-Caveat Lector- from: http://www.pei-intl.com/TOPICS/US0520.HTM <A HREF="http://www.pei-intl.com/TOPICS/US0520.HTM">New Highs Today Warn of New Highs To Come - Ma </A> ----- New Highs Today Warn of New Highs To Come By Martin A. Armstrong Princeton Economics International (London Office) © Copyright May 13th, 1999 ------------------------------------------------------------------------ The US market has exceeded the April 8th high on the S&P 500 suggesting that a summer rally is still ahead. The question of value basis the Dow Jones Industrials is addressed in our current monthly publication – "How High is High". From a basic catch up perspective, the Dow needs to reach about 12,000 to be on par with the 1966 high. That does not suggest that since "fair value" may be 12,000, that there is no correction ahead. Markets often over-shoot fair value on both sides of the equation by as much as 30%. Nonetheless, for the Dow to reach the 14-15,000 level by August is not out of the question. However, a correction of 14% or up to 23% still remains in the cards for later this year. There does remain a serious question about long-term sustainability. Our models that pinpointed July 20th as a major turning point appear to have been spot on insofar as volume and liquidity is concerned in the United States while this appears to be major economic top for Europe and the CIS countries including Russia. The broad market high basis the Russell 2000 still remains as April of last year. Depending upon the stocks you trade, the market has rallied into 1999 or it is still down 15% for year. While individual investors trading highly speculative stocks may think July 20th was a false alarm, many institutional portfolios have found nothing but difficult times since the July 20th high. The Internet stocks clearly became the big performers after the July 20 th target. This index rallied relentlessly into the next target date of April 8th. But the Internet stocks are NOT the market. Most IPOs involve 10%-20% offerings and the floats are so small that the stocks can easily be sent to the moon propelling company valuation into the billions with earnings of a scant few million dollars. Internet stocks are being valued at 34 times REVENUES while normal companies are lucky to get launched at 15 times EARNINGS. This narrow band of stocks does not constitute the broad market and by no means do they replace the Dow or S&P as a more important indicator as to long-term trend. There was clearly a directional change following July 20th that caused capital to seek the Internet stocks while new cash into equity and hedge funds fell by 50% and 0% respectively. April 8th may have marked the high for Internet as a sector, but certainly not as individual IPOs – as evidence by this week’s Street.Com. The directional change that April 8 th has brought is a shift into the cyclical stocks such as commodities. This shift in investment sectors is typically short lived and in fact the commodities may not make much of a sustainable recovery at all. 8.6 years from the October 1990 high in crude oil brings us precisely to April 1999. If the commodities cannot sustain a rally beyond this current time period, a further decline into 2002 remains entirely possible in the face of strong dollar into 2003. This would be a reflection of a continued strong US economy contrasted by a further economic decline in the third world and Russia In our upcoming special report in June, we will provide the historical evidence that must now be considered at this critical juncture within the global economy. The fact that the Dow Jones Industrials has retaken the lead at this late date in the cycle warns that we may not be near the final high any time soon. There could very well be a further economic contraction in Europe, Russia, Japan and China and any recovery in Asia could also prove to be very short lived. If the world economy remains under pressure, then the risk of a strong dollar into 2003 could also cause a capital concentration within the US economy more similar to that of Tokyo in 1989. Those that expect some message from God that will provide ample warning that the high is in place have never studied the history of markets. Those who think that as long as the fundamentals remain sound, then there is no risk of a stock market crash have also not read their history. In our special report we have addressed these issues in detail. In the limited space provided here, it is sufficient to state that at the peak in 1929, car sales were at record highs as was the case with corporate earnings. Mutual fund cash levels also stood at a record high in August of 1929. When the crash began, General Motors fell by 75% within less than 6 weeks while earnings and sales stood at record highs. The media came out stating emphatically that NOTHING had changed and t hat there was NO SANE REASON to sell stocks! The press simply chalked it up to insane people who sold in a panic without reason. At best, the only fundamental that one could point to was a rise in interest rates by Britain. So much cash had left Europe and poured into the US, that severe shortages of cash were developing outside the US economy – particularly in Europe. The rise in rates in Britain was viewed by some as bearish for the US because it would force foreign investors to sell and go home. We have not quite reached that level of international capital concentration in the US, but we may still face that between now and 2003 and in the process, such a trend would cause the Dow Jones Industrials to rise to touch the face