Prepared by

Dohmen Capital Research Institute, Inc.

For the 10th anniversary of the crash of 1987, the worldwide markets staged a replay. It was beautifully executed, starting only 10 days later in the month than 10 years ago. Ten years and 10 days! Who says the market's are not mathematical?

In last month's issue, I expressed my concern over the chart pattern of the Dow Industrials, which was almost identical to that of 1987 before the crash. I called it a W formation, which sometimes aborts. And when it does, the market plunges, fast and furious.

In late September, when I wrote the October issue, I referred to the W pattern of the Dow Industrials, saying:

“Now we have such a “W” bottom, which usually is bullish. But when it aborts, and the market suddenly starts downward, one must get out without hesitation. An aborted W formation is very bearish. We will stay alert.”

But such aborted W's occur so rarely, that one is really reluctant to act on them. Nevertheless, my caution on the market was reflected in the mutual fund recommendations. We made sure we stayed out of the international markets, especially the emerging markets, and out of the U.S. big company stocks. Both plunged. But our mutual funds only gave up a small portion of the big gains.

Here are two charts showing you the market in 1987 and the market now. It's very interesting how patterns repeat.

This is not magic or voodoo. Charts merely reflect human emotions. And human emotions have not changed in a million years.

The alleged trigger for the U.S. market plunge was the collapse of the Hong Kong stock market. In July, I predicted a crash in Hong Kong, saying that eventually the market would plunge to the 7,000 level. As you know, the high for the Hang Seng Index was over 16.000, which made this quite a courageous forecast. The low of the crash was around 9.000. Not far from my target. But in my opinion, it's not over yet.

Over the past several months. I warned about the precarious state of the Asian markets, and strongly advised staying out of them, no matter what your favorite mutual fund manager told you. In fact, I had several conversations with top-flight Asian mutual fund managers over the past several months, all of whom expressed their bullishness on Asia. We also see them on CNBC almost every day. The theme is always the same: “strong economic growth must lead to higher stock markets.”

Don't they see that the Asian markets have plunged in the past three years even without the recent debacle, while economic growth rates were two or three times greater than ours? One good friend of mine in Korea has a huge company. When the economic growth rate in Korea declined to 7% a few years ago, he complained that the country was in a depression. Yes, it all depends what you get used to.

Over the past several months I wrote that I didn't know if a problem in the Asian financial markets would eventually effect the United States. Now we have the answer.

The explanation in the media for a market crash, and the subsequent recovery, is always comical to me. On Monday, the day of the crash, Wall Street analysts and “the head of a major stock exchange explained that over the weekend investors became concerned about future inflation and interest rates.”

Therefore, they sold at the opening on Monday. It's incredible that the media does not question why suddenly every individual investor in the country should turn negative without any specific cause.

On Tuesday morning, when the market was staging a powerful recovery, the identical people explained that “investors reassessed the situation overnight, and had wisely concluded that nothing had really changed.” Therefore, they decided to buy stocks.

Now I ask my subscribers, did you sell or buy because of the above explanation?

The truth is that individual investors do not make the market decline or rise. It's the professionals on the floor of the exchange and the program traders who produce sudden, sharp market moves. But they can only do so when conditions are right.

In last month's issue, I referred to several factors that were bearish, and concluded the section:

“I've been bullish for well over two years now.

We've caught the big moves and have participated very nicely. But somehow, I don't feel comfortable with the correction in August, namely that this should be all there is. Stay invested, but cautious.

Enthusiasm is still too high, cash levels at mutual funds are still too low, valuation levels of the big cap stocks are still much too high, especially in light of what should be continued disappointments in earnings. The bigger readjustment in the market would be very healthy and eventually will be very necessary. But it would primarily effect the big company stocks.”

Well, the correction that started on August 7, the day that I gave a sell signal, was not concluded in September or October when the small-company stocks went to new highs. As it turns out, the big cap stocks needed a severe correction, which is exactly what they got.

