WAVETECH ENTERPRISES, LLC
Private Account Wealth Management Services
Newsletter Issued 12-08-05:
By: John T. Moir
Chief Editor: Sara E. Collier
Position overview . . .
Our recent newsletter, dated November 8th, forecasted volatility to remain high with an anticipated trading range for the DOW between 10,000 and 10,600. The actual result was a higher range, with increased levels of volatility, between 10,388 and 10,959. The extended move above DOW 10,600 occurred with thin pre-Thanksgiving Holiday volume, allowing for an advance primarily propelled by short-covering — investors who sold-short stocks that they did not own and were forced to buy them to essentially offset their initial short position. There remains significant resistance for the DOW at 11,000, which was last tested in March 2005, prior to a subsequent decline. Following the Thanksgiving holiday weekend, the DOW, along with the other major stock indices began their decline to lower levels, with new support now existing at DOW 10,600.
The US dollar was expected to continue its ascent, with a trading range between euro fx equivalent of $1.16 and $1.21, based on our wave pattern technical analysis. This forecast proved to be very accurate, with an actual trading range for the month between euro fx equivalent of $1.1665 and $1.2114. The rising twin deficits (US trade imbalance and current-account deficit) remain a prevailing deterrent for a continued US dollar advance, however, we felt that the US dollar had one more advance prior to resuming its primary bearish decline, which was the case.
The US treasuries were anticipated to rise in price and decline in yield during the month, with the 10-year Treasury Note peaking with a yield of 4.65%. This assessment proved to be accurate, with the yield for the 10-year US treasury Note declining from 4.66% to 4.40% before settling the month at 4.49%. The US treasuries have realized that inflation pressures remain low and that the US economy is beginning to slow, resulting in the rising prices and declining yields throughout the entire treasury yield curve.
Looking forward . . .
We are expecting business failures to rise in 2006, after steadily declining for more than four years, as noted in reviewing the bankruptcy index. Also, owing largely to a forecasted slowdown of the US economy, the global business-failures index will rise next year by 1%, after falling by 2% this year.
Business failures are highly correlated with Gross Domestic Product (GDP) and to a certain extent long-term interest rates. US failures are expected to increase by 3%, after falling over the past few years to 32,300 at the end of the second quarter — the lowest in 25 years. This increase will eventually affect US GDP growth, which is forecasted to fall to under 2.5% in 2006, from an estimated 3.6% growth rate this year.
The US economy is facing significant drags that have not yet been factored into the marketplace. Higher energy prices and a flattening yield curve brought on by repeated hikes in the short-term rates will be fundamental catalysts for slower US economic growth. In addition, the tougher bankruptcy laws initiated in October and the impact of Hurricane Katrina will cause Chapter 11 conditions to weigh more heavily on debtors. The food retailers are one of the major industries that will be critically affected.
The consumer, who largely supported the strong third quarter GDP numbers, is poised to take a break after or maybe even before Christmas, owing to the drying up of free-cash and the leveling off of the employment picture. Consumers can only spend more than they earn for only so long before they are forced to retrench, and start saving.
The savings rate recently hit an incredible -1.5%, with the last time such a comparable number existed being in the 1930s. Consumers have eagerly been using their homes as cash ATMs, foregoing the desire to save, with equity extractions so far this year from homes weighed in at nearly $160 billion. These extractions are fueling the great majority of the spending boom, since consumer’s pockets are essentially empty. Consumers feel their mighty homes will appreciate by quantum leaps every year, a stimulating trend that, of course, is impossible to continue.
Currently, household real estate assets as a percentage of GDP is nearly 150%, which only 8 years ago was 100% of GDP — illustrating a large leap similar to the final stages of the bullish stock market bubble in early 2000.
There are a number of reasons to further quantify the housing situation as overly extended. For example, affordability of homes is at a 14-year low. The sales of new and existing homes are leveling off or worse, dropping even as prices continue to rise. Furthermore, inventories of unsold homes are more than ample at 17-year highs, and mortgage applications are running some 20% below the August highs. Home builders, at least a few, insist that business is as good as it gets, but could improve even further.
Moreover, the regulators are growing restless with the speculative frenzy that is reaching a fever pitch in the housing market, which could lead to the drafts of new rules that would tighten standards on risky loans.
These risky loans are those that cheerfully do not require the consumer to pay down principal. The originators of such loans do not have a real notion as to whether said consumer can afford the house he or she is buying. A crackdown of these risky loans could have a significant impact on the housing market, bank-lending activity and the broader US economy, beginning in the first half of next year.
