Prepared by Chart Analysis Limited

-Trend acceleration has given way to churning top development for the recently in-form stock markets.

-Lagging stock markets are unlikely to experience significant catch up moves in coming months.

-Long-dated government bond prices have broken their April to August uptrends, JGBs excepted.

-The global love affair with the U.S. Dollar continues, albeit questioned by fears for Wall Street and jawboning from the Bundesbank and Japan's MOF.

-Sterling has peaked against most of the other major currencies, but is currently somewhat oversold, and will experience occasional sharp rallies due to interest rate differentials.

-Crude oil continues to encounter support near U.S.$19 in an apparent developing base.

Wake-Up Call For New Age Bulls-Over the last two and a half years most of the world's stock markets have been celebrating the taming of inflation, accommodative monetary policies, globalization, the triumph of capitalism, corporate share buy-backs, rising corporate profits, takeovers, a technological revolution, a new era, downsizing, upsizing, the delights of leveraged portfolios in a rising trend and Aunt Sally's inheritance. It's been a great story. It's been an even better bull market. Now it's injury time.

The trend acceleration evident last month for many previously in-form stock markets has given way to churning top development. The U.S. capital gains tax cut is unleashing previously deferred profit taking. South East Asia's problems have reminded people that stock markets also fall. The lead from fixed-interest markets has turned from bullish to neutral, at best. I believe that new highs for global bond prices are now required to delay a significant slide by stock markets, beyond further top formation development.

Nothing has changed, people will say. What about sentiment? Many who are fully invested now lie awake at night. The bears are emboldened, and their ranks are likely to grow. When markets decline, everything that was previously seen as right, is suddenly viewed as fully discounted or wrong.

How far will stock markets fall? I don't even know if they will go down, and neither does anyone else. However, I sense that the risks are now higher than at any other time since January 1994 and October 1987. I've seen enough. This old-age bull is now a new-age bear.

If stock markets do fall, no one could feign surprise, and it would be no bad thing for those who took some profits when the going was good, hedged their portfolios or sold short. We could also look forward to the movie. Michael Crichton and Stephen Spielberg would join forces once again to bring us another splat film-"Crash"-featuring John Goodman as Bill Clinton, Ralph Fiennes as Robert Rubin, Henry Kissinger in a cameo role as George Soros, Ernest Borgnine as Eddie George, and with another Oscar-wining performance, Anthony Hopkins as Alan Greenspan. I can hardly wait!

No Strong Case For Changing Short-Term Rates-It is the nature of market crowds to worry about changes in short-term interest rates far more frequently than is ever justified by events. Will the Bundesbank lead higher rates across Europe? They could, but the short-term case is hardly compelling and could only be politically divisive. While there would be no similar political consequences if Japan finally lifted rates, the economic recovery is currently weaker than forecast by the government. The U.S. Federal Reserve has three reasons to postpone a rate increase for a while longer-inflation remains very low, the U.S. Dollar is strong and it would probably spook Wall Street.

U.S. Eurodollars Break Their Upward Trend-After a retest of the April low at 93.31 (December contract), Eurodollars commenced a strong recovery with a decisive upward dynamic. This advance was checked with a key-day reversal on August 1st , near the December and February peaks, followed by a break of the uptrend. Rally scope now appears limited to top extension prior to some further retracement of previous gains.

U.S. 30-Year Treasury Bonds Establish A Significant Peak-The April-July advance gathered pace over the last month before ending dramatically with a decisive downward dynamic off the high. The speed with which the price fell suggests that here also upward scope is limited to possible top extension before renewed weakness is seen.

UK Gilts Fail To Maintain The Upward Break-Gilts finally managed to break above lateral trading at 115 (September), but could only manage one more upside point, and hold the move for only seven days, before flopping back. This upside failure suggests that further sideways and eventually lower trading will follow.

Italian And German 10-Year Bonds Establish Peaks Of At Least Near-Term Significance-Bunds and Italian bonds saw substantial extensions to their overall upward trends from April to late July before falling sharply. While this weakness is not excessive relative to previous and temporary setbacks, and prices have subsequently steadied, it has occurred later in the cycle from higher levels. Therefore I assume that peaks of at least near-term importance have been seen. Upward dynamics are now required to indicate top-testing rallies. Conversely, closes under the recent reaction lows at 101.50 and 134.73 for September bunds and Italian bonds, respectively, would indicate renewed vulnerability.

Australian Bonds Also Break Their Uptrend-Australian bonds recorded one of the strongest and most consistent uptrends from April through July. The price then gapped down from the peak at 93.695 on August 1st to break the pattern consistency, and gapped again to complete a small top. There is some potential support evident at 93.00, but a very clear upward dynamic will be required to suggest more than temporary steadying.

