Sky Blue Monthly (March 2000)
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March 6, 2000
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Special Note from the Editor: The first 3 issues of Sky Blue Monthly (Dec. 99, Jan. 00, & Feb. 00) are the most important issues because they contain introduction, brief economic history, basic ideas, essential concepts and important economic theories that may not be repeated in the later issues. So, if you have not read the first 3 issues, you are missing a lot of goodies! Besides, you may encounter difficulties while reading the later issues if you skip the first 3 issues.
Well, we were half right, and half wrong. We were bearish on US stock market. S&P 500, Dow Jones Industrials Average, and NYSE Index had a correction in Feb. 2000. However, NASDAQ (which contains a lot of technological stocks and internet stocks) continued to march upward. On T-Bond, we wrote this in Feb. 00 Sky Blue Monthly: "Unless T-Bond (March 2000 contract) closes above 95-06 decisively, T-Bond's downtrend remains intact. " March 00 T-Bond closed at 95-27 on Feb. 22, 2000 at the highest point of current upward movement. As you can see, we are doing mediocre on our T-Bond outlook.
A few things happened in Feb. The most boring and the most spectacular was "Greenspan says can't tell if stock "bubble" exists". This statement was very boring because it was not the first time that Federal Reserve Chairman Alan Greenspan said that. Nonetheless, as the central banker of the USA, it was surprising that he didn't know anything. (Greenspan said on Feb. 23, 2000 that it was only possible to discern whether a so-called "bubble" existed in stock prices after the event. In answer to questions posed by the Senate Banking Committee, Greenspan also said he could not make a judgment on whether the effects from rising asset prices on the economy were "overdone".) Then again, maybe the central banker shouldn't scare the market by claiming a financial bubble exists. In our opinion, it is not too difficult to prove if a stock market bubble exists. If most investors have converted from P/E Ratio (Price/Earnings) believers into P/R Ratio (Price/Revenues) believers, then a stock market bubble exists. Think about this, use your own judgement and ask yourself if there is a stock market bubble in America.
On Thursday February 17, Federal Reserve Vice-Chairman Roger Ferguson said, "The Fed cannot target specific levels in equity markets. " He went on to say that experience in other economies has shown "the bursting of bubbles in financial markets can create unsettled conditions that affect real economic activity," so the Fed must be aware of that potential. These comments were far more interesting than those words from Greenspan. We think what Ferguson had in mind was that since the bursting of bubbles in financial markets could be very bad for the economy, we had better keep the bubble alive. Too bad he didn't know our unique Far-from-equilibrium Macro Economic Theory (FFEE). According to FFEE, a financial bubble either expands or collapses. Besides, the longer the bubble lasts, the more damages it causes. The bigger the bubble, the more destructive its power. We really wish Ferguson were right. And we hope we are wrong in our theory.
Recall the conclusion of our previous analysis "rising yen and falling bond are deadly to the current American stock market bubble". Japanese Yen continued its downward retracement against US Dollar (USD) in Feb. When March 2000 Japanese Yen contract fell to 90.00, we were shocked to see Bank of Japan (BoJ) did not sell yen for USD at that critical support level. A golden opportunity was lost, maybe forever. Hence, we expect yen will appreciate against USD in the coming months. On the question of which way T-Bond is going to go, we become neutral. Since June 00 T-Bond contract (USM00) still has not broken 93-22 level, and since the action of T-Bond buybacks by US Treasury was a dynamic factor, T-Bond will turn bullish if June 00 T-Bond contract closes above 95-31 decisively. Certainly, if June 00 T-Bond contract breaks 93-22, T-Bond will sink. So, now T-Bond is at critical moment. We have to be patient and watch which way USM00 will go, 95-31 or 93-22? Then, we will have a much clearer picture.
Because yen weakened against USD and T-Bond moved far away from its recent low, US bullish stock market was temporary safe during Feb. 2000. Thus, Greenspan could open his mouth and said whatever he liked. On Wednesday February 23, Alan Greenspan hammered home his message that the U.S. economy was growing too fast, signaling he would continue to raise interest rates to slow it to a more sustainable pace. The timing was perfect. (Remember "yen weakened against USD and T-Bond moved far away from its recent low" in Feb. 2000?) Due to these 2 factors, US stock market would not panic even if Greenspan said he was eager to tighten monetary policy gradually. So, we had corrections in S&P 500, Dow Jones Industrials Average, and NYSE Index. The epicenter of speculation frenzy, NASDAQ, didn't even have a slight correction -- it had a pause. Does it really matter to stock market if the Fed raises interest rates? Of course, it matters. However, there are 2 factors why current bull stock market in the USA may continue to run upward even if the Fed decides to raise interest rates. (Did those 3 interest rate raises by the Fed in 1999 break the stock market in America? Obviously, they didn't.)
