Private Account Management Services
Newsletter Issued 06-12-02:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw

Position overview . . .

Our May 9th Newsletter expressed major concerns about the US current-account deficit at 5% of GDP and we projected a decline in the US dollar. Over the course of the month, the US dollar dropped 2.4%, which generated a profitable trade for our clients, especially those with the European currencies. Buying the various European currencies, served as a hedge for clients with large US non-liquid holdings and offset the decline in the US dollar.

We projected that the DOW had bottomed near-term at 9,810 on April 7th and was expecting a bear market rally to 10,485 during the month before resuming its primary bearish trend. The DOW did put in a near-term bottom on April 7th, as expected, and performed a countertrend rally, but only to 10,353. Since this was within 1% of our objective, we notified our clients of the limited potential rally remaining and suggested that they liquidate any remaining stock holdings. We profited from this minor rally, but quickly made adjustments when it failed to meet our optimum objective.

Looking forward . . .

Currently, we are expecting the US dollar to continue its decline over the next 3 to 5 years, which should serve to reduce the US current-account deficit to a more manageable level of imbalance. Without intervention by the US government or foreign governments to prop up the US dollar, we are anticipating a US dollar decline of between 15% to 25% from its current level, already 8.2% off of its January 2002 peak. This decline will eventually cause interest rates to rise due to the reduced demand for corporate and US government bonds from foreign countries. The increase in interest rates will effect corporate profits due the higher interest borrowing expense. Real estate valuations will also be effected since corporations and consumers will be faced with their own imposed limitations on what is an affordable increased monthly payment.

Last Friday, we witnessed a decline in the unemployment rate to 5.8% from 6.0% with a nonfarm payroll increasing by 43,000 new jobs. However, this modest nonfarm payroll increase was largely offset by a revision for the April 2002 rise of 43,000, which was revised downward to a mere 6,000. Even bigger shrinkage’s slashed gains in both the February and March 2002 nonfarm payroll numbers. Hence, even with the Fed cutting interest rates 11 times over the past two years, the employment situation has yet to show major improvement.

We anticipate that the Fed at their FOMC meeting on June 25th and 26th will keep the Fed funds rate at 1.75% and continue to maintain a neutral stance on future interest rate adjustments. It is possible that they could make one more interest cut during their August 2002 FOMC meeting before shifting toward an interest-rate-increasing mode.

We feel that the DOW offers limited upside potential and are projecting a larger range between 9,450 and 10,000 for the month of June 2002. The sharp decline over the past few weeks, all major stock indices could result in a larger selloff if the DOW closes below 9,000. Stocks, in general, remain an undesirable investment due to poor corporate earnings, low dividends and declining consumer confidence. Corporate officers, commonly referred to as insiders, still remain sellers of their own company stock by a 3-to-1 ratio, projecting a further lack of confidence at the highest level.


It is simply inappropriate to include increases in the value of pension funds in corporate earnings, which are falsely supporting the bottom line for many prominent blue chip companies. For example, General Electric (GE), by including the contribution from its overfunded pension plan, reported a per-share net last year of $1.40 when it should have been $1.10.

At the end of 2001, GE’s pension plan had $45.7 billion worth of assets and was 45% overfunded. The value of the fund declined last year, reflecting the poor performance of the stock market, but still contributed more than $2 million of the company’s $13.6 billion in reported earnings.

GE’s pension fund contribution to the company’s earnings may fade in the years to come, should the market’s performance proves to be relatively subdued.

The percentage of pension funds portfolios in equities is a towering 75%, which causes a problem. Many companies also are counting on returns of 9.25% to 9.5%, a level substantially higher than they are likely to enjoy.

Last year the 50 biggest US pension funds took a hit to the aggregate value of their portfolios of $36 billion. However, thanks to generous assumptions of how much their investments should return, the fabulous 50 reported to shareholders a “hypothetical” pension fund gain of $55 billion, and included $9 billion of these “hypothetical” pension fund earnings to their net income.

The spread between reality and innovative accounting was a cool $92 billion. Projecting pension funds requires basing their accounting on long-term assumptions. Those assumptions may be entirely too cheerful with the contrast between the real and the hypothetical providing a strong argument in favor of excluding pension fund earnings when reporting corporate net income.

Pension plans enjoyed surplus funding through the roaring ‘Nineties. At the end of 1999, a mere 15% of the big pension plans were underfunded. Currently, about half of them are and, in the absence of another bull market, that proportion will inexorably grow. The surplus in the top 50 plans in the two years ended 2001, in any case, shrunk an incredible 90%.

While none of those plans are deemed in danger of running short of cash, it is not inconceivable that companies may have to start providing funds from their operations to meet their obligations to their retirees. For example, General Motors (GM) at the end of last year, had pension-fund obligations of $93 billion, against assets in its plan of $76 billion.

In the ‘Nineties, as stock prices went racing to the moon and assumptions on how much portfolios would return over the long term went along for the ride, pension funds changed from cost center to an important profit center. The trip back to cost center from profit center, unfortunately, is proving to be much less fun.

Public pension funds are also hurting: their assets plummeted $370 billion in the past two years. Liabilities are mounting by about 7% a year and state as well as local governments have no choice but to make up the shortfalls. This will translate into possibly higher taxes and/or reduced services.


Our allocations will remained the same as compared to the previous newsletter. However we may change them in the near future. Since the US treasuries may have limited upside potential, we are suggesting inflation-protection index bond (TIPS) to lock-in an effective yield of 4.0% and to protect our generated profits. Once we are convince of a US treasury market peak, clients will be notified to liquidate the various US treasury positions. For now, the US treasury market will remain a favorable investment tool since the one-year treasury bills are still factoring in a Fed funds rate of 3.87%. We still feel this level of interest, may be unrealistic within a year, given the current state of our economy and global concerns. This, together with limited opportunities within the various stock indices for price appreciation, guide us in suggesting the following investment allocations:

1) A 30%-35% allocation into 2 to 10 year maturity of US Government bonds;
2) A 10%-15% allocations into 20 to 30 year zero coupon bonds commonly referred to as STRIPS. This type of bond will provide a greater rate of return, as compared to the conventional bonds, due to the leverage associated with this instrument:
3) A 40% allocation into inflation-protection index bonds (TIPS). If the treasury prices decline this instrument will effectively lock-in the profits generated with the US bonds and STRIPS with an overall effective yield of 4.0%.;
4) 0% in individual growth stocks due to the limited upside potential, low level of dividend yield and higher level of risk;
5) 5%-10% 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 bull or bear 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: Standard & Poor’s, Federal Data.

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