Dan Ascani's Commentary September 25, 1998
Failed Hedge Fund Strikes Investors Right At Home
gmsresearch.com
Investors React Exuberantly To Greenspan's Latest Comments
Today's Market Commentary
September 25, 1998 05:34 GMT -- Thursday's announcement that a large hedge fund, Long Term Capital Management, owned in part by Nobel-laureate partners winging around large leveraged transactions, is in the verge of collapse and that brokerage and banking firms with the
blessing of the Federal Reserve are taking over and shoring up its operations, slapped investors in
the face with a real dose of exactly what Alan Greenspan has been talking about this month when
he indicated that the US is not an oasis and that contagion has arrived.
The stock market used that as a reason to sell off sharply Thursday, but what is interesting about
that sell off -- all worsening fundamentals aside--is that the market had closed at the top of that
channel line Wednesday at a Fibonacci 50% retracement (S&P 500 cash index) and at a 38%
retracement in the Dow. With respect to the S&P, the close Wednesday also tested the 200-day
moving average, which had been broken in August and at which time we reported that that event
would bring in additional selling. This latest rally provided a test of that 200-day moving average,
which is now resistance, and now the market has fallen off.
Although today only marks one day's worth of trading, and the fact that investors may now have a
little better idea of what Alan Greenspan was referring to, it suggests that the market may have
completed the Double Zigzag countertrend rally from the Sept. 1 low and that the market may be
setting up for an October plunge. This is partially supported by the Elliott Wave Count, where the
decline from the bull market high in July forms what we're counting as an A-B-C followed by an
X-Wave just completed, or in the process of being completed. That should be followed by another
A-B-C decline. We have not cancelled our projection for the year of Dow 7000 corresponding to
855 in SP cash.
Although the market may try to hold up into next Tuesday's FOMC meeting on interest rates, the
Fed is highly likely to ease credit. Not only are the markets suggesting that, but talk on the Street
is that the Fed may have cut a deal with the banking industry taking over Long Term Capital
Management by indicating that if they absorbed their operations the Fed will reciprocate with
easing next Tuesday.
From Today's Market View 24-Sep-98: Wednesday marked Fed Chairman Alan Greenspan's third
speech or testimony of the month, and yet the third time the U.S. stock market has soared in
response. The reason? The Fed Chairman has acknowledged that the contagion effect from this
years' overseas global meltdown is finally flagging the U.S. economy, and that it will keep inflation
in check. The implication is that the Fed will, in fact, ease interest rates for the first time in many
months. Indeed, futures traders in Chicago bid Fed Funds futures for October delivery to a Fed
Funds equivalent of 5 1/4%, implying a 1/4% cut in interest rates at next Tuesday's Federal Open
Market Committee (FOMC) meeting.
But are investors again reacting exuberantly to the only ray of hope (lower interest rates) in a sea
of bad news delivered this month by the U.S. Fed Chairman? Is the market, with this month's
requisite rebound rally, setting up for yet another dreaded October plunge? If one considers
flocking into Internet search engine stocks by bidding them up 15% in one day (Yahoo! was up
15% in the wake of Greenspan's Senate testimony Sept. 23) exuberant, then the first question is
answered (the same type of advance occurred at the July bull market top, and we commented on
the significance then, too). An October plunge? That remains to be seen, but in the midst of a
fairly typical market decline consisting of two legs down with an intervening rally as the market
progresses from a summer peak into a fall low, the 1998 pattern is adhering to this pattern.
In fact, an old adage is to buy Rosh Hashanah and sell Yom Kippur. Monday was Rosh Hashanah
and the market bottomed as it typically does that day. The day after next week's FOMC meeting on
interest rates is Yom Kippur. If the market rallies until Tuesday's FOMC meeting, it may, in fact,
reach a typical peak and set up for an October decline.
But typical market patterns or not, Alan Greenspan had nothing good to offer in the wake of the
global economic crises of the past year, save a possible interest rate cut next week if the FOMC
agrees to do so. Even an interest rate cut, he has been indicating, is in response to the global
wave of contagion and deflation gripping the globe. How could he, in fact, offer much good to say
when the worst economic fundamentals since the 1930s are presently gripping the globe, sending
one-quarter of it into recession or depression?
