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<A HREF="http://www.pei-intl.com/TOPICS/LQ031299.HTM">Beware the Ides of March
March 12th, 1999 by Ma </A>
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Beware the Ides of March
By Martin A. Armstrong
Princeton Economic Institute
� Copyright March 12th, 1999
------------------------------------------------------------------------
There is a growing undertone of uneasiness that is spreading around the
globe from market to market. Capital has lost its conviction and
market-makers have lost their appetite for risk. This deadly combination
of trends is silently undermining the capital market structures raising
the risk of volatility among an ill-prepared world. The most noted
casualty has been the backbone of the global economic expansion -
liquidity. Whenever capital is confident and content, it flows freely
bringing with it liquidity through which both trade and investment
expand. When capital becomes unsure about the environment in which it
finds itself, a contraction in liquidity takes place unleashing a
variety of side-effects ranging from an increase in volatility for
investment and a contraction in economic activity known as recession.
The liquidity crisis that was unleashed in the aftermath of the Russian
default was perhaps at first abated by the swift actions of the Federal
Reserve. Nonetheless, what began in panic following July 20th, 1998 has
now transformed into a silent movement waiting to strike at the very
heart of global capital investment and thus the economy itself. As a
life-long trader and a lover of history, I can say that after thirty
years of observation, there is no better teacher than the free market
system. For all the theory and folly of "what if" scenarios and schemes
of all sorts to politically control the economy, nothing ever prevails
other than the sheer ebb and flow of capital and the effects thereof
upon the vital element known as confidence. Man has never been able to
cheat death or the free markets. Theory and design have always fallen in
battle to the swift sword of reality. While some will cry foul when they
have lost demanding government insurance, regulation and schemes to
solve the faults of capitalism, in their own self centered interests
they inevitably fail to see the beauty of the whole. No other has ever
captured the spirit of this process better than in the observations of
Adam Smith he dubed the invisible hand. Yet through it all, like a wild
animal fearful of becoming the lion's next prey, we must forever remain
alert to the most subtle shifts in the wind that may carry a sent of
danger. For survival depends upon our ability to rely not upon the
safety of the herd, but on our individual cunning and swiftness of
action in the aftermath of the sent of danger.
Many took offense at our warnings about the Euro. Some argued that we
were an American firm threatened by the prospect of being dethroned by
Europe. The fail to look beyond the mere name, for if they did, they
would see a company in which all nations are represented and where
Americans are actually the minority among its ranks. But in such shallow
criticism stood an air of arrogance that became the very element of
deception. For it is this deception that provided the cover for those
whose intent it would be to become the hidden movers and shakers in
Europe. The only way to succeed in an effort toward creating a new
federalized Europe, was in fact to tap into a nationalistic spirit that
depicted an epic battle between the Dollar and the Euro. While the media
and rhetoric constantly cast the Euro in this battle of nationalistic
pride, the silent but deadly aspirations of creating a "new social"
Europe remained cleverly hidden from public debate until its launch had
succeeded.
The Euro has been perhaps the best short position ever for a new
currency. The hallow promises of knocking the Dollar into oblivion
yielded to the harsh reality of social designs. While Mr. La Fontaine
may have been forced to resign, the policies he espoused remained very
much part of the agenda. The European Tax War will continue and expand
as it raises the risks of evolving into a new form of protectionism.
Germany and France will continue to spin their web of intrigue as the
weaker nations gradually give up the very elements of their success -
tax incentives that attracted jobs to their land. Ireland, Portugal,
Spain and Italy all now stand to lose far more than they can possibly
gain from EMU. Without tax incentives, German corporates will be forced
to export their operations outside of both the EC and EMU to remain
competitive within the global economy. This trend of hide and seek by
the politicians of EMU has contributed greatly to the confusion and
undermining of confidence in global capital. It has been this new age of
socialism that has replaced the dreams of American style reform, which
has been solely responsible for the poor performance of the Euro.
