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Fasten Your Seatbelts

August 11, 1999

Part I

Market Plunges, Signals Change In Psychology

Ripped by profit-taking and a negative reaction to the announcement of a record Trade Deficit number, the U.S. stock market's sharp decline Tuesday left many puzzled as to why the market chose a week in which key companies have announced good earning to fall. Tech-weighted stock indices lost nearly 5% Tuesday despite stellar earnings by Microsoft and IBM announced the day before.

The decline provided the kind of technical follow-through that appears to signal that the financial market trend change we have forecast is upon us. Although a two-day market decline does not provide enough evidence to conclude with certainty that the third quarter market collapse our research argues is likely has begun, intermarket relationships (relationships between the U.S. dollar, bonds, and stocks for example), wide spreads between emerging market debt and U.S. Treasuries, and a steep market sell-off directly in the wake of good news (earnings) point to a developing trend change that will bring home the merits of reallocating and rebalancing porfolios, as our monthly market letter advises.

That market letter, The Global Market Strategist®, details the likely affects on the financial markets--particularly the U.S. stock market--that global economic events that are beginning to resurface will have on the investment markets, and what investors should do about it. Just like last year at this time, we recommend the July issue just published this week (July 20) and specially timed for the current important time period.

In 1997 as well as in 1998, July was the month in which the very beginning stages of domestic and global events that would serve ultimately to upset the U.S. investment markets surfaced. In 1997, for example, the first hint of the Asian meltdown surfaced in the news when it became known that Thailand was in trouble. The resulting dominoes effect contributed greatly to the global market collapse that ensued after an early August top. Last year, the market peaked on July 17 with Russia soon emerging as the next global hot spot.

This year, Argentina has already emerged as a potential hot spot. During July and August of every year, the market is particularly vulnerable to news that would upset it since seasonal rallies have typically already brought the market to overbought levels, and since regular market cycles typically complete their upward influence on the market by then.

Yet, bad global news is not always needed (or apparent) to cause a significant market decline. Tuesday's steep slide did not occur on the day Argentina's problems resurfaced. It occurred directly after the good earnings announcements by Microsoft and IBM, and during a week in which hundreds of companies release earnings figures. It occurred during the week in which the dollar reversed trend, and during the week following further widening of yield spreads between emerging market debt and U.S. Treasuries.

Widening spreads are a symptom of underlying economic problems since the free marketplace is demanding higher yields in order to offset additional risk to investors. Narrowing spreads are an indication that things are coming back under control (if there were, in fact, prior problems) or that all is good on the economic front.

As our July 20 issue of The Global Market Strategist® observes and illustrates with a chart, these yield spreads never came back to normal levels after the series of crises of 1997 and 1998--a fact that Alan Greenspan pointed out in his testimony in June. This month, the Argentine situation (possible debt moratorium or default) brought home once again that the economic problems that surfaced in 1997 still plague the global economy, and spreads began to widen still further. Alan Greenspan speaks Thursday in his semiannual Humphrey Hawkins testimony before Congress. We will feature a transcript of his prepared testimony, as well as analysis and commentary, right here in the Today's Market View section of our Web Site.

In the meantime, this is a time of great global political and economic change, and it is a time in which we timed our July 20 issue in order to optimize the timing of our recommended strategy to rebalance portfolios, an important and prudent thing to do at this critical juncture. Those who do will look back on this time as, in fact, having been an important time to reassess the risk/reward equation, to rebalance portfolios, and to prepare for opportunities to invest in newly emerging market trends coming up later this year. We hope that investors look below the surface--below what can be reported on the news media and from financial resources, for not all that is happening is being reported (or can be reported), and not all that is relevant is always apparent or visible to the naked eye. Rather, as we do at our GMS research facility, monitoring important and not-so-obvious domestic and global indicators and intermarket relationships is the key to early detection of what will become obvious to the majority later.

Part II

Wednesday, our analysis of the current position of the U.S. financial markets here on Today's Market View included an introduction to our July 20 monthly market letter entitled, Fasten Your Seatbelts And Keep Your Hands And Feet Inside The Ride At All Times.

All right, so it's a little corny. But that's what our work argues will take place during the second half of 1999--a market roller coaster ride. And if this volatility does occur, it will fulfill the rest of our forecast given in this year's annual forecast report, Forecast '99: Investing During The Void. The second half of this year, in fact, will resemble a roller coaster ride originating from three major categories in which life common to all those living on the planet Earth can be classified: economic, political, and religious.

On the economic front, our research firm continues to find global hot spots that could possibly become the next global economic boil-over points. We address those once again in detail in our monthly and daily Web research products. Additionally, Fed Chairman Alan Greenspan spoke again this week before the U.S. Congress in his semiannual Humphrey-Hawkins testimony (view exact transcript of his prepared testimony), and it seemed to upset U.S. financial markets Thursday. Seems the Fed Chairman was serious last month when he and the policymaking arm of the Federal Reserve Board, the FOMC, indicated they are tightening monetary policy to slow down the potentially overheating U.S. economy. The market rallied sharply when the Fed raised interest rates last month, investors hoping that the FOMC would not tighten policy again. But Mr. Greenspan shattered those hopes Thursday, and the bond market tumbled 1 2/32, putting the 30-year U.S. Treasury yield close to 6% again, closing at 5.967%.

