February-02-06-2000

Newsletter 2-6-00:

In my January 2000 newsletter, I was projecting a near-term top for the stock indices between January 18th and 21st 2000. Well, the DOW and S&P 500 topped on January 14th and the NASDAQ and Russell 2000 topped on January 24th 2000. Since I trade the wave patterns in these market(s), which are developed by levels of “greed and fear,” the seven percent correction from the projected top offered a profit between 12 to 18 percent with an initial 2 to 3.5 percent of risk with diversity in the S&P 500, Treasury-Bill market(Eurodollar), and a foreign currency spread.

Even though the NASDAQ traded to new highs on Friday, February 4th, the upside potential for DOW, NASDAQ, S&P 500, and Russell 2000, in the near-term, remains very limited. My wave pattern technical analysis shows the stock indices remaining in a corrective mode for at least the next several months. There is a possibility that the DOW could test 10,000 in the near-term, then advance to 12,800 before the end of the year. We are close to a major top, but the wave pattern in the last four weeks shows the possibility that we may make one more advance to new highs before a significant correction takes place.

There are a number of important issues that I will now cover in regard to the Stock, Bond and Foreign Currencies Markets that are giving distinctive signs that we are close to a major top and significant correction:

STOCK MARKET

1. Expected “January Effect”: For the past several years, investors have expected a rally in January due to the inflows of IRA and 401K funds in mutual funds. However, with so many consumers and institutional investors expecting this occurrence, the January effect was already factored into the market by late December 1999. Inotherwords, the January effect actually occurred in December 1999. Seasonal tendencies and investment cycles shift when a strong majority of investors know about it’s occurrence and it becomes factored into the market place. With wave analysis, I was able to see these changes and projected a top on either January 6th or on January 18th through 21st where the upside risk was limited to less than 2 percent with the results explained above.
2. January Indicator for the year: Since 1950, the month of January, with an 80 percent accuracy, has been able to predict the direction for the stock market for the remainder of the year ahead. With the DOW, NASDAQ, and S&P 500 finishing down 6.68%, 8.43%, and 6.35%, respectively, for the month of January 2000, we should either see a sideways or declining market. Some studies say that actually the first five trading days of the year are more important than the entire month of January, but in both cases the performance was negative, which doesn’t show well of the remainder of the year 2000.
Even with this being an election year, this January indicator has been accurate 8 of the 11 such annum years. And, when the month of January was down, it was preceded with a new or extended bear market or a flat performance for the year.
3. NASDAQ vs. GDP: Since 1990 the value of the NASDAQ has risen from 5 percent of the Gross Domestic Product(GDP) to over 55 percent. A majority of investors feel it is too big to fall, but look what happen to Chase and Citicorp about 12 years ago, which were quoted as being “too big to fall” and barely survived a near death experience.
Part of the reason for this high percentage is due to the Internet stocks which are highly overvalued with no relative earnings to justify their market capitalization. It is perceived that a majority of products sold on the Internet are cheaper than going to your local mall. But, when you add on the shipping and handling charges associated with most of the products sold on the Internet, the product becomes actually more expensive than purchasing from you local mall. I suggest that you use the Internet to research what you want to purchase, and simply purchase the item(s) at a local location, if possible.
4. Supply vs. Demand: Since 1982, demand for stocks has been mounting, while the supply of them is shrinking. Available supply of stocks have been reduced when a merger and acquisition is done for cash or when a company buys back some of their outstanding shares. However, we could be witnessing a change where supply of stock will exceed demand. This January, we saw a high level of demand through mutual funds, but very few cash mergers and acquisitions. Therefore, the supply of stock swelled in the month of January.
It is estimated that $138 billion of fresh money will be placed in mutual funds this year versus $111 billion last year, which is a $27 billion increase in demand. In terms of supply, new offerings could increase the pool of stock by $194 billion compared to $157 billion last year, which is an increase of $37 billion. Also, it is estimated that only $40 billion of stock will disappear in the year 2000 through cash mergers and acquisitions, compared to $145 billion last year. This means there will be $105 billion less shrinkage in supply of stock this year compared to 1999.
By adding the difference is demand versus supply and the factoring in the reduction in merger and acquisitions this year, supply will outstrip demand by $115 billion this year.
Furthermore, last year $64 billion was raised via IPO’s, which only represented 27 percent of the issuing companies market capitalization. It is estimated that $215 billion of stock will be available to sell by insiders since they will have exceeded the lockup period. It is estimated that 30 percent or around $100 billion worth of insider stock selling could occur this year. For example, on Monday, February 7th, Priceline.com and Red Hat’s lockup period will expire, and their restricted shares will be released and available for sale.
In summary, we could see supply outweigh demand by as much as $215 billion, which could represent a significant amount of pressure on the stock market no matter what fundamental reasons there are to support it.