To take this a step further, Mr. Greenspan acknowledged Wednesday that the Russian situation
reflected "a significant jump in contagion out of East Asia, which, until then, had been assumed to
have gone into remission. The shock drove yields on dollar-denominated debt securities of
emerging market economies sharply higher across the globe, engulfing economies that are as
radically different as Korea, Brazil, Poland, South Africa, and China." The Fed Chairman also
testified about another ominous sign: that "the shift internationally has also been accompanied by
a rising concern for risk in the United States, presumably reflecting the fear that the contagion
would adversely affect our economy." The global wave of economic contraction, then, is spreading
as it did in the 1930s.
The bottom line? Mr. Greenspan, perhaps correctly from the standpoint of a Fed Chairman acting
only when the evidence is there, reports to Congress and to the markets only on what the evidence
shows. By contrast, those investing in the marketplace must not only consider the evidence at
hand, but must anticipate future occurrences within the global economy that affect corporate
earnings. This is because the financial and commodity markets are discounting mechanisms,
anticipating weeks or months in advance what fundamental conditions will likely be. In order to
profit, then, investors must not only consider current evidence, but must also anticipate what the
market will do in discounting future fundamental events.
As a result, Global Market Strategists, Inc., strives to project out into the future likely events and
to recommend appropriate strategies for investors and traders based on the probabilities at hand.
To do this, we combine fundamental, technical, and market psychology models. Indeed, even Mr.
Greenspan this month acknowledged that "our advanced economy is primarily driven by how
human psychology molds the value system that drives a competitive market economy" (speech at
U.C. Berkeley, Sept. 4, 1998). Even the International Monetary Fund (IMF) acknowledged in a
recent report that global market turmoil during the past year cannot be explained by fundamentals
alone. Investors, then, must consider the psychology of the marketplace, and right now the
psychology remains one of denial and of exuberance.
Thus, consider the evidence at hand--yes. However, to anticipate what will occur in the near future
is of paramount importance. Our research suggests that the present rebound in the stock market
will set up yet another decline that will, given the market's tendency to ignore bad news, surprise
the majority of investors. To address this, our September issue of The Global Market Strategist and
our daily research and Web updates, constantly assess, monitor, forecast, and strategize. Go to the
Federal Reserve's Web Site for a complete transcript of Greenspan's prepared testimony before the
U.S. Senate Budget Committee September 23.
September 23, 1998 05:32 GMT -- Mutual Fund Stats Show Investor Tendency To Flee
It's official: U.S. investors will, in fact, sell when the going gets tough. Initial statistics released
Tuesday by Lipper Analytical substantiate that premise and corroborate the first net outflow from
stock funds since the 1990s bull market began--an important occurrence if, in fact, our forecast
that the bull market in stocks ended in April 1998 for the average stock and July 1998 for the
major averages is correct.
Stock mutual funds, which have been pillars of the bull market, have been losing their
attractiveness.
Last month saw net outflows of $9.28 billion out of stock fund and another 0.50 billion out of
balanced funds according to Lipper Analytical. This statistic also validates one of our forecasts for
this period of time when global economic pressures are contributing to the most severe global
equity market declines in decades: that, when the U.S. stock market declines below the average
investor's pain threshold, investors will, in fact, redeem. This is in contrast to conventional
thinking, which holds that investors are long term oriented and will not sell. This thinking, in fact,
has been an industry mantra that investors don't react when the market tumbles.
This is the first net outflow since the 1990s bull market began. While there are still $2.7 trillion
invested in equity funds, faith in the bull market was shaken last month in a correction that has
taken the Dow Industrials approached levels last seen in October 1997 and January 1998. If, in
fact, further decline occurs (as is likely after the present rally phase, according to our research),
investor mutual fund redemptions will likely exacerbate the market's decline.
September 19, 1998 01:04 GMT -- Global Monetary System Is In A State Of
"Supernova"Reports are that the average NASDAQ stock is down a whopping 50% from this
year's record highs, and the average NYSE stock down 35% or more. While many investors ask, "is
this a bear market?", portoflios are being slaughtered like no time in recent history--at least since
1974, a key bear market year and--not coincidentally--the last time a U.S. president was subject to
impeachment proceedings.
