Prepared by AIC Investment Advisors, Inc.

Collapsing currency markets in South East Asia over the past few months finally focused on the Hong Kong stock market in late October. The uncertainty regarding China's ability to maintain the Hong Kong-U.S. Dollar peg and higher interest rates in Hong Kong resulted in a sell-off in the Hong Kong market. The attempt by currency speculators to force a devaluation of the Hong Kong Dollar vis-a-vis the U.S. Dollar was the immediate cause of this sell-off. Thus far, the efforts of speculators to topple the HK$ have failed, and Chinese officials have indicated that they will defend the HK$ vigorously. Behind that resolve by the Chinese are reserves in Hong Kong of $60.0 billion in hard currencies and upwards of $120.0 billion in U.S. Treasury securities held by Chinese Communist monetary authorities. The Chinese have a substantial war chest to support the Hong Kong Dollar, and speculators could be unsuccessful in their efforts to force a devaluation. Nevertheless, the uncertainty and higher interest rates generated by the speculative activities caused a sell-off on the Hong Kong Stock Exchange, which quickly spread to equity markets around the world.

The panic selling that enveloped the market on October 27 originated among the professionals–money managers, brokerage houses and mutual funds. In an attempt to raise liquidity, increase cash and reduce equity exposure, the trade attempted to sell en masse on Monday. The Monday debacle was simply a continuation of trading action during the preceding five trading days where falling prices were accompanied by ever larger volume. The collapse was a culmination of the build-up in selling pressure.

When the Dow Jones Industrial Average (DJIA) dropped 350 points, the circuit breakers, which were instituted following the 1987 market collapse, were triggered for the first time ever. The market remained closed for one-half hour after the DJIA had dropped 350 points to allow participants to ponder the advisability of continuing selling into the abyss or turn bullish and, commence to buy. Regrettably, a metamorphism in traders' expectations did not evolve. In fact, the circuit breakers had the effect of concentrating the selling pressure, and when the market reopened, the DJIA dropped an additional 200 points in one unceasing flushing of whatever optimism may have evolved during the break. Once again the markets were closed as the second circuit breaker came into play; this time the close was for a one-hour break in trading. Because the second close came late in the trading day, trading would have resumed after the 4:00 PM (EST) close so the second circuit breaker closed the market for the day. Many pundits applauded the usefulness of the circuit breakers for stopping the economic carnage on Monday, especially when the DJIA recorded the largest ever point advance on Tuesday, October 28.

Overnight, all the powers of the American establishment and media were marshaled to convince the American public that a grand buying opportunity was at hand. Even President Clinton was brought forward to reassure Americans that the economy was sound and inflation no problem. (A goodly portion of the inflationary effect had evaporated that Monday for sure.) Chairman Greenspan of the Federal Reserve offered no comment on Monday or Tuesday as he was scheduled to testify Wednesday before Congress. (It is unlikely that anyone could have extracted a positive opinion from any commentary of Mr. Greenspan, a man who specializes in obfuscation as a fine art.) Authority figures such as Presidents and Chairmen of banks or corporations have a dubious record as financial and economic prophets. For example, on January 8, 1931, the renowned Sir Herbert Holt, then President of the Royal Bank of Canada, opined the following to, what one writer called, an inattentive world. “The present interruption in the normal trading relationships of the world is not going to persist.”

The buying that occurred on Tuesday, October 28 was a marvel to behold. Wall Street and the money interests launched an all out buying offensive that totally negated any continuing selling that would be occurring and propelled the major market indices relentlessly higher throughout the day. Once the market opened, a full fledged buying panic ensued, and volume rapidly rose. When the trading day ended, the DJIA had risen 337.17 points, or 4.17%, and volume rose to 1.196 billion shares–the first 1.0+ billion share day ever recorded. Despite this outpouring of enthusiasm for equities, the rally was not all that impressive. The DJIA gained back about 60.0% of the previous days loss and the forcefulness of the buying onslaught had the appearance of a contrived event.

The accompanying charts show the price trend of the Dow Jones Industrial Average and the Standard & Poor's 500 index from early May forward and will illustrate the weakness that is developing in equity markets.

The DJIA has failed to exceed its August high and many of the premier multinational corporations have failed to advance to new highs since earlier peaks were recorded. In our judgment, the market remains suspect. We would guess hat further retrenchment will be experienced in the weeks ahead. Allocations to equities should not exceed our recommended 45.0% to 65.0% levels for the three investment programs. Remember, as equity prices decline, the equity purchasing power of your cash reserves and U.S. Treasury holdings advances by a like percentage.

The Dow Jones Industrial Average recorded its peak in early August and has failed to better the earlier high since that time. On three occasions, the DJIA has traded down to the 7650-7550 level and managed to recover somewhat. However, the latest break below the 7550 level was severe and was accompanied by substantially higher volume. Notwithstanding the one-day recovery, the trend of the DJIA is not reassuring. The trading range has broadened to 8150 on the high end to 6900 on the bottom. Moreover, the on balance volume line (dotted line) on the bottom portion of the chart indicates that a gradual disgorging of the shares making up the average has been underway since the peak was recorded in early August.

The more erratic solid line on the bottom portion of the chart is a 3-day moving average of trading volume. The fact that volume rose dramatically as prices fell is not a reassuring sign. The time to buy has not arrived.

The Standard & Poor's 500 index chart shows that the early August high in the index was exceeded in early October. After a brief pullback, the average rose slightly and then began a downward plunge that broke the bottom trend line that had shown support during August and September pullbacks. Once again, the on balance volume line in the bottom portion of the chart (dotted line) has been trending lower since mid-October indicating that the shares making up the index are experiencing consistent selling by holders. The erratic sold line indicates that the volume of stocks traded also skyrocketed during the past 10 trading days as investors sold out positions as the market gradually receded and then plunged. The fact that trading volume increased as quotations fell is an indication that market sentiment had turned negative and the market was subject to a correction. The magnitude of the correction, of course, cannot be known before the fact. However, investors should note that the historical measures of stock valuations will not be of any help in providing support for valuations until substantially lower prices are recorded.

November 3, 1997Richard F. Maloney

AIC Investment Advisors, Inc.

440 South Street, Pittsfield, Massachusetts

Consensus National Futures and Financial On Line Index

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