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THE YAMAMOTO FORECAST
Prepared by
Irwin T. Yamamoto
The Test
52% in Stocks; 25% In Rydex Ursa Fund; 23% in Cash.
Indicators: Fundamental - Negative; Technical - Negative; Monetary - Neutral; Sentiment - Negative
A Dangerous Period
The financial markets are entering a dangerous period. The 6-month time frame beginning October 1, 1997 and ending March 31, 1998 may indicate where stocks and bonds go from here. Does the bull market continue to make new record highs or is this the finale? If the market can survive this period, then it might be well on its way. If not, it could be Aloha for this bull run.
I have been saying all along that the upcoming 6- month time span will be a critical one for stocks and bonds. What's the reason? And why? A lot of the economic questions should be answered between the fourth quarter of 1997 and the first quarter of the brand new year.
The answers might turn out positive. Or they may be negative. With most market averages near their highs, investors are betting everything will be fine and dandy. I think not. Whether we're on the brink of a correction or a bear market, at best, we are staring into a difficult 182-day period.
Economically Speaking
Good news is going to be bad news. What's positive for Main Street won't translate to happy times for Wall Street. The U.S. economy enjoyed a powerful first quarter. In the next 3 months, it took a bit of a breather. While in the just completed third quarter, the indications point to renewed strength. For the last quarter, the vigor in the economy should be apparent. And that spells trouble for investors.
The ramification of a 24-year low in the unemployment rate and a booming equity market is a resurgence in business conditions. At first glance, the news looks good. But a pickup in economic activities increases the chance of higher interest rates. With the prospects of rising rates, the stock market will be in rough waters.
Unemployment
In the past, a 24-year low in the unemployment rate would induce deep concerns among the economists. The premise, a tight labor market entails more disposable income floating in the system. At some point, these monies are going to be chasing a limited amount of goods and services. The outcome, rising prices. In other words, inflationary pressures.
But for the moment, at least for now, the low unemployment rate has not resulted in higher inflation. The majority of economists are saying that there's a new paradigm. The old economic model has been rendered obsolete. The global economy is the basis of this conclusion.
Worldwide competition has made the unemployment rate indicator outdated and no longer useful. That's the argument of the bulls. Before you form the same opinion, you might want to reconsider. Just because inflation has not been spotted yet, it doesn't necessarily mean inflation is a thing of the past. Not by a long shot.
One may talk about the new paradigm and the global scene, but the tightness in the labor market prevails. Check the pay increases at Boeing and UPS (United Parcel Service). In the latest hiring survey from Manpower Inc., the approaching fourth quarter should be the strongest period on record since Manpower started tracking hiring plans in 1976. Of 16,000 employers surveyed, 28 percent of the companies expect to hire more in the fourth quarter. A solid 25 percent increase from last year.
The “quit rate,” the number of people who voluntarily leave their current job for another place of employment, is high. This measurement shows how hiring within the economy is so intense that people feel secure enough about their finances and the business landscape to quit. many move on for an increase in pay.
Corporate Profits
For the bulls who feel international competition will keep inflation at bay because corporations won't be able to increase prices, I have something to tell you. The effects of worldwide marketplace are not all good. If companies can't pass the costs on to consumers, then another thing occurs. The profit margin gets squeezed. Corporations must “eat” the higher costs. Costs such as new employees and higher salaries and bonuses for the work force. The bottom line is going to be affected.
The rumors of weaker corporate profits are already being heard. In the just completed quarter, some warnings about earnings disappointments were issued. We anticipate the news on corporate profits to get progressively worse later this year and into 1998. If business is booming, then why the decline in the bottom-line picture? Inflation. Inflationary pressures have not shown up in the figures reported by the government. Yet how do profits fall in a robust environment in which we are now in? It would be understandable if the economy was slowing down, but it's not. On the contrary, there's a pickup in business activities.
Demand
Most economists seem to be focused on the positive results of worldwide trade. So much so that they are blind to the negative possibilities. It's true how competition could restrict price increases. However, on the other side of the coin, international demand may raise prices in the long run as too much demand outstrips supply.
Inflation
Inflation is nowhere in sight, at least according to Wall Street. And the Federal Reserve could be waiting to see the eyes of inflation before interest rates are raised. Not a smart idea. if Federal Reserve Chairman Alan Greenspan waits until inflationary pressures are detected, that will be too late to fight it. One avoids inflation by taking steps before it arrives. To increase rates before inflation is confirmed is not an easy thing to do. Politically, it's a difficult task. Still, if you're serious about beating inflation, then you must do it.
Sentiment
On the August 4th cover of Newsweek magazine, the headline reads, “The New Rich.” The story was about how people were getting rich. Many of them got there via the stock market. Since I'm a contrarian, I saw the cover story as a warning sign. Notwithstanding, precisely on the same day, August 4, Time magazine had these words on its cover, “Stocks–Preparing For A Crash.”
