Sky Blue Monthly (April 2000)


 All Rights Reserved, 2000

Mervin Yeung Editor/Publisher

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April 9, 2000


We did a short survey last month. Sadly, we received only a few replies. In fact, the number of replies was too low to be statistically significant. Most of the replies indicated that Sky Blue Monthly was easy to understand, useful but too short. On this survey, we were disappointed because we knew from our Website Statistics that about 7,000 hits occurred at our site in March 2000, significantly less than the total hits in Feb. 2000, which were almost 30,000. Our guess was that most readers didn't bother to answer the survey. US Census, in our opinion, is going to have a hard time.


Our analysis indicates an equity bubble exists in the USA. So, in the long run, we are bearish because no financial bubble was able to last forever historically. In March 2000 Sky Blue Monthly, we predicted that the correction in US stock market would end and the bubble would expand again, thanks to the policies from the Fed, Bank of Japan (BoJ) and US Treasury. We also pointed out that the risk for both bulls and bears in the US stock market was high. We were right on both counts! Maybe because we expected the equity bubble to expand, we scared bears away. So, the number of hits dropped sharply in March 2000. We want to emphasize the fact that Sky Blue Monthly is written to forecast the directions in financial markets, not to appease bulls, nor bears. (For those bears who thought that we were the traitors of the bearish folks, we wish that they had done all right on March 16, 2000.)


Most of our readers know that we usually look back at our previous forecasts at the top of each Sky Blue Monthly in order to evaluate how accurate our predictions were. In this issue, we want to do a general review on how we have done in our forecasts since Sky Blue Monthly was available online in Dec. 1999.

Our forecasts in Dec. 1999:

"What policy can the government take to "cure" this problem? No, nothing can cure the problem. Once the bubble has formed, it will either expand or burst. Therefore, the Fed has only 2 opposite choices: 1. Let yen take off and then the US T-Bond market will get smashed and US stock market bubble will burst right here. 2. Intervene the forex market with BoJ and ECB to suppress yen and increase money supply to jack up the stock market. (i.e. pump up the bubble to an even bigger size) From the Fed's past behavior, we expect the Fed to take the second option."

What actually happened in Dec. 1999:

Bank of Japan intervened the foreign exchange (forex) market to suppress yen by selling yen for US Dollar (USD) during the last days of last millennium. BoJ was rumored to have bought about $2 billion USD during those thin volume days. Meanwhile, money supply was soaring in the USA in Dec. 1999. M3 is a good measure of board money supply. M3 growth has surged to an annualized rate of 21.8% in the 8 weeks ended December 20, 1999 in the USA. This meant that the total of M3 (not adjusted for seasonal variation) was up $244.9 billion. This huge amount of new money guaranteed that US stock market bubble would not burst and would expand again. (In other words, our predictions came true!)

Our forecasts in Jan. 2000:

Let us do a short conclusion: If yen appreciates against USD, US T-Bond will sink. Besides, it is possible for US T-Bond to tumble even without soaring yen; if US T-Bond (March 2000 contract) breaks 90-00 decisively and then heads south sharply, US stock market, particularly NASDAQ, will be in deep trouble. Rising interest rate (particularly rising real interest rate) is deadly to asset bubbles, including stock bubbles and real estate bubbles. Also, T-Bond won't bottom until stock market bottoms. In the next few weeks, we will glue to the monitor and watch T-Bond very closely.

What actually happened in Jan. 2000:

T-Bond (March 2000 contract) broke below 90-00 but not decisively. Then, T-Bond shot up due to US Treasury's first-ever T-Bond buyback scheme. (In other words, our predictions did not come true because US Treasury intervened the bond market. Now, you know why we are market letter writers, not traders!)

Our forecasts in Feb. 2000:

We remain bearish on US stock market and US T-Bond market, although we are not as bearish as we were due to US Treasury's buyback scheme. Unless T-Bond (March 2000 contract) closes above 95-06 decisively, T-Bond's downtrend remains intact.

