WAVETECH ENTERPRISES, LLC
By: John T. Moir
Chief Editor: John Allen
Associate Editor: Barbara Crenshaw
Position overview . . .
In the August 6th newsletter, I wrote that the DOW would hold the tops placed on June 5th and July 20th at 10,863 and 10,874, respectively. To my surprise, the DOW has made another extended move this past Monday to 11,319.06. There were two additional attempts later in the week to pierce that level, that proved unsuccessful.
Even with the various S & P 500 hedges to reduce the DOW short position exposure, there was still a loss for the month between 1.5% to 2.4%. However, with diversification in the currency markets and a few productive currency spreads, the overall monthly return was positive. Depending on the client profile and the five different trading models used, the return was between 4.2% to 6.3%. This brings the cumulative year-to-date gross return on management services to between 61.8% to 89.9%.
Looking forward . . .
Currently, even with this recent rally to 11,319.06 in the DOW, the wave pattern still suggest that there will be a retracement in the DOW to 10,550 and possibly lower. The wave pattern would only change to a bullish tone if the DOW closed above 11,320. However, with its three failed attempts last week, it is simply offering an opportunity to further reduce stock holdings. With the upcoming election, the DOW, along with the other major indices could remain “range-bound” until late-November 2000. In the month of September we could see the DOW offer a reasonable shorting opportunity by declining to between 10,550 and 10,900. Diversification into the foreign currencies and the bond market will also prove a useful tool like in the month of August 2000 in augmenting profits.
Why do people invest large amounts in a down market?
There are several psychological reasons for investor’s commitment to the market. One is simply the Baby Boomers’ love of investing. The stock market has become a cultural phenomenon that provides intellectual and emotional challenges that evoke this generation’s need to test their skills and talents.
Another is that this generation is enchanted by technology. Couple their love of investing with using the latest gadgetry and the combination has proven to be most addictive. Now, add the Internet sites that have turned investing into a form of entertainment and advertising that touts quick riches and you have created a generation that feels empowered to win. If not, certainly, compelled to win.
Additionally, this generation of Baby Boomers is among the most optimistic in decades. Hope lures most people into the market with the promise of fulfilling financial fantasies and dreams otherwise unavailable to them. Realistically, where else does the average person turn to build a secure retirement or chase the escalating college costs? It is hope that keeps investors in the market through downturns where few are making money and shows us to be more conditioned to not missing out on a market upturn then suffering a bear market downturn.
The mutual-fund industry spent years educating the public about long-term investing, and their efforts have finally paid off, but no one quite believes yet.
There are three key catalysts that further justify a stock market correction or bear market:
STOCK-MARKET CAPITALIZATION AS A PERCENTAGE OF NOMINAL GDP:
From 1920 to 1995, this percentage has varied between 20 and 80 percent. Prior to major stock market corrections, the stock-market capitalization as a percentage of nominal GDP was at 80 percent. This was the case in 1929, 1968, and 1974. In all three years, this percentage peaked about 6 to 12 months prior to the major corrections.
Currently, this percentage is at 165 percent and it peaked about 6 months ago at 180 percent. With this relationship between total value of the market and GDP, it raises major levels of concern. What it tells us is that despite the great damage done to the various sectors, this market by any historical — or rational — yardstick is still unbelievably too high.
The great stocks, the ones that provide such a disproportionate share of the market’s capitalization and which funds own by the ton, are thus also unbelievably too high. The day of reckoning will not come to pass until they fall back down to earth.
INSIDER STOCK SELLING CONTINUES:
Insiders are hell-bent to sell, which is outstripping insider purchases by record amounts. Now insiders — management, directors, venture capitalists and other big holders — are not necessarily smarter; however, they do enjoy access to information we poor mortals lack. Certainly, the huge cascade of fledgling-company stock that has flooded into the market this year (price be damned) once the lockup restriction were lifted, intimates a foreknowledge of what is in store for such companies.
In a recent report, insider selling of big blocks of stock (large being defined as with a value of at least $1 million worth or 100,000 shares or more) weighed in at $43.1 billion. That’s twice as much as sold in the comparable spans of 1998 and 1999.
