Private Account Management Services
Newsletter Issued 01-16-03:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw

Position overview . . .

Our previous newsletter, dated November 6th 2002, forecasted that the DOW would be within a larger trading range between 8,835 and 7,775 for the remainder of the year. The actual range for the DOW was narrower than expected between 9,043 and 8,252. We further forecasted that the US dollar would continue its bearish descent due to the terrorist threats and the looming large trade deficit imbalance. This projection proved to be accurate, but was not a major emphasis within our clients various position allocations at the time.

The reduced level of volume and open interest liquidity within the month of December restricted the accuracy of our projections and hampered the results for the stock indices and the various treasury positions. As a result, we have decided to offer our private account management services during the months of January through November, and allow clients to use the month of December for evaluating their tax situation and planning various individual and/or corporate expenditures without any uncertainties of the year-end results.

Looking forward . . .
We would be surprised by a sharp rebound in retail demand for stocks this year, given that a number of recent rallies have amounted to little more than selling opportunities. Besides, history shows a tendency for outflows to continue for some time after an episode of severe net redemption’s such as we have just seen. Between mid-May and mid-October of 2002, domestic equity funds were hit with net outflows amounting to almost $100 billion. In some ways, the boom-bust market cycle of 1999-2002 appears like 1987 in slow motion. By early-October 2002, there were enough similarities for us to recommend an asset allocation back into stocks (October 2002 Newsletter available upon request). Clients were informed, at that time, that our wave pattern technical analysis projected a bottom for the DOW to occur on October 9th at around 7,500. The actual intra-day bottom was on October 10th at DOW 7,197. Fundamental history provided some assistance in projecting the bottom, however, our wave pattern technical analysis expertise more accurately projected the date and approximate price for the DOW bottom. This is just an example where our analysis has projected turning points for the various stock indices, foreign currencies and different treasury maturities with strong prevailing volume as well as high open-interest liquidity.

Like 2002, the 1987 market crash caused the following things to happen: 1.) provoked widespread fear and capitulation in a manner that had not been seen in years; 2.) improved valuations dramatically — especially as compared to bonds; 3.) motivated a monetary policy response by the Federal Reserve. Various market and business cycles have a tendency to return but with slight variations to test consumers and government officials responses to new situations.

On December 30th 2002, clients were notified of an upcoming bear market rally in stocks, based on our technical wave analysis, and suggested the investments allocations mentioned at the end of this newsletter for non-managed tax-deferred retirement funds. These “suggestions” for our client’s placement of their retirement funds yielded rates of returns on investment between 7% to 17% for year 2001 and between 25% to 40% for 2002.

We are projecting that the DOW, during this month, will have a trading range between 8,210 and 9,250. There is key resistance for the DOW at 9,000. A successful close above this level would project a move to 9,250 and maybe 9,850. This current rally is just another bear market rally within a primary declining stock market trend. We would suggest that investors who still own stocks use this rally to liquidate them even if it results in a loss. It remains probable that the various stock indices will remain within a large declining trading range for many years to come where profits will only be cultivated through market timing and wave pattern technical analysis as offer through our private account management services. A fundamental investment strategy of “buy and hold” with fund allocations into various stocks, bonds, and/or mutual funds will simply show a gradual continuous loss year-after-year due to the bearish stock market. This type of investment strategy works well within a trending bullish stock market, but is undesirable within a consolidating and/or trending bearish stock market.


Inflation is noteworthy. We see it at 2.8% in 2002. And a lot of that has been below the radar screen because most inflation statistics, year-over-year, include data from fourth-quarter 2001. Post-September 11th, we had a few months of deflation. As those numbers drop out and we look at calendar 2002, we are by no means looking at a deflationary environment.

Monetary spigots are on full throttle (money supply is growing at an annualized rate of over 8%), with a real fed-funds rate of negative 0.75%, meaning that inflation year-over-year, including fourth-quarter 2001, is just 2% and fed funds are at 1.25%. You have a negative real fed-funds rate, an extremely accommodative monetary policy. On the fiscal side, you have a budget deficit, in contrast to a surplus 18 months ago, as well as proposals that will make the budget deficit substantially larger, somewhere in the $300 billion range. That is because of the current economic situation, weaker tax revenues and continued government outlays, and because of proposals like eliminating double taxation of dividends and the cost of going to war in Iraq.

We are in the process of reflating and inflation will likely peak between 3% to 4% during some form of economic recovery. Everything policymakers can do to get us there is being done, but the level of recovery still remains uncertain.

The Fed is going to wait until they see the whites of the eyes of inflation before they tighten. And that is a significant change form past policy, when they tightened at the first sign of recovery and were slow to ease. That was good policy for the 1980s and the 1990s when they were bringing inflation down. Now inflation is so low that the Fed has changed its orientation 180 degrees. They will tend to ease at the first threat of weakness and be slow to raise.

