Private Account Management Services
Newsletter Issued 05-09-02:
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw

Position overview . . .

Our April 9th newsletter expected the Fed to hold the Fed funds rate at 1.75% and we’re continuing to suggest a larger allocation of funds into US treasuries and zero coupon bonds. Clients were notified on April 18th to increase their allocation to both instruments as we felt that the US treasuries would remain a safe haven due to the uncertainties in the Middle East and lack of confidence in the stock market. The US treasuries continued to rally, during the course of the month, resulting in a nice profit for our management services clients as well for our clients with non-managed retirement funds.

We projected that the DOW would be range-bound between 10,550 and 10,000 and continued to suggest a 0% allocation into stocks due their poor level of dividend yield and limited price level appreciation. This range was somewhat accurate with the monthly intraday high for the DOW being 10,394 and the intraday low being 9,811. We notified our clients regarding our US treasury outlook on April 18th and explained the likelihood that the DOW would break the near-term lower range of 10,000 and that we were expecting a new lower support range of 9,650. The revised support level was lower than what actually occurred, but we still captured profits as the stock indices trended lower to 9,811.

Looking forward . . .

One of our major concerns, looking forward, is the US current-account deficit which is running close to 5% of our Gross domestic Product (GDP). This is due to rising risk of corporate defaults, continued pressure on corporate profits, and further credit-quality deterioration. Foreign inflows into US corporate bonds totaled just $7.1 billion in February, the lowest monthly level since early 1999. Bond inflows, during the first two months of 2002, totaled $22 billion, about half the level of the same period last year. In sum, the US is not the capital magnet it was for many years.

We need to offset the US current-account deficit with foreign flows of roughly $1.2 billion per day. The US is going to have to adjust, if these funds are not available, either via higher interest rates, a weaker currency, or a combination of these. A weaker dollar could add incrementally to growth, but a 10% decline in the dollar would add 1.1% to inflation the first year and .7% the next.

The stimulative effect from a weaker dollar would be positive for GDP, but negative for US treasuries and real estate values since the Fed would have to respond by raising rates. We are suggesting, in light of this uncertainty, the use of inflation-protection index bonds in direct proportion to the size of the recommended US treasury position. This will effectively lock-in the profits generated and produce an overall yield of 4.0%. Or, investors could simply liquidate their US treasury positions, and reenter at a later date.

We feel the DOW put in a minor bottom at 9,810 on April 7th and will now perform another bear market rally to DOW 10,485 before resuming it’s primary bearish trend. Investors who still holding stock should use this rally to liquidate them and reallocate those funds to the investment instruments mentioned within the asset allocation section of this newsletter.

We are in a primary bear market. Thus, the conventional investment strategy of “buy and hold” for the long-term will simply not work due to the declining market nature of a bear market. However, the most effective strategy during these periods of market decline, is “market timing,” which we perform with our wave pattern technical analysis in our private account management service. Our analysis helps determine the appropriate date, price and time to enter or exit a particular US treasury, stock indices, or foreign currency and can capture profits by either being a buyer (going long the market) or being a seller (going short the market). This type of trading instrument, futures/derivatives, can provide existing investment portfolios further diversification and hedging through these changing times.


Median home prices across the country have jumped nearly 40% since 1995, helped by modest interest rates. The increases are higher in some cities such as Boston, where home prices have jumped 95%; San Francisco, up 81%: San Diego, up 72%; Denver, up 68%; and New York Metro area, where has risen 53%.

These price jumps might not seem great when stacked up against the stock-market boom of the late ‘Nineties. However, the residential realty market is showing sure signs of a bubble psychology:
1.) Potential homebuyers have a sense of urgency — buy now or risk having to pay more later.
2.) Mortgage obligations do not matter as long as future investment gains are perceived as a sure thing.
3.) Leverage is seen as an enhancement to eventual return rather than as a liability.