Such declines are triggered by big investment syndicates which see that the market is vulnerable. I noted in our fax services during the two weeks before the crash that stocks having upside breakouts had no follow through. This was unusual, and was a warning that a lot of selling was taking place.

Yes, such declines are engineered by professional groups. It has nothing to do with small investors suddenly turning bearish over the weekend, and then 24 hours later deciding that they were wrong and everything was still very well. But the head of a leading stock exchange said this on national television with a straight face. Well, it was almost a straight face.

Once the Dow 7,600 support level was penetrated, it was down fast and furious. The Dow Industrials on blue Monday, October 27, declined 554 points, closing at 7,161. It was a one-day loss of 7.2%. Similar losses were recorded by other major indices.

So-called trading curbs stopped trading twice. The second time was for the rest of the day. There is much debate about whether trading curbs help or exacerbate a market decline. What I have observed is that the trading curbs make things worse.

The market was stopped the first time when the Dow had declined 350 points. When it reopened, it quickly dropped another 200 points. It was a straight-down move, with very little trading. The ticker tape was far behind actual action. The market could have been down 1000 points if trading hadn't been stopped the second time.

My observation is that a stop just alerts everyone that something terrible is going on and that it is time to get all the sell orders ready for the next time that the market reopens. They are destructive.

As I commented on October 27's special hotline, the selloff was “climactic,” as advancing issues were swamped by decliners by a ratio of I to 20. In that special hotline, I wrote: in the Dow Industrials there is good support at 7000. But the market could go substantially below that level on an intra-day basis, and then close above it.

That should happen tomorrow, unless the end of the world is here.

Once again, we pinpointed the bottom of the move to the exact date. The next day the Dow Industrials plunged to 6,975, after which a powerful rally started. At the end of the day, the Dow Industrials were up a huge 336 points, closing at 7.498. for a 523 point turnaround.

On the day of the crash, I wrote in our special hotline:

“When will the crash be over? During such a selling avalanche, the would-be buyers usually step aside just to see how far it goes. Once there is an indication of a bottom, they all jump into the market simultaneously, in order to pick up the bargains. Therefore, a rebound from the bottom will be very vigorous. But after the initial buying spree, for several days, there will be another decline because people sell in order to get to safety. The market will test the lows.”

The next day, the worldwide stock markets followed the U.S. lead. Even Hong Kong, which declined about 50% since my sell signal in July, staged a strong rally.

This chart shows the short sales of the public versus those of the specialists on the floor of the exchange. Note that in August, the public virtually stopped shorting relative to the specialists. That means the public was very optimistic about the market. It opens the door for the big syndicates that are geared to drive the market lower under such conditions.

Chart courtesy of McGinley's Technical Trends

But some hedge fund operators were caught by surprise. One well-known figure in the business, who wrote a best selling book entitled “The Education of a Speculator,” is said to have losses as high as 100% of his capital. How do you lose that much? By short selling put options. That's how many speculators went broke in the 1987 crash. Apparently this particular expert also bought the currency of Thailand earlier this year, which was followed by a 50% plunge. That's what you call “having a bad year.”

It is also rumored that the so-called mysterious “Sheik,” who has been a big S&P index futures trader, lost tens of millions of dollars by short-selling put options.

If you look at the chart, you will see tremendous resistance at the Dow 7,600 area. Resistance is usually a level which formerly provided support. Technically, when support is penetrated, the next time the market goes up, that support becomes resistance to an upmove. In fact, after a steep plunge, the rally back to such a resistance level is very normal, before a decline recommences.

But at this writing, that resistance was penetrated when the Dow soared to 7,673 on November 3rd. That's bullish!

I think it's highly probable that the market, especially small company stocks have seen their lows. But the big cap stocks have a lot of churning to do between Dow's 7,600 and the Dow 7,000 area's.

The perma-bears now declare that this is the start of a bear market. What do I think?

