In my March 2000 newsletter, I mentioned the higher probability of profits available in the currency and eurodollar (T-Bill equivalent) spreads, which did result in between 11.5 to 13.5 percent profits for the month. This month my wave analysis shows the same if not greater possible return in these two trading instruments. Also, after reviewing the wave pattern for the DOW, it appears that a near-term top has been place at 11,418.24 and we are on our way down to retest the lows at 9,731.81 set on 3-8-00, and am projecting a move to 9,400 by mid-June 2000.
Currently, the expectations that the FED will raise interest rates another 25 basis points in the their May FOMC meeting still remains. There is actually about a 40 percent chance that they will increase rates by 50 basis points In addition to rate concers, there are a number of additional fundamental reasons to justify such a decline, which I have outlined below, along with a suggested means of diversification to prevent such a decline from effecting your portfolio and the possible reversal of the created “wealth effect.”
Complacent levels of confidence in the stock market:
1. Mutual funds cash reserves are at all-time lows with less than 2 percent in liquid assets as a percentage of fund assets.
2. Currently, the public’s direct equity exposure is at record levels with over 60 percent of a households discretionary portfolios invested in equities and/or equity mutual funds. The previous peak was set in 1970 at 55 percent and during the 1987 stock market correction, it was only at 33 percent.
With the Fed’s determination to slow this booming economy by raising interest rates, the continued booming stock market just make things more undesirable for stocks. If the Fed’s efforts of continuing to raise interest rates finally take hold, and control the level of growth, a slumping stock market is apt to exert pressures in both of the items listed. First, the mutual funds are so shy of liquidity, they will have to sell stocks to meet a spurt of redemption’s, thus worsening any market decline. Second, because investors are leverage and with high percentages of stock ownership, they are bound to cut back their purchases sharply, not only of stock, but of real items as well. This would in the process furnish a hit to the overall economy.
Increasing level of Margin Debt:
Over the past four years, the buying of stocks has increased at an astounding 200 percent annual rate, which is far and away the fastest ever. The main reason for this incredible increase is simply due to credit which has played a mighty part in this spur in this runaway bull market. Currently, there is over $270 billion or so of market credit, which doesn’t include the venturesome individuals who have taken loans out on other assets — like their houses — to enable them to get their additional piece of the booming stock market.
Internet companies are running out of cash:
There are currently over 100 companies that will run out of cash in less than 24 months and another 50 within 48 months. Many of these companies along with others are trying to raise funds by issuing more stock or bonds, but a lot of them will simply not succeed. As a result, they will be forced to sell out to a stronger rival or simply go out of business altogether. Here is a partial list of some the more popular Internet companies along with the number of months before they run out of cash: CDNow (CDNW) (1 month), Digital Island (ISLD) (3.5 months), Egghead.com (EGGS) (4.5 months), FTD.com (EFTD) (6.5 months), Amazon.com (AMZN) (10 months), eToys (ETYS) (11.3 months), E-Stamp (ESTM) (11.8 months), uBid (UBID) (12.2 months), Juno Online Svs (JWEB) (14 months), Stamps.com (STMP) (30 months), Priceline.com (PCLN) (36.5 months), and E*Trade (EGRP) (53 months).
The Internet companies that will probably survive and acquire additional funding will be the ones that provide a distinctive service and not sell a product which could be purchases by other means besides the Internet.
Nasdaq Composite and it’s cumulative breadth:
Over the past decade the NASDAQ Composite as risen over 850 percent and just 85.5 percent last year alone. This may have been one of the greatest advances, but it has also been one of the narrowest in stock market history. Just a handful of stocks have done fabulously well and are responsible for the spectacular rise in the NASDAQ. What has been less advertised is that a vast majority of the NASDAQ stocks have not merely lagged behind the chosen few leaders, but have actually been going in the opposite direction. Hence, the relative breadth for the past decade has been declining with a stronger decline over the last three years as more and more IPO’s have been brought to the market place.
Does your current stock portfolio have proper diversification for all three(3) types of markets?
