The Bear Hibernates

Fellow bears,

I wouldn't blame you if you think this market commentary series have ceased.

Having said numerous times about how the market might behave through the

end of the decade, there really isn't a whole lot left to say regarding the market.

Plus, all of my market commentary websites are offline now. This series seems

to come out only once or twice a year now.

I could say what I think the market might behave in an even longer timespan,

but what use would that have? What I like to reiterate is that I think market

bubbles will reappear, time and again, because of human greed and intrinsic

market dynamics. I have speculated where the next bubbles might be:

China, gold, biotech, etc. I have also discussed the tendency of such bubbles

to start forming in the ashes of a previous bubble, typically during the 3rd year of

a decade, and gradually mature over the rest of the decade and finally burst.

First China. We already witnessed the mini-bubble in Chinese internet stocks

during the last year, which is now quickly bursting. Didn't we all wish we had

bought NTES when it was 50 cents. Don't blame yourself if you didn't. I didn't

either. Because it was risky.

The rest of the China bubble, however, is likely to continue to develop over the

rest of the decade, and the bubble will be located within China per se. The gold

rush to China has already begun. I can't say for sure whether the China bubble

will burst at 2010 or 2015. Afterward China will enter an era of negative growth

as a demographic consequence of its one-child policy decades ago.

Now Gold. I think gold still has potential to compete with China to be the next

bubble, as a continuing reaction to the worsening US economy. The decline of

the US economy, by the way, hasn't even started. The real test will be when the

baby boomers starts to drop out of the work force and have to rely on the next

generation to feed them.

Whether both bubbles (gold and China) will materialize is hard to say, but at

least one of them is likely. Supposed Gold is in the formative years of a decade

long bubble, now look back to 1993 to see where Nasdaq was in its comparative

stage. Nasdaq went on to increase 400+% from its 1993 levels. A similar bubble

developing on gold could put it north of $2000/ounce. Whether or not gold will

reach such bubbly levels, it's for sure that it still has upside potential.

Nonetheless, Gold has spent many many years in the $400 neighborhood during

the last two decades, and it's likely to meet resistance at these levels on its way

up. At this point, it would be healthy for gold to consolidate the gains from its recent

run-up from $260 to $400, perhaps sending it back to the $340 neighborhood, but

not to go below $300-310.

Nasdaq. Our old friend Nasdaq is back, testing the 2000 point resistance level.

Bouncing back down from this level, a preliminary support should be found at 1700,

with secondary support around 1500. Bouncing up from either support, our hope of it

going back to 2600 is still intact. If 1500 doesn't hold, then its 1200 or lower.

Babyboomer Retirement. Make no mistake, all life-sustaining materials are

perishable, and you can't store any of them to be used later in retirement. Ok, you

could save some money, and you can use that money to buy what you need during

retirement from the next generation. But if there are fewer bodies in the next generation

to sell those services to you, and more people in your generation in need of those

services, you can see how the supply-and-demand situation is going to be. As

they say in China, "have children, in case of old age". That will still be true even

after retirement has been socialized.

The market is a scam and a fraud, perpetrated by the financial elites on the masses,

who will buy at the top and sell at the bottom, and they knew it. (Well, if you are part of the

elite, congratulations. It's brilliant.)

Ya-Gui Wei
11/8/2003.

Demographic Reasons For Market Bubbles

From Baby Boom To Market Boom To Market Bust

By Ya-Gui Wei

During previous general market commentaries, I have asserted that:

- The stock market’s accounting method makes it a very deceptive pyramid scheme; it requires the continuous recruitment of new players for it to keep going up;

- Movement of money in and out of the market is translated into much bigger changes in the market’s valuations; only a tiny portion of the stockholders’ account balances is real money;

- Based on experience from past market bubbles, once the downward momentum has started, the money exodus is likely to continue until the market indexes have lost at least 2/3 of their peak values.

All these should be ample reasons enough to stay out of the market. Yet many people continue to resist taking losses, believing that the stock market is still the best place to put their savings, and hoping that the bull market will perhaps return in a few years, and Yahoo will again go back to $250 a share. Will this really happen? To answer this, we need to find out how the last bull market had come about, and why it came when it did.

We will approach this through a basic cash flow analysis for the entire market.

The Individual’s Peak Earning Period

For each individual member of society, no matter which metrics you look at, their ability is likely to increase as they grow up, then peak at a certain age, finally decline as they get older. This is true whether you are measuring their strength, their sexual prowess, or their money earning power.

The figure at the right shows the average income for each age group, based on data from the U.S. Census Bureau, indicating that the 45-54 age group has the highest average income. Another indicator is that this age group also constitutes the largest portion (32%) of the top 1/5 income bracket, followed by the 35-44 age group (25%).

One should be able to look at the census data at more detail to establish a more precise period for the average person’s peak earning power. Various authors have put the age for peak productivity and income at around 46 years of age.

If you are the average citizen, before you were 46 years old, your income level is likely to continuously go up. During this period, you’ll also be thinking about your retirement, and have more and more disposable income to put into retirement and saving funds. After 46 yrs of age, your income level is likely to go down, as will the portion of your money available for savings.

The U.S. Economy’s Peak Period

The economy is consisted of many individual persons engaging in their own economic activities. Therefore, the amount of money available in a society is the sum of all individuals’ earning power, and the economy’s peak income producing period is therefore the period when there is the most number of individuals reaching their own peak earning period, or 46 yrs of age.

After WWII, the U.S. experienced a baby boom – there was an explosive increase of newborn babies during the 15 years after the end of the war. Right now, the peak group of these baby boomers have just reached their peak earning years. In Fig. 2 (left), I have taken the year 2000 U.S. demographic data and plot it in such a way that it shows the number of people reaching 45 years of age during each five-year period. (This graph was plotted based on year 2000 U.S. demographic data, without adjusting for mortality rates.)