I think a bear market at this point is highly unlikely. After the 1987 crash, declarations of bear markets were almost unanimous amongst market analysts and so-called experts. Analysts could not believe that the economy could stay out of a recession. The market crash had caused over a trillion dollars worth of losses during the crash.

But in a featured magazine article after the crash, in which I was on the front cover, the headline was: “Still Bullish, After the Crash.”

Yes, on October 19, 1987, the day of the crash, I declared in a Special Bulletin that the next day would be the low of the crash. It was!

I noted that the long-term uptrend line in the major indices had been touched, but not broken. In other words, the major bull market trend was still intact.

I noted that the worldwide crashes would cause Fed Chairman Greenspan to come to his senses, and start letting money supply grow. Before the crash, the new Chairman Greenspan had crunched money growth to 0%, with the economy growing at over 4%. I noted in this publication that the economy was on a collision course with money supply. The collision occurred in October, as the economy ran out of money.

Interestingly, very few blamed the crash on Mr. Greenspan. Yet the Federal Reserve at the time created the conditions that made the crash possible. Everything else, such as portfolio insurance and program trading, just exacerbated the situation.

Once again, we can blame the Fed for the conditions that made the worldwide market crash of 1997 possible. The Federal Reserve has kept interest rates in the United States artificially high. The fed funds rate, which is a short-term interest rate directly controlled by the Fed, is at 5.5%. But the market puts the short-term rate, via U.S. T-bills, at 5%. The spread between the two is abnormally wide, which confirms that the Fed is being too tight.

Artificially high interest rates in the United States boosted the U.S. Dollar. Many of the Asian tiger nations had tied their currency to the U.S. Dollar. Their currency value rose along with the dollar, making their exports less and less competitive in the world markets, especially when compared to Chinese products. And China is the big elephant in the “China Shop,” pardon the pun.

This created the big “readjustment” process in those nations. Their currencies tumbled 50% or more in a very short period of time. Their stock markets followed, as foreign capital fled.

The U.S. market plunge was an outcrop of this. Hong Kong thought until recently to be immune to a market decline by the majority, finally succumbed as well.

Until the occurrences of late October, most economists took it for granted that the Fed would raise interest rates at its next meeting. I disagreed strongly. Everyone agrees that the Fed cannot raise rates because of worldwide market conditions.

Mr. Greenspan confirmed as much in his speech of October 29, when he thought that the danger of inflation had been substantially reduced by the worldwide market crashes.

It's amazing that the Federal Reserve, which really created the conditions for the crash, does not get any blame for it. In fact, it has caused crashes in order to “avoid crashes.” It's bizarre.

But now that it's happened, interest rates will decline to normal, historical levels. Long-term Treasury bond yields should decline to at least the 5.25% level. This makes long-term T-bonds, especially in the form of zero coupon T-bonds, a fantastic investment. I first recommended these in the August issue. At the time I wrote that these could give you 25-50% profit in the next two years. I was intentionally being conservative.

Since the August low, they already gained 12.5%. Not bad for the safest credit instrument in the world.

So where do we go from here? This chart of the Dow Jones Industrials (weekly) goes back to the bottom in 1994. You can see that the long-term up-trend line, which connects many of the lows, has held on this decline. That should define the low. The 7,600 resistance area has already been penetrated. That's bullish! In late December, the market could go straight upward.

From this chart you can also see that the 7000 area in the Dow is support, going back to the high of early 1997. A previous high is always support on the way down.

It's time to be cautious, but bullish. If you have big cap stocks, expect them to go lower if they are vastly over valued. Small-company stocks will do better because most of them have more reasonable valuations. If you followed my advice, you avoided all of the market disasters. We are well- positioned for what's ahead.

The NASDAQ Composite gave a good tip off that the big uptrend of the past five months was over. Note on this chart that the uptrend line was penetrated at point A. Then the market rebounded and hit the uptrend line at point B. This is a perfect technical rebound, before the severe drop. Point B is usually an excellent place to sell short.