Two national publications put the topic of equities on their covers. Stocks are the only game in town. Here's my interpretation. The market is close to a top. But it, s not quite there yet because at the peak, nobody will be worried about a crash. Or anything else.
Insiders Selling
Corporate insiders, the people who should know, are selling their securities. Recently, stock sales by insiders reached the highest level in over 4 years. Do they see what others cannot? Perhaps. it also appears the selling is related to a certain extent to the capital-gains tax cut. Since long-term profits are now taxed at a lower rate, nailing down gains must be considered as an attractive option.
Allow me to give you something to ponder. Back in 1981, the market hit its high the day President Reagan signed the capital-gains tax bill. In August of 1997, equities also reached its top the following day after President Clinton signed the bill into law.
El Nino
The El Nino event. El Nino holds the potential to stir up problems by causing shifts in weather conditions. Hence, agricultural production could be affected in a negative way. The prices of coffee, cocoa and wheat have already gone up.
What El Nino does or doesn't do might not be the important point here. In the bigger picture, a surprise of any kind would send securities falling in no time. All the good news is reflected in this overpriced equity market.
The Market
Earlier in the year, the big- capitalization stocks were the winners. Lately, it has been the small-cap issues. Currently, the Dow-type equities are the underperformers while the smaller stocks have surged ahead. Maybe the larger stocks deserve a rest, but a confirmation of the bullish trend must include both chiefs and Indians.
A broad advance is required. If the moves are restricted to a certain group, then the rallies may not be sustainable. For the market to achieve new highs or even attempt to, a wide-based climb is paramount. Without it, any rallies will soon peter out.
A message to market participants. The slide in the big-caps serves as a signal. In a market decline, there's no place to hide. Investors won't scurry to the big-cap names. In fact, they would be the first ones to be sold because they possess the most liquidity.
As for the small-cap index, the journey's far from over. However, it could also be the initial indications of speculation creeping in. Especially considering the lofty levels we are presently hovering at. Be careful.
Although I'm bearish for the long term, I anticipate the next correction or bear cycle to develop at a higher level than where it's at today. In simple terms, the bull run remains intact for the foreseeable future.
Selected Information
To get a feel of the pulse of Wall Street, note how only selected information is processed. On September 16, traders focused strictly on the low inflation number, the Consumer Price Index. They totally ignored what seemed to be the more telling statistics. Industrial production soared 0.7 percent in August as output in manufacturing rose by the largest amount in 16 months. Also, America's factories, mines and utilities were operating at 83.9 percent of capacity in August, the highest rate in 24 months. In all the euphoria, investors seem to want to ignore how inflationary forces are picking up steam. To pretend inflation's not there won't make it go away.
Interest Rates
The direction of interest rates is heading down again. And rates, based on the yield of the 30-year Treasury bond, could re-test the July mark of 6.29 percent. On the surface, the outlook looms promising. But on the second thought, the combination of a low unemployment rate, high consumer confidence, a bloated stock market, a strong economy and now lower interest rates virtually assures a tighter monetary policy by the Federal Reserve in the months ahead.
Gold
We continue to believe the central banks are selling gold into any rally. Most of the selling pressures are coming from the European countries as they try to satisfy the requirements of the European Monetary Union. And based on our research, the selling's not done yet.
Our stance remains negative in the short term. Nevertheless, we still hold a bullish forecast for the long term. The mixed outlook can be explained by the current supply-and- demand situation. In response to low metal prices, many mining companies have announced the closings of their high-cost operations.
Despite the seemingly bearish scenario of mines being shut down, in actuality, the implications are quite bullish for gold. In the long run, the closing of mines will curtail the industry's overall production figures. Furthermore, the gloom- and-doom atmosphere regarding the bullion should cancel the plans of new mining projects of gold producers.
The bottom line, the supply of the bullion is going to be reduced. With the prospect of diminishing inventories and the strong demand for the metal, especially from the Far East, a light can be seen at the end of the tunnel. Still, the obsession with the selling of gold by the central banks overshadows everything else at the moment. Be patient. Think long term. And take advantage of the depressed prices in the metal market.
Strategy
At this stage, our financial strategy is very defensive. We feel our positions will benefit handsomely in a market downturn. A note. The Rydex Ursa Fund is not for everyone. For conservative investors, cash should be substituted in place of the fund. Likewise, our 52 percent stake in the precious metals must be considered high. For the average person, 5 percent would be appropriate.
October 1, 1997Irwin T. Yamamoto
The Yamamoto Forecast
P.O. Box 573, Kahului, Hawaii
Copyright 1997, by Consensus Inc. All American and Pan American rights Reserved. editor@consensus-inc.com
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