Newsletter Issued 04-09-02:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw
Position overview . . .
We projected, in the March 14th newsletter, that the DOW would be range-bound between 10,650 and 10,300. This proved to be accurate with the monthly intraday high for the DOW being 10,673 and the intraday low being 10,276. This accuracy generated a profitable performance for our clients in the various stock indices, the majority DOW positions.
It was stated that the US treasury market had bottomed on March 12th and that the Feds would not raise interest rates in the future in spite of the expectations of those holding treasuries. US treasuries actually bottomed two days later on March 14th and have moved higher. The Feds did change their bias from easing interest rates to neutral at the March 19th FOMC meeting, and no adjustment in interest rates was recommended. We were off the bottom by two days, but a small profit was generated during the course of the month by both long and short positions in the various treasuries.
Our stock market projections for the period were very accurate and generated profits in all three months. The US treasury projections were most accurate in January 2002 when a majority of the first quarter 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, generated a net rate of return (including fees) on investment for the standard model between +23.4% to +30.9%. The conservative model generated a net rate of return for the first quarter (including fees) of between +8.1% to +10.3%.
Our higher performance, as compared to a majority of mutual funds, hedge funds, and annuities, is due to our technical wave pattern analysis expertise and the lower fee structure. The fee structure is lower primary because we do not charge a commission or profit on the spread for executing trades on our clients behalf. Mutual funds, hedge funds, and annuities, as a rule, generate a majority of their revenues from commissions for executing trades while profiting from the price difference between the bid and offer prices for stock and/or bond transactions. This price difference is commonly referred to as the spread. For example, a stock may have a bid price (current selling price) of $10.00 and an offer price (current buying price) of $10.25 with a 25 cent spread per share. A fund manager, as a buyer of the stock, is required to place the stock in the fund at or below the offered price of $10.25. However, even if the stock is, say, purchased at $10.15, it will be placed into the fund at $10.25. The fund firm managing the fund generates a 10 cent profit per share, which does not have to be reported or documented to the fund holders.
These commissions and spread profits permit no-load mutual funds and non-incentive based hedge funds to attract investors who may think that their fee structure is lower. All mutual funds, hedge funds, and annuities have annualized break-evens between 8% to 25% depending upon the size, structure, and specific type of fund or annuity. This high break-even usually is not readily noticed during a trending bull market, but becomes much more noticeable during consolidating periods or during an actual bear market like the past two years. Diversification during this changing climate is essential and is prudent for investors looking for an overall long-term positive rate of return, which we can provide through our private account management services.
Looking forward . . .
Oil prices have probably topped out for now, and higher prices are certain to dampen consumer spending and restrain the recovery of profit margins. Slower recovery in earnings are apt to translate into restrained increases in employment. March’s lackluster data, reported last Friday, with nonfarm payrolls expanding 58,000 following a 2,000 decline in February, originally estimated as a 66,000 increase, i.e., a statistical break-even. Meanwhile, the jobless rate ticked up to 5.7% from 5.5% last month.
There are several Fed Governors who are inclined not to raise rates while the unemployment rate remains above 5%, which appears likely in the near future. Therefore, we would suggest the continued holding of the US treasury and STRIP positions suggested in our previous newsletter. We may recommend an increase in their allocations in the next month of two, once we have received confirmation of a bottom in prices and a top in yield for the entire treasury yield curve. With M2, which is a broad measure of money supply growth adjusted for inflation, only growing at a 2% rate during the latest three months, we do not see inflation as a major concern, even with spikes in oil and gold prices. However, stagflation could pose a major concern in the future, which would represent higher operating and living cost (food and energy related products) during a continued slow economy. Inotherwords, the “Seventies”, where everybody paid more but received less.
We expect the DOW to be range-bound between 10,550 and 10,000. However, an acceleration in the intensity of the Middle Eastern situation could create havoc for the stock market. We continue to recommend a stock market allocation of 0% due to it’s limited potential price appreciation and a low or no level of dividends.