The strong appreciation in owner-occupied home prices have been important in keeping consumer spending surprisingly strong during the recession of the past two years. Home price growth alone has added nearly $2 trillion to the wealth to US households’ — not a trivial amount in a $10 trillion economy. Homeowners were able to tap some of this new wealth by means of home-equity loans and “cash-out” refinancings. Last year’s $1.2 trillion of mortgage refinancings not only saved Americans an estimated $15 billion or so in annual debt service, but also allowed folks to take out an additional $80 billion from their homes over and above the old mortgagees. In addition, the untapped equity makes Americans feel wealthier and more willing to incur more debt and spend more than they might otherwise. Economists call this the “wealth effect.”

This wealth effect has stabilized consumer spending despite a slowing economy and a serious decline in the stock market. The aforementioned $2 trillion rise in real estate wealth between the first quater of 2000 and the fourth quarter of 2001, to a total of $12 trillion, was seemingly more than enough to counter the headwinds of a $3.8 trillion decline in household stock-market investments (to $8.7 trillion) over the same period.

Only a smattering of generally affluent Americans have large equity portfolios. However, homeownership rates are high throughout the developed world. The middle classes’ spending habits are far more likely to be influenced by major changes in net worth than is the case with the rich.

Likewise, real-estate wealth is easier to tap through home-equity loans and cash-out refinancings than much stock-market wealth that is locked away in retirement accounts. The number of ads inviting people to take equity out of the home for a fancy vacation or major luxury expenditure is amazing.

The outsized impact of housing prices on consumer spending makes the health of the housing market of crucial importance to the economy. Any serious dip in home prices could abort the US’s fledgling economic recovery and perhaps trigger a second leg in the recession. Fed Chairman Alan Greenspan has worried in recent testimony that housing this time around may not contribute as much zip as usual to the recovery. And some experts have even determined that homeowners experiencing realized or unrealized capital losses on their properties cut back consumption more than they boost spending.

Even with many observers disputing that the housing market is a bubble about to burst, there are a few simple economic facts to consider. For housing prices to continue rising, either incomes are going to have to move up at an unrealistic rate, or interest rates are going to have to fall sharply. Because ultimately, home prices can only rise as fast as people’s ability to pay for them.

While we may see slightly higher home prices this spring, this will represent the final move upward for quite some time. There is substantially more overprices housing now then existing at the previous peak in the early ‘Nineties.

In particular, there is trouble ahead for the following cities with their overpriced percentages: Boston, 40%; San Diego, 35%; Fort Lauderdale, 34%; Orange County, Calif., 34%; Detroit, 33%; Oakland, 33%; Miami, 30%; Denver, 25%; and New York Metro Area, 24%.

A strong economic recovery in the second half of the year, together with rising mortgage rates might be sufficient to pop the housing market by deterring new buyers and increasing debt-service burdens of existing homeowners. Falling housing prices could administer the ultimate blow to an already fragile consumer confidence, in effect creating a negative wealth effect and blighting an incipient recovery.

In addition to high real estate valuation levels, there are three areas that further support the strong probability of a real estate bubble which are as follows:

1. ) Mortgage Debt: Over 50% of all mortgages in 1999 had down payments of 10% or less. Sometimes, new homebuyers can and have borrowed to pay the closing costs in 103% loan-to-value special mortgages. Sub-prime lenders at times even make 125% loans just to consolidate credit-card and auto debt into one loan package. The second mortgages give sub-prime lenders the hammer of additional liens on a borrower’s property and effectively take away his option to refinance at lower interest rates.

Three great waves of refinancing during the ‘Nineties also pushed US mortgage debt higher, as homeowners have increasingly used cash-out refinancings to suck additional equity out of their homes. It is estimated that Americans took $80 billion in equity out of their homes last year, compared with $50 billion and $28 billion, in 1998 and 1993 — the previous refinancing peaks. Meanwhile, home-equity loans jumped to more than $620 billion in 2000 from $287 billion in 1995. Increasingly, borrowers pay interest but do not bother paying down principal on their home-equity balances.

Twenty years ago, annual consumer-debt payments — basically mortgages, credit cards and auto loans — stood at around 60% of disposable personal income. That ratio has since risen steadily to slightly above 100% of personal income in the fourth quarter of last year. At $5.5 trillion, mortgage-debt accounts for the majority share of total household debt of $7.6 trillion.

