Private Account Management Services
Newsletter Issued 08-07-02:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw

Position overview . . .

Our July 11th newsletter forecasted that the crisis level of consumer confidence would continue and the DOW would remain under pressure with a trading range between 9,400 and 8,080. This proved to be fairly accurate with the monthly intraday high being 9,410 and the intraday low being 7,532. The DOW did proceed below our expected support level of 8,080. However, our next level of support was at 7,550 which proved to be accurate.

We further expected the US dollar to remain under pressure until the reduction of the US current-account deficit of 5% to a manageable level. During the month of July, the US dollar continued lower by 2%. When the stock market hit our DOW 8,080 objective, we booked our European and Asian currency positions since we were expecting a US dollar bear market rally in the short-term. This proved to be accurate with the US dollar rallying over 4.5% from it’s low of 1.014 versus the euro and 115.16 versus the yen.

Looking forward . . .

The widely cited market valuation method, i.e., the Fed Model, has leapt from obscurity to ubiquity in the past five years. This model currently is being hoisted like a battle flag by Wall Street strategist because it indicates that the stock market is more than 25% undervalued, thus theoretically providing analytical support for a bullish stance on stocks. However, this model, in the past, has achieved extremes before an actual bottom or top has been fully established. For example, when the major stock indices topped out in March and April 2000, the Fed Model read nearly 80% overvalued. Thus, we could have rallies within a bear market trend and not actually bottom out until the Fed Model shows an undervaluation of some 80%. This situation could take 8 to 10 years to materialize.

The current minor bear market rally has led us to suggest to our clients to reduce or liquidate all of their US treasury positions within their non-managed fund portfolios and allocate between 5% to 10% into low P/E stocks (under 8) or large-cap equity mutual funds. We feel the rally in stocks will be limited, but the US treasury market has already factored in a 25 basis point (1/4th of one percent) cut in the Fed Funds rate of 1.75%. Thus, it was prudent to book this profitable position due to the limited upside potential. A change in the market climate may change in the not-to-distant-future could lead us to recommend, once again, that we eliminate our stock positions and reposition back into the US treasuries.

We are anticipating, during the month of August 2002, a large trading range between 9,250 and 8,080 for the DOW. This current bear rally has limited upside and is purely fund reallocations and short covering by traders. The bearish trend remains in place, but since the DOW reached our objective of 8,080, we feel there could be a small countertrend rally. The time duration for this rally could be short. Thus, those investors uncomfortable with a 5% to 10% allocations into stocks should simply increase their cash position and look for a more desirable level to repurchase the various US treasury positions.


Global funds are facing a critical dilemma in the wake of the recent turmoil in the stock markets. Many may be reallocating more funds into stocks as a mechanical response to the decline in the value of their equity holdings, while others are waiting on the sidelines or mulling cutting their stock weightings over the long term.

Many funds’ equity allocations have probably dropped as investors have taken their lumps. Fund managers are likely to pare back their recommended proportions in stocks for those investors who are close to retirement.

There is still a very strong possibility we are headed for a double dip recession with the next Fed move remaining toward the easing mode.

Sluggish gross domestic product, a manufacturing sector that barely expanded last month and a jobless rate stubbornly remaining at 5.9% all spell tepid US growth. The economic rebound in Europe and Japan also appears to be faltering. All of which looks friendly to government bonds and hostile to equities.

Many pension plans appear to be delaying their rebalancing (of stocks versus bonds) in light of the current environment.

Insurers and pension funds, in continental Europe, allocate some 30% to equities. This is dwarfed by their UK counterparts allocation of 60%-65%, and around 60% in the US (see June 2002 Newsletters for further details on US pension holdings).

Many fund managers feel equities currently appear cheap. However, we remain cautious since the economic rebound could run out of steam, causing stock prices to become even cheaper. That risk for the stock component of pension funds is the top issue facing chief financial officers of many big companies in the UK and the US. Market capitalization of many companies is falling. However, pension funds as a proportion of the market cap are rising resulting in dwindling pension fund solvency.


Trading volumes on Wall Street are large. We are interpreting this to mean that some funds are thinking that a climatic bottom occurred on July 24th and are loading up their books in anticipation of a move higher. The proof of this in the number of articles we have read recently in which interviewed managers are highly skeptical about the recent fall. One can search for these sorts of articles in vain at a major trading bottom.

There is a deeper and more disturbing question — If foreign holders of American equities are among the sellers (not an unreasonable assumption) to what other markets will their selling instincts spread? Shall we see dollars stampede into Europe, causing a long-term run-up in the euro? Given America’s huge and growing current-account gap of 5% (see May 2002 Newsletter for further details), what will it take to tempt these traders and investors back to these shores?

There will be many incidences, as this long-term bear market further unfolds, where fund managers think they have found a climatic bottom, but will be disappointed as the rally loses it’s footing and resumes the 8 to 10 year bearish trend.


Our allocations have changed with the liquidation of the US treasury positions due to their overpriced levels and a fed fund rate cut of 25 basis points to 1.50% from 1.75% at the next FOMC meeting on August 13th has already being factored in.

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, though for a short period of time, out of bonds and into stocks as the stock market performs this bear market rally. But, be advised, that we may change our allocations back into bonds in a number of weeks or a month if the bear market rally in stocks runs it’s course quicker than expected. However, for now, we are suggesting the following investment allocations:

1) A 5%-10% 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. We wish to caution investors that this is considered a speculative investment and investors may prefer to remain at 0% since the time duration of this rally could be short. 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

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