WAVETECH ENTERPRISES, LLC
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw
Position overview . . .
In the September 5th newsletter, I wrote the wave pattern analysis for the DOW would not change to a bullish stands unless it closed above 11,320. Furthermore, I projected the DOW to be range-bound, but there was a strong chance of a selloff in the DOW to between 10,550 and 10,900 by late-September 2000, which offered a great shorting opportunity. The day after the September newsletter was released, the DOW put in it’s highest closing price of 11,310.64 and proceeded to selloff to a low of 10,567.32 by late-September 2000. The wave pattern analysis accurately projected the top, on a closing basis, and the bottom, on an intra-day basis within 20 DOW points, respectively.
This accuracy provided desirable profits for the short DOW position, but were reduced due to the diversification in the foreign currency spreads for the month. Depending on the five different trading models used, the return on investment for the month of September 2000 varied between -4.6% to +1.5%. This adjustment in profits brings the cumulative year-to-date gross positive return on management services to between 57.2% to 91.4%, which still represents a respectable performance since most mutual funds have no positive return for the year. The aberration in the currency markets is further discussed later in the section titled: “A strong dollar versus the EuroZone at least through this year’s election.” It is anticipated that the loss due to the currency spread this month will be more than offset with a higher level of profits next month since the currency spread position is still being held and expected to resume it’s respective primary trends.
Looking forward . . .
Currently, with the upcoming election, the DOW could be range-bound between 10,500 and 10,900. If the DOW does break above this range and rallies to 11,210, this will offer a desirable level to further reduce US stock holdings and/or a reasonable DOW shorting opportunity.
The US dollar should remain firm through the election and the remainder of this year, but could be due for a major change in direction as the current-account deficit reaches 4.2% of the US Gross Domestic Product (GDP), as discussed within the September 2000 newsletter. Once the US dollar starts this change in direction, the bond market, in all likelihood, will be putting in the highest price and the lowest yields, and will offer a desirable level in shorting the various US Treasury instruments from bills to bonds.
INFLATION, ONCE AGAIN, IS STARTING TO REAPPEAR:
It normally peaks after the economy peaks so it would not be unusual to see the economy slow and inflation continue to rise or accelerate. The lag between the peak in the economic cycle and the peak in the inflation cycle is not precise.
Economists have long recognized two types of inflationary impetus: “cost-push” forces from the supply side of the economy and “demand-pull” pressure. The upward tilt to core inflation is coming from red-hot demand, as many companies pounce on the opportunity to regain some pricing power. The Federal Reserve is trying to vent this demand-side pressure before spending tightens the labor markets so much the costs and prices begin to spiral upward.
The upward creep in inflation in 2000 makes the outlook for 2001 especially tricky. As discussed, next year could see an unsettling combo of faster inflation and a slower economy, especially if oil prices remain high and cut further into demand. Plus, any economic slowdown could complicate the inflation outlook. If as is widely expected, productivity growth slows a notch as overall output cools, unit-labor costs will very likely speed up, bringing new pressure from the cost side into play.
Prices are growing especially fast in the service sector. Core service inflation sped up to 3.4% in August. That’s the fastest 12-month pace in 4 1/2 years, and it’s up sharply from a low of 2.5% late last year. Moreover, the upturn in service inflation has been broad, although the biggest acceleration has come in basic housing costs, apart from energy, and medical care.
Unlike services, core goods prices aren’t twitching at all. Even without the month’s falloff in gasoline, core goods prices still declined 0.1%, and the yearly inflation rate, at 0.5%, shows no sign of turning up. Goods inflation is being held down by competition from imports, thanks to the strong dollar, and falling prices for new-technology goods.
Keep in mind, though, that services less energy are 54% of the total Consumer Price Index (CPI) and 70% of the core CPI. Far less directly affected by those factors, especially global influences, services are driven much more by domestic demand, especially from consumers. And so far, the question of how much household spending is slowing — and for how long — remains unanswered.