The political news this past week was not the only bad news Congress received. This past week,
Fed Chairman Alan Greenspan's testimony before the House Banking Committee delivered even
more bad news to the U.S. congress. Fed Chairman Greenspan won't lay it on the line like we will,
but he certainly has been "coming around" in admitting that the contagion effect is beginning to
catch the U.S., and that global deflation is, in fact, here.
So, what exactly is happening in the U.S. and global financial markets? Our introductory
commentary in the September Issue Of The Global Market Strategist®, just published this week,
discussed the big picture and what is happening to the global financial markets. An exerpt from
this issue:
Some saw it coming. Most did not. Many say it is overdramatizing the situation to say the global
monetary system is dying. Whatever the perception, though, our monetary system as we know is,
in fact, in a state of Supernova, and the repercussions across the globe are phenomenal.
Not to say that investors must now become pessimists because of these times of the worst global
fundamentals since the 1930s. In fact, it seems that whenever we publish analysis that appears
"negative" (is realism negative?), we must reiterate our philosophy regarding the fact that we are,
in fact, eternally optimistic that humankind will be able to learn from current events and put into
play a system that does, in fact, work. It is not being pessimistic to observe the fact that, for most
of the globe, the monetary system in force since the gold exchange standard was dropped in 1971
does not work. Neither does it take a pessimist to observe a death in progress. It merely takes an
observer willing to take off the blinders.
Yet, global investors this decade once again decided that they would, in fact, trade with their
blinders on, and trillions of dollars of wealth have been wiped out in the ensuing financial market
collapse. Fed Chairman Alan Greenspan had warned that investors were too optimistic and that-to
capsulize-they were investing with their blinders on. He had, in fact, warned beginning in
December 1996 that investors were "irrationally exuberant," and that they were overly optimistic
about corporate earnings.
The simple fact is, the monetary experiment launched in 1971 when the globe dropped the gold
exchange standard (and the Bretton Woods agreement of 1944) did not work. As discussed in
intricate detail in our report, Gold In A Deflationary Economy, this experiment has been one which
allows all central bankers of the world to attempt to manually tweak currency exchange rates and
monetary policy instead of having the gold standard do it for them. What that actually meant, in
reality, is that the central banks of the world, regardless of political orientation, suddenly had great
discretion to create or destroy credit at will. The operative word here is "discretion." Give too much
discretion to humankind, though, and sometimes grave consequences must be paid.
Those consequences, in fact, are now being paid. Yet, the resounding realization that the
experiment did not work will be wonderful information, if accepted and put to immediate use. So,
it didn't work-no big deal. Just get back to business and recreate a monetary system that works for
all (not just the country that prints the world reserve currency, in this case, the United States). If it
were possible to create a system in which the different governments of the global economy could
have discretion, then go for it. However, we see by the resulting global financial market collapse
what discretion can do. So, why not go back to the gold standard, as we advocate, and as Fed
Chairman Greenspan-a central banker who has discretion-has always advocated? Well, because, as
Mr. Greenspan also realizes, there is just too much political advantage to the countries who
dominate world economics. To give up that discretion is to give up the competitive edge in a
competitive global (and political) economy. So, don't count on the gold standard any time soon
(although Russia and some other countries are making noises to that effect. What choice to they
have?).
The real question for investors, in the meantime, involves what to do during the time the void
between the old monetary system and the new exists. As a whole, regions of the globe will likely
spend years in this void, and as a result today's investor must do something different with
investment capital than he or she has been doing in the recent past.
Information on how to continue reading this, and other analyses, in the September issue of The
Global Market Strategist®.
To go to the Federal Reserve Board's Web site and read the Greenspan speech.
Previous Commentary from August 24, 1998 0500 GMT -- Downturn In Global
Economy Is Serious Reality, Not Alarmist Most people do not wish to be alarmist, nor do
they wish us to be alarmist. Yet, sometimes the reality of a situation sounds alarmist. Such may be
the case now with the global economy, especially given this weekend's tense waiting game over
the situation with the international banking system and Russia's probable default on a debt
payment Monday.
To be more specific, many market analysts sometimes do, in fact, sound alarmist at times. To
scream "1930s-stlye depression" every time the global economy moves from an expansion phase
of the business cycle into a declining phase (typically, in turn, leading to recession) would not be
desirable. However, once every 60 years, 1930s style depressions typically do occur, and this time
the global economy is, unfortunately, experiencing the kind of economic collapse that occurs only
every five or six decades or so. It is, in fact, a full-blown depression in some parts of the globe
and spreading at an alarming rate to other parts.
