It was another explosive week on Wall Street with extraordinary stock market gains across the board. The Dow rose 5% and the S&P500 gained 4%. Cyclical and consumer stocks rose alike with the Morgan Stanley Consumer index rising 4% and the Morgan Stanley Cyclical index surging 6%. The transports gained a less noteworthy 3%. The meltup throughout the technology sector continued with the NASDAQ 100 gaining 4%, the semiconductors 5% and the Morgan Stanley High Tech index nearly 7%. The internet speculative run continues with this group gaining almost 8%. Financial stocks were also strong performers with the S&P Bank index gaining nearly 8% and the Bloomberg Wall Street index 5%. Small stocks also surge with the Russell 2000 rocketing another 6%.

With deteriorating fundamentals obviously not justifying ever-higher stock prices, all eyes are now turning to the force behind surging stocks, excess liquidity. Importantly, the overheated financial system is creating too much credit which is feeding into the stock market. Yesterday the Federal Reserve announced that the money supply is growing at an annualized rate of almost 16%, the highest money creation since our economy was coming out of a prolonged business slump back in 1982. The important difference today being that money supply is exploding at the same time that the economy is slowing. Clearly, credit is being created in the financial markets to purchase financial assets instead of financing economic growth. Dangerously, as the economy slips into recession, stock prices surge due to too much money. This is a textbook case of a massive credit and asset bubble that will end in disaster.

This extraordinary money growth is, not surprisingly, a clear concern for fixed income investors. With the Fed now likely on hold for the November 17th FOMC meeting, short-term interest rates are rising dramatically, today yielding 4.64% after yields dipped below 4% just over two weeks ago. And bond investors have been hammered as nervousness understandably rises as to the causes and ramifications for huge money creation and rising short rates. We would expect long term rates to continue to rise and the companies will be paying increasingly higher interest rates. We also believe that the recent calming in the credit markets is but the "eye of the storm." Simply, there is just too much debt and too much financial and economic uncertainty present for normalcy to return for long.

Interestingly, dismal news continues to come from Japan. For the first time since the Great Depression, Japanese savers are now seeing negative interest rates. So fearful of a banking system collapse, investors are willing to pay a small fee to ensure the safe return of their capital. Such an absolute lack of tolerance for risk is devastating for an economy, but is the price of a financial bubble turned bust. It is frightening to remember that Japanese stocks hit their highs all the way back in 1989.

IS THE CURRENT STOCK MARKET "A BUBBLE"?

"Bubble" - a light hollow ball, Webster's II. The stock market is a "bubble" looking for a pin. The purchase of a securities at one price may be an investment, at a higher price - speculation, at an even higher price - irrational exuberance, and today, 2500 points above "irrational exuberance", the greater fool theory.

Everyone is investing in the market. People buy at high prices and expect to sell at ever-higher prices. The overall stock market is selling at the highest valuation in more than seventy years. People have forgotten that in order to "buy low, and sell high", you have to sell.

It is extremely rare for a Federal Reserve Chairman to warn investors about the stock market. This has happened only twice before in this century (1929, 1965), and in both cases, a severe bear market followed that required more than twenty years to breakeven after inflation. Alan Greenspan chooses his words very carefully. Yet Greenspan referred to the stock market as "a bubble" in a prepared speech when the Dow was about 6000.

Only in a bubble can a stock like At Home Corporation be worth $2 billion on its first day of trading when it posted revenue of only $2 million and lost $23 million for its previous six months. Slow-growing companies like Procter & Gamble and Coca-Cola are posting sales growth of 4% and 2%, respectively, yet are selling at 31 and 41 times earnings. Normally, the P/E's of stocks sell closer to their growth rates. These companies have been posting earnings growth slightly faster than sales, but not by much, and this never lasts forever. In the 1960's, people justified paying-up for great companies that would continue to grow, but look at their market returns from 1973-74 - (Coca-Cola -70%, Walt Disney Co -85%, PepsiCo -67%).

So why can't I wait until the end gets closer? "Times are too good now for the bubble to burst yet", you say. I only wish it was this easy. People always ignore history. They fail to realize that markets always get the most overvalued when times appear to be wonderful. The view is always clearest at the top. But it "feels so good" when the economy is strong, and everyone is making money "hand over fist" that people ignore the perils of a ridiculously overvalued market. Stock market moves nearly always precede economic events, and therefore people rarely predict the event which might cause a market decline. But in a bubble, they always think they can. When times are the best, all you have left is risk.

Stock markets never go up forever. It's not as easy as Wall Street would like you to believe. It isn't typical for money to be given away on Wall Street, but with the Dow Jones average increasing at a 19% rate since 1982, it seems like it. Consider the recent warnings of Greenspan, Buffett and Templeton. Think more about preservation of capital and less about greed. Expressing caution today is like being against motherhood and apple pie. History does repeat itself, so to protect yourself and your family's future, don't invest in a "bubble".

David W. Tice
6 November 1998

DAVID W. TICE manages the Prudent Bear mutual fund.
His Dallas-based research firm advises more than 150 institutional investors.
Prudent Bear Fund: http://www.prudentbear.com