Only Japanese Bonds Have Yet To Break Their Uptrend-JGBs have extended their break above the April peak and a close below 126 (September) is needed to indicate an upside failure. Given what is now virtually a global trend change, it is hard to see how Japanese bond prices can maintain their uptrend for much longer.

Conclusion On Bonds

It would be prudent to assume that we have seen peaks of at least near-term significance for long-dated government bond prices. The previous gains were substantial so there is scope for further corrections before the next significant rally occurs. Very clear upward dynamics are now required to indicate more than temporary technical rallies.

Risks Now Outweigh Near- To Intermediate-Term Rewards Following Acceleration, Loss Of Upward Momentum And Also The Previously Bullish Lead From Bonds-Acceleration is a trend-ending characteristic and it would be surprising if the previously in-form stock market indices saw no more than shallow corrections before ranging higher. Consequently the risk that many of the world's share indices have commenced top formation development is quite high, especially now that the all-important bond lead is neutral at best. This greatly reduces any scope for even partial catch-up moves by South East Asia's lagging markets in the current cycle.

Watch The Charts-As many indices now show trading ranges, eventual moves out of these patterns will give important clues as to the next major move. Most important would be failed upward breaks (bearish) or the downside equivalent (bullish). Wall Street will obviously remain the dominant influence but is unlikely to lead. It would be a good idea to monitor many more of these indices than may be of immediate interest, for evidence of confirmation as breakouts occur.

The Chart Analysis World Market Indicator (currently 1819) looks overextended having seen its largest uninterrupted advance since 1993 and 1987. Consequently, the next reversal on this chart is likely to mark a penultimate peak or worse. CAWMI is unweighted and calculated in local currencies every Monday.

MS Capital International's World Index (953) has not maintained its latest upward break. While this is a warning, a decline of over 60 points, exceeding the March/April correction, is required to indicate a clear loss of overall upward momentum. MSCIWI is capitalization weighted and calculated in U.S. Dollars.

The USA's Dow Jones Industrial Average (7919) would commence an erosion of underlying trading below 8000. This would look significant beneath 7800. Until or unless this happens, the short-term upward trend remains intact, albeit overstretched. The Standard & Poors 500 Index (923) shows some loss of overall upward momentum but would have to break the progression of higher lows to provide further evidence of pattern deterioration. The NASDAQ Index (1584) looks overextended following its April-July advance, would start to eat into prior support below 1580, and the pattern would look toppy at 1535.

Canada's Toronto Composite Index (6771) which also looks somewhat overextended, would be testing initial support at 6740 and show a potentially significant loss of upward momentum at 6640.

Argentina's General Index (24,512) is testing psychological resistance from the important February 1994 peak near 25,400. A move under 23,800 is required to reaffirm resistance from that area.

Brazil's Bovespa Index (11,882) nearly doubled this year before commencing a sharp correction. A sustained move over 13,600 is needed to indicate higher potential, while the pattern would look like a completed top under 11,250.

Mexico's IPC Index (5007) remains generally steady following a brief correction, but potentially important pattern deterioration would be progressively indicated with each point beneath 4800.

Japan's Nikkei Stock Average (19,223) has edged lower but would need to fall under 19,000 to indicate a test of the January to April trough within the six-and-a-half-year base formation. A move to 20,800 is needed to signify a challenge of this pattern's upper boundary.

Taiwan's Weighted Price Index (9632) hesitated near the psychological 10,000 level and has commenced an erosion of support under 9800.

Hong Kong's Hang Seng Index (16,498) looks somewhat overextended but would require a fall beneath 15,700 to indicate a potentially important challenge of the first important region of support.

Indonesia's Jakarta Composite Index (643) fell sharply after moving back beneath the February peak at 712, breaking a consistency characteristic evident since the last major base was completed in January 1996. While some steadying may be seen around prior support near 630, this pattern cannot sustain more than a technical rally at present.

Malaysia's KLSE Composite Index (919) has slumped back towards its important January and November 1995 lows between approximately 885 and 850. As the decline looks somewhat overextended these should offer at least temporary support but in the absence of a base formation upward scope currently appears limited to a technical rally.

Singapore's Straits Times Index (1892) has now breached its January 1995 low at 1920. A move back above 2000 is now required to break the progression of lower rally highs and questioning the overall downward bias.

Thailand's Bangkok SET Index (629) accelerated to what looks like a sustainable floor near 450 in June, but is now susceptible to a pullback and potentially lengthy base extension phase before the recovery is extended.

Australia's All Ordinaries Index (2627) has fallen back from its July high to break the last reaction low near 2640, and needs a move over 2750 to reinstate the upward trend rather than an additional retracement of recent strong gains. The All Mining Index (824) had its brief rally reversed by supply beginning at 880 and needs a move over this level to offset further pressure on the February 1995 low at 800, at least.

