wmeubank@ocp.kcmo.com
THE YAMAMOTO FORECAST
Prepared by
Irwin T. Yamamoto
A Collision Course With Destiny
52% in Stocks; 25% in Rydex Ursa Fund; 23% in Cash.
Indicators: Fundamental - Negative; Technical - Negative; Monetary - Neutral; Sentiment - Negative.
Newsweek
I had to take a second glance. On Newsweek's June 2, 1997 cover, the headline read, "The Day The World Crashes." It referred to the 2000 computer bug problem. As far as I'm concerned, Newsweek ran the cover too early. I'm talking about the financial markets. For all intent and purposes, the magazine should save that headline for the approaching stock market debacle.
A Replay Of Japan
The Japan equity market enjoyed an upward journey which lasted from 1980-1989. The trip took the Nikkei index from 5,000 to over 39,000. Then it suffered a 63 percent sell-off. To this day, 8 years later, the market has never attained its former high. Likewise, the Dow Jones Industrial Average experienced a glorious ride from 1974 to 1997. The jaunt propelled the Dow from the 577 zone to the 7,800 level.
If history repeats itself, as it usually does, the U.S. market is primed for an upcoming disaster. A collision course with destiny. The comparison of the Dow Jones Industrial Average and the Nikkei index is uncanny. Eerie.
My long-term prognostication. The DJIA will likely top out in late 1997 or in the first quarter of 1998. Then the ensuing bear cycle could run for 3 to 6 years.
Being A Stockbroker
These days, everybody wants to become a stockbroker. Think of the commissions. Feel the excitement of trading. For the next 6 months, it will probably be a great time to be a broker. But after these 180 days, the following 6 years could be lean times. You'll be lucky to keep your job. Yes, I see the return of a long bear market.
No Justification
People can provide reasons and excuses for buying equities in today's stock market. However, they cannot justify their actions by calling the market cheap. No way.
The Standard & Poor's 500-stock index trades at 21 times trailing operating earnings. The highest in 30 years. The dividend yield hovers at a record low of 1.72 percent. The market is at 4.5 times book value. Another record.
The excessive valuation of equities doesn't mean the market won't move higher. It most likely will. But there's no justification for being in the market because it's cheap. By any historical standards, current valuations are among the highest ever.
Irrational Exuberance
Federal Reserve Chairman Alan Greenspan talked about "irrational exuberance" in the stock market. That was 1,400 points ago or 1,400 points lower. If the market was in the midst of "irrational exuberance" at that point, then what is it now?
On top of the 1,400 point gain, consider how fast equities went up to gain that amount. Seven months. In the past, it would take years, many years, for stocks to move like that.
In addition to the 1,400 point surge, remember the Dow Jones Industrial Average soared 1,282.68 points in 1995. And another 1,331.15 points last year. Basically, the Dow has tacked on another 1,400 points after the Dow exploded for 2,613.83 points in the 2-year period of 1995-1996. In essence, the DJIA has shot up virtually in a straight line. "Irrational exuberance" may be an understatement.
To get a perspective of how irrational the market is, recall the average return of stocks on an annual basis is between 8 percent to 12 percent. Well, in 1995, the Dow Jones Industrial Average rose 33.45 percent. That gain was followed up with an increase of 26.01 percent the next year. And in the first six months of 1997, the Dow was up again, over 20 percent. With these back-to-back gains, the odds are we're due for a setback. A major setback. Nothing goes straight up, including the stock market.
In terms of equities, Alan Greenspan realizes that a bubble is forming. In fact, it has already developed. What do all bubbles eventually do? They burst. At some point, the Fed chief needs to do something to keep the bubble from getting larger. Regardless of the economic situation, Mr. Greenspan might have to raise interest rates just to cool off the euphoria of the financial markets. If not, this mania will end in a bang. A shot heard around the world.
Debt
In the midst of the longest economic expansion of this century, bankruptcies are at record highs. There was a 29 percent increase in filings for personal bankruptcies in 1996 compared to the previous year.
If people can't stay solvent in a booming economy, what will happen to them in an economic slowdown or worse yet, a good old-fashioned recession? Imagine the consequences. How deep will the next downturn be?
Another Kind Of Debt
Margin debt is over 30 percent higher than what it was at the 1987 stock market crash. In the wild pursuit of profits, investors are borrowing money at an alarming rate. A typical occurrence at a major market top. When this financial bubble disintegrates, there will be speculators and businesses trapped in a bind because of heavily-leveraged positions. You won't hear the stories of leveraging as the market reaches new records. But when it turns south, these investors are going to be totally wiped out. Remember the derivatives a few years ago.
The Market
In January of 1997, in my monthly column in The Hawaii Herald newspaper, I predicted that there would be a boom and then a bust. We're experiencing the boom now. Also, earlier this year, in my newsletter, I forecasted a powerful rally, then a correction of 10 percent to 12 percent, and another rally back up. All three events happened. The market climbed to new heights in early 1997, then declined 10 percent (intraday), and later skyrocketed to historic highs. My long-term view is that this current bullish scenario is actually setting up the biggest trap Wall Street has ever created. A collision course with destiny.
For the near term, equities can extend their move merely by momentum alone. Both bulls and bears alike should not step in front of this oncoming train. There's no doubt on a short-term basis that this market is overbought. But as long as inflation and interest rates behave, give the nod to the bulls.
For the bears, in the short run, a strong employment report or a string of economic numbers displaying strength could cause a correction or make the market pause. Also, in spite of warnings about future earnings from high-tech companies, investors seem to be largely ignoring them. If these developments fail to materialize, the bears must wait until later in the year.
Gold
The price of gold has dropped below $340.00. There are various reasons for the decline. Supposedly, there's no inflation (I don't agree, but I'll save my thoughts for a future issue). Producer prices fell for the fifth straight month in May. This has not occurred since 1992.
Another reason. Although the demand for the bullion is rising, the production from new gold mines has kept supply high. In time, in reaction to the depressed price of the metal, production will be curtailed. However, due to the spectacular climb of the price of gold in 1993, and the new technology of mining, producers invested heavily on exploration activities. Hence, the supply works as a depressant regarding price.
But the main constraint of the bullion continues to be the selling of the metal by the central banks. The latest report, Belgium is now unloading gold. Psychologically and physically, the concerted efforts of the central banks have been just too much for the bullion to overcome. I suspect, the activities of these banks are not done yet.
The central banks are selling because gold as an asset has been a poor performer for years. This idea doesn't make complete sense. An investor should analyze the potential of an investment on not what it did in the past, but on what it will likely do in the future. Nevertheless, at this moment, the central banks don't care for the bullion.
As of late, the metal had something else to contend with, the European Monetary Union. The EMU has plans for a single currency. There's speculation of some countries such as Germany and France not being able to meet requirements of the monetary union. To do so, Germany might need to sell gold. Therefore, more pressure on the bullion. On the other hand, a collapse of the EMU could cause the gold to rise as investors seek a safe haven. But for now, traders are concentrating on the possibility of the gold sale by Germany.
Our position, we remain bullish on the metal for the long term. As for the near-term outlook, our stance is negative except for technical bounces on an intermittent basis.
July 1, 1997
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