-Caveat Lector- <A HREF="http://www.pei-intl.com/TOPICS/APROACH.HTM">Approaching April 8th - April 5th, 1999 by Ma </A> ----- Approaching April 8th By Martin A. Armstrong Princeton Economic Institute © Copyright April 5th, 1999 ------------------------------------------------------------------------ There has always been a debate over the subject of the business cycle and whether or not it is quantifiable. Some seem to hold up a silver cross in hopes that the entire field of research would simply go away. In their minds, if a cycle is quantifiable, then the future must be predetermined and therefore no one has free will. Of course such ignorance dominated the conceptual beliefs during the same debate of whether the world was flat or round. In those days, they feared that if the world was round and it orbited the sun, then there was no definitive up or down, which interfered with the vision of heaven and hell. The existence of the business cycle and the ability to quantify it does NOT threaten the concept of free will nor does it mean that the future is predetermined. The sheer number of variables involved behind the business cycle ensures a complex system of interaction while at the same time history indeed repeats. Japan, for example, is currently going through the same identical pains that were experienced in the United States during the Great Depression. Through the US experience, banks were prohibited from becoming investors in the stock market. When a bank is a big investor and the share market declines, the bank obviously loses money. In turn, the bank begins to curtail lending unleashing a credit crunch. The more the share market declines, the worse the banks become causing a deeper contraction in credit within the economy thereby forcing the share market even lower. In this sense, history repeats. What is different, lies in the actors - not the play. It is also why Japan remains two years away from any true sustainable recovery. The business cycle to a large extent is quantifiable due to the very nature of the economy itself. When one sector becomes very profitable, it acts as a strange attractor sucking in capital from other sectors within the economy. As that sector pulls in more and more capital, an over-expansion develops. When excessive competition unfolds profits decline and losses develop thereby unleashing a corrective process known as a recession. It is this process that we are attempting to quantify. The process merely involves the study of how long do expansions take place BEFORE reaching that point of excessive competition. In the investment world, assets are bid up in price as more capital is attracted to that particular investment. Under a floating exchange rate system, this trend can be magnified by also attracting capital from overseas. Overseas capital invests based upon a contango involving the underlying asset in addition to the value of that asset expressed back in terms of its own currency. Thus, fluctuations in the currency markets have a significant impact upon domestic market trends. The fear that this process means that we are all sheep that are stripped of our free will is absurd nonsense. Life itself is a process of trial and error through which we hopefully learn from our mistakes. Nonetheless, no matter how many times you tell your child that if he/she sticks their finger into the flame of a candle it will hurt, the child will inevitably explore the experience first hand. Thus, as we all move through life, we not merely possess free will; we also possess our own unique cycle of experience. Today, there are those looking for the next crash due to their prior experiences. This is contrasted against new investors who have never before witnessed how fast a market crash can unfold. The battle between these two groups is what makes the market "free" and in no way does the study of the system as a whole alter individual behavior. We all individually retain the freedom to buy new highs without fear, to stand on the sidelines in amazement or to attempt a short position knowing that gravity does exist. The Princeton Economic Confidence Model is a quantified study of the economic activity of the global collective behavior of mankind. We can determine that global capital flows shift about every 4.3 years causing some markets to become attractors of capital while others lose their capital base, crash and burn as is the case in emerging markets currently. Like world trade, it is impossible for everyone to experience a trade surplus - someone must experience a trade deficit in order for another to gain a trade surplus. The investment sectors operate in the same manner. For one market to become a raging bull market, it MUST attract capital away from other markets. This is the process that causes capital to concentrate first in one region and then within one particu lar sector. Perhaps because humans become tired and are unable to sustain their energy without taking a break, investment behavior displays the same pattern. There are minor 8.6-month timing intervals that appear to reflect key decision points for investment. Twelve 8.6-month timing periods are contained within one major 8.6-year business cycle configuration. A review of the first 6 waves in the S&P 500 between 1994 and the present offer a guide as what we should expect as we approach the next such target - April 8th, 1999. WAVE #1 April 1st, 1994 (MAJOR LOW) The current 8.6-year business cycle began on April 1st, 1994. The next trading day was actually April 4th, 1994. This turning point provided the precise intraday low for the US share market. It was at this juncture that the capital flows began to shift away from Southeast Asia and back toward the United States and Europe. The precise low in terms of the S&P 500 was spectacular and it was contrasted against highs for Asia. WAVE #2 December 16th, 1994 (Directional Change) The December 16th target produced a decisive Directional Change. The S&P 500 had reached a high on August 31st at 478.25 basis the nearest futures. From that August high, a correction of 7.3% unfolded going into December 9th. The turning point of December 16th marked a sharp GAP where the market opened more than 600 points higher, which in those days was a huge move. This Directional Change marked the resumption of the bull market with the GAP left behind that day never since having been filled. WAVE #3 September 5th, 1995 (Directional Change) The next turning point on the 8.6-month interval came on September 5th, 1995. The bull market had run sharply higher during this cycle period reaching a high on July 27th, 