New Zealand's Capital 40 Index (2457) has not maintained its break above the July high and further deterioration would be indicated on a breach of last month's low near 2450. Conversely, the uptrend would be reaffirmed at 2580.

South Africa's Industrial Index (9238) looks a little overextended but downward risk will be limited to a temporary consolidation provided that support is encountered above 8700 during the next reaction. The pattern would deteriorate progressively beneath that level with the recent gains looking like a failed upward break. The previously weak JSE Gold Index (1042) looks overstretched and the steep decline has lost momentum recently. A clear break beneath 900 is needed to indicate renewed vulnerability.

Belgium's BEL 20 Index (2418) has seen its biggest numerical fall since the bull market began in 1995. There is some minor support between 2400 and 2350, but upward scope now appears limited to top formation extension.

Franc's CAC 40 Index (2922) has slipped back from the psychological 3000 level. While 3080 would revive the uptrend, a break under the July reaction low near 2880 would suggest significant pattern deterioration.

Germany's DAX Index (4231) has now lost upward momentum following an accelerated advance and also recorded a failed break above 4400. It looks susceptible to a further and possibly steep correction, although this risk would be delayed by a move over 4420. However that would most probably indicate no more than extended top development rather than a significant resumption of the prior uptrend.

Spain's Madrid SE Index (589) has broken its uptrend consistency with the biggest reaction since the bull run commenced in early 1995. There is some minor support evident between 575 and 550, but a sustained push over 625 is needed to question the top building hypothesis.

The Netherlands' CBS All Share Index (635) shows a loss of upside momentum following an overextended advance. The pattern deteriorates progressively below 650.

Sweden's Affaersvaerlden General Index (3240) has not maintained its latest upward break. The overall advance looks overstretched and further evidence of top development would be apparent at 3100.

Denmark's Copenhagen SE Index (631) shows a loss of upward momentum following an overextended advance. A break above 660 is needed to question the current outlook for a more extensive correction than the 30- point pullback seen in March and April.

Norway's Oslo SE Index (2160) resumed its upward trend following a brief pause, but this would look increasingly like an upside failure with each point below 2100.

Italy's BCI Index (905) looks much less overextended than Europe's other indices but it may have left its bull run too late. In any event, a reaction is underway and a move above 960 is needed to reaffirm the uptrend.

Switzerland's Swiss Market Index (5580) has been a spectacular performer this year but the current broadening pattern looks like top development. A push above 6000 that holds for more than a day or two is required to challenge this hypothesis.

The UK's FTSE 100 Index (4991) extended its choppy uptrend, but has encountered resistance above the psychologically significant 5000 level. However, the FTSE has almost never sustained its initial rallies to new highs. Consequently a break of 4800 is required for decisive evidence of pattern deterioration.

Conclusion On Stock Markets

The parabolic uptrends for so many stock market indices were beginning to look climactic last month. Now we are seeing a loss of form on the charts for a number of these, following downward moves by bonds, which I have always regarded as the crucial lead indicator. The long awaited U.S. Capital Gains Tax cut, which I have often warned would be bearish, was finally passed this month. The early indications are that it is releasing a wave of deferred profit taking, just as occurred following the last two reductions, which produced corrections from which Wall Street did not recover for at least a year. Finally we have the sobering spectacle of additional declines by South East Asia's share indices, which led so many previous global uptrends, to remind new age bulls that no market rises in perpetuity. I can only conclude that the risks in all stock markets, and particularly those that have risen the most over the last two years, now greatly outweigh any likely reward over the short to intermediate term. Moreover there is scope for some panicky declines.

Global Love Affair With The U.S. Dollar Tested By Wall Street Pre-Nuptial Agreement-Most of the world has stopped fighting the U.S. Dollar, and if not exactly loving it, learned to accept its advance. The Bundesbank grumbles most days, but primarily due to the speed of the mark's recent decline, while maintaining a monetary policy of devaluation. They do not give the impression of wishing to emulate Japan's Pyrrhic victory of last May, and talk the dollar down too much. Even the more quixotic South East Asian governments have learned that tilting against the market is expensive.

However, while traders had loved the greenback second only to themselves a short while ago, their ardour has been tempered recently by a Wall Street pre-nuptial agreement. That is, if the U.S. stock market falls, one receives fewer dollar gains, or even a loss, depending on the timing. The DJIA and the U.S. Dollar have been in lockstep recently. The link is purely emotional, of course, as any other explanation is tenuous, to say the least. But isn't 90% of what happens in the markets on a day-to-day basis due to emotions?

