Issue No. 5. October 1997 Posted 27.X.1997
The effects on
Japan are also starting to become visible and unequivocal. As I write
this, the Nikkei 225 Index is at 17,038, its lowest close since August
14th 1995 (16,917). It has been ratcheting down implacably and 17,000 is
widely perceived as a crucial psychological level. It is almost certain to
be breached tonight. During the last trading session (October 27th) the
key No. 182 Japanese Government Ten Year Cash Bond fell to a record low
yield of just 1.650% (closing up just a little). Japan looks to be in big
trouble economically: since I posted the last Issue of the Skeptical
Investor
In Europe and the
USA the realisation that investments still have "risk" has finally come
back. The psychological turning point was the collapse of the Hong Kong
stock markets. I explained in the mid-June Issue how the US bull market
was being driven to a large extent by a sanguine belief that buy-and-hold
investing had become risk-free. And I predicted that it would most likely
collapse not as a consequence of some sudden external shock but in
response to a more non-specific breakdown of investor sentiment. In this
light, all the fine-sounding economic analyses which we are now reading
about how much of the North American economy will or won't be directly
affected by events in Asia are largely irrelevant indicators of the
ultimate effect on US stock markets. The psychological effect on investors
in these grossly overvalued markets of the realization that in booming
Hong Kong the Hang Seng Index could collapse by 25% in a week is what will
matter. That has gotten their attention. Like the proverbial two by four
between the eyes. Hence the sharp falls throughout Europe, North America
and Latin America during today's trading sessions. One
of the main arguments that has been used in support of the belief that we
are in a New Era is that globalisation has resulted in tremendous economic
growth as markets open up whilst at the same time the increased
competition is holding back inflation. Another is that governments and
central banks have now learned how to "get it right" and maintain steady
inflation-free expansion without triggering inflation. Such trends are
argued to have eliminated the business cycle: the prices of equities
(particularly those in the USA) assume decades of steady growth and
increased profits ahead. But, as I have said before, I consider this New
Era thinking to be nonsense: nothing more than post hoc rationalisation
and wishful thinking. Globalisation has indeed been
a major factor lying behind the unprecedented economic expansion of the
last several years, but it has to be remembered that governments and
central banks (whilst they may attempt to act in concert ) are
institutions of nation states with ultimately only domestic power and
authority. Globalisation has increasingly eaten away at their power to
manipulate the economy: accordingly I see the world as a whole now
operating in the most laissez faire environment since before the Second
World War. ( In fact, this is yet another resonance of the period leading
up to the Great Depression.). In support of this are observations by a
number of investment analysts who have noticed the increasing correlation
of stock markets around the world. A typical example:- " But a new
school of investment management argues that geographical allocation is
becoming a thing of the past. As companies become globalised and economies
are increasingly run along the same lines, it is not a question of where
you are investing but what you are investing in." (Juliet Oxborrow,
Investment International, September 1997.)
But ,if true, this means that the global economy as a whole has obviously
become subject to the forces that lead to classic business cycles. I think
it has.
Looking at the world in this way as a single economy, the equity markets
have been in a bear market since August. The Morgan Stanley Capital
International Index of world stock markets which has experienced the
biggest bull run in history, peaked in August and has been falling
since.
What do I think will happen next? I am sure that the bulls still believe
that we are just experiencing "healthy corrections"--a wonderful buying
opportunity--but I see all significant stock markets around the world as
overvalued. Obviously, the problem is most severe in the United States,
but it is also true of Europe, Latin America and (very apparent now) has
been true of Asia. As the excess credit and production capacity that have
been created by the boom of the last fifteen years unwinds, all of them
will, I believe, fall much further. The sequence is unpredictable, and
probably doesn't matter anymore. I anticipate that Japan's problems will
become significant fairly soon. The most overbought market--the USA
--could well be actually the last to reach bottom: after all the forces
that have led to such overvalue are more powerful there than they are in
other countries. How far down will the equity markets
go? If we revert to mean, then 50% and more in the US is eventually
feasible, with comparable declines around the world. As I said in earlier
Issues it is this huge downside risk in stock markets that led me to sell
out of them some time ago. As of today, that certainly looks to have been
the right decision!
And, if my assessment above is more or less correct, it means that the
global economy has now entered the deflationary contraction phase of a
massive credit driven bubble. It will be very difficult, if not
impossible, even for the USA to arrest this through domestic
reflation.
Copyright© 1997 Max
Moseley and The Skeptical Investor, All Rights
Reserved.