After the 1987 crash, it took the market almost two years to make a new high. It will not take as long this time, because conditions are different. Most important, long-term interest rates are destined to head downward rapidly if I am correct, which would produce new fuel for the stock bull market.

But after such a severe decline, it takes time for the market to reestablish a strong base from which to launch the next bull market upleg.

I believe that the mutual funds on our recommended list are still excellent choices for the most part. We may do some weeding out after a rally.

Conclusion: During any strong drop, buy some of the well-situated stocks or mutual funds. I strongly recommend mutual funds, because of professional management and diversification.

Lower long-term interest rates will restore better valuation levels, and eventually make stocks the investment to beat. But do your best to buy the lows and sell the highs, and not the other way around.

Tokyo has also been a hard since my sell signal on July 25 on Japan.

Note that the actual top of the bear market rally was made in the middle of 1996. It's been downward ever since. Blame Japanese bureaucrats, who still don't get the message from the market.

The important support level around 17,400 was decisively penetrated, which sets up the old low in the 14,000 area as the next likely support. Yes, Japan is returning to the depression, not because of any force of nature, but because of the stupidity of its politicians. They still don't understand that you cannot raise taxes in the middle of a depression and then hope for an economic rebound.

The Euro Top 100 Index, which contains the biggest 100 companies in Europe, has a clear and very powerful double top. The recent decline went down to the first support in the 190 area. For this index to make a new high will take a long time and a lot of work. The double top looks ominous, and a break through the 190 area would be extremely bearish.

Of course, European bureaucrats don't get it either. They raise taxes while having double-digit unemployment, and raise interest rates while not being able to get out of a deep recession. If a visitor from Mars would see this, they would most certainly question the sanity of Earthlings.

The German DAX Index has an ominous top.

Considering that this is a long-term chart, the probability is high that an important long- term top is in place.

Of course, all the action, at least in the media, was in Hong Kong. In our July issue I wrote to expect the top to blow, and then a crash. That's exactly what we saw the following month. From a high above 16,600, the Hang Seng Index crashed to 9,000, in little more than two months. It was a text book case in technical analysis. My forecast was for the market to go down to 7,000, which is the 1995 low. It will.

On Thursday, October 30, just when everyone decided it was time to relax, that the worst was over, the Brazilian market started tumbling again, taking other Latin American markets with it. A number of banks had huge losses in the recent market turmoil, and some quick mergers with foreign banks were arranged as bail outs. The Dow Industrials, as a result, tumbled 125 points.

The Brazilian Central Banks raised short-term interest rates to 40% in an effort to stop the raid on its currency. As a result, the markets on Friday, October 31 rallied strongly in the first hour. But such rescue efforts usually are short-lived. The fundamentals are not corrected.

What we are seeing is a flight to safety, out of any currency that could be suspect. This forces central banks in those countries to significantly boost interest rates, in order to stop the short-sale of their currencies. In Hong Kong, short-term rates were lifted to 300%. That makes it very unattractive to borrow the currency in order to sell it short. But such high interest rates kill the domestic economy, especially the real estate sector.

In my SMARTFAX message of October 26, I said that a rescue package for the markets would be announced, probably the next day. It was. The International Monetary Fund (IMF) announced a $23 billion package for Indonesia and Asian economies. That was a strong, supporting message for the markets.

In my opinion, the United States is now the safe haven of the world. Keep your investment dollars at home.

Conclusion: I would avoid all of the international investment markets. I believe that the next big problem will be in China, which will take down the rest of the Asian nations and emerging nations around the world. It will also effect Europe and big export companies in the United States adversely, as it is a major trading partner for most industrialized nations.

The Asian disease is contagious, and has not been cured. This is one reason why Treasury bonds right now are such an excellent investment, especially on a risk-reward basis.

Of course, short-sellers in those areas have some excellent opportunities. I recommend that you look at the so-called WEBBS, which are almost like closed-end country funds, traded on the major exchange. You can select the country you want to sell short. When you short them, you don't even have to wait for an uptick.