Sterling-Always A Thrill-A-Minute On A Roller Coaster-Once upon a time one could sound almost informative during forex chat sessions by observing that sterling was the world's weakest reserve currency-except for brief periods when it was the strongest. The reverse has been true over the last year and a half, but the pound spiked downwards recently. The peaks look significant but a sustained downtrend is highly unlikely until the BOE actually starts to lower those mouth-watering interest rates.

The U.S. Dollar Breaks Its Short-Term Upward Trend Against The Mark-Following its breakout from the February to June range against the mark, the dollar rose in an orderly upward trend to DM1.8905 before commencing a corrective phase. This peak is likely to hold for a few weeks, at least, with the dollar ranging somewhat below it in a consolidation of the previous strong gains. There is currently little reason to believe that we have seen more than a short- to intermediate-term peak. The greenback would have to fall back under DM1.70, which I do not expect, to question the longer-term upward trend.

The U.S. Dollar's Advance Against The Swiss Franc Has Paused Near Psychological Resistance From The 1992- 1993 Peaks Just Under SF1.55-Those former highs represent a logical reaction point for the dollar but it is unlikely to encounter more than temporary resistance. The greenback is currently less overextended against the Swiss Franc than versus the mark, and that large February to July trading range below SF1.49 should cushion downward risk. If the dollar holds above that level during the present consolidation, we can expect further gains before too long.

The U.S. Dollar Has Dropped Back Into The Upper Region Of Its Prior Support Against The Yen-The dollar's recovery faltered beneath initial resistance at ¥120, followed by a flop back into the mid-May to mid-July range. The speed of that decline will worry the bulls and encourage bears. They have a point, and this remains a nervous market, but I suspect we are seeing no more than an extended phase of support building by the greenback before it rechallenges the year's highs. However, this hypothesis would be questioned increasingly with each ¥1 move below ¥114.

Sterling Looks Temporarily Oversold Against The U.S. Dollar-The pound took one look at its November to January peaks centred on U.S.$1.70 against the greenback and bungee-jumped. The speed with which it moved beneath prior trading suggests that it will be a very long time before those highs are retested. Currently, sterling looks temporarily oversold, but this pattern appears incapable of supporting more than a technical rally before somewhat lower levels are seen.

The Australian Dollar Is Unlikely To See More Than A Temporary Technical Rally Against The U.S. Currency Before Heading Somewhat Lower-The downward break in early August was not maintained, setting the Australian Dollar up for a test of last month's rally high at U.S.$0.750. While failed breakouts from trading ranges are often followed by a return to the pattern's opposite side, at least, extensive overhead supply should limit upward scope to a technical rally, followed by lower ranging for the Australian Dollar.

Overhead Supply Should Eventually Force The New Zealand Dollar Lower Against The U.S. Currency-The Kiwi Dollar finally broke down out of its large top formation against the greenback in June. The decline has subsequently slowed near some old support. Nevertheless this pattern cannot sustain more than a temporary short covering rally, at best, before the top area forces further weakness.

Sterling Has Established A Peak Of At Least Intermediate-Term Significance Against The Mark-One clear downward dynamic, from just under the high to DM3.00, broke sterling's short-term uptrend consistency against the mark. Moreover this decline is larger than the approximately 13-pfennig corrections that occurred several times on the way up. Consequently it looks as if the pound has established an important peak. However, potential support is evident from prior trading below DM2.82 which should at least cushion the fall and spring a technical rally in coming weeks.

The Mark Should Stage A Significant Recovery Against The Swiss Franc-The mark had been ranging lower against the Swiss Franc since February, returning to historic support. It has steadied above SF0.810 on a dynamic in late July and that level held on a retest. A clear push over SF0.830 would break the progression of lower highs and indicate a further recovery, which could be substantial.

The U.S. Dollar Extends Its Advance Against South East Asian Currencies Following A Consolidation-The U.S. currency first broke up out of its long trading range in early July. Those initial gains were consolidated in trading ranges for three weeks, followed by renewed strength this month. There is no sign that the greenback's advance against the Singapore Dollar, Indonesian Rupiah and other South East Asian currencies is near a significant peak. Moreover, the extensive underlying bases can still support considerably higher levels.

Crude Oil's Developing Base-U.S.$19 for NYME crude oil continues to look like a floor. There is a large developing base formation characterized by rising lows. A break above U.S.$21 (October contract) would provide further evidence of higher scope. A close under U.S.$19.50 is currently required to question present scope for sideways to higher trading.

Zinc Should Eventually Trade Low Following The Buying Climax-Zinc's uptrend ended spectacularly with a parabolic acceleration followed by collapse. The price has subsequently ranged higher, retracing approximately half of the one-day plunge, but upward scope now appears limited to top formation extension prior to further weakness.