BOND MARKET

1. Inverted Interest rate Yield Curve: Recently, the US Government announced that they would be trimming the sale of 30-year bonds including the smaller than expected $10 billion auction due this week. The total for the year could fall to $16 billion from the $20 billion level last year. This announcement created a rush to purchase the 30-year bond on simple supply and demand reasons. Further purchasing came in from institution and investors who were short the 30-year bond with expectations of higher interest rates who were covering their position to book their profit or minimize their losses.
Under normal conditions, the yield on a 2-year note is lower than a 30-year bond with the expectations of a higher interest rate returns with a longer term instrument. However, with the significant buying of the 30-year bond last week, and still a strong concern of inflation in the front portion of the yield curve, we have the 2-year note yielding 6.63 percent and the 30-year bond yielding 6.27 percent.
This inverted curve also exists in the UK where there is a 90 basis point spread between 2-year and 10-year note, which is almost one full percentage point. If the US moves further towards a spread similar to the UK, it would spell major trouble for the Fed who are determined to slow the pace of economic growth. The US hardly needs the stimulus created by falling interest rate when trying to slow economic growth.
The simple reduction in the size of available 30-year bonds maybe the reason for the inverted yield curve; however, in the past, it has represented the late stages of an economic expansion. If the current expansion is nearing an end, we will within a year, see stocks fall out of favor with the new preference being the 2-year note through the 30-year bond. Since the stock market tends to anticipate economic trends by six to nine months, any future economic weakness brought on by further Fed tightening, should manifest itself in money flows out of stocks into bonds as investor look for an attractive yield and safer investment instrument.

CURRENCIES

1. European Currency unit: In my January newsletter, I was expecting the new Euro currency unit known as Euro Fx, to hold above the parity (1.000) against the US dollar. Well, it has dropped below this parity level down to .9824 and could continue lower. This break has created a further flight to safety move into the US dollar and could further effect a trade imbalance. However, if the US economy does start to slow and produce lower interest rates, it would weaken the US dollar against the Euro Fx, and assist in reduce the trade imbalance and the overall trade deficit.

SUMMARY

The Feds could be placed in a very difficult position where signs of inflation are starting to appear as shown in the fourth quarter GDP at 5.8 percent and Employment Cost Index at 1.1 percent. Should another financial market crisis appear similar to that of Long-Term Capital Management (LTCM), the Feds may want to lower interest rate to assist the financial markets, but it could be like adding oxygen to a fire with inflation around.

It will be a very interesting year with the strong signs of a stock market top either already in place or possibly later this year. There are ways to diversify or hedge your existing portfolio in the futures/derivatives markets where you can protect your portfolio value and generate profits as the markets make these various waves patterns movements throughout the course of the year.

Should you have any questions in regard to the information discussed in this newsletter or the available trading strategies in the stock, bond or currency futures markets, please feel free to send me an e-mail at JOHNTMOIR@aol.com or call me at (775) 841-9400.

John T. Moir

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