CREDIT CYCLE ROTATION IS CURRENTLY OCCURRING:
The tap is being closed on some issuers in the commercial-paper (CP) market, while the corporate-bond market continues to provide large sums for many of the same companies. This is a manifestation of the turn in the credit cycle.
Credit that once was provided at negligible cost through the money market now gushes through the bond market, albeit at a higher price, for reasonably creditworthy companies. The ability to replace short-term borrowings with permanent financing is cushioning the impact of tighter conditions in the CP market.
The credit-tightening cycle — which began at the end of 2000 as the economy began to slump and deepened after the Enron meltdown — has led to a “significant and rapid balance-sheet restructuring process.”
Companies cannot simply rely upon refinancing opportunities to repay maturing CP and debt. They must now look to other sources of cash, including cash flow from operations, asset sales and equity issuance. That has meant concentrating on maximizing free cash flow, which in turn has forced many companies to scale back drastically on capital spending and other expenses.
The equally important concerns about short-term funding, followed by public criticism of GE’s heavy short-term borrowing, have put pressure on US corporations to curb their reliance on the CP market.
The fact that this trend has hit a highest-quality American company — for example GE — signals to us that the credit cycle likely has hit rock bottom and is poised to improve. The Enron crisis has filtered its way from the most severe and easiest to predict stages to one that has investors focusing on the reliance of US firms on short-term funding.
The biggest weekly drop in financial commercial paper since November 2000 has been reflected in the market — to $1.16 trillion from $1.2 trillion. If financial companies follow the pattern seen last year for non-financial companies — replacing CP with permanent financing — the corporate-bond market could be pressured, leading to a widening of spreads (the risk premium corporate bonds pay over “riskless” Treasuries).
The total credit market debt is continuing to accelerate, even with this credit cycle rotation, and now represents nearly 300% of the US Gross Domestic Product (GDP). Our level of credit debt, from 1950, has equaled 100% of GDP, but has been gradually rising. Today’s level of 300% of GDP has surpassed the previous high of 260% of GDP that occurred back in 1929 just prior to a major stock market correction, commonly referred to as the stock market crash of 1929.
The next bubble to burst could be the credit markets, quickly followed by a decline in real estate values. This pattern occurred in Japan two years after their Nikkei 225 Stock Market topped out in late 1989 at 38,915. Japan’s stock market today is worth 30% of it’s previous high at 11,335, a prime interest rate of 1.375% (down from over 6.00%) and real estate values down 20% to 50% from their peaks.
Hence, business cycles continue to occur in spite of attempts to prevent them. Attempted manual manipulation by government officials in any country simply cause these cycles to be exaggerated and, in most cases, magnify market corrections. Attempts to prevent these adjustments in market conditions obviously are made with the best interest in the countries’ long-term economic picture in mind. However, there are cases when business cycles should be allowed to run their course with fewer intervals of intervention.
If the Fed leaves interest rates at their present level near-term of 1.75%, the US treasury market will remain a favorable investment tool since the one-year treasury bills are factoring in a Fed funds rate of 4.10%. We feel this level of interest, a year from now, is unrealistic given the current state of our economy and global concerns. Furthermore, with limited opportunities within the various stock indices for price appreciation, we are suggesting the following investment allocations:
1) A 25%-30% allocation into 2 to 10 year maturity of US Government bonds;
2) A 5%-10% allocations into 20 to 30 year zero coupon bonds commonly referred to as STRIPS. This type of bond will provide a greater rate of return, as compared to the conventional bonds, due to the leverage associated with this instrument:
3) 0% in individual growth stocks due to the limited upside potential, low level of dividend yield and higher level of risk;
4) 35%-40% 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. (Note: the suggested cash percentage will decline once a bottom is confirmed within the treasury markets where the difference will be applied toward increasing both the conventional US bond and zero coupon bond positions);
5) 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