On the political and religious front, our July 20 issue of The Global Market Strategist® updates our Forecast '99 report for political upheaval, rebellion, and other such seemingly unpleasant changes in a year that will be characterized as a year containing the most significant global changes in decades. Quietly remaining in the news are the demonstrations in Tehran (which not-so-quietly entered the news about a week or so ago, then seemed to leave despite ongoing protests there), along with other political hot spots involving demonstrations of public discontent with their political leaders (Ireland, Indonesia, Colombia, and Taiwan, among others). And quietly entering the news Thursday was the fact that public demonstrations in China have again accelerated--this time not over the bombing of an embassy or over a rebellious province attempting to assert its independence, but over religion. The demonstrations are the largest since the infamous Tianenman Square demonstrations in 1989, and have been characterized by large-scale demonstrations in 30 Chinese cities by a spiritual sect called Falun Gong, or Wheel of the Law, which was founded in 1992 by a former Chinese soldier named Li Hongzhi who now lives in the United States. It combines Buddhist teachings and other traditional Chinese principles with meditation and martial arts discipline as a prescription for physical and spiritual well-being.

We typically include political trends in our financial market research publications when they are expected to be relevant to the financial markets. The year 1999 contains the potential for both political and religious upheavals to destabilize the global economy enough to upset the financial markets and lead to a market collapse in the wake of this year's speculative bubble. Fed Chairman Greenspan, in fact, reiterated in the question and answer period Thursday his opinion that the stock market is overvalued and that he suspects it is, in fact, a bubble.

The point of all this is that a sea Change --Change with-a-capital-C, as our Forecast '99 report dubbed it--is occurring during 1999 in the three categories described above and will serve to substantially destabilize the global economic and political environment. The destabilization will be sufficient enough to upset the stalwart U.S. stock market, which will be reeling in uncertainty as to the outcome of these events. This is not yet to mention Y2K, a subject for which we cannot be classified by any means as sky-is-falling-Y2K-alarmists but that we indicated in Forecast '99 will, in fact, be a problem because many countries are not yet ready. The U.S. is for the most part ready, but several sectors of the global economy are not yet Y2K compliant, according to sources.

Once this political and economic destabilization becomes apparent to investors--at least with respect to uncertainty it adds to the Y2K situation--bank run-type psychology in the stock market could emerge in which investors sell out (in the face of other uncertainties, of course) to bring home risk capital presently exposed to an overvalued stock market. During bank runs, panicky consumers typically withdraw money from banks indiscriminately, helping bring down those which would likely have remained solvent absent the bank run. Indiscriminate selling of stocks is likely now that the market has again failed to sustain its advance to record highs in the wake of many nonconfirmations and divergences (which we have spoke of in our research and on Today's Market View. See our analysis that follows, and our archived articles, for additional information)

Combine all of this with Fed Chairman Greenspan's worry about domestic inflationary pressures and his alert given to Congress Thursday that the Fed will tighten on a moment's notice if necessary, and we have the formula for a sustainable market sell-off. Rallies notwithstanding along the way, the market appears to be beginning its first waves down of a decline that will not likely climax until the market stages a collapse marked by capitulation.

Mr. Greenspan also indicated that the FOMC, which hiked rates by 1/4-point June 30, "did not believe that its recent modest tightening would put the risks of inflation going forward completely into balance." Translated, this is "Greenspeak" for "the 1/4 point increase in the Federal Funds target on June 30 was not enough to completely slow inflation, and if I see any more economic numbers revealing a strong economy or upward inflationary pressures or labor costs, we'll raise rates again."

Regardless of whether the reader agrees with our forecasts for a sea change on the political, religious, and economic fronts, we continue to maintain that there are times when portfolios should be rebalance, when investments should be reallocated, or when exposure to a particular investment market should be reduced or virtually eliminated. Like the period of time last fall when we recommended pulling out of long-term bonds and moving capital into shorter term maturities (after which bonds plunged over 14% in value and resulting in a negative return on investment for those who hold on), it is time to reallocate stock market portfolios. Our monthly issues of The Global Market Strategist recommend specifics, and our Send-Us-Your-Stock Service, where we analyze your stocks and send you a written analysis, recommendations, and charts, assists investors in making decisions as to the potential risks versus rewards of buying and selling stocks.

Part III

Another Greenspan
Economic Indicator One-Two Punch Socks Stocks

Wednesday, our analysis of the current position of the U.S. financial markets here on Today's Market View included an introduction to our July 20 monthly market letter entitled, Fasten Your Seatbelts And Keep Your Hands And Feet Inside The Ride At All Times. The Ride just intensified Thursday.

Stocks plunged again Thursday after another set of economic numbers reminded investors that Alan Greenspan and company are on the verge of another interest rate hike. Only one day after Alan Greenspan, in his semiannual Humphrey Hawkins testimony before Congress, indicated again that he is watching labor costs closely for signs that the economy is heating up and that the Fed should respond with another interest rate hike. Thursday, the Labor Department reported that the Employment Cost Index rose 1.1% in the second quarter, providing the Fed as well as investors with another clue as to the possible future direction of the Fed. Investors had expected only about a 0.8% increase.

The strong ECI number convinced the majority of traders that the Fed will, in fact, likely tighten policy at its August FOMC meeting. Greenspan has paid particular attention to labor costs and to explaining his concern that rising labor costs could re-ignite inflation. Traders were so concerned with Thursday's surprise number that Wall Street's sell-off overshadowed the Gross Domestic Product report, also released Thursday. That report showed that the U.S. economy is slowing, with GDP up 2.3% against expectations for a much more robust number such as the 3.4% rate that was expected.

And, slowing is the name of the game here since our research has shown that the global economy is not only slowing but is beginning to become unstable again. As it destabilizes, it will drag down the United States economy, too. Apparently, the global economy has already had an effect on the U.S. economy as evidenced in part by the slower, 2.3% GDP number.

All of this week's events adds to our prior analysis, which indicated that the market is due to turn down into a decline that should climax with a plunge, collapse, or crash by this fall. There are many reasons why this possible scenario now sits on the front burner in terms of the most likely outcome.

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