Apparently, as a result of the baby boom, the number of people reaching their peak productivity and earning ages has been steadily increasing, and has more than doubled during last 20 years. The productivity and earnings from the boomers propelled one the longest economic expansions during this period (except for a few short interruptions). During this period, the Dow Jones Industrial Average increased from around 1000 points to the peak of around 11,600.

Unfortunately, the number of U.S. peak earners has now peaked and is set to decrease during the next 15 years. This will lead to slower growth in the economy, or even economic contraction, which means slower corporate earning growth or decline in earnings, both of which call for lower stock prices.

Demographic Reasons For Past Market Bubbles

During the 1980’s, there was a similar economic expansion and bull market in Japan, with the key Japanese market indexes increasing more than 1000%. At the end of the decade, the Japanese market collapsed, losing more than 2/3 of its peak value. Eleven years later, the Japanese market decline is still continuing today, although at a slower pace.

If you look at the Japanese demographic data (Fig. 3), there is likewise an apparent peak of 45-year olds around the year 1990. Apparently, the Japanese baby boom occurred immediately after the war, and reached its peak about a decade before the U.S. baby boom.

The 1920s U.S. bubble is also likely to have arisen from the baby boom following the American civil war. The U.S. population increased by almost 30% in the 10 years after the civil war, the babies born during this period would have reached peak earning period during the 1920s, producing the great market bubble of that era.

So here’s how the market bubbles were likely to have developed: as a new generation of baby boomers came of age, their increasing earning power drove economic expansion, and their savings and investments propelled the stock and asset markets upward. The increasing markets began to attract speculators. At the later stage of the bubbles, speculation became the main force driving the markets to sky-high levels.

Market bubbles driven by speculation is simply not sustainable. While the general public’s participation in speculation is quite irrational, there was a group of speculators who were quite rational: they were the first to get in, and the first to get out. Once these speculators have gotten out, the bubble was punctured. Other speculators soon followed, but many lost a lot of money. During the market’s downward spiral, consumer confidence collapsed, and the economy fell into deep recession. The stock markets’ deflation eventually led to deflations in the real estate markets and consumer goods markets.

The Gold bubble, being a bear market bubble, has arisen from the other side of the coin. The severe baby bust (reduced birth rate) during the 1930s Great Depression era – when the U.S. population grew only 7% in 10 years – would have lead to a shortage of peak earners during the 1970s to early 1980s, causing the economy stagnation of that era. The gold price’s initial rise was caused by its own unique set of circumstances, including the dollar’s decoupling from gold and the oil crisis, but eventually attracted enough speculators to form a single-sector bubble. In terms of the amount of money involved, the Gold bubble probably cannot compare to the Japan bubble or the current U.S. bubble.

[03/17/2001]

Follow The Retirement Funds

By Ya-Gui Wei

Back in April 2000, I wrote an analysis of what drives the stock market up and down. One of the conclusions of the piece was that the stock market is a fragile thing – small movements of funds in and out of the market are magnified into huge changes in the market’s total values. The other conclusion is that the market’s direction is the composite of all the money that is moving in and out of the market, and that dissecting the various sources of funds into the market will give us insights about where the market is going.

Follow The Retirement Funds

One of the things that became apparent after the violent crash of the Nasdaq market last spring is that, despite the violent nature of the crash, it essentially would not go below an imaginary line. That imaginary line, which I have called the Basic Trend Line, happens to be the extension of Nasdaq’s previous trajectory before its magnificent rise.

This behavior of adherence to a basic trend line does not just exist in the Nasdaq. If you look at the chart of the S&P 500 Index during the last several years, you’ll also see that the famous index also hovers above an imaginary line, except for a brief interruption in the fall of 1998.

The basic trend lines in the Nasdaq and the S&P 500 basically represents a stable source of continuous new investments into the market, most likely the retirement savings of the population. Most of us set up the retirement savings as a once-a-month automatic deposit into some mutual funds (and a lot of this goes into S&P index funds), and don’t mess with it except under very unusual circumstances.

I have not been able to find a number that sums up all the various different kinds of retirement savings, but I do have anecdotal data. Most of my former employers provide 401(k) retirement accounts into which employees can contribute up to 14% of annual salary. Some of the companies also provide matching contributions, bringing the total to up to 20% of salary. This amount is comparable to the effective income tax rate of most workers. (Other types of company retirement plans are probably of similar value.) It means that the retirement savings could be in the same order of magnitude as the federal government’s budget, which currently stands around 1 trillion dollars a year.

The Hovering Speculators

Let’s distinguish between two components of the market: the steadily rising basic trend line(s) representing the steady infusion of retirement savings money, and the part that causes the market to fluctuate and hover above the basic trend line, representing speculative money.

The S&P 500 index has come back to visit the basic trend line in each October of past 3 years. In 1998, it dropped significantly below the trendline – as we may recall, that was during the Asian currency crisis and when Russia defaulted on its national debts and an international economic crisis was looming. That was about the only time when the retirement money was fleeing the market during the last few years.

In 1997, 1998, and 1999, the S&P 500 Index came back to visit the basic trend line only once each year, and each time around October. However, the index has visited the basic trend line 4 times so far this year: in February, April, May, and again August. We can perhaps safely expect another return visit this coming October.

There will always be a certain amount of speculative money hovering above the market. But for Nasdaq at least, the glorious days of last spring’s speculation is essentially over. Back in march, the speculation money causes the Nasdaq to depart 2000 points (nearly 70%) from its basic trend, now it’s only 400 points or 12% above the trend line.

The speculation money is always quick to flee the market, but it also doesn’t want to stay out of the market for long. If the market sticks to the basic trend line during the coming correction, we can expect some of the speculators to come back afterward, perhaps fueling another late year rally.

There is a vast reserve of potential speculators: the $1.5 trillion of savings in low interest U.S. bank accounts. Giving a large enough amount of hype, some of this money would be lured into market speculation. That was probably what happened to Nasdaq last spring.

Riding the Tide That Lifts All Boats

Supposed we ignore all the speculators, and invest only with the basic trend. What kind of return might we expect?

