Heinz:
A Hong Kong guru's commentary. I agree with much of what he says but think he is dead wrong on tech stocks. The next rebound will be led by value stocks IMHO
Gold and Stock Market Update
Overview
Bonds ? the rally we were expecting has commenced and should continue for the next few weeks.
Stocks ? a correction is underway and should continue, with the occasional rebound, until late Feb /
early March.
Gold ? heading towards a low in early 2000. We expect gold to rally strongly from whatever low it
reaches during the first quarter of 2000.
Explaining the Markets
With today's proliferation of financial news across several media there is never any shortage of
explanations as to why the market did what it did during any trading session. For example, we are
told that the big hits taken by stocks on Mon and Fri of last week were due to interest rate concerns.
In particular, strong economic numbers released on Friday supposedly mean that interest rates will
now rise further and faster, thus reducing the attractiveness of equity investments. This may be
true, but at the same time that stocks were taking a bath long-term interest rates were declining.
One of the explanations put forward for this apparent anomaly is that the supply of T-Bonds will be
reduced as the US Government pays off its debt (this is a case of 'spin' getting the better of reality,
but that's another story). A reduced supply and a constant demand naturally mean higher T-Bond
prices (lower long-term interest rates).
It all sounds very logical, but where was this logic two week's ago? When the price of T-Bonds was
dropping like a stone almost every day, not a word was heard from the experts in the financial
press about a reduced supply resulting in higher prices. So, what has changed during the past two
weeks? The answer is nothing, except price. When bond prices started to rally (as we predicted they
would) the pressure was on to come up with a plausible-sounding explanation.
With regard to stocks, there is no doubt that higher interest rates are a negative influence.
However, since Oct '98 the senior stock market averages have zoomed upwards in parallel with
rising interest rates. Therefore it is certainly wrong to think that rising interest rates have an
immediate effect on stocks. It is clear there were, and still are, other forces at work in the market.
When stocks drop sharply the experts are obligated to tell us why ? this is what they are paid to do
(or at least what they think they are paid to do). With the Fed likely to raise rates next week and
bond yields having recently touched their highest levels in more than two years, interest rates
provide a convenient and plausible-sounding reason for the sell-off. And, if the stock market rallies
during the coming week in parallel with an increase in official interest rates (as we suspect it
might)? Well, the popular explanation will most likely be that the market is now confident the Fed
has inflation under control and that further rate increases may therefore not be necessary.
Putting aside the explanations that are currently being bandied about concerning last week's
machinations in the financial markets (interest rate fears, reduced T-Bond supply, hedge funds in
trouble, etc.), here's our take on what happened. Bonds have rallied because, until one week ago,
they were completely friendless. Bullish sentiment had plummeted to all-time lows, meaning that
the vast majority of short-term traders were lined up on one side of the trade. In other words, there
was no-one left to sell. Under such circumstances a rally is almost guaranteed. Stocks, on the other
hand, were at the opposite end of the sentiment spectrum. There was widespread bullishness with
the vast majority of market participants having poured all available money into stocks for fear of
missing the next huge move up. Such circumstances almost guarantee a near-term drop. When
sentiment is so lopsided virtually anything can act as a catalyst to propel the market in the direction
opposite to that expected by the majority.
Inflation Watch
Whilst short-term fluctuations in the markets can often be explained by psychological factors, we
do not wish to downplay the influence of fundamental issues. Our Year 2000 Forecast stated that
"we believe the Fed will move aggressively during the first few months of the year to mop up the
excess liquidity that was introduced during the latter part of 1999 to combat a perceived Y2K risk.
Such an action on the part of the Fed would tend to put upward pressure on short-term interest
rates as money becomes less readily available, but would provide a boost to long-term bonds as
expectations regarding the future rate of inflation are lowered". Although the contraction in the
total money supply that has occurred during the first few weeks of the year is small compared to
the massive increase that preceded it, any contraction is significant. In fact, even a reduction in the
rate of growth would have an effect since the 'credit bubble' requires the creation of money in
ever-increasing amounts for its sustenance.