Capital has been placed on notice that its tax rates must rise in order
to fund the new social Europe state. And now, the imposition of a 20%
withholding tax on Euro bonds threatens to cause a mass selling of these
very instruments. About 10% of all Euro bonds issued to date, some $3.5
trillion, have an exit clause that allows for the early redemption at
par should the tax code change.
The fundamental structure of EMU is completely unsound. In its present
form, lacking a centralized control over fiscal spending in each state,
a single currency cannot possibly survive. However, there are those with
whom we have discussed this matter with directly among the political
elite of Europe and they themselves admit that this statement is fact.
Nonetheless, EMU in its current form is not intended to be a final
version of their grand design - only a mere stepping stone along the way
to a fiscal union as phase II followed by a political union in perhaps
20 years. Their primary reason for not disclosing such a grand scheme is
their fear that popular support has not yet been acquired. It is
believed that with time, the people will grow accustomed to the idea and
a federalized EMU will indeed emerge by 2007 if not by 2004. It is this
calling in the wild that has lured Tony Blair to surrender the proud
British tradition for the grand idea of one Europe.
We also warned that serious problems were emerging in Japan as the
government's policies to help the banks was causing the economic disease
to spread into the pension and life insurance funds that depended upon
at least some interest returns to remain solvent. We reported two months
ago that the single largest fund in the world, the Japanese Postal
Savings System, was insolvent. Some asked us why were we so bearish on
Japan when others were touting the recovery was at hand? Today, the
Minister of Finance told the Diet that government funds would be needed
to cover the short fall in the Postal Savings Fund in 2000 when massive
redemptions were due. The crisis in Japan is indeed becoming worse and
the capital injection for the banks has done nothing to relieve the
credit crunch, but rather it threatens a dangerous trend toward a
potential nationalization of the banking system that could postpone a
true recovery for up to another two years.
We warned about Asia when the capital markets peaked in 1994 and a
steady stream of capital began to migrate to richer opportunities in
North America and Europe. We warned in 1994 that this shift in capital
flows would cause the Dow to reach 6,000 by 1996 and come close to
10,000 by 1998. After three years of net capital outflows, the Asian
bubble burst and only when the currencies gave way in 1997 did anyone
notice. We warned that our models had monitored $100 billion in capital
moving into Russia with a $150 billion in net capital outflows. We
sounded the alarm bell about the IMF and that it would not be able to
prevent the collapse of Russia. In the end, what our models had picked
up was Russia itself moving its own reserves offshore in an attempt to
hide them from the IMF.
We also warned that this global whirlwind of capital flows has been
increasing in speed shifting and moving from one currency to another. We
warned that July 20th would mark the high in economic activity and
indeed European share markets peaked precisely to the day our model had
projected more than 4 years in advance. By now, it must be clear to all
concerned that no individual, no matter how intelligent or experienced,
can possibly foresee the global future as accurately as our computers
have demonstrated. While opinions are cheap and understanding maybe a
virtue, knowledge comes only with experience and it remains the most
expensive of all things held so dear to mankind.
We have tried to provide important information well in advance before
the mainstream media has a clue. It has always been vital to monitor the
major shifts in trend even though such issues fail to impact the
immediate outcome of perception on a day by day basis. Still, the
underlying tone established by such fundamental trends are the very core
issues that create confusion and destabilize the global economy by
undermining the very essence of its soul - confidence. Thus, the process
remains very much like standing before a mirror. Each day changes take
place yet we cannot distinguish the process of aging until we pull a
photograph out of some drawer from the past. Then and only then, can we
suddenly recognize just how much change has taken place right before our
eyes.
There is little doubt that the confidence of capital has been severely
shaken if not stirred. There has come that moment when the future takes
shape but the majority chose to ignore the early signals of change. Most
will wait for the bolt of lightening to strike before they are prepared
to accept that the storm has truly arrived. The undertone of the
marketplace has revealed that the foundation upon which this bull market
has been based is now crumbling silently beneath the marble floors. This
foundation has been undermined ever so gradually since the Russian
default and the process has now reached the critical stage of peril.
