Last week the DJIA tested the 9000 mark for the first time in history. (Furthermore, the London FTSE reached the 6000 mark and the French CAC tested 4000 for the first time in history.)
As I explained in my previous article, "Dow 9000 & The Shock" (an updated version is below), historically, when the Dow reaches psychologically important thousand marks and reverses, negative shocks tend to erupt that upset investor's expectations and send stock prices lower. This might recur here at Dow 9000. What sort of shock could occur? Increasingly, it looks as if Asia might be at least the initial catalyst of a stock market reversal from Dow 9000.
Late last week, just as the DJIA was reaching all-time highs near Dow 9000, Japan's stock market and currency were nose-diving due to a spate of bad news about the Japanese economy. First, the Bank of Japan released the widely followed "tankan" survey, which measures business sentiment four times a year. The survey showed that business confidence in Japan has plunged to its lowest level since 1994. Next, on Thursday the chairman of Sony Corporation warned that "the Japanese economy is on the verge of collapsing". His comment came on the heels of a 3.3 percent, 538 point drop in the Nikkei stock average on Thursday. Finally, on Friday the credit rating agency Moody's Investors Service signaled it may downgrade Japanese government debt. Moody's changed its outlook for Japan's economy to "negative" from the previous "stable" - a sign it may be considering lowering its appraisal of Japan's ability to repay its debts.
If one examines charts of the U.S. and Japanese stock, currency and bond markets over the past six months, a notable pattern emerges. Going into early-January of this year, it appears that some sort of panic started to develop concerning Japan. By January 9th, the Japanese Yen and Nikkei stock average were dropping sharply and testing multi-year lows. In association with this, U.S. stock prices started to dive while the long-bond was soaring in price, the latter apparently due to a panic-driven flight-to- quality. Fortunately, any sort of panic abruptly disappeared after January 9th, suggesting some sort of government intervention took place to stave-off an international financial crisis triggered by Japan's faltering economy and banking system.
Now, just as Wall Street's expectations are at the most irrational heights ever, it appears the panic that came to an abrupt halt in early-January is redeveloping with a vengeance. Last week, the value of the Japanese Yen dropped below its January low to the lowest level since 1992. In association with this, Japan's stock market dove nearly 10 percent on the week. The widely followed Nikkei stock average is quickly approaching the critical 15,000 mark that has been support for the market since the bear market in Japanese stocks started in 1989.
The important question here is, if the DJIA is going to reverse from 9000, what bad news is going to precipitate a sell-off in U.S. stocks. As I mentioned in my last article, when the Dow reversed from 1000, 3000, 4000, 7000 and 8000 between 1966 and last year, each reversal was caused by so-called negative "shocks" that upset investor expectations and sent stock prices lower.
Notably, thus far the current situation is a remarkable parallel of the Dow's test of the 3000 mark in 1990. In mid-July of 1990, the DJIA closed at 2999.75 *two days in a row*, and then reversed course, falling twenty percent by October of that year. This sharp reversal from 3000 coincided with Iraq's invasion of Kuwait and a Persian Gulf crisis that sent oil prices soaring- the shock that pushed the U.S. economy into the last recession. Likewise, on Thursday and Friday of last week, the DJIA closed at 8986 and then 8983, i.e., just below 9000 two days in a row. If the pattern that occurred in 1990 is going to repeat here, then the odds are a new shock is about to occur that will upset investor's expectations, push U.S. stock prices lower and possibly trigger a new economic recession.
Since the potential top at 9000 last week coincided with news that Japan's economy "is on the verge of collapse", there is reason to suspect that Japan and the worsening Asian financial crisis will be the source of Wall Street's upset and a reversal from Dow 9000. Indeed, when the Dow reversed from 8000 and suffered a mini-crash last October, it was triggered by Asia's financial turmoil. This time around, however, U.S. stock prices and investor sentiment might now bounce back the way they have since last October.