The major bond markets in the world are rising steeply, confirming that lower interest rates are ahead.

This chart of the British government bonds, i.e. Gilts, show the nice recent upmove. It's a long-term bull market.

The long-term U.S. T-Bond chart is also very bullish, just having exceeded the last rally peak it made in late 1996.

The old high at the beginning of 1996 is the next goal. This is a strong bull market.

Also note from this chart that the German government bond market has been very strong since late 1994. This is a powerful bull market, which is ready to break out to a new high.

Long time subscribers know that I have been bullish on the emerging markets bonds since their bottom I early 1995. But something very important appears to be happening. During the October massacre, these bonds plunged through their uptrend line. This occurred while the government bond market soared upward. In other words, these bonds are no longer considered safe.

I believe that this flight to safety will have a long-term adverse effect on the stock markers of these countries as well. If international investors are afraid of the government bonds in those countries, they will be even more cautious about their stocks. This chart tells you that the emerging stock markets should now be avoided at all cost.

It is said that nothing happens by chance in the world of politics. Earlier this year, when the Federal Reserve raised U.S. interest rates, I wondered why it did it? There was no sign of inflation. Yet it raised rates. The Bank of England about the same time had several interest rate hikes in a row. Recently the German and the French central banks raised rates, as well as the Bank of Canada. Remember, Germany and France have unemployment above 11%.

I believe those interest-rate hikes had a lot to do with the debacle in the Asian markets. But why would the major central banks of the industrialized nations want something like that to happen?

You can only guess. And your guess is probably as good as mine. But one thing is for sure, the interest-rate hikes were so out of the realm of reality, that they looked very suspicious.

Conclusion: As a stock market investor, you must exercise caution. I recommend eliminating all international exposure if you have disregarded my advice over the past many months. Even in the United States, you must be very selective. Because of overvalued big cap stocks.

At the last bottom, in November 1994, cash levels of mutual funds were between 8% and 10% depending on the category. Now cash levels are about half that. This means that there is 50% less buying power to drive the market upward.

The small cap stocks do not need that much money to drive them higher. Therefore, that is the preferred area.

For many investors, the bond market will be the best investment on a risk-reward basis. But if you know how to pick your categories of stocks, you can do well in the small cap area.

The next several weeks will be very volatile. Don't be in a hurry to plunge in.

In the Summary of last month's issue I wrote: “I would be careful with international investments, especially avoiding Asia. Latin America will be the next time bombs...”

That's exactly what happened. The potential “aborted W” chart pattern in the Dow which I discussed in last month's issue was very similar to that preceding the 1987 crash. I continued to warn about that in our Friday hotline. As it turned out, it did abort and precipitated another crash.

I was pleased that our recommended mutual fund positions performed so nicely. In fact, many of them made new highs in the week preceding the plunge. When the plunge finally affected even our funds, it was only for about three days.

The funds that held up best were the value funds and the realty funds. We even had some big winners: the zero-coupon T-bond funds, namely, the American Century Target Funds. They actually gained more than 12%-16% since my August recommendations. From October 21 to October 31, they rose 6% to 7%! Not bad for a crash.

The Dow Industrials broke the previous support level of 7600 on black Monday. After that, it was like the dam broke. The Dow plunged 554 points. At the end of that day, we issued a special hotline, predicting that the next morning would be the low of the crash. I wrote that the market would open sharply lower and then stage a very strong rally late in the day. That's what happened, as the Dow closed Tuesday with a gain of 336 points.

Small company stocks should be bought on any setback. That's where the profits will be made over the next 12 months.

Have we entered a bear market? No way. At least not in the broad market.

In my opinion, the next 12 months will once again see great profit opportunities. But you must be very selective. This is the time to have the best advice possible available to you.

November, 1997 Bert Dohmen

Dohmen Capital Research Institute, Inc.

A Division of Dohmen Capital Group

66 Queen Street, Suite 301, Honolulu, Hawaii

Consensus National Futures and Financial On Line Index

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