What actually happened in Feb. 2000:

S&P 500, Dow Jones Industrials Average, and NYSE Index had a correction in Feb. 2000 while NASDAQ had a pause. March 00 T-Bond closed at 95-27 on Feb. 22, 2000. Thus, T-Bond's downtrend was over. (In other words, our predictions were mostly correct!)

Our forecasts in March 2000:

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.) We expect US stock market bubble will continue to expand. 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.

What actually happened in March 2000:

Yen went up sharply against USD on the last day of March. BoJ sold yen for $10 billion USD in a huge intervention on the following Monday! US stock market went up in March (except NASDAQ, which was flat). In early April, NASDAQ went down sharply. US stock market was highly volatile in early April, like a yo-yo. T-Bond has been rising since USM00 closed above 95-31 decisively. (Wow! We were right on almost every count! Both bulls and bears in stock market were hurt by the volatile market. Hey, we said the risk was high for both bulls and bears, didn't we? Sadly, our forecasts were tainted by NASDAQ's dive in early April.)


We are pleased with the accuracy of our forecasts. For the fans of Sky Blue Monthly, we have a bad news. Because the current editor of Sky Blue Monthly will be very busy in the near future, we are not sure if we shall continue publishing Sky Blue Monthly. Let's tell you the whole story. The current editor of Sky Blue Monthly, Mervin Yeung, was working in the research center of a $102 million hedge fund for more than 3 years before he decided to write Sky Blue Monthly, first privately in e-mails, then publicly in our internet website. The research center of that hedge fund consisted of 3 persons: Director of Research, and 2 Assistants to the Director of Research. Mervin Yeung was one of the Assistants to the Director. Recently, after finishing the private research project of development and completion of Far-from-equilibrium Macro Economic Theory (FFEE), Mervin Yeung wanted to go back to the hedge fund business and has been actively seeking related positions. Therefore, Mervin Yeung may not have enough time to write Sky Blue Monthly. We'll see. For our fans, don't feel bad. Because there is another wonderful market letter, and it is available daily! This market letter is Kevin Klombies' IMRA (Inter-Market Relationships Analysis) and his Home Page is at: The subscription rate for IMRA, in our opinion, is low considering the high quality of the newsletter.


Bogeyman Return


Well, the bogeyman is Japanese Yen. The most important thing of doing economic analysis is to figure it out what are important and what aren't. We have to pick the important factors and analyze them. Which ones to pick depend on the economic environment. For the current US stock market, the most 4 important factors are Yen/USD cross, Euro/USD cross, US T-Bond, and M3 Growth Rate (board money supply growth rate in the US). On Friday March 31, 2000, Yen (June 2000 contract) shot up against USD for more than 300 ticks. The following Monday April 3, 2000, BoJ sold yen for $10 billion USD. In fact, BoJ had intervened twice in March 2000 but yen kept going up. If yen goes up, Yen Carry Trade will blow up and US stock market bubble will come to a nasty end. When the burst comes, our title will not be "Bogeyman Return"; it will be "Bogeyman Forever"! Now, yen is temporary suppressed by BoJ's interventions. So, the calm has temporarily returned to US stock market.


When BoJ sold yen for $10 billion USD on April 3, 2000, we thought this intervention would give bulls a break (in a good way). Well, it didn't; instead, it gave US stock market a break! Apparently, more and more traders started to wake up and realize that rising yen will kill the US stock bubble. Many started to doubt BoJ's ability to intervene and keep yen down forever. Surely, the news that Microsoft lost the lawsuit set a bearish tone in NASDAQ market, which contains lots of technological and internet stocks. Nevertheless, was it a coincident that NASDAQ sank sharply after the 300-tick Yen rise? We believe it was a cause-and-effect, not a coincident! Yen rocketed up against USD for more than 300 ticks on Friday March 31, 2000, and the following trading day (Monday April 3, 2000), NASDAQ fell apart. Enough said.