of the Wall Street gods somewhere around 19,000-20,000. This depends entirely upon the fate of the dollar. The short-term still is thwarted with intrigue and danger. While the older investors like Warren Buffet continue to warn about the overvaluation of the US market, the younger generations appear to care not. Sometimes, value cannot be accessed solely in nominal terms. We adjust everything for inflation including our wages – but God helps us – we can’t possibly do that with the Dow! Forecasting the future is never easy. No one is capable of seeing tomorrow before the dawn. The best chance we have at seeing tomorrow is through a broad perspective of the past intermingled with the present. While there remains the threat of choppy markets for the near-term and the prospect of testing 12,000 before August 17th, there also remains the danger of another quick and fast correction during the 3rd or 4th quarter. The next correction is more likely to last a bit longer than the previous. We may see a 5 to 6 month correction/consolidation phase from the summer high. This will allow the short positions to build up once again and if the capital flows shift next year into the dollar quite aggressively, then we could still see that extended rally into 2003. Therefore, the question of a high here in 1999 or 2003 is the main topic of our upcoming special report and of vital interest to the world economy as a whole. ===== from: http://www.pei-intl.com/TOPICS/CPI0514.HTM <A HREF="http://www.pei-intl.com/TOPICS/CPI0514.HTM">The Return of Inflation Or the Beginning of Y2K </A> ----- The Return of Inflation Or the Beginning of Y2K? By Martin A. Armstrong Princeton Economics International (London Office) © Copyright May 14th, 1999 ------------------------------------------------------------------------ Today the markets were surprised by the sudden rise in business inventories and inflation statistics. The implication of today's numbers was clearly reflected in the price action that immediately followed - higher interest rates. The insane interpretation in currency was that the foreigners would begin to sell stocks so sell dollars while you're at it. Today's release of the CPI (Consumer Price Index) and business inventories should have come as no surprise. We have been warning that the effect of Y2K will be inflationary - NOT doom and gloom depression as some have touted over the Internet. Many businesses have realized in the United States that there may be a disruption in supply and as such they are starting to stockpile necessary goods. This effect will keep the US economy quite strong into year-end, but there is a risk of a slowdown come next year should Y2K turn out to be a flop. This will leave these same businesses with excess inventories and as such a slowdown in purchases will cause a downturn in the US economy in 2000. We may even see another sector shift that causes the real old forgotten stocks like elevator manufacturers, electrical contractors and perhaps heating and air conditioners to emerge as the darlings of 2000. If there are severe problems with power grids causing brownouts, that is a formula for record sales of electrical motors of all sorts - including computers. Even Coke has announced that they are accumulating a 3-month supply of raw materials needed for the manufacture of their soft drinks. Medical companies are anticipating the public to stockpile medicine and the manufacturers of those pretty bottles are running at full capacity. Every aspect of the economy is starting to heat up for Y2K and this may be the best reason of all to resign as the Treasurer of the United States while you're still on a high note. The question of whether or not the Fed will respond to this type of inflation depends entirely upon the performance of the stock market this year and long-term inflation next year, should Y2K cause a jump in general costs of doing business. If the market cools off a bit into June BEFORE running off to new highs perhaps in August (or a test of the April high), then the Fed may stand firm with a wait and see approach. If the majority continues to ignore the Fed as a threat, then they may need to be taught a lesson or two. The Fed will ONLY raise rates if there is something else such as wages that start to show sizable growth for within that statistic lies the seeds of sustainable inflation. The Fed itself has been experiencing its own problems thanks to the Euro and Y2K combination. The fact that the Euro does not physically exist poses serious problems when people are worried about the viability of the banking system outside of the United States. In some regions, including Europe, the issue of Y2K has been portrayed as an American plot to force companies to buy more American products. Nonetheless, the lack of attention paid to Y2K issues outside the US is having a major impact upon the demand for physical dollars. The Fed, for the first time in history, has established vaults overseas - one in Europe and one in Asia. This means that the Fed is now having to worry about the demand for dollars globally and how to facilitate that demand to avoid another major crisis next year as a result of international banking problems. Therefore, the overseas vaults of the Fed are intended to make sure that anyone who needs dollars due to banking problems in their local area will be able to get their hands on some greenbacks due to Y2K fears. The Fed is keenly aware of the Y2K issue and it is NOT likely to respond irresponsibly to a rise in inflation that is directly linked to increased stockpiling of