The fundamental change in the monetary outlook that has occurred since the beginning of the year
has, and will continue to have, knock-on effects. With excessive leverage and a proliferation of all
sorts of derivatives within the financial system, an unexpected trend change will tend to be
self-perpetuating as speculators rush to close-out their wrong-way bets. The current situation, with
an inverted yield curve, a dangerously extended stock market and highly-leveraged players lined up
on the wrong side of an unfolding trend change, provides a huge challenge for the 'crisis managers'
at the Fed and the Treasury. The outcome of next week's FOMC Meeting will thus be more
interesting than usual. A rate increase appears certain, the only question being whether it will be 25
basis points or 50. A 50 basis point hike would probably be the more positive result for both the
stock and bond markets (because it would be seen as mitigating the need for further Fed action) and
is the right move based on the accumulating evidence of pricing pressures throughout the economy.
However, such a move would tend to exacerbate the inversion in the yield curve. We don't know
whether a further increase in short-term rates relative to long-term rates will create a major
problem for banks and large hedge funds, but the Fed surely is aware of the risks. It is possible that
Greenspan and Co. may soon find themselves having to inject liquidity to 'fix' yet another crisis of
their own making.
Finally, it is truly astounding that many commentators have portrayed the 5.8% increase in 4th
Quarter GDP (reported on Fri) as bad economic news. Growth is good! Low unemployment is
very good! Excessive credit expansion is bad! Real economic growth and credit expansion are two
completely different things ? you can have one without the other.
The US Stock Market
The early January low in the March S&P was taken out decisively during the past week, with the
nearby futures hitting 1362 at one point on Friday before closing at 1366. Friday almost certainly
didn't give us the ultimate correction lows and further declines over the next 4 weeks are very
likely. However, with a lot of trepidation now in the market due to the recent sharp drops in the
major indices and the upcoming FOMC Meeting, a strong rebound should occur very shortly.
Whatever low point is reached on Monday or Tuesday (or Friday's 1362 level if this is not taken
out during any further sell-off early in the coming week) will then provide the next line in the
sand, penetration of which will probably set off another round of liquidation.
Whatever happens over the next month as the market tries valiantly to restore some semblance of
value, the inability of the S&P to surge upwards in January makes us far more confident that we
have not yet seen the ultimate highs of this bull market. We also note the current strength in the US
Dollar and the weakness in the gold price ? these are certainly not the characteristics of an equity
bull market finale (especially not the greatest of all equity bull markets). What this means is that
when a few more high-profile support levels are taken out (for example, Dow 10,000) and
pessimism is running rampant, another buying opportunity will be upon us. In other words our
longer-term outlook for the stock market, and tech stocks in particular, remains bullish. In the
short-term the market holds considerable downside risk.
Gold and Gold Stocks
Over the past few years the easiest way to make a small fortune in the stock market has been to start
with a large one and then invest in gold stocks. However, our belief is that things are about to
change and gold will be one of the best performing market sectors for many years to come.
In the very short-term the outlook is not quite so rosy for anyone who has a long position in gold
or gold stocks. Firstly, Market Vane's bullish sentiment reading for gold was still around 40% as of
last week meaning that the level of optimism is far higher than would normally be found near an
intermediate low (we expect that bullish sentiment will have dropped into the 20s before a
sustainable rally gets underway). Secondly, the latest Commitment of Traders data shows that
commercial interests are slightly net short COMEX gold futures. A rally is unlikely to commence
until the commercials are significantly net long. Thirdly, gold stocks continue to perform poorly,
indicating that the gold price is likely to move lower over the near-term.
With last Friday's sharp fall in both gold and gold stocks, some our favourite gold stocks have
reached prices that represent exceptional value. Anyone who currently has no gold stock
investments may consider taking an initial position in Harmony Gold (HGMCY) at around $5 and
Gold Fields (GOLD) at around $4. As far as the North American gold stocks are concerned,
Franco Nevada (FN) is our preferred investment and represents good value at around C$20. For
those who already own some gold stocks we recommend that no further purchases be undertaken
until there is some evidence that gold has bottomed.
It is almost never sensible to try to pick a bottom in a stock or an index. A safer tactic is to wait
until a bottom has been established and the trend has turned up before committing significant
investment dollars. It is much better to miss the first 10% of a rally than it is to catch the last 30%
of a decline. We will only be confident that a bottom has been established in the gold market when
we see the following:
a) Much lower levels of bullish sentiment
b) The commercial interests net long gold futures
c) A BUY signal from our gold momentum model (currently, a BUY would be signaled with a
daily close of 286.75 or above for spot gold AND 65 or above for the XAU).
Steve Saville
Hong Kong
1 February 2000
The reader is invited to respond to Mr. Saville's wisdom via email:
sas888@netvigator.com
Our detailed Year 2000 Forecast has been posted at
www.speculative-investor.com |