What, then, distinguishes a 1930s-style downturn from a more normal, or even severe, downturn
leading to a period of recession? Almost always, the difference lies in the status of debt service of
a particular country and the state of the global monetary system as it relates to the foreign
exchange market. In a nutshell, human complacency typically builds to an extreme state every five
to six decades, leading to poor decision-making with respect to credit expansion and speculation
on both the part of governments and the private sector. The resulting financial debacle due to the
collapsing debt pyramid that goes along with that complacency typically leads to a global
depression, not a recession.
This, I have repeatedly written about for the past 11 years, is what the Kondratieff Long Wave
Cycle is all about. Many mistake this cycle, based on the findings of Russian economist Nikolai
Kondratieff, to be one that is used to predict where a market or an economy is going. To the
contrary, though, it is a cycle that he discovered occurs regularly due to the excesses of debt that
develop during the easy money days of the decades-long economic expansion. The Kondratieff
cycle, then, is actually a cycle of debt repudiation, and that is exactly what is beginning to occur in
parts of the globe. Indeed, the world has eyed Russia's recent decision, only a week after it
effectively devalued its currency, the ruble, last month and declared a debt moratorium. Russia, in
fact, is in such bad shape (some report them on the verge of anarchy) that even if they were to
make Monday's debt payment, it would wipe out remaining reserves and render them technically
bankrupt.
Human nature, therefore, is to become too overconfident during the decades of expansion that
characterizes the "upwave" of the Kondratieff cycle. Many even feel "it is different this time" at the
top of each revolution of this cycle, unfortunately just at the wrong time when the whole debt
pyramid is about to implode. Reflected in this type of thinking is perhaps the urge to be chic, to
buy, as we heard had occurred in Hong Kong in the days leading up to their 1997 debacle, a
second Mercedes Benz. Word last October was that some in Hong Kong were having to sell their
second Mercedes to meet margin calls emanating from the stock market crash.
This is certainly not to single out Hong Kong as a bastion of hedonism since this kind of behavior
still occurs everywhere and will continue to occur until humanity learns to be more prudent and
less impetuous with their finances. Moreover, Hong Kong and Asia's financial debacle last year and
this year provided the alert investor an opportunity to realize that, no, this time it is not different,
that financial collapses and depressions do, in fact, happen in the modern day global economy.
Presently, Americans, in fact, are being put to the same test, albeit not to the same private or
banking sector excess as had occurred in parts of the Pacific Rim. American investors, however,
still appear very stubborn about holding onto stock holdings no matter what, even sending more
money to their mutual funds or brokerage firms during this year's steep market correction.
In conclusion, this generation of investors is on assignment: to learn what no prior generation has
yet learned; to go where no generation has gone before. The assignment is to learn to be prudent;
to not be "irrationally exuberant," as we and the U.S. Fed Chairman have discussed so many times
in the past. It is to learn to balance portfolios as the marketplace changes, and it is to learn that
being a conservative investor is not defined by holding onto stock and taking no action but,
instead, to reallocate portfolios and keep them balanced (i.e., between stocks, bonds, cash, gold,
etc.) at all times. Perhaps an optimistic view is in order to sum up this outlook: every time the
4-year cycle drags stocks lower, it creates a significant buying opportunity. The reality of the
situation, not to sound alarmist, is that bear markets involve very deep declines and the typical
investor will usually sell out just at the wrong time, ala 1987.
More Analysis....
The average stock on the New York Stock Exchange was down over 25% from its 1998
record high coming into mid-August, the average NASDAQ stock down over 35%. And
this only a month after the record high of Dow 9337 set in July.
Yet, regardless of overall global conditions--good or bad--our services are designed to help
prevent an investor's worst enemy: the kind of portfolio "blindside" that occurs when today's
complex world produces economic or market conditions that investors and professionals may not
see ahead of time, slamming portfolios seemingly out of the blue. Indeed, keeping track of today's
complex global economy is a full time job, and most investors do not have the time or the
knowledge to execute the sophisticated investment strategy required in a market environment
consisting of both rising and falling trends..
