Private Account Management Services
Newsletter Issued 02-13-03:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw

Position overview . . .

Our January 16th newsletter forecast that the DOW would perform a bear market rally with a trading range of between 8,210 and 9,250. Initially, during the course of the month, the DOW rallied to an intra-day high of 8,869 before declining to an intra-day low of 7,919. The projected direction was initially correct for a 600 point rally (7%), however, the eventual decline was further than anticipated. We further forecast that the US treasuries had put in a near-term top in terms of prices with yields expected to rise through “reflation.” This proved to be correct for the longer maturity US treasuries (5 year notes through 30 year bonds) with only a 10 basis point advance within the shorter 1 to 2 year treasury bills maturities. We also anticipated the US dollar to retain a bearish trend and were forecasting an euro fx to advance to $1.12 against the US dollar. This projection proved to be accurate with the US dollar continuing its decline to $1.09 euro fx due to the geopolitical uncertainties with Iraq and North Korea as well as declining US consumer confidence.

Looking forward . . .
We are expecting the DOW to perform a bear market rally during the month of February with a trading range between 8,850 and 7,600. Once the geopolitical events are more clearly defined, the true economic conditions within the US will be more apparent. An invasion of US troops into Iraq should initially produce a stock market rally, but the actual duration of the war could dictate the magnitude of the rally. The proposed US fiscal-stimulus package also could be the catalyst for the expected rally. However, once both events have disclosed to their true effect on the US economy, the stock market will resume it’s bearish trend.

We are now expecting a countertrend US dollar rally since it came close to reaching our euro fx objective of $1.12 at $1.09. This rally, which may have begun on February 7th, could continue for the next 30 to 90 days with a possible return to parity with the euro fx. We would suggest that US investors use this rally to reduce their real assets holdings (i.e., US commercial and residential real estate investments) and position into more flexible investment vehicles to hedge the resumption of the US dollar long-term decline.

The US treasuries anticipated “reflation” is still expected over the next 30 to 90 days due to the negative real fed-funds rate relative to the current levels of inflation, rising commodity prices and the near-term reallocation out of bonds and into stocks. However, beyond this adjustment, it still remains possible that a deflationary scenarios could occur if the proposed fiscal-stimulus package only creates a temporary US economic recovery and geopolitical events continue for longer duration than anticipated.


We have what could be the biggest bubble of them all — the huge ballooning of the total debt in the United States. Aggregate borrowings of all household, businesses and governments (federal, state and local) zoomed up from about $4 trillion at the beginning of 1980 to $31 trillion as of the end of 2002.

While some observers see no cause for alarm, others fear that this debt surge could be edging the US economy toward a possible depression. Credit-market debt now equals 295% of gross domestic product (GDP), compared with 160% in 1980 and less than 150% during much of the 1960s. Debt as a percentage of GDP, now exceeds the previous record reading of 264% attained early in the Great Depression — when the aftermath of the Roaring ‘Twenties borrowing binge collided with a sharp economic contraction. Today’s debt load is clearly starting to pinch consumers and businesses. Credit-card charge-offs of bad loans exceed 7% of total debt outstanding, compared with the previous peak around 5%, reached in the mid-1990s.

US personal bankruptcy filings in last year’s third quarter jumped over 12% from the level a year earlier. And when 2002’s total is in, it will almost certainly eclipse 2001’s record 1.43 million.

Mortgage delinquencies are soaring, particularly among less creditworthy borrowers. In the “sub-prime” market, delinquencies have jumped to 8.05% from just 4.45% in 1999. This market, which caters to people with checkered credit histories, account for about 10% of the $5.8 trillion of US mortgage debt currently outstanding. Delinquencies of Federal Housing Administration loans (FHA), which make up about 15% of the dollar amount of US mortgage debt, are at a 30-year high of 11.7%. The typical FHA borrower is a first-time home buyer with limited funds. Despite the big home-price jump seen in many regions, soaring mortgage debt and dropping stock prices have severely crimped the net worth of US households. Net worth’s at the end of the third quarter 2002 had fallen to just 4.8 times disposable income, about 21% below the 6.3 at the end of 1999.

The probability of a US depression over the next 2 to 5 years is starting to rise and is further explained through a comparison between a recession and a depression as follows:

During a recession, interest rates can be lowered to stimulate the economy by making it cheaper for business to invest and consumers to buy big ticket items. Lower interest rates also boost asset prices, by raising the capitalized value of future income streams.

Depressions have a different dynamic. They tend to come after years of debt buildup, when monetary easing no longer works because interest rates are already near zero. Thus, no further debt-service relief is available for overburdened business, consumers or governmental units — especially if deflation causes their income to fall. Even if rates hit zero, the real burden of debt rises during deflation. Borrowers still have to repay their debts in current dollars while their revenues and collateral falls in value.