The first factor may be best explained by an old Chinese saying that money is like water. Imagine if you are swimming with your shirt and pants. Surely, your shirt and pants will be wet. It takes a few hours of sunshine and wind to dry it. After years of easy money and credit expansion, the whole financial system is soaked with money and credit -- it is "wet", so to speak. It will take a while or it will take a really tough measure to rein in the speculative bubble. We will use an economist Dr. Benjamin M. Anderson's excellent book "Economics and the Public Welfare" to tell you some old history. Dr. Anderson knew several American and European central bankers personally and he had the first hand knowledge on what had happened during 1920's and 1930's. He described an interesting phenomenon on the rare event (in 1927) when the Fed's policies had no effects on the speculative bubble: "Intoxication Begins. At the beginning of the movement in the autumn, the stock market took the money somewhat languidly, tempted by the lower rates. But it took the money and it used it to put stocks rapidly higher. The rising prices themselves generated a psychological boom atmosphere. Alarmed Reversal of Federal Reserve Policy. Alarmed, the Federal Reserve authorities reversed their policy in the winter of 1927-28. They sold government securities. They raised rediscount rates. The New York Federal Reserve Bank, which had reduced its rate to 3.5 percent in August 1927, raised it to 4 percent in February 1928, to 4.5 percent in May, and to 5 percent in July. … But the Boom Went On. Here was a real restraining influence. The Federal Reserve authorities were using measures which, on the basis of their past experience, should have sufficed to stop the stock market boom, and did suffice to stop the expansion of bank credit. But the boom went on. There was a new factor in the situation. The public had taken the bit in its teeth. The rise in stock market prices and the lure of stock market profits had caught the public imagination. And the change in Federal Reserve policy, designed to restrict the supply of money, met with an overpowering increase in the demand for money. … " (Indianapolis: LibertyPress, 1979, pp. 193-194) Notice that those actions were taken in 1928, not in 1929! In a runaway speculative bubble, like the one in America during late 1920's, or the one in Japan during late 1980's, or the one currently in America (Dare we say it!), central banks' actions to crush the bubble may not have immediate effects.
The second factor may be even more important. In order to crush the rising yen, Bank of Japan decided to maintain its zero-interest rate policy. Hey, we are in a new globalization world, aren't we? Liquidity from Japan has spilled over to the capital markets in the rest of the world. Oh, yes, maybe the Fed will raise 25 basis points at the next meeting, but investors can borrow money at zero rate or extremely low rate in Japan. If yen doesn't appreciate against USD soon, this sort of activities cannot be stopped. Besides yen, Euro is also a source of liquidity for US bull stock market. In the first six months of the single currency's existence, European companies launched E90bn of bonds, a multiple of what they had borrowed from the bond markets in the combined European legacy currencies and the US dollar in 1998. This spectacular success has been sustained from then to now. After those companies get the money by issuing bonds denominated in Euro, do you know where the money is going to go? From the Euro area, there was at least $100 billion capital outflow in 1999 (some estimates put the number between $120 billion and $130 billion). This capital outflow went to the USA and Japan. Now, you should pull out your forex (foreign exchange) charts and look at Euro/USD cross and Euro/Yen cross. Is it any wonder that Euro has been so weak against USD and yen? Maybe we should give it a new name "Euro Carry Trade". This Euro Carry Trade is similar to Yen Carry Trade -- it is like pouring gasoline right onto the wild fire! Look at NASDAQ chart and decide yourself that if this thing is on fire.
A piece of news on US trade balance from Reuters: "The U.S. trade deficit rose a staggering 65 percent last year (1999) to an all-time high of $271.31 billion despite a slight improvement in December, as oil prices more than doubled and a booming U.S. economy drew in a flood of imports, the Commerce Department said Friday (Feb. 18)." Isn't trade deficit bad for USD? We have studied this again and again so we won't repeat it here. Please go to our paper Dynamic Economics vs Static Economics for details. Originally, we also wanted to write a commentary on Greenspan's refusal to change margin requirements. (Greenspan said any change in margin requirements would only impact smaller investors who have no alternative means of financing, adding that any move to tighten margin rules would not hurt larger investors.) However, it is not as important as the factors we have discussed. Besides, no readers requested it. So, we skipped it.
We hope you can understand the content of this Monthly (March 2000 Sky Blue Monthly) very easily. If not, you may have to read the following articles:
Conclusions: We believe that yen will appreciate against USD. (But we also think BoJ will intervene and sell yen for USD if yen goes up against USD.) Because Euro has been depreciating against USD (besides, yen weakened against USD in Feb.) and T-Bond is now far away from its recent low, we expect US stock market bubble will continue to expand, probably violently upward. (Remember to say "Thank You!" to the central banks if you are a bull.) The risk is high for both bulls and bears in US stock market because how long this bubble can last will be determined solely by central banks (Federal Reserve, Bank of Japan and European Central Bank). We are neutral on T-Bond. Since June 00 T-Bond contract (USM00) still has not broken 93-22 level, and since the action of T-Bond buybacks by US Treasury was a dynamic factor, T-Bond will turn bullish if June 00 T-Bond contract closes above 95-31 decisively. However, if June 00 T-Bond contract breaks 93-22, T-Bond will be quite bearish. In the long run, we believe that the current US stock market bubble will bring economic calamity to America, and remember we say it.
April 2000 issue of Sky Blue Monthly will be available by April 14, 2000.
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