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RELATED ARTICLES
-------------------------------------------------------------------"Sony chairman says Japan's economy on verge of collapse"
by MICHAEL ZIELENZIGER
Knight-Ridder Tribune NewsTOKYO -- In an unusually blunt assessment of this country's bleak financial outlook, the chairman of Sony Corp. warned Thursday that "the Japanese economy is on the verge of collapsing" and echoed Washington's call for the government to move quickly to stimulate consumer spending.
Sony Chairman Norio Ohga said the new business year, which in Japan began Wednesday, will be "very difficult" for the electronics and entertainment giant if Japan isn't rapidly pulled out of its economic tailspin. "If consumer confidence continues to decline," he said, "we'll face a long spiral of deflation that would have a damaging effect on the world economy."
For American investors, Wednesday's pessimistic outlook raised new questions about how much longer the robust U.S. stock market can continue to set records while the world's second-largest economy is trapped in a downward spiral. (The Dow Jones industrial average closed Thursday up 118 points, within spitting distance of 9,000.) By all indications, 1997 will be the first year in more than two decades in which Japan's economy has actually contracted.
"I have great concern about Japan becoming a trigger for worldwide recession," Ohga said, likening Japanese Prime Minister Ryutaro Hashimoto to U.S. President Herbert Hoover, whose fiscal austerity after the market crash in 1929 helped exacerbate the Great Depression.
Ohga spoke to reporters just an hour after the Nikkei stock index fell 3.32 percent, or more than 538 points, dragging down markets in Hong Kong and other Asian nations. Earlier in the day, the Bank of Japan reported that business confidence has plunged to its lowest level since 1994.
"We're just starting to see Japan's darkest hour," said Jesper Koll, chief economist for J.P. Morgan. The new data, he said, confirms "that the Japanese economy has slipped into a very deep recession."
Thursday's pummeling of the Nikkei stock index, which fell to its lowest level since Jan. 14, wiped out a big injection of cash from the Japanese government. On Tuesday, the government apparently pumped $730 million into stocks in order to boost year-end closing prices. The money helped Japanese banks, which hold much of their portfolios in stocks, dress up their year-end balance sheets -- but only for two days.
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"Forecasts about Japan's faltering economy getting darker"
Associated Press, 04/03/98
TOKYO (AP) - The head of a top company says the economy is near disaster. A leading credit rating agency is losing confidence. A quarterly survey finds deepening pessimism.
The forecasts for Japan's economy are getting darker.
Tokyo stocks tumbled today after credit rating agency Moody's Investors Service signaled it may downgrade Japanese government debt, and the U.S. dollar soared to a six-year high against the yen.
Moody's changed its outlook for Japan's economy to ``negative'' from the previous ``stable'' - a sign it may be considering lowering its appraisal of the Japan's ability to repay its debts.
That came a day after the chairman of consumer electronics giant Sony Corp. warned that Japan's economy is on the brink of imploding and could threaten the health of the global economy.
Norio Ohga spoke to reporters Thursday, shortly after the Japanese central bank released its latest survey showing businesses are increasingly pessimistic about the state of the country's economy.
``The Japanese economy is on the verge of collapsing,'' Ohga said. ``If the economic situation continues to decline ... this will no doubt have a damaging effect on the world economy.''
He urged the government to stimulate consumer demand, and said that simply cutting taxes wouldn't be enough.
The Bank of Japan's quarterly survey said big companies cited sluggish economic growth at home and worries about the impact of Asia's financial crisis for their deepening pessimism.
``I think this is a pretty catastrophic report,'' said Russell Jones, chief economist at Lehman Brothers Japan Inc. ``Japan is sliding deeper into recession.''
``Even the U.S. economy will not be able to maintain its healthy state'' if Japan's economy continues in its slump, Ohga warned.
Speaking to a press conference after the Moody report's release on Friday, Japanese Finance Minister Hikaru Matsunaga said the government may move to prop up the yen, which he said has fallen too far.
The Moody's report pushed both the yen and Japanese stocks into a Nose-dive by heightening already intense concern about the country's faltering economy.