For the last 3 years, the S&P 500 Index’s basic trend line has risen about 200 points a year. Since the basic trend line currently projects at around 1450, it gives us a potential return of about 14% a year. For Nasdaq, the basic trend line increases by about 650 points a year and current projects at about 3650 points, or 18% annually.

This means that, even if we take away all the speculation money, we can still expect to earn about 14% on S&P, or 18% in Nasdaq just by riding on the retirement funds. Or put it another way: if you enter the market when it drops back to the basic trend line, a year later, even if all the speculation money is not there, you can still expect to make that much money.

Instead of just riding the tide, you may be able to do a little better by surfing the waves a bit, especially during the current turbulent market: For example, if you enter the S&P Index funds during the 4 times that it touches the basic trend lines this year and then departed during its subsequent peaks, you would have made 60% since last October (This is only the theoretical possibility. Timing the market is usually harder than it seems since the benefit of hindsight is not there.)

Re-Assessing the Mid/Long Term Prospects of the Market

During the last several months, when speculation money dominates, certain segments of the market have been decidedly bearish since last April. But now that the speculation money has subsided, what is the mid-long term prospect of the market?

I have visited upon the Dow Jones Industrial Average’s charts a couple of times during the last few months and saw a couple of reversal signals there. Coupled with Nasdaq’s reversal, I have forecasted a long-term general market reversal. Now we should perhaps incorporate the theories from this article into the forecast.

I wish to de-emphasize the Dow Jones average for a couple of reasons: its narrow representation of the market (only 30 stocks), and its significant reconfiguration early this year (the addition of Microsoft, Intel, and Home Depot) has called into question the continuity of its charts.

The Nasdaq and S&P 500, representing the technological and the general markets respectively, will be our favored barometers. One nice feature of these two indexes is that they allow us to distinguish between speculation money and steady investments. If we subtract the basic trend line from these two indexes, we can see that the speculation portion has been decidedly bearish: in addition to Nasdaq’s actions, the S&P 500’s speculation has dropped back to the base line 4 times so far this year already, whereas in previous years none would have happened until October.

Ignoring the speculation portion of the market, so far there has been no exodus of retirement funds since the Asian currency crisis. So this portion of the market is neutral or even slightly bullish.

So watch the Nasdaq and S&P 500’s charts closely. If either of these charts should drop below the basic trend line and doesn’t quickly bounce above it, then the long-term bear market has arrived. We can expect the retirement money exodus to begin once there’s a perceived down turn in the economy. Another possibility is that, after the speculation money is gone and doesn’t come back for a while, the retirement money will get nervous and begin to exit too.

But the long-term prospect of the market remains bearish. The market has simply risen too much during the last 10 years: even from a basic trend line standpoint, the S&P has risen 70% during the last 3 years. It’s hard to imagine the natural cycle of the market to not set in sooner rather than later. But at this point, that bearishness has not spread from speculation money to retirement money just yet.

The S&P 500’s basic trend line has been rising 200 points a year. Since the index stands at about 1500, you’d think that S&P 500 was at zero 7.5 years ago. But that is of course not the case. There has been a redirection of retirement funds into the stock market during the last several years. (Another possibility is that the basic trend line is really a composite of retirement funds and some other recently arose source of stable investments.) This trend would be reversed as the economic slows down and baby boomers approaches retirement age. The first baby boomers are now 55 years old and financial advisors typically tell us to move money from stocks to bonds 10 years before retirement.

Concluding Words

None of this new analysis changes my original assessment that the financial markets are pyramid schemes that depend on the continuous recruitment of new money to keep going up.

I have increasingly come to view the financial markets as the center of wealth redistribution rather than wealth creation. The sometimes appearance of wealth creation in the market is, like I have pointed out, actually an accounting gimmick and conspiratorial recruitment tool of the markets.

So, if the retirees have put X trillion dollars into the market, that will perhaps be the amount they are likely to get out (if the market’s recruitment prospect doesn’t change). The only difference is that, some will take out more than they put in, others who act late will take out less.

So, remember, retire early.

09/10/2000

A Brief History of Market Bubbles

What does past market bubbles tell us about the current one?

By Ya-Gui Wei

---

Since late last year, I have been writing in these spaces (for example, 1, 2, 3, 4.) about the Nasdaq/internet stocks being in a perilous bubble waiting to burst. Well, this spring, the bubble did burst.

While the technology stock market will continue to fluctuate, and money will continue to flow from one sector to the next, it's important not to forget that the U.S. technological stock market is at the post-bubble stage. How will the market behave at this stage? Is it more likely for Nasdaq to get back above 5000 than going below 3000? Perhaps we can gain some insight by looking back at some of the past market bubbles.

The market bubble is not a new phenomenon. Some 380 years ago in Holland, when tulip bulbs became the hot investment vehicle, the price of a single tulip bulb eventually ended up equal to a wealthy merchant's annual income (5). Those who bought near the top still have not recouped their investments four centuries later.

In the 1920s, the Radio Corporation of America was the hot momentum stock, rising more than 2,600% in 3 years before it crashed more than 70%. Then, 5 months later, it rebounded, regaining 50% of the loss, but then the second wave of the crash ensued. RCA eventually fell back to its pre-bubble price a couple of years later. Those who bought near the top had to wait 30 years, when RCA began to make television, to break even. (See 1924-1934 RCA chart.)

The bull market that gave rise to RCA had a lot in common with the current bull market: Then as is now, the U.S. was in one of the longest periods of continuous economic expansion, and the stock market had been rising since 1923. Then as is now, the market was infatuated by a new form of rapidly growing technology for public communication -- broadcast radio. By 1929, the stock market was in frenzy speculative craze with almost everyone wanting to own radio stock, with the talk of a "new era" of technological innovations, productivity increases and that the old rules of valuation no longer applied (6). But suddenly, it all ended. The time was October 1929.

Fast forward to the 1970s, when the U.S. government decoupled the dollar from gold, and the price of the metal began to rise in 1972. By January 1980, the price of gold reached $800 an ounce, a more than 2,000% increase from 1972. But then the bubble bursted.

