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Today's Market View By Ascani

March 20, 2000

If I hear it again, I'll get a megaphone and broadcast it myself right on Wall Street. Or, maybe not Wall Street--those guys probably already know. Instead, I'll drive a tractor up to CNBC studios in New Jersey, kind if like the farmers do when they want the government to hear something and they drive their tractors up on Capitol Hill in Washington. Maybe CNBC will put a mike out the window for all to hear this crazy guy yelling something about a problem about which investors need to know.

Of course, how could investors know? The masses never know these things. In fact, no one really does. It's hard to tell when you're living in the shadow of events. They just kind of appear one day and slap investors in the face with the harsh reality of how an economy actually works, and how its investment markets which reflect that economy interact with it.

It is that dreaded macroeconomic equation about which I speak again. Not just that, but the fact is that what I'm hearing more and more of from traders--professional traders, that is, screaming that all the liquidity is gone from the "other" markets--is becoming disturbing, for a harsh reality is about to enter the realm of the on-line trader, the consumer, and the government: falling asset prices.

Don't worry. I really won't get into economics too much here. Nor will I get into a doomsayer mindset, for it is better to reveal what is found with the hope that it empowers investors with a knowledge they perhaps did not previously know. Yet, there is a delicate balance within the economy and its financial markets that is being upset by events in the stock market, the Treasury market, and the commodity markets, the past few months, and we figure we ought to be telling all what our research finds--even with a megaphone if we have to. After all, we are a market research and advisory firm.

Back to that problem, which is one of liquidity--or a lack of it, and of a marketplace sucking all the available capital right out of the economy. Volume in Treasury futures at the Chicago Board Options Exchange has literally collapsed. Bond futures used to trade the highest volume of any futures contract, yet since last summer, volume has collapsed from over 1 million contracts per day to less than 250,000. On many days, 200,000 cars don't even trade. I hear similar lamenting about even the cash bond market, and certainly about foreign exchange trading and....don't forget commodities, which except for oil futures have been lying dead in the water for months.

At the risk of sounding like a parent lecturing his children, I appeal to investors to take a very hard look at the big picture, and at what the real implications are for the behavior of the masses, for they are serious and will, in fact, come back to slap us all in the face if something doesn't change.

Don't get me wrong. I love the stock market. I have been involved in it in one way or another since the sixth grade, and professionally since 1982. I want to see a bull market, and I wish everyone could make money. I want the stock market to survive its present bear market so that, one day, it will perhaps reach Dow 15,000 or 20,000 or whatever number it goes to long-term. Why not? It's already reached 11,000 (I laugh when I recall what investors used to do when I indicated our forecast was for a mere Dow 2000, or even 4000 in 1991--perhaps some of these same investors buying the market now at Dow 10,000. They would laugh!).

The Financial Market Mechanism: No Laughing Matter

Yet, what is happening in this new millennium year 2000 is no laughing matter, for our desires to see Dow 15,000 or 20,000 are in jeopardy. It has to do with a lot of things, but today I speak specifically about the problems created within the economic mechanism by consumers and investors with a constant, one-sided attitude that stocks are where all investment dollars (maybe even all savings dollars) should go, and that stocks should be purchased no matter what happens--global crisis, depression, deflation, inflation, old economy, new economy, or whatever.

If, for the sake of example, all investment dollars were to be placed in one investment market, what happens? Among other things, it first takes away from available capital for the other markets, and for the economy itself, for humans are a dichotomous lot--they work off of either fear or greed, humility or complacency, but rarely somewhere in between. They tend to see the world as black or white, Republican or Democrat, Democracy or Communism, bull market or bear market--even though there are other colors, other parties, other governments, and other investment markets.

So, when all the capital is sucked out of the other financial markets, and much capital is pulled out of the economy into a single asset class like stocks, asset prices in that class rise, and decline in other classes. Capital produced from an increasing money supply that is intended for the economy instead goes into the single asset class, and it drains available capital normally earmarked for use in the economy. Investment markets lacking capital become illiquid, and the lack of capital flows undermines the capital structure of businesses dependent on those sectors of the financial market mechanism.

When all the available capital funneling into that single asset class like stocks has been used up, and there exists literally no more capital to bid prices higher, a vacuum develops and that single asset class collapses. When it collapses, deflation occurs.

During deflation, capital is literally destroyed--wiped right off the books. A friend of mine says it "goes to money heaven." This is not untrue, since capital used to purchase NASDAQ stocks, for example, at, say, NASDAQ 5000, is literally devalued--destroyed--when the NASDAQ falls to 4000. Since the end of the bubble produced a situation in which capital was robbed from other sectors of the economy and the financial markets in favor of the high-priced NASDAQ, that capital does not return. In fact, there is now less capital to return to the other asset classes and industry sectors than before the NASDAQ ever rose from 4000 to 5000, for if it had never risen to 5000, that capital would theoretically have remained in the economy or been put to use in some other form.

This example, as are many brief examples used to characterize a complex situation requiring a textbook to explain, is oversimplified. There are many other factors at work, and all else is not constant in the real world.

Still, some variation of it is, in fact, existent in the real world. It has been proven to humanity time and again, most recently in the Pacific Rim, including the world's second-largest economy, Japan. When Japan's bubble burst a decade ago, it sent the country reeling into a deflationary depression for reasons not unlike those which I describe in this article. They still strive to recover from the capital wiped off the books during the 1990s, and they aren't faring well these days.

So, last night when Japan announced that their Gross Domestic Product declined 1.9% last quarter, effectively aborting their attempted recovery, and investors rushed in to buy the huge down opening in the U.S. market, we heard it again from traders: liquidity is lacking in the "other markets," and for another day the stock market got its way. As it came back, it forced bonds back down, foreign currency back down, and commodities--well, they never awakened. Bonds fell off their highs when the stock market recovered, and even the almighty foreign exchange marketplace couldn't keep from being overpowered by the U.S. stock market.

Seems there's not enough liquidity left in anything but the stock market to properly operate the macroeconomic equation that is so critical to the stability of our domestic and global economies. Can't exist for long without liquidity; without interest rates competing with stock prices at some point; without the piper being paid for all the seemingly easy money simply buying NASDAQ stocks is perceived to provide no matter what global conditions are, or what defines the monetary system presently employed by an integrating global economy.

Yes, year 2000 contains many lessons for humanity, and it is unfortunate when they're learned the hard way, for asset price deflation is not fun. Yet, it's a reality once again as we watch the stock market try to come back, even as two-thirds of all stocks are declining, economies are still reeling, and the Federal Reserve and SEC Chairmen warn investors repeatedly because they know the dynamics of how it all works, and that they are the institutions that will have to clean up the mess when it becomes bloody.

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