WAVETECH ENTERPRISES, LLC
Private Account Management Services
Newsletter Issued 05-10-05:
By: John T. Moir
Chief Editor: Sara E. Collier
Position overview . . .
Our previous newsletter, dated April 8th, forecasted a DOW trading range between 10,200 and 10,565. We further stated that if the DOW produced an end-of-the-day close below 10,385 it could quickly decline to the next level of support at 9,800. We appear to have been partially correct in our assessment of the DOW, with the actual trading range for the month between 10,000 and 10568. The DOW traded below the key support level of 10,385 and continued lower as forecasted, but found formidable support at 10,000. This new level of support created a counter trend rally toward the previous key level, now referred to as resistance, at 10,385. The technical process for the stock market decline is unfolding, but the major stock indices are carefully evaluating each support and resistance level before continuing lower.
The US treasuries were predicted to resume their rise in price and decline in yield during the month. Again, this proved to be accurate, with the release of a weak retail sales report, higher than expected jobless claims numbers, and lower than forecasted gross domestic product (GDP). We further stated that the rise in crude oil prices has not produced runaway inflation as most are expecting, but is actually a tax that will knock a full percentage point off of the GDP. Inflation levels remain contained at 3.0% (excluding food and energy at 1.7%), even with the dramatic rise crude oil prices, currently at $52 a barrel.
Looking forward . . .
Crude oil inventories are almost at a three-year high. The draw down in the fourth quarter of last year was the result of the hurricanes, which ravaged oil production in the Gulf of Mexico. Gasoline stockpiles are even more plentiful, at their highest level in five years. It appears that oil traders have adopted the same one-way mentality that currently dominates real estate, at least until fundamentals can no longer be ignored.
Sometime during this second quarter, oil traders are going to realize that the current oversupply of crude oil and gasoline can cause prices to fall. We feel that crude oil prices will trade down, from their peak of $58 a barrel to $45, or possibly lower. By late summer, OPEC will be cutting production to support oil prices.
A decline of this magnitude in crude oil prices will likely spread to some of the other raw materials commodities that have experienced large price advances, such as copper, lumber and other metals. If commodities ease as we expect, the inflation pressure from raw-material prices will lessen. This may take several months to develop, but inflation worries should abate, and ignite speculation of a pause in Fed rate hikes.
We feel that the non-farm payroll employment number, showing 274,000 new jobs, released last Friday, was merely an aberration. This level of job growth would indicate that the US economy is improving at an annualized rate of nearly 6%. There is simply no feasible way that such levels of growth exist, especially when our GDP was just released less than two weeks ago at 3.1%. Therefore, we feel the April jobs data vastly overstated economic conditions last month. The gains that supposedly occurred in retail, construction and telecom just do not coincide with what has been happening in those sectors, leading us to conclude that next months report will show a revision to this release and a non-farm payroll number around 130,000 with an unemployment rate of 5.3%..
THE REAL ESTATE BUBBLE CONTINUES:
When the economy slowed during the last recession, the Federal Reserve dramatically reduced interest rates in order to stimulate the economy. Not only did these actions successfully boost economic activity, but they also led to significant property value increases.
Real estate investors and speculators have taken advantage of the 40-year low borrowing rates, and have purchased, and are still purchasing, as much property as they can finance. Total mortgage debt outstanding has been increasing at a significantly higher rate than normal (up 12% since last year), while the average amount that investors have borrowed against the value of their homes has increased to near record levels of 45%.
As rates have hovered at historic lows, real estate has become an attractive, seemingly risk free investment alternative. In the past year, real estate values in some cities have appreciated by over 50%. Anecdotally, we have heard numerous people say that real estate prices never go down. Either these people have forgotten the pain caused by real estate bubbles in the late 1980s and early 1990s, or they have never experienced the previous bubbles because they are new to real estate investing.
People seem to get a kick out of being the highest bidders and securing the property they always dreamed of owning. Buyers that are trying to project a more sober attitude invent innumerable reasons to justify their purchase. Since we are certain that a majority of people have heard the arguments — which are outlined in detail within our October 2004 newsletter — we will spare illustrating them once again. Suffice to say that they are almost identical to the ones used in the late 1990s and early 2000 to justify the purchase of overvalued equities.
Without a doubt, houses have become the single most important source of wealth, and housing prices are expected to rise in perpetuity, offering double-digit returns every year. Studies show that homeowners expect significant price appreciation every year for the next ten years, and this holds even in smaller markets, with estimated increases of 11% to 13%.
It appears that most people confuse the level of prices with rate of change. A large number of households think now is a good time to get into the housing market because it is a good investment. The operative word here is investment. And, since all of these “investors” are often in need of cash, they expect their “investment” to pay some sort of dividend, which in this case comes in the form of equity extraction.
