The us Bubble

April 24, 1999

The stock market is certainly taking on all the characteristics of a runaway train, completely out of control and destined for an accident. The volatility and completely reckless nature of trading within the marketplace is simply astonishing and certainly anything but a sign of health. The unfolding debacle is fostered by unprecedented speculation at the retail level with the proliferation of online daytraders, and at the institutional level with the widespread use of momentum strategies and derivative trading, both irrespective of underlying business fundamentals. As such, the end result has been a market completely dislocated from reality. And although the bulls celebrate higher prices today, it should be disconcerting for all involved that we have experienced a breakdown in the market mechanism so crucial for effectively allocating resources to our economy. Certainly, this will have devastating consequences for our financial system and economy. In what is truly a tragedy, our stock market has regressed into little more than a wild money game and the world's biggest casino.

So far this week, the Dow and S&P 500 have gained about 1%. The Morgan Stanley Cyclical index is unchanged while the Transports have risen about 1%. The Morgan Stanley Consumer index, which has traded unimpressively for months, came to life today for a 3% gain. Utility stocks, which have been under heavy selling pressure for most of this year, have come under intense buying pressure this past week, gaining 6%. The small cap Russell 2000 continues rallying strongly, gaining almost 3% today and 11% since commencing its rally late last month. The financial stocks continue to rise with the S&P Bank index gaining 1% and the Bloomberg Wall Street index 3% so far this week. The technology indices have been strong with the NASDAQ 100 and Morgan Stanley High Tech indices gaining 1% and the semiconductors 3%, although the Street.com Internet index has declined 5%. These performance numbers, however, completely mask what has become chaotic trading throughout this sector. For example, the Morgan Stanley High Tech index declined 6% Monday, gained 2% yesterday and surged 5% today. The semiconductor index dropped 3% Monday and gained 7% today. The Steet.com Internet index sank 16% Monday, gained 6% yesterday and 7% today. And individual stocks make the indices look tame as moves of 10%, 20% or more occur in just hours in uncontrolled volatility. Let there be no doubt, this is one big accident in the making.

Meanwhile, looking at economic fundamentals, the US trade position continues to be an unmitigated disaster. The February trade gap came in at a record $19.4 billion, 15% greater than the consensus estimate and 65% larger than last year's. Year-over-year, imports grew 7%, while exports declined 3.5%. For the first two months of 1999, our trade deficit was $36.2 billion compared to $21.8 billion in January and February of 1998. Leave it to the bulls, however, and their "New Age" analysis, to actually view the shocking US trade data in a positive light. Bloomberg quoted a Wall Street economist as stating, "I don't think the trade deficit is a scary thing. It's just a reflection of our success." Other bullish economists aver that the deficit is healthy because it is indicative of an economy that is "investing more than it is saving" or, as stated by an economist from the Cato Institute, "Trade deficits may even be good news for the economy because they signal global investor confidence in the US and rising purchasing power among domestic consumers." Wow, bullish euphoria has certainly tainted economic analysis!

There are two points that should not be obfuscated. One, surging imports into this country are primarily the result of overheated consumer demand, not an investment boom. Specifically, the exploding trade deficit is one of many damaging effects of unprecedented excesses of money and credit creation within our financial system and economy. And, along with the resulting stock market bubble, it provides perceived wealth that allows us today to live much beyond our means, both running up way too much debt and depleting our savings. Second, exports are declining because of a global crisis that is much worse than generally perceived and not, as the bulls would like us to believe, showing much improvement. How the bulls can look at these two factors and come up with such a sanguine analysis for our trade deficit is certainly a sign of how truly nutty things have become. Granted, the bulls have worked hard to mold the perception that we now live in state of "permanent prosperity" and that the global crisis is well on the way to being rectified. The reality of the situation is, however, that the US stock market is an accident waiting to happen and when it goes, as goes our bubble economy. As we have said before, there are just too many examples of bubble economies that have turned into terrible busts for there not to be some recognition of how dangerous things have become. And while the global crisis has stabilized somewhat over the past few months, actual fundamentals in no way justify the huge stock market gains experienced around the world. Instead, higher stock prices have been fueled by the extreme measures taken by global central bankers to add liquidity.

For a good example of the huge gap between stock market performance and economic reality, just look south of the border. The Mexican Bolsa has a year-to-date gain in dollars of 41%. The economy, though, is showing increasing signs of trouble. Yesterday Mexican posted disappointing retail sales for February, the first decline in sales in almost two years. Mexico's largest retailer reported same-store sales declined 2%. Sales at the wholesale level actually declined 3%. Meanwhile, the unemployment rate in February also increased to 3.2% from 2.8%.

And while the talk is that Brazil has weathered its crisis well, much of this optimism seems misplaced. Last week, Brazil reported that its annualized budget deficit for the month of February was 13.9% of GDP, much worse than expected and surpassing IMF targets. The government has announced additional spending cuts that are sure to hurt an already weak economy. Industrial production fell in February by 5%, the ninth consecutive decline. Automotive output was 31% below the same period in 1998. And while economists expect the Brazilian economy to contract 4% to 5% this year, the stock market has staged a stunning rally.

Yesterday, Argentina's Industry Secretary estimated that industrial production slumped by 10% in March. He estimated that imports declined 25% in the first quarter overall, and 35% from Brazil. Recent reports out of Japan are similarly discouraging. Tokyo March department store sales fell 8.5% from a year ago, the largest drop in 12 months. Sales were 4.3% below February levels. Unemployment is at the highest level post World War II and, with huge recent layoff announcements, the situation is certain to continue deteriorating. For the month of February, salaried workers household spending shrunk to a 13-year low.

Just today, the International Monetary Fund released its revised projections for global economic growth, expecting weaker growth than earlier forecasts and the third straight year of slower global growth overall. "The balance of risks remains on the downside", stated the IMF's Research Director. IMF forecasts were reduced most dramatically for Latin America. The fund had expected growth of 1.5%, but now expects growth to actually contract. Furthermore, the report stated, "There is considerable risk of a more severe contraction." The fund now expects the economies in Brazil and Venezuela to contract almost 4%, Argentina 1.5% and Ecuador 5%. Estimated growth for Mexico was reduced from 3% to 2%. The report stated that Venezuela, Ecuador and Columbia have unsustainable fiscal situations. The IMF also had these comments about Japan, "Japan's economy remains weak and resumption of self-sustaining growth is not yet clearly in sight." The report also stated that Europe was "suffering from slowing domestic demand and slumping business confidence." About Russia, the fund expects the economy will contract another 7% with continuing very high inflation and said, "widespread graft and a culture of nonpayment…have eroded the social fabric."

In sum, this situation is getting increasingly dangerous. An unprecedented gap has developed between bullish perceptions and the reality of an historic US stock market and economic bubble with the backdrop of a global financial and economic crisis. This is much too closely following a similar course to previous debacles and we strongly encourage extreme caution.

In every cubic mile of sea water there is 25 tons of gold