In a frenzy to raise cash, debt holders sell assets and cut spending. As a result, the value of the collateral underlying existing debt suffers. Deflationary forces are only exacerbated by businesses cutting prices to stimulate demand in a vain attempt to support cash flows. In addition, as unemployment rises, consumer demand falls.

The process is not reversible by normal fiscal or monetary stimulation, as seen in the US during the Great Depression and in Japan since the end of 1989. However, the US may avoid depression and simply muddle through the next few years.

Still a number of questions worry us: Why has the bear market been so impervious to two consecutive years of aggressive monetary easing? Normally stocks would be on fire after such a span of interest rate cuts. And what will a Federal Reserve, currently out of monetary bullets, do if unexpected problems in Iraq or another major terror attack on US soil further upset the economy?

We feel that the tipping point will come at a time of “general alarm,” when borrowers seeking to get liquid or creditors worried about repayment trigger distress selling. Credit availability contracts, as does monetary turnover. Prices tumble and business fail. Output, trade and employment careen lower. In short, the psychology of extreme optimism gives way to pessimism and loss of confidence. Finally, deflation causes money’s purchasing power to rise sharply, making debt all the more burdensome to repay in both real and nominal terms. This is the real secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the economic ship tips, the more it tends to tip.

However, the US government is taking steps to “reflate” the economy — to stimulate it by monetary means — but it remains uncertain what the long-term effects will be on the US economy.

If the US debt bomb ever bursts, the detonator will probably be the residential mortgage market. Home loans account for nearly 70% of the US’s household debt. Academic studies show that changes in home prices have nearly twice impact on consumer spending as the “wealth effect” from rising or falling stock prices. After all, stock ownership is more concentrated in higher-income groups, and nearly 70% of US households own a home.

Home prices have been on a tear, rising nearly 50% nationwide over the past six years bolstered by falling interest rates and looser credit standards. Consumers have tapped this surging equity value through cash-out refinancings, transforming homes into ATMs. Refinancings have totaled $2.4 trillion over the past two years. American home-equity loans stand at around $800 billion.

At the same time, Americans’ equity in their home, net of debt, has dwindled to 56%, compared with 84% a half-century ago, even with the recent powerful surge in home prices. We estimate that 38% of US homes are owned free and clear, and that the remaining homeowners have debt burdens exceeding 80% of the value of their homes. Many Americans have little margin of safety should prices level off or should they fall as much as 20%, as they did in the many overheated areas in the late ‘Eighties.

There is potential trouble for consumer spending, even if house prices and mortgage rates merely stabilize at current levels. Under such a scenario, refinancing volume is likely to drop markedly, simply because nearly everyone who wants to refinance has already done so.

It is estimated that Americans sucked out $320 billion more in equity from their homes than they reinvested in real estate. This is substantially more than the $60 billion in additional outlays the White House says its fiscal-stimulus plan could generate this year. We think most of the equity withdrawals went into consumption, since savings rates still remain at 4% compared to 8% in the ‘Sixties. Consumer spending could rise less than 2% this year due to less refinancing.

Home values are at record values, compared with either rents or median household incomes. Our concern is that housing is now highly vulnerable, owing to the likelihood of higher interest rates, rising unemployment and lower home prices. If the housing bubble bursts, instead of gently deflating, the nation’s economy could be in for a major decline. In essence, as long as housing values stay high, the nation is sheltered from a detonation of the debt bomb.


Our allocations have not changed from the previous newsletter. We still believe that “reflation” will occur in the near-term and are suggesting an allocation into the inflation-protection index bond (TIPS), which can generate profits as the bond market declines and yields rise through this adjustment in bond prices. We still are suggesting a small investment allocation into stock index funds and/or large cap mutual funds. The allotment into stocks is small since there is limited upside profit potential, and we remain within a primary bearish stock market trend. Fund managers will change their allocations, out of bonds and into stocks as the stock market performs this bear market rally thinking that the bull market has once again resumed, and will be faced with an eventual surprise. Hence, we are suggesting the following investment allocations:

1) A 0% 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 50% 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 between 4.5%-5.5% yield and possible price appreciation as the bond market declines.;
4) 10% in stock index mutual funds or large cap growth mutual funds during this bear market rally. There is limited upside potential and a majority of stocks provide a low dividend yield with many providing none at all;
5) 20% 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 bullish or bearish stock, bond and/or currency 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
E-mail: JOHNTMOIR@aol.com

Acknowledgments: Federal Reserve flow-of-funds data, Standard & Poors, Loan Performance, Economist: Irving Fisher, Economist: Gary Shilling, Economist: Jan Hatzius

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