materials. They will be far more concerned about the global banking system and only if inflation soars dramatically will the Fed respond short-term. They will also be watching not the rise in inventories or raw materials due to stockpiling, but wages. If wages start to rise, then this will translate into consumer demand inflation that is more associated with a bubble top in an economy. This could yet become a problem if consumers begin to stockpile goods for year-end in sizable quantity. The Fed may in that case have little choice but to RAISE rates in order to prevent a carry-over effect of inflation as was the case during the late 1970s. Those who have interpreted today's numbers as bearish for the stock market may not be totally wrong short-term. We still show that volatility should begin to rise starting next week and extending largely into the week of June 14th. A low at that time could still lead to new summer highs going into mid to late August or at least a retest of those highs established in April. Nonetheless, the prospect of extending the bull market beyond 1999 (assuming a sizeable correction takes place in late 1999) is still a viable outcome. We have stated many times before, that a dollar bull market into 2003 is still a highly likely event. The failure of the Euro has merely increased that outcome and indeed the performance of gold has further demonstrated the deflationary trends that exist outside of the United States. With gold closing within 40 cents of its 19-year low, one can hardly make a case that gold will prove to be a buying opportunity. We still see gold falling to slightly BELOW $200 on the London spot market before there is even a hint of a bottom coming in place. When gold drops BELOW $200 and silver under $3, then the global trend may begin to change - but not before! The real issue becomes the insane selling of dollars on the threat of foreign selling of stocks. This knee-jerk reaction following the morning numbers was quickly reversed and for good reason. The Europeans are NOT heavily invested in the US market and the majority of the "value" investors of Europe have almost ZERO exposure to US shares since 1994! The Japanese sold out for July 20th and have not returned. The popular view in Japan is that the US is in the middle of a "bubble top" and if anything, it is probably much easier to sell a put on the Dow than a call in Japan these days. The number one question we get from Japan is about the risk of a MAJOR crash in the US as they experienced back in 1989 in the Nikkei. Foreign participation in the US market is approaching a historical LOW at this time and in no way should the dollar be sold based upon fears of foreign capital repatriation due to a declining stock market. The more important issue behind the Euro weakness is the dirty little secret that is being kept from the general media at all costs - the Euro clearing system still does NOT work! Merchants who take Visa or Master Card normally receive instantaneous cash when they deposit your transaction with their bank. This is now true for all currencies EXCEPT the Euro! Euro credit cards are taking days to clear and as such the Merchants have been the first to feel the effects of a clearing system that still does not work. Between banks, all currency transactions settle at the end of every day. Euro settlements are also taking days. Banks in London are putting Euro checks on a 4-week clearing status. The net effect, many are starting to discount the Euro in order to accept it. Even American Express has issued only 5,000 Euro based cards. This is not such a good story for a currency that was going to knock the dollar off this planet. Most central banks are still unofficially not accepting Euros as a reserve currency, which has been told to us on a confidential basis. If publicly confronted on this issue, everyone would naturally deny it, but the failure of the Euro has been expressed in its near perfect swan dive since January 1st. The Europeans are having extreme difficulty solving the problems of the Euro. Most computers cannot calculate fractions of a currency and therein lines a far worse problem than merely Y2K. China's work around for Y2K is to simply turn their computers back 20 years. That trick will work, but calculating fractions of a currency remains impossible when such functionality never before existed. For this reason, your taxes in Germany are still payable in DMarks - not Euros. So while the stock market remains in peril of its life in the midst of short-term sustainability, the question of long-term remains unchanged. Record new highs in August from a June low may raise the risk of a more serious correction lasting 5-6 months starting in September. Nonetheless, there remains no doubt in our mind that this is not yet a bubble top in the US and that could still await us in the future. When the ALL the foreigners are here, as was the case in Tokyo of 1989, then the big one has arrived. Nevertheless, a minimum correction of 14% appears likely with the chance of a 23% correction during the later part of 1999. With liquidity drastically reduced since July 20th, the downdrafts will be much faster and deeper. A correction of 7% into June or worse yet only a sideways movement would tend to point to a new high by August 17th. At this point in the bull market, another scare to the downside may be just what the doctor has order to breath some life back into a bull that is starting to show his age. ===== from: http://www.pei-intl.com/TOPICS/JP0520.HTM <A HREF="http://www.pei-intl.com/TOPICS/JP0520.HTM">Failing