While there are many who now proclaim that the bull market will last
forever, the dangers it now presents are starting to converge on many
fronts. Liquidity has shrunk rapidly. The Russian default hurt many
banks that engaged in derivatives. We have all grown accustomed to the
depth and breadth of the capital markets. We failed to notice that the
massive leverage employed within the derivative markets also added
liquidity. Massive positions of short the S&P and long the DAX allowed
the German share market to rise by more than 40% for 1998 going into
July 20th compared to a meager 15% in the United States. But the
collapse of Russia sparked a contraction in emerging market investment
that then sent interest rates going nuts even within the primary markets
of Europe. This trend destabilized the derivative market and caused the
collapse of the cash Interbank market as well. The launch of the Euro
couldn't have come at a worst time for it too contributed greatly to the
shrinking process of the currency markets. At least under the ERM, the
European currencies traded within a band. However, the Euro introduced a
fixed rate system between the 11 nations within EMU. This effectively
closed down trading even further, which contributed to the shrinking of
liquidity.
The crisis in liquidity has now undermined the very soul of the global
economy. While new highs may be cheered as onlookers tout 15-year bull
markets and how baby boomer's endless savings will ensure an
ever-brighter future, the very soul of society may be at risk. Media
compete for readership and viewership by espousing the endless bull
market and people are quitting their jobs so they can stay at home and
trade stocks. A president lies under oath and to a grand jury, but the
people don't care as long as the economy is good. Democrats attack
Clinton and then cheer him as a great model based solely on polls. Yet
the haunting question that in this whitewash remains: Have we now
established a precedent that perjury does not rise to an impeachable
offense? What happens in the future? Presidents can now lie under oath
free of penalty because of the bull market that once was.
This bull market has change much more than perhaps we are prepared to
accept without the advantage of hindsight. But we should make no
mistake. Bull markets never end gracefully. By their very nature, all
bull markets suck in the very elements of society corrupting the soul of
its people. Like banks that failed to due their due diligence on Russia,
this liquidity crisis has now raised the stakes for disaster. Without
liquidity and a curtailment in derivative market-making, it becomes only
a matter of time before volatility will strike. With the public enamored
with buying, who will they sell to when the curtail falls? There have
been countless investigations that were launched in the aftermath of
every crash. In 1907, the act of short selling was declared a criminal
act only to be overturned by the US Supreme Court. Every investigation
sought to find that short position that caused so much pain. Still,
government never succeeded - not in 1907, 1920, 1929 nor 1987. They will
not find them again in 1999.
Markets crash the hardest when short selling is scant or prohibited by
law. A good bull market NEEDS short selling to survive. Without the
short position, there is no one in the middle of a panic that has the
courage to step up and buy. In Asia during 1987 some markets failed to
open because there were no bids. What happens when some event spooks the
masses and selling begins? With a the contraction in derivative markets,
the next dip will not find the buyers that there once were even during
last October. The US market was saved by the unwinding of short
positions on the S&P500 futures that were spread against long positions
on the DAX. So while Germany was crushed, the unwinding of such
derivative plays saved the US market. Such derivatives no longer remain
and the next shock could become far worse for everyone concerned.
Like the soothsayer that pleaded with Caesar, "Beware the Ides of
March", our models show that a clear and present danger now lurks
silently beneath the apparent calm. March is a dangerous month for many
sectors of the global economy. Beginning with the 15th of March, extreme
caution becomes advisable. Heed the warnings that our models have put
together. Whether this is the big one or not is irrelevant. Few survive
the first 3 months even in a 10-year bear market. Only new highs beyond
mid April will warn of one more stroll in the sun before the dark clouds
appear. For now, exercise caution and survive. Sell NO puts against
anything at this time. The pennies you think may be easy money will be
the undoing of everything you have won. Indeed, Beware the Ides of March
or a change is now in the wind.
-----
Aloha, He'Ping,
Om, Shalom, Salaam.
Em Hotep, Peace Be,
Omnia Bona Bonis,
All My Relations.
Adieu, Adios, Aloha.
Amen.
Roads End
Kris
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