In the face of the greatest mania and stock market bubble in history, President Clinton and Federal Reserve Chairman Alan Greenspan appear more than happy to just throw more gas on a raging fire. In last night's State of the Union Address, President Clinton told Americans "We are on course for budget surpluses for the next 25 years." In fact, his administration now estimates a 15-year, $4.35 trillion surplus. And last night, President Clinton proposed spending $2.7 trillion, or 62% of this surplus on saving social security, and went so far as to recommend investing $675 billion of these funds in the stock and bond markets.

Today, before the House Ways and Means committee, Mr. Greenspan began his speech, "The American economy through year-end continued to perform in an outstanding manner. Economic growth remained solid, and financial markets, after freezing up temporarily following the Russian default, are again channeling an ample flow of capital to businesses and households. Labor markets have remained quite tight, but, to date, this has failed to ignite the inflationary pressures that many had feared."

It is our view, however, that our leaders are being less than forthright. Today, we are in what can be described as a deep "delusion of grandeur." A massive expansion of debt throughout the financial system and economy has led to an unsustainable stock market and economic bubble. And while Mr. Greenspan trumpets the failure of inflationary pressures to ignite, today we see the most dangerous type of inflation in asset prices that so distorts the entire balance of the economy. Interestingly, in a historic speculation, the NASDAQ Composite has doubled since Mr. Greenspan's "irrational exuberance" speech two year ago. This stock market boom has increased the value of US stocks from just over $4 trillion in 1995 to almost $12 trillion today.

It is, however, ridiculous to extrapolate this trend into the distant future - it is simply unsustainable for the stock market to expand at multiples of economic growth. And clearly, these huge capital gains have been an unprecedented boon for the economy and government coffers, but this too is simply not sustainable. Keep in mind that today, the stock market trades at almost 150% of GDP, or the total output of the economy, by far an all-time record. For comparison, during the peak of the stock market bubble in 1929, the stock market traded at 80% of GDP.

It is further instructive to look back at Japan at the top of its financial and economic boom. Back then, the government was running a significant budget surplus, consumer confidence was high and retail sales were growing at nearly 10%, corporate profits were expanding at double-digit rates, the economy was growing at about 5%, and consumer price inflation was nonexistent. It truly looked like an economic miracle. At the time, few citizens, economists or government officials would have believed that the bubble was soon to pop and that the coming decade would see the Japanese stock market and economy collapse with government deficits reaching today's 8% of GDP. Unfortunately, the great Japanese prosperity of the 1980's proved in hindsight to be but a seductive creation of massive debt, a stock market bubble and massive unproductive investment. But this unhealthy boom years later. Now, all around the world, we see the painful consequences of unbridled booms; just look at Indonesia, Malaysia, Hong Kong, Taiwan, Philippines, Korea, Russia, and now Brazil and Latin America.

But today here at home, the perception is that the economy could not be healthier and, supposedly, stocks are still to be purchased despite the S&P500 trading at 33 times earnings and the NASDAQ 100 with a P/E of 107. And somehow, the President can claim that the government should now buy stocks to protect the social security system. This is crazy.

So far this week, the Dow has lost 5 points as the S&P500 gained 1%. Trading action has been particularly sporadic with big divergences between individual stocks and groups - the type of trading action indicative of a coming change in trend. The cyclical stocks have been the worst performers with the Morgan Stanley Cyclical index declining 2% and the Transports losing 1%. The Morgan Stanley consumer index has declined 1%. The small cap Russell 2000 gained almost 1% as did the Bloomberg Wall Street index while the S&P Bank index was unchanged. The leading performers, once again, were the technology stocks. So far this week, the NASDAQ 100 has gained 3%, the Morgan Stanley High Tech index 2% and the semiconductor stocks 3% as reported earnings have generally come in better than reduced estimates.

And while the Internet stock indices do have gains for the week, it looks like the Internet stock bubble could be coming apart. Today, Amazon.com was clobbered for 27 points, Yahoo! 36, and Broadcast.com 17. Actually, today had the look of a significant reversal for the Internet stocks and technology generally. The key NASDAQ 100 and Morgan Stanley High Tech indices gave back all of their earlier gains of more than 3%. Certainly, we have seen all the characteristics of a speculative blowoff and would expect an imminent sharp decline. As contrarians, we would not be surprised if the investor euphoria surrounding the President's State of the Union address and strong earnings from Microsoft proved the top of the market.

David W. Tice
22 January 1999

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