The gold price bubble, like the Japanese stock bubble mentioned below and the 1920's U.S. bubble earlier, is notable in that it bursted near the beginning of a decade. Coincidentally or not, we are now at the beginning of a new decade in a new millennium.

The Gold Price lost nearly 40% of its value in the initial crash. A few months later, it recovered 60% of the loss in a rebound. But then the second crash began. By 1982 the price of gold has dropped to the $300s where it remains today. (In inflation adjusted terms, where the then $800/oz price tag would equal to about $1500 in today's dollars, the price of gold has not remained steady since it has not kept pace with inflation. To say that gold will insure you against inflation is a bit of a myth. Gold may insure against a currency crash but not normal year-to-year inflation.)

The story with the Japanese market is hauntingly similar. Beginning around late 1982, the Japanese economy began to expand. By the end of the decade, the Nikkei index had risen nearly 1,000%. But then, a few days before January 1st, 1990, the bubble bursted.

The initial crash in the Japanese market in 1990 took away about 30% of its value, but a few months later, it has recover nearly 50% of its initial loss. But then a second wave of the crash follow, in the same fierce magnitude as the first crash. The second crash also saw a nearly 50% recovery a few months later, but then a third crash. Eventually, by 1992, the Japanese market settled on a bottom that is about 1/3 of its peak value.

What is there to be said about the current U.S. stock market? Well, like the previous market bubbles, it began about 2.5 years into the decade. In the summer of 1992, when Bill Clinton ran for President, the Nasdaq composite was at 580 points. (Click here to see how Nasdaq has risen since 1992.) And that the crash began at the dawn of the new decade. And that by mid-year, it has recovered 50% of the initial loss, but it is going down again.

The rest, however, is history not yet written.

One thing we learnt from all this historical review is that, even though the indexes would rebound 50% after each of the major crashes, all of them went on to crash a second time, equal in magnitude to the first crash.

Each of the market bubbles, including the current one, began the third year into a decade. Each reached their apex at the end of the decade and began to go down and crashed as a new decade dawns. They all went to their bottoms about 2.5 years into the new decade. Isn't it comforting to know that, after a bubble bursted and burnt to ash, another bubble of similar scale will begin to rise, perhaps somewhere else on earth? I guess people just cannot sit idly with money in their pockets.

Counter examples do exist. The U.S. economic expansion that began in the 1950s lasted for almost two decades. The difference is that the stock market did not go up parabolically then.

07/28/2000

Why Does the Market Go Up&Down?

Analysing the Stock Market Using A Mathmatical Model

By Ya-Gui Wei

I have warned about the danger of the current stock market (1, 2) and its imminent collapse (3, 4) since last December. Now the market collapse is in full swing (5, 6). Today's column should ballance things out a little and put it all in perspective.

[I do like to ballance things out. For example, a week after I predicted that Qualcomm would rise to 600 in a month -- it did finally rise to 800 in 36 days -- I began writing about the fraudulent nature of the market (1, 2). But after that I no longer feel comfortable recommending momentum stocks in this column.]

Simply put, the current phase of the market downturn, while ugly, and still not finished, is not going to go all the way down. Isn't that comforting?


A Model Stock Market

Why does the market go up and down? It's because money flows in and out of the pool of funds that investors use to trade stocks. When this pool increases, the market goes up. When this pool of money declines, the market goes down. But by how much? (Some will say that the stock market goes up and down because of the underlying companies' businesses go up and down, but recent market history has proven that to be mostly fiction. The market is capable of detaching itself from reality by large measures.)

As we are about to see, every 1 dollar of change in the trading fund pool will be magnified into hundreds, if not thousands of dollars in the overall market capitalization.

Let's device a model of the market by hypothesing a market that is the simplest possible: a market that has only one stock, and two traders (it takes 2 to trade), and no fructuation in trading volume. Suppose the stock has ten million shares outstanding, with each trader holding 5 million shares. Each day, 10,000 shares change hands between the traders.

The first day, Trader A bought 10,000 shares from Trader B for $10 a share. $100,000 of funds is transferred from Trader A to Trader B, and this amount shall constitute the initial size of the trading fund pool. Suppose the next day, the value of the stock somehow rises, and Trader B decided to buy 10,000 shares back for $11/share. Now the amount of money he had in his trading account is not going to be enough, and he will need to put up an additional $10,000 to complete the trade.

Now between the first day and the second day, the size of the trading fund pool increased from $100,000 to $110,000, and the total market capitalization increased from $100,000,000 to $110,000,000. We are seeing a 1000-fold magnification in the additional money Trader B put up. How could that be? We put up $10,000 and got $10,000,000 in return. Where did the extra $9,990,000 come from?

Nowhere. The answer is the money comes from nowhere, except through magical imagination by the savvy accounting scheme that I have been denouncing -- when even a single share of the stock changes hand at $11, our accounting scheme assumes that every share of the stock is also instantly worth $11. (The extra money is really not there, but most people actually assume they are, and it is the way real world markets operate, so we'll have to work with it.) Through this accounting scheme, every dollar invested in our model stock market is instantly magnified 1000 times -- the ratio between the total shares outstanding and the number of shares traded each time. (Likewise, each dollar taken out of the trading pool will be amplified to be a much larger reduction in the overall market capitalization.)

What's the value of the magification ratio in the real world markets? I've heard that U.S. stocks turned over every 80 days to a year. So the magnification ratio for U.S. markets should be between 80 and 360.

Real world situations are a bit more complex. A lot of trades will cancel each other out without affecting the size of the overall trading pool; this and other factors will make us under-estimate the magnification ratio. On the other hand, some investors may let funds sit in their accounts for a few days before making another trade, this would make us over-estimate the magnification ratio. Since we don't have a metrics of these factors, we'll still assume the ratio to be around 80 to 360.

The actual magnification ratio doesn't matter. What matters is we are aware that the crazy magnification exists.