Gold Is Ranging Above Historic Support-If we were talking about anything else, people would be interested in this pattern. Gold has seen a long bear market, is currently not far from historic support, showed a trend-ending characteristic by accelerating to its recent low and has seen some small upward dynamics recently. Consequently, a close under U.S.$316 (October contract) is now required to indicate renewed vulnerability. Conversely, a clear break above U.S.$332 would indicate recovery scope.

The Global Investment Scene

In a departure from my usual format of reviewing global economic developments by region, I have decided to share some thoughts and concerns for the world's financial markets where in my view risks have clearly increased recently. Some may say, hold on, for two and a half years you have been writing about abundant liquidity, wealth creation on an unprecedented scale due to the almost world-wide adoption of the market economy, the greatest technological revolution ever and dormant inflation. So what has changed?

Nothing concerning these factors which are primarily responsible for the great bull trends in bonds and most stock markets around the world. Moreover they fully justify long- term optimism. However decisions affecting liquidity can sometimes be mercurial, altering both its availability and cost, as we have seen in South East Asia during recent months. That situation will be resolved, with devaluation and IMF help, but the sheer scale and speed of bond and stock market gains around the world creates its own instability. Our challenge is to anticipate, or at least identify and react to a genuine catalyst for change in a timely manner. In stock markets, turning bearish much too early has usually proved to be worse than benign neglect, otherwise known as buy and hold.

With inflation on the back burner, what could jeopardize global liquidity and trigger the largest stock market sell off since 1994, at least? Probably not the "Thailand syndrome," formerly known as the "Mexican problem," although if more stock markets weaken sufficiently in coming months it will certainly be cited as the initial domino which started the chain reaction. Nevertheless, on its own the Thai-factor is regional, small and not sufficiently serious to panic Japanese or American investors.

Many strategists have long regarded Japan as the key to global liquidity flows. Certainly yield-hungry Japanese investors have helped to fuel the bull market in global bonds. Might they now repatriate a significant proportion of these funds? I doubt it. Japan's economic recovery has sputtered, keeping interest rates rock-bottom low, and the Nikkei remains rangebound. The MOF and BOJ would talk down an overly strong yen, should this arise in response to the current account surplus, as they have before. While Japanese investors would understandably also take fright and retreat to cash in a global sell off, they are unlikely to be the trigger for a wide spread equity slump, barring heaven forefend, a serious earthquake in Tokyo.

Many pundits have long described Wall Street as a bubble, often by underestimating the profits growth that has helped to propel the advance, but valuations are certainly high in a number of industries. While I have little doubt that the Federal Reserve's next monetary tightening will pose problems for shares, Alan Greenspan and various other governors have gone out of their way recently to state that the next rate hike is not imminent.

Investors frequently worry about global hot spots, but only the paranoid would see a serious military conflict on the horizon today. Yes, the Israeli/Palestinian situation remains tense, but no Middle Eastern country has the justification or stomach for a war today. However some petroleum prices have risen independently recently, notably gasoline and natural gas, due to temporary shortages. These are priced in an appreciating U.S. Dollar and the additional costs will show up when oil importing countries report their PPI and CPI data for August.

I believe the problem for high-flying stock markets today is gravity. Admittedly, this is a highly subjective assessment, at least in terms of timing. However this year's strong gains for so many national bourses, on top of last year's considerable advances, now look unsustainable to me. The charts show many trend accelerations, which the technically proficient will recognize as ending characteristics. If I chose one word to summarize feelings among the investment managers to whom I have spoken recently, it would be bemused. They are very edgy, and calm nerves by saying there is little on the horizon to prevent the bull run from continuing for a few more months, at least. In other words, they see no smoking gun.

Most share price slumps are triggered by an unwelcome shock to waning confidence at a time of market overvaluation. In 1987 it was the unexpected raising of interest rates by the Bundesbank and BOJ. In 1990 shares plunged and the oil price soared when Iraq invaded Kuwait. In early 1994 the U.S. Federal Reserve embarked on a change in monetary policy which doubled short-term rates. While most investors knew that a hike was coming, eventually, they were hoping that it would be postponed for a while longer.

Today we know that Japan will raise rates from the current level of 0.5%, but the BOJ says not yet, with good reason as the economic recovery is faltering. The Federal Reserve's next move will almost certainly be to tighten, and the bond market has taken fright recently, but some investors had previously deluded themselves by speculating that short-term rates might even fall due to deflation! I can only see Greenspan cutting rates in response to a stock market crash, because there is currently no deflation in the U.S. economy requiring the Fed's attention. The only U.S. deflation is due to economic success, as we see in the computer industry where manufacturers are often benefiting from lower costs and profiting by selling more at lower prices. Finally, we have the recent threat by the Bundesbank to lift rates. That may be only jawboning to check the mark's recent slide, but it surprised the markets and has halted uptrends for European long-dated bonds and stock markets.