The fact is, the Dow Jones Industrial Average is down close to 10% from its record high set July
20, the day we forecast earlier this year as the ideal day for the peak of the entire bull market. In
fact, in the days following that peak, our Today's Market View commentary had said, "don't look
now, but the bull market just ended." The reasons are many, and we have been giving them in
advance. Asia, Russia, a slowing economy, the four year cycle, and the end of the now-infamous
"irrational exuberance" period in which U.S. Fed Chairman Alan Greenspan had warned several
times that investors were too exuberant and were too optimistic about earnings to come. Our work
strongly argues that, despite the extent of the U.S. market's plunge, it's not over yet.
Severe technical damage has been registered on the market decline. Many stocks on the NYSE have
recently set new 52-week lows. And, as if the average investor isn't already reeling from the 1998
stock market damage already, the Russell 2000 Index of small capitalization stocks is down over
19% from its record high. Clearly, the damage is severe during the past 3 months or so--the time
we suggested our clients and subscribers use to reduce exposure to the stock market to the lowest
point in 8 years.
In my money management program for mutual fund investors, called The Bull & Bear Enhanced
Index Program in which utilizes bull and bear Index funds such as the Rydex Nova and Ursa funds
(strategy for which I created for them earlier this decade), I call the negative Advance/Decline
technical action a Negative Breadth Event to refer to a change in personality in the market from
positive to negative. Positive Breadth Events define a change from bear to bull phase, and vice
versa. Presently, the recent Negative Breadth Event confirms from that indicator's standpoint that a
bear market, or bear phase, has begun, and that this is not just a "normal" correction along the
way to new highs.
Our forecast for just this type of stock market action makes this month's plunge not so surprising.
Declines of exactly this nature occur regularly every 4 years in the stock market. This year is no
different, and the damage may ultimately become fairly severe by the time the dust settles later this
year.
In fact, recent issues of our monthly publication, The Global Market Strategist, observed that, while
the U.S. financial markets were likely to soar higher until July, the worst of the Asian situation, in
fact, is not behind us, and that a market peak was due in July. Nor is the worst of the Russian
situation, where Russia so seriously lacks structure, a viable monetary system, and even sufficient
Rule of Law that to send billions of dollars of bail-out money there would, unfortunately, not likely
help much, making a bail-out of Russia a far different story than bailing out Japan or Asia. The
"other shoe," then, has yet to drop.
In fact, both our daily and monthly research products have observed that, after an ideal market
peak the week of July 20, the market is likely to fall into the 4-year cycle due later this year and,
for the economy, into 1999. The stock market, in fact, reached a bull market to-date peak right on
July 20 at Dow 9367 and plunged 10% from its peak. This type of plunge is a typical symptom of
a bull market peak followed by a bear phase. We had also noted in our research in advance of the
market peak the fact that a severe deterioration in the internal technical condition of the market
was occurring, and in the patterns of buying and selling that seemed to be changing character
whenever the Dow moved above 9000.
Internally, the bear phase in U.S. stocks actually began in April when the broad market peaked
and the market began to show, on balance, more declining issues than advancing issues. This bear
phase is expected to see the U.S. and Europe join many other global markets in bear market
declines as is so typical of this stage of the market cycle when past history shows that the many
global markets tend to peak ahead of North America and Europe. In 1998, this pattern again has
thus far played out in classic fashion. Stay tuned for more on these developments, as forecast in
our August issue of The Global Market Strategist, published the week of August 10 (see our
Special Introductory Trial Offer).
Don't Look Now, But The Bull Market Just Ended from July 21, 1998 Today's Market View
Commentary -- Although Monday's 90-point Dow rally was ostensibly a good recovery after 500
points of decline in only a week, the internal technical condition of the market raised the red flags
in perhaps every technician's book: the advance/decline ratio was terrible at 2 1/4 to 1 in favor of
declining issues. This is the first time such a negative event has occurred on a 1% Dow rally in
years, and it is, to say the least, not good for the prospects for much further rally in U.S. stocks.
Those familiar with our analysis perhaps know not to expect much further rally since the balance of
evidence suggests the bull market just ended. In fact, when U.S. Federal Reserve Board chairman
Alan Greenspan spoke before the U.S. Congress in his regular semi-annual Humphrey Hawkins
testimony on the U.S. economy last week, he may have helped our own mar |
