-Caveat Lector- from: http://www.pei-intl.com/TOPICS/CONFU614.htm <A HREF="http://www.pei-intl.com/TOPICS/CONFU614.htm">Air Pockets & Economic Confusion a sign of the </A> ----- Air Pockets & Economic Confusion a sign of the times? By Barclay Leib June 14th, 1999 Copyright Princeton Economic Institute ------------------------------------------------------------------------ Subsequent to Princeton Economics April 8th Confidence Interval, few participants in the market have been particularly happy, and the dispersions between various market indices have become more and more noticeable. Volume overall has continued to dry up, and the market, for lack of a better word, has taken on a feeling that is somewhat "eerie." While the Dow Jones has rallied over 700 points since the beginning of April, many of those oh-so popular Internet stocks have fallen by over 40%. Dell Computer, about which we commented at some length in the February World Capital Markets Report as an alleged potential modern-day version of the old Ponzi scheme, is down over 20% since we inked our thoughts. The Dow Jones Utility Average just reached new all-time highs, while the usual best proxy for this index, U.S. T-bonds, just broke to new lows, and are now sporting yields greater than 6%. Meanwhile the Dow Jones Transports peaked not in April with the Internet stocks, nor in June with the current highs of the DJUA, but with the last thrust higher in the S&P 500 index in early May. Since that time, the DJTA has traded off a fairly substantial 12%, while the S&P 500 is off just a minor 3%. Very little seems in synch here. Even many of the technical indicators are flashing completely different signals. Complacency in the market would still appear to be quite high as witnessed by Investors Intelligence tally of bullish advisors at 61.6%. The last time this particular indicator reached these levels was back in August 1987, just before a wee-bit of weakness one may remember that October. And yet, the latest CFTC commitments of traders report shows that speculators, as of June 1, are at their highest level of net short index futures positions since late 1994. Late 1994 was of course when this market took off on its latest bull run. The disparity between such usually reliable indicators is exactly the way the U.S. equity market feels at present: flaky and unreliable. It is slowly stumbling lower but without any pace or conviction. Occasional spikes higher keep the dreams of riches alive in the popular media, but in reality, no one is getting quite as rich, quite as quickly, or quite as easily as they were before April 8th. Seemingly stock pickers and equity market pundits are all still bullish, but the large speculative futures traders (hedge funds?) are all positioned short. At the same time, the net short open interest in many individual stocks has dropped precipitously. As Fred Hickey of the High Tech Strategist points out, when Dell was at the equivalent price of 20 last October, the entire short position in Dell totaled over 100 million shares. By early February, when Dell finally peaked at 55, the net short position in Dell had fallen to under 48 million shares. Overall, the mania had simply gone too high and had carried on for too long -- some 17 weeks with only a few shallow down weeks among them – for most shorts to have survived. This is not dissimilar to the void of players created back in 1980 when silver had finally reached $54 an ounce. Liquidity declines as prices turn more and more exponential, and it does not tend to come back even after the market breaks. Instead, players both long and short get tired of getting "stopped," so they just stop trading. Capital retreats. The market finds a temporary equilibrium and just sits. This may be one reason that the amount of traffic on the Internet on major financial web pages actually dropped in April compared to the previous month for the first time ever. Even the typical correlations that we usually see between markets when we look at our own artificial intelligence models, seem to be pointing to very different internal market rhythms. Although the entire period between mid-July and mid-August shows up as singularly volatile, the respective panic cycles of the S&P’s, Dow Jones, Nasdaq, DAX, CAC, FTSE, Nikkei, and Hang Seng barely have a single week in common. After having studied these models for over 25-years, we do not remember another period quite this complicated to decipher. Usually one would see many more cross-market similarities – much more of a cross-market macro-rhythm. What we see instead is a global financial system that already is disjointed and likely to become more so in the weeks to come. If the world feels like one giant stop-loss, it may be because that is exactly what it is: hedge funds continue to net liquidate positions right and left and retreat one by one to the sidelines. >From the Fed’s perspective, what appears to have been going on here is indeed healthy to a degree. The Fed is likely to be breathing a sigh of relief that Internet valuations have somewhat normalized, and the whiff of inflation that prompted the Fed’s move to a tightening