There are 2 questions that we will never understand. The first one is "Why would anyone want to invest in the American stock market, particularly NASDAQ? In other words, why did bulls invest in current US stock bubble?" (Some readers may object our view that current US stock market is a bubble. Read this: "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.") Many investors in the US stock market probably think that in a New Era, stocks will go up forever. Others think that they can ride the bubble all the way upward and then get out before it bursts. (How about "sell your stocks 24 hours before stock market crashes"?!) Is this possible? Can most investors get out before the crash? To answer this question, we have to investigate another question: "Can most investors get out without causing a stock market crash?"


As we have studied in previous issues of Sky Blue Monthly, the current stock market bubble in the USA was created and has been sustained by both domestic liquidity and foreign capital inflow. There have been 2 sources of foreign capital inflow: Yen Carry Trade and Euro Carry Trade. (If you don't know what they are, make sure that you read previous issues of Sky Blue Monthly: Dec. 99, Jan. 00, Feb. 00 & March 00.) To understand this subject, we have to investigate the nature of a Carry Trade. The beginning and the end of a Carry Trade are not symmetrical because, at the formation of a Carry Trade, the volume is at a minimum; at the time when a Carry Trade is unwinded, the volume is at a maximum. We had better use an analogy here: Imagine that you are at a theatre. Before the show, few are in the theatre and some are just coming in. If fire breaks out, these guys, of course, head toward the exit doors and no one gets hurt. During the show, the theatre is packed. If fire breaks out, the crowd rush to the exits. Because there are so many people trying to escape through a few doors, some are trapped inside the theatre. Hence, tragedy occurs. Same thing happens when a Carry Trade bursts. We believe that every market crash in human history was caused, is caused, and will be caused by liquidation by the holders. The current stock market bubble in the USA (especially NASDAQ) has been fueled by domestic liquidity (money creation and credit expansion) and foreign capital inflow (Yen Carry Trade and Euro Carry Trade). Due to the huge volume, the unwinding of a Carry Trade will be compressed within a very short time frame. The consequence will be catastrophic. Historically, a Carry Trade always ended in disaster. According to FFEE, a Carry Trade won't last forever. (The theoretical analysis by FFEE on Carry Trade is beyond the scope of this paper.) A Carry Trade will end sooner or later. If and when Yen Carry Trade and/or Euro Carry Trade burst, the most likely economic consequence will be a global Great Depression. (The Great Depression in 1930's may be renamed as a Mediocre Depression.)


The same can be said for a stock market bubble, not just a Carry Trade. The beginning and the end of a stock market bubble are not symmetrical because, at the formation of a stock market bubble, the volume is at a minimum; at the time when a stock market bubble bursts, the volume is at a maximum. Due to the maximum volume, the collapse of a stock market bubble will be pressurized into a very short time frame, like the unwinding of a Carry Trade. The resulting collapse, of course, is spectacular. Many bulls believe that a stock market crash is always caused by the short sellers. Nothing can be further from the truth. Let us repeat: Every market crash in human history was caused, is caused, and will be caused by liquidation by the holders. Therefore, most investors are not able to get out before the crash. The reason is that if most stock investors try to get out, it will cause a stock market crash.


My second question is more puzzling: "Why would anyone want to sell short stocks in the USA, particularly NASDAQ? In other words, why did bears go short against the stock bubble?" On the surface, it makes sense. All bubbles burst. If the timing is right, the reward can be huge. However, shorting a bubble is the most dangerous act in the financial world because irrationality is always an essential ingredient in the minds of bullish "investors" during a financial bubble. Thus, the timing of when to sell short is extremely difficult. Since 1995, there have been other factors that have benefited the bulls. In Oct. 1998, US stock indices were falling apart. Then, they bounced back. Now, we know that during the last quarter of 1998, M3 Growth Rate approached an annualized rate of 20%. (!) One year later, in Oct. 1999, US stock indices were again sinking. Then, of course, they bounced back again. Now, we know that during the last quarter of 1999, M3 Growth Rate exceeded an annualized rate of 20%. (!!) These new money and new credit were injected into the financial system, and hence, stock indices came back from the death on those 2 occasions. We know that rising yen is deadly the US stock market bubble. Since early June 1999, Bank of Japan (BoJ) has been selling yen for USD in almost 20 interventions! (Sorry, our readers, BoJ did that so often that we lost count!) So, yen is temporary suppressed. We also know that the falling bond (T-Bond was sinking fast in late 1999 and early 2000.) is deadly to the US stock market bubble. So, the U.S. Treasury decided to launch its first-ever cash buyback of government debt and snap up as much as $30 billion in high-yielding securities on Jan. 13, 2000. These artificial measures sent stock indices to the Moon. Therefore, every bullish stock analyst looks like a genius and every bearish stock analyst looks like an idiot.