1995 at 568.45. This time the correction that followed was very mild taking the form of a sideways base. Our target of September 5th marked another Directional Change as capital once again decided to pour into the market namely from Japan. It was at this time that the dollar had bottomed against Germany and Japan in April and by August the turn in the dollar was believed. We received nu merous requests from Japan to review lists of US shares for analysis. Japanese investment into the US share market began precisely at this turning point. While the domestic soothsayers were calling for another October Crash, it was the change in trend for the dollar that attracted external capital flows thus absorbing any domestic selling. The US market exploded and continued to rally going into our next turning point of May 22nd 1996. WAVE #4 May 22nd, 1996 (HIGH) The next turning point on the 8.6-month interval arrived on May 22nd, 1996. During this cycle period, there were 3 minor corrections that had reached lows on October 26th followed by January 10th and March 8th. May 22nd represented the highest closing at 680.90 while the precise intraday high formed on the 23rd at 683.20. A reasonable correction unfolded amounting to 10.6% going into a low July 16th, 1996. The May high was finally exceeded on September 16th later that same year. WAVE #5 February 10th, 1997 (Directional Change) The next 8.6-month turning point arrived on February 10th, 1997. In this case on the way up, there were once again three (3) minor corrections on September 6th, October 29th and December 17th. The high for this 8.6-month interval came on January 23rd at 799.70. Again, we saw a sideways base formation and February 10th marked the highest recovery closing. The next wave began with a short thrust of buying that forged a new high at 820 going into the following week on February 19th. A 10.2% correction quickly followed with a decline down into April 14th reaching 736. This would prove to be the final significant correction prior to the important high of October 7th. WAVE #6 October 3rd, 1997 (High off by 2 days) This particular wave formation produced a very sharp advance in the US share market as the S&P jumped from 736 to 992 - a gain of 34%. The strength of this cycle was again on the back of very strong capital inflows. There was only one (1) minor correction between August 7th and the 18th amounting to 7.8% in 7 trading days. This was quickly followed by another upward thrust as new highs began to appear on September 22nd. The high was actually reached on October 7th two trading days after the target of October 3rd. This meant that the target week produced the highest weekly closing, which was again followed by a sharp correction into October 28th. This correction this time was 14.9% as the market fell from 992 down to 844. WAVE #7 July 20th, 1998 (IMPORTANT HIGH) >From the October 28th, 1997 low, the US share market rallied sharply for 189 trading days reaching a major important top on July 20th, 1998. The percentage advance for this cycle was 42%. Still, this impressive advance paled in comparison to the advance witnessed in Europe. There were three (3) corrections during this period on October 28th, January 12th and June 15th. In this case, the sharp correction was to be the first, instead of the last. This perhaps provided the fuel for the impressive advance overall. As we approach the next 8.6-month turning point on April 8th, we must keep in mind that the majority of such minor target dates tend to produce directional changes rather than significant precise highs or lows. It is also interesting that corrections of minor significance, less than 10%, normally take place between target dates while corrections in excess of 10% form very near such target dates. We should also keep in mind that the future for the US share market has but two choices. The advance has been rather significant and a correction of 20% plus is greatly favored based upon historical comparisons of how long trends can last. The second path for the future that would support a continued bull market is completely dependent upon external capital flows. This suggests that without a strong dollar, foreign investors would tend to be net sellers, thus a continued rally becomes exceedingly difficult to sustain. However, a strong dollar on the back of war or a flight to quality may benefit bonds, but not equities. A weak dollar, on the other hand, can become a negative for the bull market by providing an incentive for overseas investors to become net sellers. There will be those who point to the underlying fundamentals as a reason why a correction is impossible. We would refer them to the Crash of 1987 where the underlying fundamentals had NOT changed yet still there was a correction of 43% in two months due to the shift in external capital flows. Nonetheless, it was also due to the strong underlying fundamentals that despite the 43% correction, nothing had changed long-term and the 1987 low held. It is of vital importance to understand that strong fundamentals do NOT PREVENT market corrections - they only support long-term trends! We do NOT see a collapse in the world economy due to capital flow movement. Thus, we see no chance for a repeat of the Great Depression within the US marketplace at this time. Besides the structural reforms that took place following the Great Depression, we are also on a floating exchange rate system that would lead to an inflationary solution today as the natural outcome compared to deflation of the 1930s. Deflation became the outcome of choice due to the gold standard and the inability to print gold in order to expand the money supply. Today, government expenditure automatically rises due to countless programs that have been promised from welfare to unemployment. These programs that would have forced government expenditure to increase did not exist during the 1930s. It must also be understood that stock markets do NOT rise with low inflation. Such theories are completely absurd. Inflation is a decline in the purchasing power of the underlying currency relative to everything within the economy including assets. If the currency buys more, then you are in a deflationary period. The mere fact that the stock market, real estate and other tangible assets are not included within the inflation indices is no excuse for the misrepresentation that stocks rise with low inflation. During all inflationary periods, assets rise in value as the purchasing power of the currency declines. If there were truly no inflation, then the stock market could NOT possibly rally