With the extended length of the current bull market, most people have become complacent and have not reviewed the three types of markets when purchasing a stock, bonds, or stock mutual fund for their investment portfolio. The three(3) types of markets consists of a bullish, neutral, or a bear market.
The following is an illustration of how these three(3) types of markets would effect a stock portfolio worth $2 million:
A. Bullish stock market: If the stock market continues it’s rally, gains would be realized from stock appreciation. The average dividend is only 1.7 percent, which is less than the current Treasury Bill yield of almost 6 percent, and is only $34,000 for this size of stock portfolio. Hence, gains would be limited to stock price appreciation and taxes would become applicable when the individual stocks or mutual funds are liquidated.
B. Neutral or flat stock market: This type of market refers to a situation where stock price fluctuation is limited and no major gain or decline in stock price is occurring. In this situation, the only return a person would see in their stock portfolio would be from dividend or interest income.
C. Bearish stock market: If the stock market starts a decline or major correction, the value of the portfolio will obviously decline, and if a person were to liquidate the stock portfolio, ordinary and capital gains taxes would become applicable. For example, if the stock market just corrected 10 percent that would represent a $200,000 reduction in stock portfolio value. Even in a bull market, we can see stock market(s) decline 20 percent or $400,000 in portfolio value and still be in a bull market, which represents a large fluctuation in stock portfolio value without including the applicable tax consequences, if liquidated. Depending on the individual stock or mutual fund gains, if a portfolio of this size were liquidated after a 20 percent correction, the after-tax value of this portfolio would be approximately $1.2 million.
Suggested solution to deal with all three(3) types of stock market conditions:
Diversification: With a 10 to 20 percent allocations of a persons current stock/investment portfolio into the derivatives/futures markets with an emphasis in using the DOW, S&P 500, NASDAQ 100, currency spreads, and eurodollar spreads, a person can effectively hedge and/or generate profits in the above three(3) types of market conditions with several advantage(s).
A. Stability: This type of diversity would offer more stability and help prevent large equity fluctuations through stock market corrections. It will also reduce the possible emotional concerns that some stock investors go through when stock market corrections occur. With 80 percent of the account funds placed in Treasury bills, interest income of 6 percent is generated, while still performing it’s function of greater portfolio stability in the derivatives/futures markets.
B. Prevent liquidating stocks through large stock market corrections: This type of investment hedge will help prevent the liquidation of valued stocks or mutual funds through stock market corrections since the derivatives/futures positions would be partially or completely offsetting the equity loss in the stock portfolio. Also, it would prevent being faced with the additional ordinary and capital gains tax obligations, and allow a person to hold the stock positions through these adverse conditions.
C. Complete liquidity: With most mutual funds, there is a 1 to 10 percent penalty for early withdrawal, which will vary depending on the time duration left in the penalty period. In the deriviatives/futures market, the funds remain liquid with no penalties for early withdrawal. This is one of the major reasons why all banks and major institutions trade these markets with funds that customers deposit in money market accounts. For example, a bank can easily move in and out of deriviative/future positions generating additional profits for the bank, which can represent 40 percent of their overall profits, while still having the money market funds available to it’s customers.
D. Reduced tax obligation: Since all banks trade in the derivatives/futures markets, the IRS has developed a form 6781, which allows individuals and/or corporations to file where that all profits are taxed with a flat 40 percent ordinary and 60 capital gain tax. There is no need to keep track and refer to when a position is entered. Along with the simplicity compared with stock filings, this form and type of trading pays about 8 to 9 percent less in taxes than conventional stocks trades, which could vary depending on the persons tax bracket.
As you can see, there are continuing to be a larger number of fundamental reasons for a near-term correction. Also, my wave pattern analysis is also confirming that we should start our next wave down in the DOW and the NASDAQ will likely follow this time for the reasons provided above.
The derivatives/futures market offers a great alternative to diversifying and hedging your current portfolio even if it’s size is not as represented in this example outlined above. Should your have any questions regarding the information discussed within this newsletter or how the derivatives/futrues market could directly help your stock and mutual fund portfolio, please feel free to send me an e-mail at JOHNTMOIR@aol.com and call me at (775)-841-9400.
John T. Moir
Wavetech Enterprises, LLC