In 2004, equity extraction equated to $237 billion, and allowed investors to increase their liabilities while decreasing their assets. This has been a very popular tactic in the world of high finance.
However, as there exists the attitude that nothing matters — this too does not matter — since the net worth remains supposedly solid. The problem is that net worth is only half of the true picture. The other half is called debt-to-equity ratio, to which no one pays any attention.
Here is an illustration of this debt-to-equity ratio: If we have assets of $1,000 and liabilities of $100, our net worth is $900 ($1000-$100) and the debt-to-equity ratio is 0.1 to 1 ($100/$900).
If we borrow $2,000 to buy an asset, then our assets grow to $3,000 and the liabilities to $2,100. The net worth, however, remains the same at $900 ($3,000-$2,100), while the debt-to-equity ratio increased to 2.3 to 1 ($2,100/$900).
When the housing rage ends, people will realize that low real interest rates along with creative financing, and not absurd theories, were responsible for all of it. And then, all of the 20-something self-described real estate investors will have to acquire a real job just like their dot-com predecessors.
Long-term conclusions and current month expectations . . .
The GDP growth level, mentioned earlier, at 3.1% in the first quarter of 2005, was down sharply from the 3.8% growth in last year’s final quarter. It was also down from the 4% as many of the Wall Streets’ pundits had been predicting, just a few weeks prior to its release. This was the feeblest growth in GDP since the first quarter of 2003.
Last week, even with this recently released weaker than expected GDP number, the Fed remained steadfastly confident in the underlying strength of the economy, and raised the prevailing fed funds rate by .25% (25 basis points) to 3.00%. Whatever the Feds particular motive, it is a safe bet that the stock market is not destined to rally anytime soon, but will continue it’s downward trend. The affects of these interest rate hikes are not apt to prove exactly positive for the US economy, either. The GDP report made it very clear that business is less than robust. What we were especially struck by was the huge involuntary build-up in inventories, which climbed $80.2 billion, compared with $47.2 billion rise in the previous quarter.
It appears that businesses have gone into a defensive mode as a means of working off the sizable overhang of inventories, which does not bode well for an already highly leveraged and job stingy US economy. This defensive mode should provide for a DOW trading range during the month between 9,800 and 10,410. There is formidable support at 10,000, which produced a counter trend rally to DOW 10,400 late-last month, but all of our wave pattern technical analysis concludes us to believe that we should breach this level and continue the bear market decline for all of the major stock indices.
The US treasuries are in the process of completing a period of consolidation prior to resuming its bullish trend, either today or tomorrow. The quarterly refunding auctions occurring this week should underpin the 3, 5 and 10-year US treasury notes, which should continue their rise in price and decline in yield with the release a additional weak fundamental data later this week, further confirming the slowing US economy.
The US dollar is at a pinnacle turning point at euro fx equivalent of $1.28, based on our wave pattern technical analysis. Meaning, if the US dollar rises and the euro fx equivalent declines below $1.27, we could see a very rapid advance within the US dollar. This rally would be propelled by various US and foreign central banks being forced to offset their short US dollar positions by buying US dollars. This may seem improbable with the large trade imbalance and the ever rising federal deficit, but it could happen — shocking central banks throughout the world — before the US dollar resumes a more defined bearish trend.
SUGGESTED INVESTMENT ALLOCATIONS:
1. A 75% to 85% allocation of their taxable ordinary funds and/or tax-deferred funds into a conservative as well as flexible investment strategy using various no-load index mutual funds and exchange traded funds (ETF’s) offered through our Private Account Wealth Management Services. The minimum investment criteria are determined after reviewing the investor’s current assets and fund allocations. These services are ideal for individuals, trusts, foundations and privately held corporations who have liquidated large stock, bond and/or real estate holdings and are seeking an active management service to generate a positive rate of return between 12% to 35% per year (after fees) through either a rising or declining stock, bond or real estate market.
2. A 15% to 25% allocation toward 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.
If there are any questions regarding the information discussed within this newsletter, the investment allocations mentioned above or our unique management service, please call the number provided below or e-mail us and we would be happy to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
Acknowledgements: Federal Data, Study by: Robert J. Shiller of Yale University in 2003.
Note: These newsletters have no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. These newsletters are issued for informational purposes and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. These newsletters are based on information obtained from sources believed to be reliable, but are not guaranteed to be accurate, nor are they a complete statement or summary of the securities, markets or developments referred to in the various newsletters. Recipients should not regard these newsletters as a substitute for the exercise of their own judgment. Any options or opinions expressed in these newsletters are subject to change without any notice and the Wavetech Enterprises, LLC newsletters are not under any obligation to update or keep current the information contained within. Past performance is not necessarily indicative of future results. Wavetech Enterprises, LLC and its newsletters accept no liability for any loss or damage of any kind arising out of the use of any or all parts of these newsletters.