Interesting reading from unknown source:
Bigger maybe better since we are seeing large cap companies, with
relatively low revenue growth, merge or acquire. In the last week we saw
America On Line announce their plans to buy Netscape for $4.3 billion,
Tyco buying out AMP for $11 billion, International Paper merging with
Union Camp in a $5 billion deal, Deutsche Bank merging with Bankers
Trust for $9.7 billion in cash, Provident merging with Unum valued at
$5.2 billion, and the big block-buster of Exxon getting close to an
offer to buy-out/merge with Mobil at a potential value of $80 billion.
Believe it or not, this is only a few of the mergers announced last
week. Revenues have stalled, expenses have escalated, and during the 3rd
quarter earnings were down 6.2% versus a year ago, for the steepest
earnings decline since 1989.
Each time we enter merger mania, creating larger companies, it allows
the survivor to announce lay-offs of the overlapping employees, and add
a few more computers who don't strike or require fringe benefits. Where
will it end?? Beats me, but every round has produced huge employee
lay-off announcements. In the last 3 months, we have seen the highest
number of lay-off announcements since the 1991-93 economic trough.
The stock market has rewarded this process, with the bigger stocks
soaring. During the latest week the large-cap dominated NASDAQ reached a
new all-time record high. This comes on the heels of a panic decline 2
months ago.
It is mind-boggling to witness the explosion of money supply in the last
three months alone. These statistics may not mean too much to you when
you see them, but for the last one year the M2 aggregate of money supply
has increased by 8.5%. If you annualize the growth in this aggregate for
the last 13 weeks, you find that number growing at 14%. This is
occurring with the nominal Gross Domestic Product growing at only
slightly above 4%. This condition is appropriately called flooding. It
is this flooding that has propelled the Dow Industrials, the S & P 500,
and now the NASDAQ composite to move to new all-time record highs, with
little regard it seems about over-valuation. For example, the latest
price to earnings ratio of the S & P 500 has moved to 31.29. If anyone
had predicted such a lofty level two years ago, they would have been
laughed out of the room. Even the Valuation composite, which adjusts the
P/E and price to cash flow ratio for inflation, is at the highest
valuation in history--by far. But now it seems to be an accepted fact by
the herd.
In the area of economic activity, if there is more money than can be
immediately applied, it floods over into financial instruments. For two
months in a row, the personal savings rate has dropped into negative
territory. Of course this is a very faulty calculation in one sense,
because it does not account for any capital gains achieved by the
investor. But in another sense, it is very revealing. It is telling the
Federal Reserve, and anyone else who will listen how vital it is to the
health of the economy to keep stock and bond prices up. With the huge
amount of mortgage refinancings, it is also important to keep the real
estate markets healthy. We believe that future statistics will reveal
the panic of the August decline in stocks caused a massive amount of
selling of long-held stock positions by the public investor, with huge
capital gains being realized. This is partly confirmed by the huge
amount of assets that have moved into money market mutual funds. Last
week, during only four days, there was $9.83 billion stashed away in
money market funds. This was not just a 1-week phenomenon either. So far
this year, there has been a total of $170 billion added to these funds,
with $100 billion of that in the last three months of panic.
In addition to this, we certainly have seen that the very low bond
yields prompted mortgage refinancings at record levels. We wouldn't be
surprised if many of those refinancings were not for a slightly larger
amount of money than the previous mortgage, giving a little extra bounty
for the consumer to spend.
And they certainly have spent. According to the latest statistics, and
the rush of Christmas traffic, the US consumer is doing its part to save
the world's economies. We believe the health of the US economy, and
consequently the world, is almost totally a result of the wealth effect.
By the way, if we are right, this same phenomena will make the US tax
receipts from those capital gains grow substantially as US 1998 taxes
are paid, which could easily open the door for vital tax cuts to be
enacted in 1999 as Clinton greases the skids for Gore's attempt into the
White House.
Like a lot of other things in life, however, the above set of conditions
has its good side, and its bad. The immediate gratification has
certainly taken away most of the bruises from the panic decline in
August. But the bad part is that it has not cured the root problem. We
had to make a major adjustment in our year-ahead outlook last week as
the huge input of money supply altered the course of events. We believed
that the stage was being set for a period of about 18 months when the US
Federal Reserve would be forced through several different financial
panics to drastically lower "real" interest rates to the healthy level
of 2%. Certainly, they have brought the nominal fed funds rate down from
the 5 1/2% to today's 4 3/4%, but with the GDP deflator dropping to a
0.9%, the "real" rate is still almost 4% above inflation. At this level,
it still doesn't encourage healthy economic expansion, or financing of
new start-up growth opportunities.