because dollars by definition would be purchasing more assets - not less, suggesting that share prices would decline. Stock prices are rising because we are experiencing "asset inflation" which is NOT part of the CPI (Consumer Price Index). Inflation has been masked by the inclusion of more than 80,000 items within the CPI watering down the perception of true inflation itself as a whole. If one restricts this definition of real inflation to wages, durable goods and the cost of government, we find that long-term inflation is alive and well. This also explains why US interest rates remain significantly above "official" inflation rates since interest rates reflect true open market conditions. If there was no inflation, including asset inflation, interest rates would reflect such an economic condition as is the case in Japan. In 1966, the Dow reached 1,000 for the first time. A Cadillac sold in 1966 for $4,000 compared to $50,000 today. With the Dow at 10,000, it is still behind the advance we have seen in both wages and durable goods. After taxes, the Dow is still nearly 40% behind the value it once had in 1966. If we consider the value of the dollar, the entire picture becomes even more distorted. If we look at a chart of the Dow expressed in Swiss francs (arguably the second most stable currency for the century), we can see that the 1966 high was not exceeded until 1992 - 9 years after the decisive breakout in domestic dollar terms back in 1983. Our chart of the Dow expressed in Swiss francs does highlight a significant problem. From the foreign perspective, the US market appears to be at a record high even in purchasing power terms. This means that a high in 1999 could be very significant, as was the case in 1966 if the capital flows either shift away from the dollar or shift from stocks to bonds. Getting down to the immediate future, timing models clearly show the potential for the month of April to produce a turning point. Likewise, volatility appears to begin rising with the week of April 12th. The potential for the April 8th target to produce a major high to the precise day is not necessarily very strong, but the fact that most serious corrections tend to appear around these turning points does at least warn that a 10-23% correction could be in the wings. Only new highs beyond April would suggest a rally into July or September later in the year warning that a major bubble top then becomes possible with all the implications for a serious decline between 2000 and 2002. An additional advance of 20% above current levels in 1999 would warn of a future decline in excess of 50% into 2002. One immediate concern for April 8th is none other than the issue of Yugoslavia. It is hard to ignore the high probability that the conflict in Yugoslavia is likely to get worse forcing ground troops to be deployed. Our sources on this matter state very clearly that NATO has never fought a war and as such there is a whole infrastructure in Brussels that would be without a job if NATO should collapse. There is no way to consider a victory at this point UNLESS the refugees are allowed to return. This contrasts against the government of Yugoslavia that sees this as their territory and merely a payback for the loss of this region to the Ottoman Empire back in 1389. In any event, this is not some Gulf War. The markets have chosen to ignore this conflict as if it were another video game. However, we see no sign that recovery for this region economically is even remotely possible until 2002. The odds of this conflict spreading are also very high as war always follows on the heels of an economic downturn. If the economy was sound in Germany following World War I, Hitler would never have gained power. The same is true in Russia. It is within this link between war and economics that we see a great increase in the tensions within Russia as its own leadership needs to find some external enemy to hold on to their own collapsing power. The tensions throughout this region, including Russia, are on the rise and will be in that direction until at least 2002. Our most disturbing sources claim that Russia is aiding the Serbs and that the Stealth Fighter was downed with the guidance and assistance of Russia. The downed plane is said to have already made its way back to Russia for analysis. When all things are considered, we must question if the market has truly accounted for the changing geopolitical landscape. The incentives at this time to escalate the war are coming from every direction. We suspect that Russian involvement may even become more blatant by mid April. Nonetheless, the impact of this conflict is likely to impact the currency markets even more and the crossrates within Europe against the Swiss franc could also find themselves in volatile times by next week. We are also at a critical juncture where capital MUST now make a decision once again to buy or sell equities. New highs this week cannot be ruled out on Tuesday or Wednesday basis the S&P 500. The true issue will be sustainability. We simply need to score new highs beyond next week (April 12th) in order to see another surge of buying ahead. Lacking that buying surge on good volume, some sort of a correction becomes likely and the risks are now only increased for a near-term correction. Whether a high here during the first week of April turns out to be a major high going into 2002 will be determined by the magnitude of the decline. A correction that HOLDS above 1147, the first line of long-term support, could still be followed by new highs later in the year. This initial support represents a potential 14% correction. However, the primary support has now risen to the 952-941 area basis the nearest futures. A correction to this level would represent a 29% decline. Still, keep in mind that the 1987 Crash of 2 months represented a 43% correction and the market still survived. A correction that produces a monthly closing BELOW the 941 level will indeed warn that this correction will last more than 2 months, which has been the life expectance of serious corrections since 1987 including the last one from the July 20th high. A monthly closing BELOW 802 would be necessary at this time before our model would warn of a bear market into 2002. Keep in mind that a decline down to 802 is still only a 39% correction, which is less than the 1987 2-month decline. ------------------------------------------------------------------------ ----- Aloha, He'Ping, Om, Shalom, Salaam. Em Hotep, Peace Be, Omnia Bona Bonis, All My Relations. Adieu, Adios, Aloha. 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