Things are kind of tough
In a speech to students and others at an economic forum at Baylor University in Waco, Texas on August 13, 2002 Dubya (President George W. Bush) noted, "Things are kind of tough". Well. I guess that is sort of like saying the Titanic kind of struck some ice. But yes things are kind of tough if you work for US Airways (Chapter 11 bankruptcy), United Airlines and its parent UAL Corp. have indicated they could be filing for Chapter 11 bankruptcy within the month, American Airlines is cutting 7,000 jobs, IBM Corp. is cutting over 15,000 jobs, Agere Systems is cutting 4,000 jobs, and Ames Department Stores are closing their doors and saying goodbye to 22,000 jobs.
It almost seems like an afterthought to note that Charles Schwab is going to cut 375 jobs because stock-trading volume is down. All of these job losses and more were announced during the week of August 12, 2002. And we suspect that there could be a lot more to come. The Federal Reserve left interest rates unchanged at its recent meeting but changed the bias to easing.
That spooked the market and the initial reaction was a sell-off. But by the next day it appeared that
everything changed and the market put in a stellar rally that carried into the August options expiration.
Options expiration volatility is nothing new as the professional arbitrageurs often control the week. When the market goes up as it did, it is because the arbitrageurs undoubtedly own a lot of calls that they bought at the market lows in July. But that doesn't stop the pundits from exclaiming how well the market is performing in the face of all the bad news. Trouble is what is needed from the pundits is a better picture of what is really happening. The Titanic did not kind of strike some ice. It hit an iceberg and it flooded. Thomas Andrews, the ships builder, finally had to admit to the Captain and the ship's owner, Bruce Ismay that "the ship will flounder". But that was it. No need to tell the passengers or else they might panic.
And so it is today. The economy is starting to roll over and sink. The announcements that started on the week of August 12, 2002 are probably just the tip of the iceberg. Corporations have too much debt.
Revenues are falling, or in the case of the airline companies costs far outstrip revenues, and then they
can't service the debt. So they fire people. The telecommunications, semi conductor and other technology companies have too much capacity. Their revenues are falling. So they fire people.
Speaking of the banks the debt collapse is only beginning to rise to the surface for them. In a deflationary environment debt is at huge risk and the business of banks is debt. Watch the upcoming numbers for the banks carefully as they should be reflecting considerably higher loan losses. In the United States the problems in the financial institutions may be even more acute. S&P Ratings Service has indicated they might cut the credit ratings on Merrill Lynch & Co. (MER-NYSE), Morgan Stanley (MWD-NYSE) and J.P. Morgan Chase & Co. (JPM-NYSE).
All of these companies deal with other companies. Those company's orders dry up. So they fire people.
The stock market is falling. No one is buying and selling stocks. So the investment community fires people. A vicious cycle. Not much different then on the Titanic when once one compartment flooded it overflowed into the next compartment until the ship sank. And like the Titanic don't expect the Captain's of the economy to tell the people that ship is going to sink. They wouldn't want to cause a panic. Times are kind of tough. But they are going to get tougher.
All of these companies are down sharply from their highs. But a cut in their credit ratings would have
serious ramifications. J.P. Morgan in particular is the $23 trillion derivatives bank. With lower credit
ratings many of their counter parties may not be allowed to deal with them any longer. That might trigger clauses in derivative agreements and even defaults. Both Merrill and Morgan Stanley are also large derivative dealers but nowhere near the size of Morgan. Still they are major counter parties and a reduced credit rating for these giants would have a negative impact on the global derivatives market. Typically Morgan has probably only allocated about 0.2% of risk capital to their derivatives portfolio but the amount at risk may be considerably higher at up to 2%. That could cause a financial panic.
We have often talked about the 1962 cycle (40 years). For the first half of the year the current market followed the cycle down. That market had a significant low that was made on June 25, 1962. A sharp rally followed that peaked on August 23, 1962. A secondary low was made that bottomed on October 24, 1962. But the 1962 institutional collapse was a correction within the context of a bull market. This is a secular bear market so there is real risk here that once that market peaks we will plunge to new lows. Best case is higher lows, which would be quite positive going into 2003.
Our chart of the Dow Jones Industrials shows this possibility. We have drawn on the DJI what is known as Andrew's pitchforks. Effectively Andrew's pitchforks are used as median lines of support/resistance. Two key points are used here at A and B a high and low respectively. The C parallel line dissects the two. Resistance on the DJI is up around 9200. As we approach that level, that could be seen the week of August 19, we should top out. As well that week coincides with the tops seen both in 1962 and in 1987. So there is a real possibility of top to be made that week. If that doesn't turn out to be the top one should be seen no later than the second week of September.
The recent breakout over what may have appeared as a head & shoulders bottom on the DJI was on
weak volume so we put less stead in that scenario now. While the 50 day moving average often acts as resistance it is not unusual to go somewhat through the point. If this area turns out to be top zone as we
suspect then we could in theory plunge to new lows into October and reach as low as 6000/6500. At that point we believe a significant low will be made that will point to a decent recovery into 2003. Typically secular bear markets have cycles of 2-3 years down then one year up to be followed once again by another 2-3 years down.
As we have consistently pointed out the collapse is all about the debt that must be washed out. Whether
it is corporate, consumer or government debt in deflationary times it will be cleansed. And all the
pontificating in the world nor the Fed pumping the money supply to 20% or even higher will not save us
from what is now almost inevitable. The Fed may delay the inevitable but even he cannot prevent it from
happening. Alan Greenspan must be wishing he could just retire instead of receiving a knighthood. "Times
are kind of tough". Even the President said so.
August 21, 2002
Charts and technical commentary by David Chapman of Union Securities Ltd.
69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email david@davidchapman.com
The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.
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