bias back in May, appears to have now lessened. But structurally one has to wonder how stable this market, now with diminished daily volume, really is. Continued "air pockets" both up and down in direction do not seem particularly reassuring to a long-term investor. Bull markets are almost always associated with high volume and that volume has now vanished. Bear markets that stumble lower on low volume are actually more common to see than the swift crash that everyone fears. And amidst all the noise in the U.S. markets, let us look at one fundamental event abroad: On May 27th the Japanese government auctioned $4.09 billion in two-year notes. The yield that they offered was a paltry coupon of 10 basis points, and the notes were priced slightly under par to yield an all-in 11 basis points. For such a note, Japanese investors lined up in droves, and the issue itself was 4.5 times oversubscribed. Now we must ask, who in any sane world would invest at 11 basis points for two-years? Why wouldn’t these Japanese investors put their money in their own Nikkei, or in our U.S. government bonds yielding 6%, or someplace – anyplace else? Even within Japan there are certainly financial institutions offering fixed income paper with 2-year yields well above these levels. The answer may be the root cause of the entire world’s financial instability: the Japanese are afraid. They are afraid of the U.S. markets and the dollar which declined some 18% in less than 72-hours last October. They are afraid of their own life insurance and pension companies that drift slowly toward the edge of financial oblivion with each passing month that yields must be guaranteed to their investors well-above those available in the market. And they are afraid of their own banks that face BIS capital adequacy requirements and new margin rules that as well-intended as these rules might be, could inadvertently serve to kill the patient via the intended cure. In a twist of fate, more Japanese investors are now allowed to invest abroad post the last stage of the Japanese Big Bang, but the desire and willingness to do so seems to have disappeared. Until this is cured, Japan is likely to be a self-perpetuating financial quagmire, and the rest of the world is likely to become starved for their much-needed capital. The BOJ should throw their investors and banks an added break. Encourage their banks to invest abroad, and with a wink and a nod, guarantee them that USD/JPY will be allowed to move up and not down while they do so. Domestic paper in the form of JGBs would undoubtedly fall, if not collapse due to such a policy, but with time, JGBs would eventually find a real price level where they could legitimately become competitive once again. Foreign markets would vault higher, and Japanese banks and financial institutions could make a lot of money, particularly when translated back into yen terms. Overall, the markets would move away from all of the current artificiality of super-low yields and an overvalued yen with trapped and scared capital. The risk longer term of creating a financial bubble in the west might increase, but the risk of a financial implosion within Japan would certainly lessen. The BOJ intervention to buy the U.S. dollar against the yen early this week may indicate that they are starting to understand some of this, but their continued words of support for JGBs seems to us somewhat misplaced and hollow. They need to let this market find its natural level, not continue to talk it up with false words and promises. If Japan tries to solve its current problems by maintaining current policies -- a steep domestic yield curve and an overvalued range bound currency -- then its problems are unlikely to be solved particularly quickly, and the rest of the world will pay for it dearly. The Japanese authorities should instead encourage Nikkei cross-holdings to be liquidated; let JGBs fall to a more natural level; encourage domestic investment by lowering taxes, and finance it all by overtly moving to a weak yen policy. A weakening yen might even put enough deflationary competitive pressures on the U.S. to keep that dreaded Fed interest rate hike at bay for a while. The chances of ending up with a "happy" world as opposed to a disastrous one would certainly be greatly increased. ------------------------------------------------------------------------ ----- Aloha, He'Ping, Om, Shalom, Salaam. Em Hotep, Peace Be, Omnia Bona Bonis, All My Relations. Adieu, Adios, Aloha. Amen. Roads End Kris DECLARATION & DISCLAIMER ========== CTRL is a discussion and informational exchange list. Proselyzting propagandic screeds are not allowed. Substance—not soapboxing! These are sordid matters and 'conspiracy theory', with its many half-truths, misdirections and outright frauds is used politically by different groups with major and minor effects spread throughout the spectrum of time and thought. That being said, CTRL gives no endorsement to the validity of posts, and always suggests to readers; be wary of what you read. CTRL gives no credeence to Holocaust denial and nazi's need not apply. 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