to Understand Japan - May 20th, 1999 </A> ----- Failing to Understand Japan By Martin A. Armstrong Princeton Economics International (London Office) © Copyright May 13th, 1999 ------------------------------------------------------------------------ The hedge fund community has suffered huge losses this year in their futile attempt to sell the dollar against the Japanese yen. Most have taken this view based upon the narrow interpretation of the trade numbers citing that the U.S. trade deficit with Japan is on the rise. It makes some sense to expect that a rising trade deficit means that the U.S. is sending more dollars to Japan and therefore they in turn will be selling more dollars. However, global trade is less than 10% of GDP and trade itself is less than 13% of the entire U.S. GDP. In other words, trying to forecast the fate of the dollar based solely upon trade statistics is not merely dangerous to one’s financial survival, it also illustrates one’s ignorance of the facts at hand. It has been this fun damental view that has led to losses on the part of the hedge funds in excess of $2 billion so far for 1999 and they are about to take another serious loss in the months ahead along with the equity funds that are rushing into Japan and Asia. The world has changed considerably since 1971 and the birth of the floating exchange rate system. The old fundamentals must simply be thrown out the window – not only are they dangerous, but they simply reflect what is often the opposite reality. The two main accounts that all governments keep are known as the "current" and "capital" accounts. These two accounts balance so when one moves into a deficit, the other moves into an equal surplus. Many people wrongly refer to the "current" account as the "trade" account. This perhaps was a definition of pre-1971 global trends, but it certainly does not fit our modern economic situation. The "current account" includes not merely trade but also ALL transfer payments, which includes dividends and interest. Prior to 1971, 90% of global capital flows were trade related. Investment tended to remain very much at home. In the post-1971 period, the fluctuations in currency values, which were inherent within a floating exchange rate system, created the appearance of profit and loss when, converted back to the base currency. For example, a major U.S. insurance company purchased a British insurance company in 1985 when the pound was $1.03. By 1987, the pound recovered rising to $1.90. This fluctuation in the dollar/pound exchange rate resulted in a paper asset profit of 84% on their investment when the assets were shown on their books in dollars. However, the pound then fell back to $1.40, which produced a 26% loss on the very same assets. The fluctuation of currency today can be as much as 40% over a two year period. This fluctuation is having a significant impact upon all government statistics including trade. What may appear to be a trade surplus is often a trade deficit. In the case of Japan, if you subtract the rise in the value of the yen you will see that Japan is actually selling FEWER goods – not more. When you travel to Japan and talk with manufacturers, you quickly find that sales have declined, not risen. If Japan were enjoying a "real" rise in their trade exports, then why is the economy still in recession and unemployment rising? In addition to the distortion that currency has added to the "current account" we also have the issue of globalization within the investment community. If we look at the current account closely, you will notice that the bulk of this statistic is transfer payments. In other words, long-term accumulation of buying U.S. bonds produces an interest income that is then paid to the Japanese through the CURRENT ACCOUNT. Because of this factor, a current account deficit no longer means what it once did prior to 1971. Today, the more foreign capital that pours into the United States to capture the huge interest rate differential (nearly 2x that of Europe and 10x that of Japan), the greater the deficit will become in the current account. The more the U.S. pays out in interest, the larger the deficit will become. The investment is reflected through the CAPITAL ACCOUNT (purchase of bonds, stocks, real estate etc.), while the income on those investments then moves back through the CURRENT ACCOUNT. For this reason, the more capital flows into the U.S., the stronger the dollar, but also this tends to expand the CURRENT ACCOUNT deficit. Those who rush out to short the dollar simply because the current account deficit is rising fail to understand how these two accounts work under a floating exchange rate system. The dollar is poised to rise to at least 200 yen by 2003 due to the fact that the Japanese economy is NOT recovering. The extremely low levels of interest rates that have been the core policy of the government are in fact undermining the entire economy. While low interest rates were hoped to be the answer to the Japanese banking crisis, after more than 5 years of such a policy, the long-term damage to pension funds, life companies and now the Postal Savings System are becoming incalculable. All savings and pension funds need a base income of about 4% in order to meet future obligations. The extremely low interest rate policy has now taken the banking crisis and spread it into virtually every sector within Japan. There is no hope for recovery when the consumer lives in fear of both their job and pension. The number one concern in Japan is that the pension funds are now insolvent. Consumer