At the same time, China, in its own way has done the same thing as our
Fed, but even more potentially devastating. They have thrown money that
they don't have at massive new infrastructure building to try to offset
the natural economic weakness. Japan has also finally gotten the
message, as they are headed down another onslaught of deficit spending,
using their citizen's savings as a forced source of funds. Their new
"flooding" of the system is the same old solution that they have been
using for the last 10 years, and once again, we do not expect it to be a
life-saving experience. But with all this money sloshing through the
system, it is like putting the patient on a breathing machine. It says
breath whether you want to or not. Nobody is letting anyone die a
natural death. So instead of expecting a start and stop economy as we
had painted in our early September analysis, the artificial
resuscitation has made the breathing go back to look normal. But
somewhere out there, the patient will have to come off the machine, and
the longer it stays on it, the more the patient will depend upon it.
As a side note, Greenspan has practiced his flooding the system already
once in his tenure. After the 1987 crash, he flooded the system, and the
much anticipated economic slow-down did not occur. But by May of 1988,
he started to put the brakes on again, which led eventually to the 1990
recession. We wouldn't be surprised to see May, 1999 return to that
discipline again. The one big difference this time will be the relative
valuation between the two periods.
Lawrence Lindsey, a former Fed Governor, is interviewed in Barron's this
week. His comments are outstanding, and he states that the current
economic expansion is the most unbalanced in the US since at least the
1920's. You can certainly see that in the statistics. For example,
Japan's economy is obviously terrible, and their highly touted new
Finance Minister who pushed through some of the latest reform
suggestions is now quitting his job. Russia is collapsing, and in Latin
America you find key countries like Argentina with their industrial
production plunging at a 17% rate. Brazil's real GDP is declining at a
6% rate, and in relatively healthy Mexico, we are seeing auto sales down
27.4% in October. Now we see European countries, where exports are
higher than imports, start to sag based upon this world weakness.
Lawrence Lindsey expects a Euro banking crisis in 1999.
The unbalance is also very obvious by breaking down the US economy.
While the service sector is still enjoying prosperity, and their workers
are seeing nominal wages increase at a 9.1% annual rate, the
manufacturing wages advancing at a much more subdued rate of 3.6%, while
farmer's income is plummeting this year down 32%.
The best barometer to measure all this unbalanced economic activity is
the price of commodities. Every index shows major declines, and last
week, the price of aluminum and copper took another step backward. So as
we sit here in the warmth of the US, the rest of the world is suffering
badly, and highly dependent on exports to the US.
At the same time, almost every index has made some kind of revealing
upside break-out in the last three weeks. Technically, these break-outs
predict a further move up. It makes for a very exciting projection, with
the Dow Jones Industrial Average now giving off a 10,000 target
projection in the months ahead. But instead of the fed funds rate
falling further as we had expected in the 3 steps up and 2 1/2 steps
down in our original expectation, in today's current euphoria, the Fed
will be hard-pressed to keep the money flowing in the months ahead, as
it has done in the panic months behind. We now do not expect any more
cuts in the fed funds rate until this euphoria has had a chance to run
its course, and the financial markets return to reality.
There is no doubt that market psychology is bubbling. For example,
bullish advisory service sentiment moved up to 57.9% last week. The
weekly equity put/call ratio dropped to 37%. The 3-week average of this
put/call ratio dropped 8% under its 39-week moving average. As a result,
our psychology composite is losing a little of the power that eventually
scared the Fed into cutting rates. Eventually, now, we expect a return
in the months ahead to the "herd" becoming worried about a Federal
Reserve that might have to tighten again. But that is still a few months
away. Our guesstimate is that the euphoria and this bull-market will
remain intact until the April seasonal strength runs its course.
We haven't changed our expectations of the new healthy conditions, but
only postponed it until a later date, when reality is accepted, and the
patient is made to breathe on its own.
But instead of expecting a healthy bout of pain in the months ahead,
with each panic attack prompting another interest rate cut, we now
expect a blow-off in the market that will continue until our asset
allocation falls into negative territory. In our opinion, the stock
market is highly dependent upon the bond market. Until bonds, and the
monetary composite drops into negative territory, the optimistic bubble
will just continue to grow and grow. The first hint that we receive will
come from the dollar getting hot again, and then Mr. Greenspan will dust
off one of his "irrational exuberance" speeches.
But so far, so good. Stay in there with the bullish trend, but avoid the
temptation to chase the speculative favorites. |
