WAVETECH ENTERPRISES, LLC
Private Account Management Services
Newsletter Issued 07-08-03:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw
Position overview . . .
Our previous newsletter, dated June 10th, forecast that the DOW had completed it’s bear market rally on June 6th and anticipated a trading range between 8,180 and 9,250. Actually, the DOW continued to rally for seven more business days before topping at 9.353. The DOW trading range for the month was between 8,851 and 9,353. The positive economic developments supported the DOW and other major indices longer than forecasted. We also projected that the US treasuries would continue it’s advance in price and decline in yield, forecasting either a 25 or 50 basis point cut in the prevailing fed funds rate of 1.25%. This proved to be somewhat accurate since the Federal Reserve did cut the fed funds rate by 25 basis point at their June 25th FOMC meeting, but changed their future bias on interest rates from easing to neutral. The US treasuries were supported prior to the announcement, but were disappointed when the fed did not cut the fed funds rate by the preferred 50 basis points. Furthermore, with the decision on interest rate occurring only three days prior to the end of the second quarter, there was a strong level of profit taking due to end-of-the-quarter balancing of the positions commonly referred to as “window dressing.” The US dollar was projected to be range-bound with a possibility of a further advance to euro fx $1.21. The period of consolidation proved to be accurate with a range of between euro fx $1.1400 and $1.1845. The US dollars decline has been so rapid that it was simply temporarily consolidating to work off it’s oversold condition prior to continuing it’s bearish decline.
Looking forward . . .
It has become obvious, over the past six months, that the Federal Reserve, the European Central Bank and the Bank of Japan will monetize the system massively in order to keep it going. The rapid expansion in the money supply, and especially in credit as a result of mortgage refinancings, is keeping consumption in the US at elevated levels. But industrial production is flat or declining, even in industries related to housing. In Asia, however, production is rising and investment activity is strong. In the first quarter Chinese exports was up more than 50% compared with a year ago. The result is a huge trade imbalance.
The liquidity creation in the US and now Europe and Japan has boosted bond prices and driven a sharp stock-market rally, particularly in the NASDAQ. Stocks are over bought right now, and are in the process of correcting the strong advance they had over the next few months. In the past few weeks Asian equity markets have started to rally, too, especially in Indonesia and Thailand. Now Japan is joining the party, but will faced stiff resistance at a Nikkei price level of 10,000. Anyone who bought the DOW, S&P 500 or NASDAQ around these recent highs will probably not make any money, or very little money, for the next five years. Reflation by the central banks is not solving any problems, but postponing them. The big issue is the imbalance between consumption in the US and production in Asia.
The US dollar’s weakness is an added advantage for Asia, because Asian currencies have weakened against the euro fx. They are now becoming competitive against the euro fx and Eastern European currencies.
The prime beneficiary of reflation could be Japan. There is a chance that the 13-year bear market in Japan has bottomed. Government bond yields are now below 0.6%. Individuals are underweight equitas. At some stage worldwide monetization will begin to have a negative impact on bonds. This is the mirror image of 1981, when the bond market bottomed and rates on long bonds in the US peaked at 15.80%. Hence, they should peak in price and bottom in yield later this year. However, in the near-term, US treasuries should continue to be supported as the US economy grows at a less than expected pace and the level of unemployment rises to nearly 7.0% over the next few months. The financial sector has shown improvement in employment due to the increased level of mortgage refinancing, however, other sectors like manufacturing have suffered large declines in employment.
The near-term outlook still remains favorable for US treasuries for the reasons mentioned above. Therefore, we will continue to suggest a large asset allocation within the various US treasures as listed at the end of this newsletter. The Federal Reserve may not cut the prevailing fed funds rate later this year, however, we feel that the US treasuries will start to re-factor into the marketplace the possibility of them changing their bias from neutral back to easing in one of the upcoming FOMC meeting. This adjustment could occur at either the August 12th or September 16th meetings.
We continue to feel that the DOW has completed it’s bear market rally and are anticipating a trading range for the month between 8,225 and 9,285. Second quarter corporate earnings announcements will be released over the next few weeks and we anticipate them to be below previously forecasted levels, causing the various stock indices to decline. The positive economic developments released over the past few months have now been factored into the marketplace. There is further evidence of it’s limited level of appreciation by the number and amount of corporate insider sellers, which recently reached a ratio of 4.11 to 1. This extremely high level of seller versus buyers was last seen in March 2000, just prior to the DOW and the other various stock indices declining by over 20% within the preceding 3 to 6 months.
The US dollar appears to have completed it’s period of consolidation and should resume it’s bearish trend from a current level of euro fx $1.13 to $1.18. The current-account deficit, which still remains at 4.1% of the US Gross Domestic Product (GDP), is an ongoing hindrance to long-term economic improvement. Manufacturers of US goods are continuing to source their labor requirements in other countries to enhance their profit margins at the cost of higher US unemployment and a rising trade imbalance.
The monetization experiment on a global scale will temporarily boost economic activity and consumption, however it could end in disaster. Eventually interest rates will rise where the 10-year US treasury note could easily yield 6% in two to four years. That would dramatically effect the housing market. And even if interest rates do not go up, the refinancing boom will taper off anyway.
Unlike Japan after 1990, the US does not have a trade and current-account surplus — it has a deficit. Investors could buy stocks today and assume that because of the reliquification, the market will continue to rise and they would have a trade. But this is a dangerous rally with limited profit potential.
We have chosen to maintain the same asset allocations from the prior month even if the Federal Reserve changed their interest rate bias to neutral at the June 25th FOMC meeting. The uncertainties over the future levels of consumer spending and corporate growth made us conclude that the Fed will continue with a low interest-rate policy until a stable and consistent level of growth within the US economy reappears. Therefore, we continue to suggest a combination of zero coupon bonds (STRIPS) and longer maturity Treasury Notes & Treasury Bonds with no allocation in the inflation-protection index bonds (TIPS). Deflation is still a concern within the US economy, but could change in the months ahead depending on the rising level of inflation, commodity prices, and rapidness of the declining US dollar. Hence, we are suggesting the following investment allocations:
1) A 35% allocation into 2 to 5 year maturity of US Government bonds;
2) A 35% allocations into 20 to 30 year zero coupon bonds commonly referred to as STRIPS;
3) A 0% 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.;
4) 0% in stock index mutual funds or large cap growth mutual funds. There is limited upside potential and a majority of stocks provide a low dividend yield with many providing none at all;
5) 15% 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 through 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