The reflationary economy will probably take hold and, as such, there will be upward pressure on all treasury yields. That is the bad news. The good news is that the yield curve is so positively sloped, you get some roll-down in all securities, meaning that a five-year security becomes a four-year. In order to lose money on that holding, you need rates to back up by at least as much as the steepness of the yield curve. So that is going to mitigate some of the cost of yield backing up. But, we are still suggesting that investors liquidate their various US treasury positions and use the suggested allocations below to purchase inflation-protected index bonds (TIPS). These TIPS can generate profits with rising yields and declining conventional bond prices. We are forecasting that the TIPS will provide a real yield between 4.5% to 5.5%. This represents a 2.5% real yield and 2.5% inflation with no capital gains. This will all come as a result of inflation expectations. However, real rates should remain fairly stable through this reflation environment.

Monetary policy remains very loose. Our preferred measure of that is the real fed-funds rate — the fed-funds rate relative to the inflation rate. Now, that appears to be around 0.75 of a percentage point (75 basis points) lower than the inflation rate, which is extraordinary. In the ‘Seventies, we had a negative fed-funds rate or real short-term interest rates for almost a decade. However, there is a big difference between then and now. In the ‘Seventies, the inflation rate was rising and surprising to the upside. So what we had in retrospect was “easy” monetary policy, whereas now we have the monetary authority intentionally running the fed-funds rate below the inflation rate. We had a similar situation in 1992 and 1993, when Greenspan (Chairman of the Federal Reserve) lowered from 10% to 3.25% in order to get the fed-funds rate down to the inflation rate.

With the fed-funds rate at 1.25%, right now the Fed is in a wait and see mode. It is not going to cut rates until it sees additional signs of weakness, or raise rates until it sees problems with inflation. So the Fed is on hold for a long time, and we do not think it will be raising rates in 2003.

The Fed has the ability to reflate. It is not a question of if, but rather whether if wants to. The consequences of reflation are less severe than the consequences of inflation.

The Bank of Japan ideologically had hesitated to allow restructuring. The elderly and aged on fixed income do not do that well when yields on their short-term instruments drop and would not be well-situated if inflation were to creep up. The Japanese still seem to respect the value of the yen in international markets. They have a large trade surplus, and devaluing their currency with abandon would effect trade barriers and tariffs. So, it is not that they are incapable of reflating the Japanese economy, but they have decided they do no want to be aggressive in doing so.

Our US Fed does not worry about unemployment, Gross Domestic Product (GDP) growth or the stock market, but instead about keeping inflation between 1% to 3%. We do not want to simply promote more investment in the stock market. The Fed cannot change the success or productivity of the stock market. In fact, the best thing that could happen to equity investors is for the market to go down. If it went up, investors would then be saddled with relatively overvalued assets that ultimately cannot deliver earnings or returns.

In Conclusion, investors should plan for low investment returns across the conventional investment vehicle spectrum. We are looking at between 4.5% to 5.5% return on TIPS. Inflation in the 2% to 3% range for calendar year 2003 is likely, and TIPS are yielding 2.5% above inflation. That gives you a 5% yield on a TIPS investment.


The euro debuted at $1.17. Then the dollar appreciated strongly, so that a euro eventually was worth less than 85 US cents. We have seen about half of that move reverse in the past 12 months; it would not alarm us if the euro continued to appreciate, since the European central banks do not quite seem ready to acknowledge how serious the deflationary threat is within Europe. If the euro appreciated 10% or so, to, say $1.12 over the next 12 months, we would not be surprised. The conundrum is that an easy policy in the US leads to a weaker dollar, and an easy one in Japan will lead to a weaker yen. And if Europe eases, too, which currency will be devaluing? All of these currencies could be weaker, however, because they have all been vulnerable versus gold. But we could have all currencies depreciating if we have aggressive central banks around the globe printing money quite freely. Financial assets were king of the hill, but now real assets are now becoming kings of the hill.

Gold is one example of a real asset, just as commodities and TIPS. The Commodity Report Bureau (CRB), which is a composite of various commodities including grains, precious metals and energy related products, has been steadily rising since May 2002. This is showing the outstripping demand versus supply for all the different types of commodities. The main thrust is that we are coming out of a 20-year period of disinflation, that politics, economic history, demographics are all lining up toward the monetary authorities doing everything possible to reflate. All of this points to real assets having a comeback.


Our allocations have changed with the liquidation of the US treasury positions in late-December 2002 for the reason discussed above. We have repositioned back into the inflation-protection index bond (TIPS), which will be able to generate profits as the bond market declines and yield rise through this “reflation” process. We have also suggested 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 since 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) 5% to 10% in stock index mutual funds or growth large cap 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

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