We know we wrote this before. However, we want to remind our readers again: If BoJ intervenes the foreign exchange market and sells yen for USD in a sterilized intervention, it will cause T-Bond to rise. For those who don't really understand the difference between sterilized interventions and unsterilized interventions, here we go: An unsterilized intervention is a monetary policy. A sterilized intervention is closer to a fiscal policy. e.g. Bank of Japan buys USD in the forex market by selling yen. If this is an unsterilized intervention, BoJ increases money supply. If this is a sterilized intervention, BoJ actually keeps money supply unchanged. In a sterilized intervention, BoJ sterilizes an intervention by selling Japanese Government Bonds equivalent to the intervention. Thus, what BoJ has done is "acquiring USD and then selling JGB", hence, a sterilized intervention is actually a loan from BoJ to the USA, therefore, a sterilized intervention is closer to a fiscal policy than a monetary policy. (If BoJ uses the acquired USD to buy Treasury issues, then it is a loan to the USA. In fact, BoJ usually used the acquired USD to buy US T-Bonds. T-Bond went up as a result.)


You see: the whole thing is a bad joke. If US stock market falls, the Fed will let M3 Growth Rate rise and hence, US stock bubble skyrockets. If rising yen is threatening US stock market, BoJ will step in and sell yen for USD to suppress yen and hence, US stock bubble skyrockets. If T-Bond is sinking (and falling bond is hurting US stock market), US Treasury Department will use budget surplus to buyback T-Bond, and hence US stock bubble skyrockets. If T-Bond doesn't rise fast enough, BoJ will use the acquired USD from its interventions to buy US T-Bonds and hence, US stock bubble skyrockets. What are we doing here? Are we supposed to write Sky Blue Monthly to forecast stock, bond and currency markets? All the above factors cannot be predicted by using any qualitative or quantitative methods. Can you read the mind of Alan Greenspan (The Fed Chairman) to know M3 Growth Rate in the next few months? Can you read the minds of those central bankers at BoJ to know when they are going to intervene again? Can you read the mind of Treasury Secretary Lawrence Summers to know when he is going to use budget surplus to buyback T-Bonds again? If you can't, you should not trade stocks, bonds, or currencies because the risk is so high. Since we can't, we should not forecast stocks, bonds, or currencies in Sky Blue Monthly! In short, Sky Blue Monthly is dead. We still have to think how to get around with this in order to save our Monthly.


Anyway, yen is rising again. Bogeyman has returned. Rising yen is deadly to the current stock market bubble in the USA. If Yen Carry Trade is unwinded due to the rising yen, US stock market will be smashed and US Dollar will crash. We expect BoJ to intervene currency market to suppress yen whenever yen appreciates against USD. We also expect M3 Growth Rate to soar whenever US stock market has a correction. Furthermore, we expect US Treasury and/or BoJ to buy T-Bonds if T-Bond sinks again. All these interventions and artificial measures will be very effective in the short run. In the long run, they are doomed to fail. Besides, the longer the bubble lasts, the more damages it causes. The bigger the bubble, the more destructive its power. The result will be a global Great Depression. We hope everything that we have written is wrong. Then again, "hope" is a four-letter word. If Sky Blue Monthly is terminated in the coming May, don't be surprised.



May 2000 issue of Sky Blue Monthly may be available by May 14, 2000.

This newsletter is for general information only and does not constitute an offer to sell, nor is a solicitation to buy securities and/or derivatives. The information is believed to be true and accurate at the time of writing and the Publisher of Sky Blue Monthly is not responsible for any actions taken as a result of reading this newsletter. No portion may be reproduced in whole or in part without the consent of the Publisher.


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