The common strand running through most countries' policies for short-term interest rates is the U.S. Dollar. Might it be a key factor in a wide-spread stock market shake out? In 1987 leading central banks altered monetary policy suddenly to stem the decline of a weak U.S. currency. Recently, we have seen a "crisis" of U.S. Dollar strength on three continents-Asia, South America and Europe. Higher rates in an effort to stem the slide of their currencies has been a major factor behind the weakness of stock markets in many Asian "little tiger" countries. There was a sharp stock market correction in South America over fears that their currencies could come under similar attack. More ominously, the Bundesbank's obvious discomfort over the speed of the mark's fall against the U.S. Dollar threatens the two platforms that have supported strong advances by European share prices over the last year and a half-accommodative monetary policies and gradual orderly devaluation.

There is one certainty in all this. When stock markets crack, various "Goldilocks" and "dream scenarios" will be quickly forgotten. All sorts of reasons will be tabled as to why it had to happen. There will be a global "I told you so." Is it ominous that we have not heard many bearish forecasts recently?

Government Bonds

A change in sentiment following a long run can affect markets way out of proportion to any change in fundamentals-real or perceived. In other words, prices are volatile because emotional humanoids trade them on a leveraged basis, while the background economic factors of growth or recession, inflation and even interest rates, inevitably change slowly and generally in broad sweeps.

Accordingly, the strong April to late-July rally in bond prices has given way to a corrective phase which could be extensive, given the initial downward dynamics for U.S. and European contracts. Recent talk of deflation in the U.S. could only have come from portfolio managers attempting to rationalize uncomfortably large bond portfolios. Therefore as people are forced to cut back on these positions, while others sell short, we may not see a new floor for bond prices until forecasts of rising inflationary pressures and tighter monetary policies are wide spread.

Meanwhile, it would be premature to conclude that short- term rates are about to rise in the U.S. or Japan, let alone Europe, despite the Bundesbank's recent discomfort over the mark's weakness against the dollar. However, economies for the major developed countries are edging inexorably towards somewhat higher rates. Once discounted by bond prices, this should no longer be a problem for long-dated issues as real yields still offer reasonable value, Japan excepted, against a background of generally prudent fiscal policies. Most governments remain willing to tackle inflation at the first suggestion of rising cost pressures. Competition for increased sales in the world's growing market place remains a powerful restraint on prices.

Stock Markets

The outlook for global stock markets has deteriorated considerably, for at least the short term. Prior trend acceleration, particularly evident in Europe and among favoured emerging markets, left many indices vulnerable to corrective phases. The all-important bond lead reversed from bullish to neutral at best in late July. Either of the factors on their own would indicate a shake out to follow. Together, they warn that many markets have either seen or are near significant peaks.

Fundamental analysts may argue that nothing has really changed in economic terms-saying that there is abundant liquidity while corporate profits are rising against a background of non-inflationary growth. This is true but expanding liquidity can be thrown into reverse if investors take fright in a falling market, causing a flight to cash. Certainly valuations had been pushed to levels of credulity recently.

As with 1987, and to a lesser extent 1994, the problems of overvaluation are by no means confined to Wall Street. Generally speaking, it is U.S. companies that have increased their sales in the global marketplace and experienced the most consistent profits growth. While many emerging markets have attractive growth prospects, the political risks are obviously much higher than in the U.S. Continental Europe's bull market has been due to the potent forces of accommodative monetary conditions and orderly devaluation, but the profit-curbing problems of excessive regulation, intransigent unions, the social wage and other high taxes remain. In fact, the corporate tax burden has greatly increased in France since the Socialist/Communist coalition came to power. In Germany, left-wing opposition has blocked proposed tax reforms.

There has obviously been a massive amount of speculation in stock markets this year, on top of 1996's substantial gains. The upward momentum has now been checked and if bonds remain weak a substantial shake out will be unavoidable. Wall Street has shown remarkable resilience in recent years by quickly bouncing back after reactions of approximately 10% for the DJIA. The risks are higher today because of the additional sharp rally and the U.S. Capital Gains Tax cut.

I have been writing about the consequences of a CGT cut since November 1995 (FM138) and most recently in FMPs 20 and 21, released on July 31st and August 4th. After a two-year battle this has finally been passed as part of the Balanced Budget Agreement between Congress and the White House. An immediate CGT reduction from 28% to 20% for all assets came into effect on August 5th, and has been back dated to May 7th. The general consensus is that it will be bullish for Wall Street. Over the longer term, yes, but the immediate impact is bearish.