Any significant jump in interest rates would hurt many debt-ridden homeowners. Interest rates are variable on over half of all credit-card accounts. Adjustable-rate mortgages that re-price in one-to-five years account for an estimated 15% of all outstanding mortgages. The more than $620 billion in home-equity-line loans have floating rates.

2.) Federal Housing Administration (FHA) mortgages: Delinquencies of FHA mortgages have soared to over 11%, the highest by far in the past 30 years. The FHA guarantees mortgages for many low-income, first-time homeowners. Also, the sub-prime mortgage market, catering to borrowers with poor credit histories, has seen a significant jump in its 90-day-plus delinquencies and foreclosure rate to 7.05% and 4.40%, respectively.

One can argue that FHA and sub-prime loans represent only the low end of quality spectrum. Their clientele, largely blue-collar and vulnerable to bad economic times, live in a world far removed from the more financially secure prime-mortgage customers. But it is hardly an obscure, insignificant precinct. FHA loans account for about 15% of the $5.5 trillion in US mortgage debt currently outstanding, while the sub-prime market comprises about 8% of the mortgage market.

It appears that the decidedly easing in credit standards in the mortgage market has worked to artificially pump up demand for housing in the last five to six years.

3.) Appraisals: Sound appraisals act as governor on home-price appreciation, however, inflated appraisals skew home prices higher than market forces might otherwise dictate. Unfortunately, appearance can effect reality in relatively inefficient markets like residential real estate. An inappropriate appraisal creates a new phony sale price that becomes an inflated comparable used to justify, in turn, ever more unreasonable sales prices in a self-reinforcing cycle.

Lenders in many markets no longer use “blind pools” of appraisers to insure independence and objectivity. Instead, lenders and brokers often use appraisers amenable to “hitting the bid” to justify higher loan amounts.

Traditional lenders, such as banks and savings and loans, sell far more mortgages into the secondary market these days than they keep in their portfolios. Hence, they retain little risk. And mortgage brokers, who account for an every-growing share of the home-loan orginations, have every incentive to push the size of the loans they arrange due to the higher fees based on the size of the loan made.

Also, some lenders are increasingly “modifying” or otherwise recasting the mortgages of troubled borrowers to artificially reduce delinquencies, defaults and foreclosures. Often, months of missed mortgage payments are merely tacked on the mortgage balance and the length of the loan is extended to get the borrower back on track. Sometimes, the delinquent mortgage holder can even garner a lower rate, making his monthly payment the same or lower, depending on the loan’s unpaid principal balance.


There are those who believe that real estate prices will continue to be supported due by overall demand versus available supply. They feel this demand for housing is determined by a combination of interest-rate movements and the number of people turning 30 for the year. While we may agree that a few small regional areas where demand may continue to exceed available supply due to land constraints; however, in true reality, real estate valuations are determined by interest rates, consumer income levels and overall level of consumer confidence. However, the key points mentioned above are additional evidence of a real estate bubble soon to burst.


On May 7th, the Federal Open Market Committee (FOMC) left the fed funds rate at 1.75% with a continued neutral bias. We anticipate the next fed move on interest rate will be in August 2002 with a cut to a fed funds rate of 1.50%. Therefore, we will remain with a strong allocation toward US treasuries until that time. However, since the US treasuries are due for a partial retracement, 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 resumption in the US treasury market rally, clients will be notified to liquidate the TIPS. 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 4.10%. We 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, as expected, this instrument will effectively lock-in the profits generated with the US bonds and STRIPS with an overall effective yield of 4.0%. (Note: This protection is only a short-term suggestion since the US treasuries remain within a firm uptrend for several months to come.);
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. (Note: the suggested cash percentage will decline once a bottom is confirmed within the treasury markets where the difference will be applied toward increasing both the conventional US bond and zero coupon bond positions);
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

Acknowledgments: National Association of Realtors, Bob Shiller, Author of the book Irrational Exuberance, US Census Report, Federal Data, Josh Rosner, Author of a report titled “Housing in the New Millennium: A Home Without Equity Is a Rental With Debt,” Mortgage Bankers Association.

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