Once we are aware of this magnification, we will also be aware that the vast majority of the stock market value -- perhaps 99% of it, -- is just imaginary money. We'll also begin to comprehend why the market is as volatile as it is. Although money itself is probably an imaginary concept, what's important now is to realize how fragile a concept it is, how easily it can be gone without a trace.


Cyclical Changes In the Trading Fund Pool

Since we know the size of trading fund pool is directly related to the overall value of the stock market, it helps if we know about how the trading fund pool changes, and the approximate magnitude of those changes.

It seems to me that stock trading funds can come from the following categories, each of which may correlate to different chronological cycles.

(A) Retirement Saving Activity. The most notable of this component is the retirement funds of the so-called "baby boomer" generation, the generation of Americans bornt between 1945 and 1965. Much of the retirement saving would find its way into the stock market, and this trend will continue until at least the year 2010, when the first baby boomers will turn retirement age. By my own estimate, retirement saving adds up to between $20 to $50 billion dollars each month, a lot of which goes into the stock trading pool.

The great bull market since the early 1990s is directly powered by such retirement savings, and the basic trendline from the first half of the past decade is likely to continue on until at least 2010. This is the part of the market that correlates to the demographic cycle. (The market has since skewed upward due to various other factors mentioned below. When these factors are removed, the market will be corrected back to this basic trendline.)

(B) Governmental Activity. The federal government's shrinking deficit reduces government borrowing, and funds that would have gone to government bonds find their way into the stock market.

Another significant governmental activity is tax collection. Both last and this year, momentum stocks peaked toward April 15. This is directly related to tax paying liquidation, and it affects momentum stocks disproportionately. Because of the high percentage returns in these stocks, people would rather hold off until April, rather than liquidate them throughout the year to pay estimated tax. Tax paying liquidation can take perhaps 100 billion dollars out of the pool within a few weeks this year, depressing the momentum market for months. Later in the year, the government is going to discover the extra revenue and retire more of its debts, thus releasing more funds back to the trading pool.

(C) Corporate Activity. Corporations contribute to the trading pool by investing their excess cash. Corporations draw money from the trading pool through activities such as IPO, SPO, private placements, stock option excercises, and other funding activities. Heavy IPO activities typically depress the momentum market. If AT&T proceeds with its $10 billion IPO of its wireless business, it's going to have a noticeable effect on the market.

(D) New Investor Activity. Increasing number of new investors are participating in the stock market, withdrawing money from CDs to play the stock market. How many such people were lured into the stock market by the bull run last year is hard to say, but ought to be a significant number.

(E) Trading Activity. Traders move money between their trading accounts and money market or margin accounts constantly, resulting in daily fractuations in the trading pool. Through margin borrowing, traders can add significant new funds into the trading pool. Between last December and February, traders took out between $15 and $40 billion new margin loans each month, all of which went directly into the trading pool.

Of the various sources of the trading pool, the margin loans are the most fragile. After the recent margin calls, the amount of margin loans, or at least its growth rate, should diminish. The increase in funding from new investors is a one time deal, and such activity is likely to have peaked. IPO activities typically correlate with market cycles, when the market peaks, IPOs also peak, thus driving the market back down. Tax paying is an annual ritual, which, together with summer vacations, causes summer market downturns.. Retirement saving correlates to the longer demographic cycle. The remainder of the trading fund correlates to the economic cycle.

Take away the extra margin loans, the market should return to its pre-November trajectory. The supply of new investors is finite, once exhausted, the market should return gradually to its pre-1999 trajectory. When the economic begins to turn sour, the market may return to its pre-1995 trajectory, but retirement savings should continue to increase until at least 2010, so the market will still go up, albeit from a level that is lower than the current level.


Micro Climates

Even if the overall trading pool stagnates, the trading pools for individual stocks can still change. These will be governed by additional factors related to the individual stocks and their sectors.



For more of Ya-Gui Wei's stock market commentary, click below.

Return to Stock Commentary Page.

04/08/2000

The End Is Nigh

The Irrational Market Is On The Verge Of Imminent Collapse

I have ridiculed the ridiculously insane market in several recent market commentaries (1, 2, 3), but this piece is more serious.

The End Is Nigh

I was reading the charts for the Dow Jones Industrial Average (INDU: 11003, -38) today and couldn't help but noticing a prominent pattern in its daily chart: Since early December, the Dow Jones Average has been oscillating with ever increasing intensity, making ever higher peaks and ever lower valleys, with increasing volume. The result is a formation called the "Expanding Megaphone Top". (The same expanding megaphone pattern is also in today's intraday chart.)

According to technical market analysis theory, the Expanding Megaphone Top indicates that the market is in a stage that is extremely emotional and is getting out of control. This pattern is a bearish signal and often signals the end of a major bull market.

There has been several reversal signals in the Dow recently. In late January, the Average decisively pierced the previous support near 11000 and dropped to around 10700. The monthly Japanese candlestick chart of the Average shows the classic "dark cloud on top" reversal pattern. Recent downward short term reversals have been strong and decisive, while upward recoveries have been weak and lackluster.

The market is also on a stage of broad popular participation -- the trading volume for the Dow has nearly doubled in 4 months and tripled in 2 years. These days, it is rare to find anyone on the street who is not trading stock on the internet. According to Contrarian Theory, the opinion of the majority is always wrong, and broad market participation frequently signals the top of a bull market.

My previous commentaries have focused on the Nasdaq (COMPX: 4073, +21), why the sudden shift to Dow? Nasdaq, too, have recently staged two strong short term reversals, on Jan 3 and Jan 24 of this year, while the recoveries have been lackluster. I believe it is currently in the process of forming the classic Head And Shoulder shampoo, excuse me, reversal pattern.

I have been interested in the Dow because it has recently served as a leading indicator for the bear market. Its most recent slide, for example, began Jan 18, a week earlier than Nasdaq. The fact that Dow has exhibited strong reversal signals should serve as a warning signal for Nasdaq, because the market will never diverge for long.

Psychology of Round Numbers

Decimal round numbers mean zero to me, but a lot of people treat them with considerable respect. The millenium New Year was celebrated with great fanfare. For many people, 10x birthdays are a time for reflection, frequently accompanied by mood reversals.