Many investors will have been reluctant to take profits in recent months, knowing that a CGT cut was a near certainty. This has created the conditions for a sudden wave of selling, which can become self feeding, especially if investors are frightened. The last two CGT cuts, in October 1978 and August 1981, triggered DJIA sell offs of 11% and 15%, respectively. Moreover it took more than a year for the market to exceed its highs prior to the CGT cut. For the record, the DJIA closed at 8198.45 on Monday August 4th, the day before the bill including the CGT reduction was signed into law.

No stock market is likely to resist a sharp reaction on Wall Street. Arguably, recently high-flying Continental European indices would fall further. The underperforming Asian exchanges could see shallower corrections because there are far fewer profits to be taken. However this is debatable because confidence is already low in South East Asia. If I have overstated the near-term risk and recently in-form indices merely range in an extended consolidation above their July lows, the leading emerging markets will probably continue to outperform all others. Conversely, they will fall the most if I am right.

Currencies

Sterling's fundamentally costly bull run for the UK economy had been dependent in recent months on market expectations for ever higher interest rates, with forecasts stretching to 8%. This was always unrealistic and the BOE has indicated that the recent hike to 7% is probably the last. The next rate move will be down, possibly before year end. Meanwhile, following its spike peak on the charts, sterling is likely to experience a choppy descent from here on. Those interest rate differentials will prove expensive for sterling bears, once the declines pause, leading to periodic sharp technical rallies, albeit within an overall downward trend against all but the weakest of currencies.

The U.S. Dollar broke its short-term uptrends against the yen, mark and Swiss Franc on Friday August 8th. The longer-term bias remains upwards, in my view, although some of you may still disagree about the yen, citing moving averages, which I regard as arbitrary. Sticking to fundamentals in this section, there is only one bullish factor for the yen-Japan's big current account surplus. Therefore if the Japanese government or investors decide to repatriate a significant proportion of their overseas capital, for whatever reason, the yen will certainly climb. However, since no one in the MOF, BOJ or any of Japan's export companies or investment institutions wants the yen to rise, they will continue to invest in higher yielding overseas assets. The exception would be a sudden event which terrifies them. This is just possible, I suppose, but meanwhile Japan's dull stock market and minuscule bond yields are uninspiring havens.

The U.S. Dollar is underpinned against the yen by a crunching 500 basis points yield advantage and a robust economy in its seventh year of expansion. In contrast, the latest economic data from Japan shows a sputtering economy, hit harder by the tax increases than officially expected. No one has mentioned Japan's budget deficit, which is the biggest in the solar system, but the U.S. continues to grow up out of its previous budgetary overhang.

Turning to the U.S. Dollar against the mark, the Bundesbank has rolled out an official a day recently to explain why "the greenback is only worth DM1.70," while hinting at intervention and/or higher short-term interest rates. This is really an effort to slow the mark's devaluation, which is only sensible, because a too rapid fall is destabilizing. However, the Bundesbank knows that its once free hand is now compromised by economic and political considerations. Therefore it can only really engage in a psychological battle, which has had some minor success recently, but only because the dollar's advance had become temporarily overstretched.

Meanwhile, Hans Meyer of the Swiss National Bank would love to see the Swiss Franc weaken against the European currencies, in particular, and there is no reason why it should not fall further against the U.S. Dollar given continued economic weakness and a 450 basis points interest rate differential. Elsewhere, the global love affair with the U.S. Dollar continues, and few NIC, let alone developing country currencies will be able to resist this trend.

Commodities

Oil prices rebounded from historic support as earlier estimates of abundant U.S. supplies proved inaccurate. Gasoline and natural gas led the advance before gains were pared somewhat by the prospect of more oil from Iraq. While there has been no repeat of last year's persistent shortage of refined products, many oil importing countries will be paying more for supplies than widely forecast by petroleum analysts only a short while ago, especially if their currencies have been weak against the U.S. Dollar.

Temporary squeezes have provided further drama in the metals markets, kiting prices skyward only to slump back as metal comes to the market. Among industrial metals, copper was first affected, reaching a climactic peak in June, then zinc which plummeted from its accelerated peak in late July before staging a partial recovery, and most recently aluminium which has rallied sharply. Strikes in South Africa and an absence of deliveries from Russia caused palladium and platinum to soar once again. While this is not untypical of previous economic cycles when global GDP growth has been increasing, it has inevitably led to accusations from metal consuming companies that the market is being "played."

A number of soft commodities have rallied recently from previously depressed levels on weather scares and speculation encouraged by all the El Nino stories. These moves are usually short term, as we saw with the soybean complex prices, recently, which have fallen back on forecasts of an end to the hot weather in the American Midwest.