Furthermore, this year’s insider selling in the first half tops the record $39 billion similarly disposed of in all of last year. Based on the SEC filings, there is plenty more where that came from. Also, the buildup of the new-issue calendar endangers the precarious balance between supply and demand in the stock market as illustrated in the February 2000 Newsletter.
RECORD CURRENT-ACCOUNT DEFICIT AND POSSIBLE U.S. DOLLAR BUBBLE:
While Washington’s budget has moved into the black, the nation’s external balance has plunged deeper into the red. The record current-account deficit has been readily funded with foreign capital, which has been an unsung hero of America’s impressive economic performance in recent years. The willingness of foreigners’ to send money to the US, has lowered bond yields and provided fuel for the massive private-borrowing spree that’s propelled the economy to sights unseen. Problem is, the influx of global capital depends to a great degree on confidence that the US economic miracle will continue.
Today, foreigners own over $6.4 trillion of US assets (66% of US Gross Domestic Product (GDP)), compared with US holdings of foreign assets of $4.7 trillion (48% of US GDP). In 1990, foreigners owned assets valued at just 33% of GDP. On net, the US has an unprecedented asset imbalance equal to 18% of US GDP.
Foreigners also own a record 38% of the US Treasury market. Excluding securities owned by the Fed, foreigners own an astounding 44% of the liquid government securities market. They also own a record 20% of the US corporate bond market. To put these figures in perspective, foreigners own just 8% of the US equity market, 14% if you include foreign direct investment in US companies. Simply put, the bond market is on the front line if international investors shun dollar-denominated assets.
The point here isn’t that foreign ownership of US assets is bad. To the contrary, it’s a vote of confidence in America, and is necessary. Remember, the balance of payments, by definition, must balance. A current-account deficit requires a capital-account surplus.
But what if a darker scenario unfolds? In the first quarter, the US current-account deficit surpassed 4% of GDP for the first time and some analysts see it widening to 4.4% by 2001. This worries many experts who think economies typically hit the breaking point at 4.2% of GDP.
Indeed, it maybe the clearest and most present risk to the nine-year expansion. If foreign investors were to become less willing to send capital here on such favorable terms, interest rates would rise and the dollar would fall. This would hardly be positive for stocks already priced at historically high valuations. And, it could induce the central bank to tighten further, perhaps sufficiently to abort the record economic expansion.
A softer dollar won’t help since several economist warn that the America’s current-account bubble will inevitably deflate, causing the dollar to lose between 12% and 45% of its value. The larger figure is possible if a curtailment of capital inflows forces the current-account rapidly into balance in an Asian-style crisis. A 12% drop may occur even if there’s a gradual, orderly contraction in the current-account gap.
SUMMARY AND CONCLUSIONS:
With the 2000 election fast approaching, if foreign investors start to draw the conclusion that both Al Gore or George W. Bush will make major changes in US economic policy, they have piles of dollar-denominated assets to sell, which would be first felt in the bond market. Foreign holdings are substantial and so much larger than US assets abroad, that they are a long-term risk to the US financial markets.
Clearly there are signs that foreigners are inclined to continue holding US obligations since Uncle Sam is having trouble inducing overseas investors to participate in it’s debt-repurchase program. This program was over $1.5 billion two weeks ago. A good outcome isn’t assured. Several economist are painting a gloomy picture of the current-account imbalance. Not only could it cause a hard landing in the economy in the short run, but it could forever weaken confidence in the United States as the solid cornerstone of the world economy.
In this type of changing global environment, normal stock and bonds portfolios will only offer a limited amount of protection through adverse equity exposure with the scenarios discussed above. It is important to consider other types of trading instruments like the derivatives/futures markets where profit can be generated by either going long or short, and can serve as a hedge and/or diversification through a period of consolidation or major stock market correction.
Should you have additional questions regarding the topics discussed within this months newsletter or would like further information regarding the investment management services, please reply with your questions and we will be glad to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400