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Global Intelligence Update
Red Alert
April 3, 1998"Sony's Chairman Warns of Impending Collapse of Japanese Economy"
Norio Ohga, Chairman of Japan's Sony Corporation, warned today that Japan's economy was close to collapse and that Japan's collapse could lead to a worldwide recession. According to Ohga, the Japanese economy was facing its most difficult time ever. He compared Japanese Prime Minister Hashimoto to Herbert Hoover: "What President Hoover was saying then, there are so many similarities with what Prime Minister Hashimoto has been saying recently. Hoover triggered worldwide recession. I just hope remarks by Prime Minister Hashimoto won't trigger worldwide recession". According to Ohga, the central problem facing Japan is deflation, driven by a lack of consumer spending in Japan. Ohga therefore called on the Japanese government to stimulate the economy, increasing consumer spending and stabilizing prices.
Ohga has merely stated the obvious. Japan has been stagnant throughout most of the 1990s and its condition is worsening. The Bank of Japan's "business condition diffusion index," which tracks business sentiment has fallen to the worst level since 1994. This understates the problem. The extended malaise of the Japanese economy is wreaking structural damage as time goes on. Both Daiwa and Tokai banks announced cuts in lending to large companies while it was announced that capital spending in general would decline in 1998. As with the United States in the 1970s, the decline in the availability of capital triggered by the banking crisis means an increasingly aging and less efficient industrial plant. As this happens, Japan's exports become less competitive, increasing pressure on the yen. As the yen declines, the willingness of investors to invest in yen denominated paper declines, increasing the capital crisis.
The obvious answer is to stimulate the economy, as Ohga suggested. But Japan's financial condition is much worse than the U.S. condition in the early 1980s. Stimulating consumption must come at the expense of the savings rate. A high savings rate at low interest is now and has always been the foundation of the Japanese banking system. The availability of nearly free money to banks that are in dire trouble is the only thing that permits them to continue functioning.
Eliminate the constant infusion of savings and the banking system would collapse and with it the inefficient, linked companies who depend on cheap money to maintain their balance sheet.
Increasing domestic consumption is the long-run solution, but as the Japanese bureaucrats understand very well, it is not clear how to get there from here. Increased consumption would stimulate the economy, but only after knocking the bottom out of the banking system. Ohga, who heads one of Japan's more successful companies, is not completely sensitive to the precarious condition of most other Japanese companies.
This means that Ohga's warning should be taken seriously while his solution cannot be. Ohga's warning is an important turning point in the Japan story, since it represents a dire prediction from a leader of the Japanese business community, someone who cannot be dismissed as merely a sensationalist or alarmist. If Ohga is worried, everyone should be. The problem is that there does not appear to us to be any way out of Japan's dilemma. This is not the first time Japan has faced this dilemma. During the 1920s, a very similar banking crisis took place. The result was a devastating recession and the emergence of political extremism.
Until this point, analysts have been focused on the question of whether or not Japan can avoid economic disaster. It has been our position that Japan's economic fate has been sealed ever since the Japanese government decided to follow a strategy that refused to deal with the emerging banking crisis--that is, since around 1992. Now, Sony's leader has come close to the same conclusion, at least in the sense of facing the magnitude of the crisis. From our point of view, the central question is no longer whether the Japanese economy is facing calamity, but rather what the consequence of that calamity is going to be. One aspect of this is its effect on the rest of the world. We are not certain that Japan's decline will have an enormous negative effect outside of Asia. The second aspect is its effect on Japan itself. Since the end of World War II Japan has been a liberal democracy, a system imposed by the United States. If Japan goes into a depression, it will be a very different country than the prosperous and cocky Japan of the 1980s. With that difference will come wrenching political changes. We urge analysts to study the 1920s in order to get a sense of the possible evolution of Japan, should Ohga be correct.
J. Adams
April 5th, 1998The *Spirit Of Truth* Page
http://www.ucc.uconn.edu/~jpa94001/
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