Round numbers are also important milestones in the financial market. The Dow often find resistance on 1000-multiples. The Gold price bubble of the 1970's ended when it reached $800 an ounce. The recent phenomenal rise of Qualcomm ended at precisely $200 (or $800 pre-split).

The market also pays great attention to round numbers on the calender. The Japanese stock market bubble was popped 2 days before Jan 1, 1990. The Gold price bubble of the 1970's was pierced a few days after Jan 1, 1980. Since the early 1900's, the U.S. stock market frequently tops out near the first day of each decade and didn't recover for years.

This year, the big round number with 3 zeros, started with a major reversal on the first trading day, and seemed destine to follow the course of other market bubbles. But both the Dow and the Nasdaq Composite ended up making newer highs 3 weeks later. Was that the last breath before the big crunch?

Both the Japanese bubble and the Gold bubble lost 60% of their values when they bursted. How bad will the bursting of the US market bubble be, with Nasdaq increasing more than 80% last year? Hundreds of mutual funds doubled or tripled last year. How many will lose 50% or 60% this year?

02.02.00

The Great Engine of Wealth Creation

Momentum Stocks: The Great Engine of Wealth Creation

Karl Marx says that labor is the only force that creates wealth. No wonder he died poor.

In a capitalist society, desire is the singular force that creates wealth. There is no other force that rivals its potency in wealth creation. Desire is what drives demand and consumption, which in turn drives the economy. The economy creates wealth when there is sustained demand and consumption.

The only definition for wealth is desirability. Wealth is what feels good. Wealth is not definable by physical "things". Undesirable things are junk, not wealth.

Hence, to create wealth, you don't need to manufacture goods and merchandize. All you need is to create desire. If you desire, you shall have.

The stock market has carried this mantra of wealth creation onto unprecedented levels.

How The Stock Market Creates Wealth

The following example illustrates how the stock market creates wealth.

Suppose there are 100 people each holding 100 shares of XYZ Corporation, with each share worthy of 100 dollars. Suppose most of the times, most of these people just want to hold on to the stocks. From time to time, one of them will want to sell. And further suppose that, when this person wants to sell, there is always someone waiting to buy.

If the buyer simply pays the seller 100 dollars for each of his shares, no wealth is created.

But occasionally, the buyer is more eager to buy than the seller is to sell, and he is willing to pay 101 dollars for each of the seller's shares. This, my friend, his eagerness, or desire, to buy is what creates wealth in the stock market.

At the moment when the above trade took place at 101 dollars, 10,000 dollars of wealth is instantly created. At the end of the day, the brokerage houses will be busily updating the accounts of all 100 shareholders to reflect the increase of wealth in their accounts, even though none of them has done a thing during this whole process.

Next time you pay market price to buy a fast moving momentum stock with a $1.00 spread, of some company with 10 million shares outstanding, remember that, even though you have not made a single penny from this trade, you have just created $10,000,000 of wealth for this society.

Now compare this process of wealth creation to, say, spending months toiling the field in order to grow a few bags of potato.

It's true that this vast multimillion dollars of wealth you have just created -- involving very little labor in your part, I might add -- will be instantly squished if the next person places a sell order at the market price. But do not fear. So long as more people place market buy orders than market sell orders, this great engine of wealth creation is intact.

In a previous commentary I have laughed about the accounting methods being used in the markets. Well, I may laugh about it, but this accounting method does make some sense. If someone buys your neighbor's house for a higher price, by association you may feel that your house is more desirable now than it was yesterday (even though it is still the same old house), and you may feel pretty good about it. The accounting method, therefore, is there simply to tally up all the good feelings in the society. If this increase in good feeling leads to higher property taxes that you will need to pay, well, that is just too bad. (The government, you see, wants a portion of your good feeling, eh, wealth.)

Stock Trading As a Zero Sum Game

Stock trading is a zero sum game. If I make X amount of money trading a stock, the other side has to be losing the same amount of money. This is true for stock trading as it is true for potato
trading.

Back to the above example of XYZ Corporation, and ignore for the moment the 99 people who are holding the stock and not selling nor buying. Now when the buyer pays $101/each for 100 shares of stock originally worth $100/each, the seller instantly profited $100. Since nothing has changed in the operation of the underlying XYZ Corporation, we can argue that the buyer just paid $101 for something that is worthy of only $100, and therefore have instantly lost $100. Right?

In the old days of 12 or 16 months ago, only day-traders were there to play the momentum stocks. Day traders, by definition, are a conservative bunch. The only kind of equity they trust is cash in their accounts. They would run some stocks up 200% or more to the top, with some traders making lots of money in the process. Then, those that have made money wanted to take profit, those who bought at the top wanted to take loss (to avoid suffering even bigger loss), and their selling drives the stock back down to the original level it has always been.

A lot of traders made a lot of money in this process. Others lost a lot of money. It is basically a zero sum game -- the amount of money made equals the amount of money lost. It is a zero sum game because everyone involved knew that it was just a game, the underlying company's business has not changed and is not worth the higher price they have paid.

This whole game changes when some of the people who bought at the higher price decide to hold on to the stock, rather than taking profit or loss.

Those people who held on to the stocks, either through sheer laziness or whatever reason, decided to ignore the underlying fundamentals of the companies involved. They decided to hold on to the stocks with the belief that, eventually, the stock will rise again and they will be able to unload the stock to someone else without suffering a loss.

When a lot of people decide to hold on to the stocks, the resulting reduction in selling pressure causes the stock to stop at a price that is higher than the original price before the momentum run started. This, in turn, elevates the wealth of every shareholder, including those who had not participated in the momentum trades.

It seems, then, ignorance is also a great engine of wealth creation in this stock market.

"The New Economy"

When some momentum traders decided to hold on to their losing positions, they helped create wealth by keeping the stock price higher than if they have sold them. (These are the people who sacrifice themselves for the greater good of the society.) The more people who hold on to the stocks, the higher the stock price will be.