Government Bonds

Investors who lightened on price strength recently need be in no hurry to re-establish those positions. The global bond market has commenced a corrective phase which is likely to retrace more of the April-July gains as people ponder the prospect of stronger growth in the U.S. and an eventual rise in Continental European rates. Bond prices would obviously be affected by a global flight to cash, but only temporarily. In the event of a stock market crash, which is just possible although obviously a rare event, bonds would rebound sharply on forecasts of deflation and lower short-term rates.

We closed all remaining bond longs in our Interest Rates-Daily Trading Recommendations service on the first downward dynamics and shorted several contracts. Prices fell too quickly to outline an appropriate strategy for traders here, but I favour standing aside or selling lightly on rallies until more of the prior gains have been retraced and we see technical evidence of new floors. Should stock markets crash, I would cover all bond futures shorts and go long.

Stock Markets

I favour defensive strategies for investors, including a further lightening of portfolios and/or hedging, through the writing of covered calls by institutions and the shorting of futures contracts. I would take the greatest precautions in the markets and sectors that have risen the most. Commodity related shares such as oils might offer some defensive qualities, for a while, but they would certainly not remain unscathed in a significant market sell off. I would not be tempted to buy on weakness without a very convincing lead from long-dated bond prices.

Speculators can concentrate on selling stock market futures short until bond markets show clear upward dynamics. Markets that have risen the most are among the best candidates. I favour the baby steps sell- high-buy-low jobbing approach because of volatility. Veteran FMs know that I follow my own advice. It has been a long time since I have sold stock market futures short, preferring to buy the sell offs over the last many months, especially when bonds were giving a bullish lead. So far this month I have had a number of short trades in the S&P, FTSE, DAX and HSI. The change in strategy involves obvious risks, because we would not have confirmation of major peaks until markets were much lower. I try to offset some of these risks through baby steps tactics and I would certainly take my losses in the event of any new highs by the indices that I am shorting, even if the bond lead remains negative.

Currencies

FM158's advice to tighten trailing stops for sterling longs against the mark and other European currencies, due to the probability of a spike peak, should have worked to considerable profit. I am not trading sterling, preferring to concentrate on the U.S. Dollar, but any sharp fall against the European currencies and the yen, such as we have just seen, creates the opportunity for a good bounce because of those awesome interest rate differentials.

The U.S. Dollar's recent and very consistent short-term uptrend until August 8th was a gift, particularly against the mark. It may take a while to consolidate those gains, but I see no evidence that the bull market is ending. However, the Bundesbank's obvious discomfort with current levels causes me to favour other trades. I prefer to short the Swiss Franc against the U.S. Dollar, because Hans Meyer has made it very clear that he would like to see the Swissie weaken against the mark, and he certainly would not oppose an additional devaluation against the dollar which isindicated by price charts. I continue to use baby steps, for dollar longs against the Swiss Franc, augmented with trailing stops when the greenback trends higher.

This position is, arguably, safer than my other favourite, dollar longs against the yen, because there is no overhead supply on the charts and the reactions have been smaller. I found myself stopped out relatively early on Friday the 8th, having tightened protection considerably, like a lot of people judging from the size of the reaction. While surprised by the extent of this move, I re-entered and sold futures after they had rallied back under the top, and will persist with a baby steps strategy because of the volatility. I am keeping positions a little smaller this time, because of the sharp correction. I would certainly prefer not to see the dollar below ¥114, but would probably continue to regard it as a buy on weakness provided that the June low near ¥110 is not breached.

An additional complication for those of us who trade the U.S. Dollar, which hopefully we can harness, is its tendency to rally with Wall Street and weaken when the DJIA falls. The link has an emotional logic but not much else behind it that I can see. Nevertheless, while it persists we have to allow for it. As I now regard Wall Street as having more risk on the downside, I am on the outlook for volatile currency conditions.

I maintain that speculators who have been buying the U.S. Dollar against the South East Asian currencies are onto a winner. After several weeks of consolidation the greenback has resumed its advance against several of this group, including the Malaysian Ringgit and the Singapore Dollar.

Commodities

These markets have been considerably more lively over the last two months, turning up a number of short- term plays for our Daily Trading Recommendation services, but there is little that I can cite here as looking appropriate for a sustained move. Zinc is the latest metal to fall back sharply from an accelerated upward trend and palladium is likely to be the next. However, these are fast moving markets that require constant monitoring.

Cash

My choice remains the U.S. Dollar, even though it is also favoured by the crowd. Sterling is now less risky as a proxy following its recent sharp fall.

August 15, 1997 David Fuller, Chairman

The International Investment Letter

7 Swallow Street, London, W1R 7HD, United Kingdom

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