So far there is little evidence that higher energy prices are filtering through to the broader economy. Air fares have shown some upward drift, but that’s about it. Pricing power among goods producers is going to remain very limited, but chances for the pass-through of higher costs in the service sector are much greater if demand fails to abate in the coming year.
Another key inflation danger from spiking oil prices lies in how they ultimately affect inflation expectations. In particular, amid extremely tight labor markets, bigger energy bills — whether for gas or heating oil — are very likely to influence wage demands. Remember that back in 1998-99, nominal wage growth actually slowed, mainly as a result of the 1997 oil-related drop in inflation, which lowered the inflation expectations of workers. Despite the smaller nominal pay gains, real wages actually sped up.
Now, the opposite is occurring. After making great strides in 1997-99, real wages of production workers have stopped growing thanks to the oil-driven runup in inflation. Higher total inflation this year will push up wages growth next year, especially for workers with cost of living adjustments.
Throughout the postwar era, economic history has taught us that just when you think something is dead — such as inflation — that’s usually the time to keep an eye on it. This looks like another one of those times.
A STRONG US DOLLAR VERSUS THE EURO-ZONE AT LEAST THROUGH THIS YEAR’S ELECTION:
Many Europeans think the dollar’s strength is sapping the life out of their single currency. The sense is that the euro does not have a chance until the dollar stops hogging all of the world’s capital. But it’s doubtful that intervention alone could bail out the flagging euro. All that’s changed over the last three weeks is that the G7 has intervened — not the forces undermining the euro. It’s being dragged lower by genuine capital flows out of the 11 European Monetary Union (EMU) countries to America. That will not change until European markets offer higher returns and European companies stop acquiring US ones.
Meanwhile, the US economy continues to grow faster than Europe’s and is experiencing a productivity boom that has made America an attractive investment destination. The dollar’s brawn is a natural byproduct of an economy that’s undergone an information technology paradigm shift ahead of others. The rest of the world still has a ways to go before investments in productivity-enhancing technologies pay off, and it’s not surprising that capital would flow toward America.
In Europe, the slow pace of structural reforms, particularly those relating to labor markets, remain a concern. And the kind of political uncertainty that have plagued the euro are not going away. The European Central Bank (ECB) still must conduct interest-rate policy for 11 disparate economies, some of which are growing rapidly, while others are inching along. That number will grow to 12 next year when Greece joins EMU. The number would have reached 13, if the Danes had voted in favor of the euro. They did not, and that certainly will not help the euro’s credibility problems.
Furthermore, last week, the ECB raised it’s key repo rate to 4.75%, which was aimed at keeping inflation pressure under wraps, and failed to get a productive move upward in the euro. The ECB tightening reflected concerns about the combination of fast money growth and surging international oil prices. Yet economist worry about the ECB’s ability to walk a tightrope between containing inflation and not killing the euro-zone economy. The risk is that the European growth is already slowing and the latest rate hike ends up putting even more pressure on the euro later this year.
SUMMARY AND CONCLUSIONS:
As inflation continues to reappear and our economy slows, it will become even more important to have a proper asset allocation into types of trading instruments like the derivatives/futures markets where profits can be generated by either going long or short the various stock indices, bond instruments and/or foreign currencies. This type of trading instrument can serve as a hedge and/or offer further diversification through a period of consolidation or major stock market correction.
The US dollar could remain the currency of choice through the end of this year, but if and when the imbalance of the current-account deficit (currently 4.0%) reaches between 4.2% to 4.4% of the US GDP, we could see a significant reallocation of funds out of US dollars as explained in detail within the September 2000 newsletter. This would ultimately have a major effect in values for the US Treasuries as well as Corporate bonds, and cause a significant decrease in price, increase yields for these instruments.
Should you have additional questions regarding the topics discussed this month, would like a copy of a previous month’s newsletter, or have questions regarding the management services, please reply with your question and we will be glad to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400