The market for momentum stocks has entered a brand new era since late last year. Before then, only some individual Internet traders bought and held the momentum stocks. But the big mutual funds got jealous of the Internet traders and have joined in the game.

Mutual funds are buy-and-holders by default. They don't buy a stock in the morning and take profit in the evening. With their huge buying power, their entrance into the momentum scene has created a unique situation in momentum stocks: now momentum stocks go up and don't seem to come down.

Not wanting to be let behind, the corporations -- yes, the very corporations underneath the high flying stocks in the market -- have also joined in the game. These companies have billions upon billions of cash in their coffers, some of which they have just collected from investors, and they are not content with the money sitting in the bank collecting interest. They have discovered that if they'd invest those money back in the stock market, they can collect much better return for themselves.

So now we have a bit of a circular situation: the companies invest their cash in the high flying stock market, the investment profits boosting their earning, thus further boosting their stock prices ... It was reported that some of these companies even "invested" in their own stocks!

These are great times for day traders. They can now "safely" run the momentum stocks to the top without having to worry that they will crash all the way down.

This brilliant party will too end, but not until the last mutual fund that wants to enter the game have done so. Then, the first mutual funds that entered the game will want to realize profit, and other mutual funds will follow suit. The big and clumsy mutual funds will be left holding the bag in the end.

And the end will be ugly.

01.21.00

Strategies for stock trading

Strategies for Stock Trading

An experienced trader should know what to do during a market reversal. Here I would
like to address some issues faced by less experienced traders. If you are turning over a lot of stock without making money, or is making less money than you would buying
an index mutual fund, then you belong to the less experienced trader category.

The traders that I know of who lose money in the stock market generally use the
following approach to stock trading:

(1) They buy into a stock because it is hot, everybody is talking about it;
(2) When the stock begin to make some money, they sell it;
(3) If the stock goes down and they begin to lose money, they hold on to it. Eventually,
they end up cutting loss at the bottom in a panic.

This kind of strategy is doomed to lose money based on the following analysis:

Supposed we divide all the stocks you would buy into 5 categories based on their
profit potential.

(a) Those that would go up a lot after you buy it;
(b) Those that would go up a little bit after you buy it;
(c) Those that neither go up nor down;
(d) Those that would go down a little bit after you buy it;
(e) Those that would go down a lot after you buy it.

With the above trading strategy, you would make a bit of money in categories (a) and
(b), not making any money in (c), lose a bit in (d), and lose a lot in (e). Adding them
all together, you'll be losing money on average. Note that this calculation holds true
regardless how you define "a bit" and "a lot".

A quick-learning trader would see a consistently money-losing strategy and immediately
knows that he has found a good strategy, because all he needs is to do the exact opposite,
and he will be making money consistently.

For example, the above strategy can be reversed by switching "buys" and "sells": instead
of buying the hot stocks, short sell them. If they continue to go up (to the same threshold
where previously you would have sold it), buy it back to cover the short. If they go down,
you hold on to the shorts (again until the same threshold where you would have cut loss),
then you take profit at the bottom.

This reversed strategy may be psychologically difficult to operate, but it should work.
While it is hard to short sell a hot stock, and harder to pretend to panic while you are making
money, the basic trueth in this reversed strategy is worth remembering: you let your profit
grow until it stops growing, while you cut loss before the loss grows too big. Then, on
average, you will be making money.

The Time Dimension

A stock may go up, go down, or stay roughly the same. But there is another dimension to
a stock that is worth considering.

Supposed you have a choice to make 10% in a few days or to make 50% in a few months,
which choice would you pick?

The 10% choice is obviously a better choice, in fact it is better by about an order of
magnitude. The way to compare them is to normalize the returns to the same time period.

Like interests, trading profits compound. Making a little bit of money in a short time is
better than making a bit more money in a much longer time. This, of course, is based on the
assumption that your basic strategy is already a consistently good strategy.

Dichotomy of Stock Prices

Last week I commented on the transient nature of the market, and said that all the hot
stocks will eventually come down.

In fact, every stock price in the market can be divided into two components: a transient
component and a more fundamental component. The transient component may be due to
sudden news exposure, irrational exuberence, herd mentality or other undue optimism.
This portion of the price will go up quickly and come down quickly. The fundamental
component will track the performance of the company much more closely and is subject
to less fluctuation.

If a stock is going up faster than the underlying business, then we can safely assume that
much of the surge is due to the transient component.

Knowing about this dichotomy should bode well for both day traders and long term
investors. As a long term investor, you would be wise to avoid buying a stock when it is
most popular.

Actually, even this dichotomy can be further subdivided. The slower moving "fundamental"
component can itself be divided into a longer-period transient component and an even
more "fundamental" component. Even the business performance of the company can be
divided into transient and relatively stable components.

The following is a list of companies in four categories, with their valuations in terms of
price/sales ratio. The P/S ratio of the established traditional companies tend to gravitates
toward the S&P500 average of 2.13. One can only assume that the current crop of
high-tech and internet companies, once their growth curves level off, will have a similar
P/S ratio. Can we seriously assume that AOL's business will grow another 20 fold, Yahoo's
another 100 fold, Phone.com's another 500 fold, before their growth curve levels off?
Of course not. Instead, their stock prices will come down as soon as the growth rate begins
to slow. When Dell's growth rate slows from 50% to 40% -- it still grow at a rate of
almost 40% a year -- its stock fell almost 40%.

Category	Company	P/S Ratio
Traditional	Exxon-Mobil (XOM)	1.91
	Walt Disney (DIS)	2.47
	Coca Cola (KO)	8.03
Trad. Technology	Dell (DELL)	4.48
	Intel (INTC)	8.38
	Microsoft (MSFT)	22.87
Major Internet	Amazon (AMZN)	29.88
	America Online (AOL)	40.45
	Yahoo (YHOO)	213.94
New Internet	Phone.com (PHCM)	979.20
	Internet Capital (ICGE)	1420.59
	InterTrust (ITRU)	4253.12

Lessons of Life

In life as well as in the stock market, it helps knowing when to hold on, when to cut loss,
and use time efficiently. Holding on to a hopelessly lossing cause will not benefit anyone. Still, the comparison can only go so far. I may be a perpetual bear on momemtum stocks,
but I believe in the general goodness of humankind, therefore I am a perpetual optimist
in life. Perhaps in life there is something that is worthy of "buy and hold".