confidence is starting to hit all time record lows in Japan and there is no hope in sight for the short-term. Currently, Japan still represents 40% of total world cash savings. There has been no banking panic because the government has stated that they will guarantee ALL deposits in Japan 100%. However, the banking panic in Japan begins next year. By April 1st, 2001, all deposits in Japan will be insured for ONLY the equivalent of $100,000. It will be at that time when the big name Japanese corporates will be forced to start pulling their cash out of the banks. The average Japanese citizen will begin to pull their cash out to limit their risk as well. In other words, the sizable deposits of the Japanese banks, that once made them the largest institutions in the world, will be forced into a consolidation phase that will leave them looking much more like a western bank. In order for Japan to recover, the dollar MUST strengthen – not weaken! A weak dollar raises the cost of production in Japan while a strong dollar LOWERS the cost structure in Japan allowing for corporate profits to rise. The market traders that have been running in to buy the Japanese stocks are doing so because they are looking at the currency as if it were a stock. A strong economy is normally associated with a weak currency while a strong currency produces deflation. In the case of the U.S., the economy is strong but corporate profits are starting to weaken due to the strong currency. While our models do show that the dollar is poised to rise into 2003, the economy will continue to gradually decline and corporate profits will sink along with that trend. The strong dollar in this case is a reflection that the balance of the world, Asia and Europe, are both in economic downward spirals. Economic activity itself if shrinking by more than 7% annually in Russia and we see the same trend emerging in China. This is causing the U.S. to become the safe haven for capital and it is this capital inflow that is pushing the dollar higher. Ultimately, the push on the dollar to press higher is the mechanism that finally causes a recession to be imported into the United States. Many of the stock investors within Europe are NOT involved in the U.S. market. The "value" investors bypassed the U.S. opting to invest in the Euro, Russia and Southeast Asia since 1994. They missed the entire U.S. move and are not about to buy now. Instead, they are rushing back to Asia and Japan looking for value. But just as their "value" interpretation of Russia failed, their prejudice against the U.S. is leading them to another huge loss in Asia and Japan once again. About 40% of the Japanese market is held in what is known as "political cross holdings" of shares. Following World War II, the industrial corporations of Japan were unable to raise needed capital on their own. The Japanese banks were in a position to raise capital and they lent it to the corporations. In turn, cross ownership of stocks between the banks and the corporations became the hallmark of the Japanese marketplace. Today, this is seen as a major weakness because it has impacted the banks on a mark-to-market basis on their balance sheets. The more the Nikkei declined, the more the banks lost and hence the less they lent setting off a spiral of collapsing economic activity. Today, the government has been forced to set up loan programs for small business because they cannot borrow even one yen from the banks. The stated policies in Japan by both banks and corporates have resigned themselves to unwinding these cross share holdings. This means that there is an overhead supply of shares that need to be sold. The likelihood of a sustainable bull market simply emerging at this time is not very good. Add to this the fact that our models reflect that a true recovery in Japan will NOT materialize for about another two years and the long-term trend is neutral at best. The IMF itself came out last month and stated that Japanese recovery is two years away. Wayne Angel, former board member of the Federal Reserve has just come out this week and stated that the dollar yen should be at about 140 based upon current economic conditions. When the facts are looked at objectively, the optimistic analysis that has been used by the trading community as the reason to sell dollars against the yen makes no sense and it threatens any recovery by causing a further collapse in Japanese corporate earnings. In turn this only increases unemployment and dampens any hope of recovery. In short, there is no recovery in Japan or Asia. Reaction rallies within a broader bear market are ALWAYS commonplace. China WILL devalue and this will have a serious impact upon Southeast Asia. China will NOT allow its reserves to disappear, as was the case in Korea. China will devalue like Russia to preserve its cash and that event is most likely coming after August and no later than the first Quarter of 2000. In the end, a dollar rally into 2003 may keep the U.S. share market alive while it helps repair the damage in Japan and the third world by increasing their domestic profits. A weaker dollar will undermine the entire world economy and threaten the U.S. bull market like no other event possible. ----- Aloha, He'Ping, Om, Shalom, Salaam. Em Hotep, Peace Be, Omnia Bona Bonis, All My Relations. Adieu, Adios, Aloha. Amen. Roads End Kris DECLARATION & DISCLAIMER ========== CTRL is a discussion and informational exchange list. Proselyzting propagandic screeds are not allowed. Substance—not soapboxing! 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