The regulators have become more antsy, since many of these already-stretched consumers are taking “interest-only” or so-called “option adjustable-rate mortgages” (ARMs) which are due for major payment shock when the loans reset, as a large amount of them are slated to do over the next several years. Suddenly, these consumers will have to start paying down the principal loans, which will be adjusted for the higher interest rates over the past few years. This will serve as a double whammy that could raise their monthly mortgage payments by 50%, or even 100%.
Many options ARMs and interest-only loans accepted by banks are based on “stated income”, which they cheerfully accept on the borrower’s word, with no documentation required to substantiate. The shock to the borrower is sure to be much greater, but lenders might become a bit queasy as well.
These risky-type loans now account for nearly half of all of the loans in the past 18 months — quantifying the significance of these loans existence as compared to the total mortgage market. The major housing bubble is showing unmistakable signs of running out of steam. A regulatory crackdown could easily turn a long-term staple retracement in real estate values to a full-blown decline. Either way, it would clearly signal the end to the housing boom.
Long-term conclusions and current month expectations . . .
The severity of the upcoming winter could have a major impact on energy prices. The weather experts monitor the fluctuations in the North Atlantic Oscillation (NAO) not only since it contributes to the number of hurricanes each year, but because it also effects the kind of winter to be expected. When the NAO is positive, as it has been this year, more hurricanes develop and the Great Lakes and Northeast experience colder than normal winter conditions. If this pattern holds up this winter, energy prices will be above normal, affecting consumers’ ability to spend on nonessential items.
The US economy has held up better than expected, however, the stage is set for a consumer led slowdown in the first half of 2006. Consumers are facing increases in adjustable-rate mortgages payments, higher minimum credit-card payments, elevated cost for all forms of energy-related necessities, less home-equity available extractions, and lower rates of home value appreciation — if not an actual decline.
The Dow Jones failed to trade above the March 2005 high at 10,940 — on a closing basis — giving us further confidence that a major topping process (peaking in price) is occurring for the major stock indices, and we are therefore forecasting a DOW trading range for the month between 10,200 and 10,936. There remains formidable support for the DOW at 10,000, but with a end-of-the-day close below this key level would signal a resumption in the primary bearish stock market decline.
The US dollar appears to have reached an extended level in price, and should start to resume its primary bearish trend this month, with an anticipated trading range between euro fx equivalent of $1.165 and $1.20. The ever growing US trade imbalance and current-account deficit can only be reduced to a manageable level with an actual weaker US dollar. The growing pressures of these twin deficits should start to take hold, resulting in the decline within the US dollar against both European and Asian currencies.
The US treasuries are forecasted to continue their rise in price and decline in yield, with the 10-year note peak yield occurring at 4.52% during the month. The Federal Reserve is scheduled to meet for their Federal Open Market Committee (FOMC) meeting on December 13th and is expected to raise the prevailing fed funds rate from 4.00% to 4.25%. This rate hike could be their last upward adjustment before entering a new easing cycle, as the US economy begins to slow, once again.
SUGGESTED INVESTMENT ALLOCATIONS:
1. A 75% to 85% allocation of their taxable ordinary funds and/or tax-deferred funds into a conservative as well as flexible investment strategy using various no-load index mutual funds and exchange traded funds (ETF’s) offered through our Private Account Wealth Management Services. The minimum investment criteria are determined after reviewing the investor’s current assets and fund allocations. These services are ideal for individuals, trusts, foundations and privately held corporations who have liquidated large stock, bond and/or real estate holdings and are seeking an active management service to generate a positive rate of return between 12% to 35% per year (after fees) through either a rising or declining stock, bond or real estate market.
2. A 15% to 25% allocation toward 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.
If there are any questions regarding the information discussed within this newsletter, the investment allocations mentioned above or our unique management service, please call the number provided below or e-mail us and we would be happy to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
Acknowledgements: Federal Data, Euler Hermes (unit of Allianz), Dan North, Economist, David Rosenberg, Economist, Ed Hymans with ISI, Federal Reserve Data, FDIC, Comptroller of the US Currency, Financial Commentator.
Note: These newsletters have no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. These newsletters are issued for informational purposes and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. These newsletters are based on information obtained from sources believed to be reliable, but are not guaranteed to be accurate, nor are they a complete statement or summary of the securities, markets or developments referred to in the various newsletters. Recipients should not regard these newsletters as a substitute for the exercise of their own judgment. Any options or opinions expressed in these newsletters are subject to change without any notice and the Wavetech Enterprises, LLC newsletters are not under any obligation to update or keep current the information contained within. Past performance is not necessarily indicative of future results. Wavetech Enterprises, LLC and its newsletters accept no liability for any loss or damage of any kind arising out of the use of any or all parts of these newsletters.