12.11.99

The Stock Market Is a Sham

The Stock Market Is a Sham, But There Is Money To Be Made...

Governor Ventura says: Organized religion is a sham and a clutch for weak-minded people who seek strength in numbers.

No offense to organized religion, but I thought Governor Ventura was talking about mutual funds. A mutual fund is a sham and a clutch for weak-minded people who seek strength in numbers.

A mutual fund is a sham, first of all, because the stock market is a sham. Mutual fund is a clutch for weak-minded people who seek strength in numbers. Unfortunately, in the stock market, there is no strength in numbers, only weakness. Those who seek strength in numbers are just following the crowd. But one needs to beat the crowd in order to make money in the stock market. Therefore, mutual funds are double sham.

Much has been written about the miraculously skyrocketing stock market. Some said that the market is rising because investors perceive less risk. Others say that the market is rising because productivity is rising. Here I would like to offer another explanation.

The stock market is rising because it is a pyramid scheme that is still developing. Remember pyramid schemes? -- And the unscrupulous neighbor who tried to get you to pay him $1000 so that you can later collect millions from other fools like you? Those kinds of pyramid schemes are sometimes illegal, and you know that you can make money from it only if more and more people can be recruited to join. But simple math tends to say that there just aren’t enough people on earth to keep that kind of scheme going very far.

The stock market is rising simply because more and more people are putting money into it. It's that simple. Like the illegal pyramid schemes, the stock market is dependant on recruiting more and more people (or money, rather) into playing in order to keep it rising the way it has been.

Actually, the stock market is a bigger sham than pyramid schemes: When a newly recruited fool bought some stock of company X for a higher price, supposedly everybody else's holding of company X stock is instantly also worth that much. What a joke. Even illegal pyramid schemes don't do accounting like that. In reality, your stock is worth that much only if YOU were the one who sold it to that fool or fools like him. Otherwise, the value of your holding is undetermined (until you sell it).

Pyramid schemes aren't all illegal. Some are even government sanctioned. For example, social security is a government sponsored pyramid scheme that takes money from late players and pay them to participants who had joined the game early. It too depends on a continuous recruitment of more and more players. Apparently, lately there has been some worry about future recruitment prospects.

Like all pyramid schemes, there will be one day when the stock market will be unable to recruit enough new players to keep it rising. And when that happens, it will crash and burn, like every other pyramid schemes before it. It is just inevitable.

All this from a guy who has just predicted that Qualcomm will rise to 600 in a month? Are you surprised? You shouldn't be.

Qualcomm is just another example of the pyramid schemes being played out in a smaller scale. Right now it is rising like mad, because there are still more and more people being recruited into buying it.

The moral of this story? Well, when I say the sentiment of a stock is bullish, I am really referring to the sentiment of the current market. My own sentiment will always be bearish because I believe that all of the high fliers, as well as the general market itself, will eventually crash. I am a perpetual bear.

Being a perpetual bear is not so bad. I will still play the momentum game while it is on, but a perpetual bear will always guard his capital jealously -- good for capital preservation, and will never be complacent enough to "buy and hold". Buying and holding a stock that is not going up like crazy just plainly doesn't make sense for a perpetual bear, because you are holding a piece of paper that doesn't even pay you interest, and you expose yourself to the risk of an eventual market crash.

The perpetual bear does not have any emotional attachment to the momentum stocks. When they turn and crash, the perpetual bear will be able to quickly reverse course and short the suckers.

And the perpetual bear who knows how to play the pyramid game will make money in this bull market.

Stock Update:

Update of stocks mentioned in this page:

Stock	Date Mentioned	Price Then	Price Now	Gain %	Comment
QCOM	11/29/99	371	392 5/16	5.7%	Bullish
PUMA	11/23/99	42	68 15/16	64.1%	Still Bullish
KEYN	11/07/99	49	65 3/8	33.4%

Return to Stock Commentary Page.

12.06.99

QualComm to go to 600 in a month

[Dairies from bubbles past ... these posts may have been out for a while, but the bear market is just beginning, so they should still be interesting reads ...]

QCOM : Bullish, entry point 360-380, price target 580.



Qualcomm (QCOM: 371, -13) has gone up by nearly 1000% since January, and has nearly oubled in November. Such meteoric rise could make a lot of people nervous. Yet, recent price action suggested that all signs are still bullish and the stock could reach the vacinity of 600 before the end of the year.

From a height of 220 at the beginning of November, the stock raced to 400 in as few as 9 trading days. The stock has since entered a consolidation phase, oscilating between 400 and 320. However, the amplitude of the oscilation is narrowing with the volume decreasing, bullish signs that the stock is getting used to its new height. The stock could break out of the oscillation any day now and continues its stellar rise.

Entry point should be between 360-380, and price target should be 200 above your entry point.

By some estimates, wireless access could become 25-30% of the internet world within a few years, and digital cell phone growth continues at a rapid pace in both developed and developing countries. As the dorminant IP holder for wireless technology, Qualcomm is well positioned to profit from this phenomenal growth.

During the spectacular rise, Qualcomm management has declared a 4-to-1 stock split on Nov 2, pending stockholder approval Dec 20. The actual split will come after that. After the split the stock would be priced again in the vacinity of 100. However, impatient traders and investors may not wait for the split, but may push the price toward our target before the end of the year.

If the stock ever reaches 600, it will be one of the highest priced stock ever in the history of the stock market.

Risk: watch for signs of reversal in the general market.

Sector Watch:

Bullish for the wireless internet sector. Main attractions in this sector
are QCOM and PHCM, with many other smaller players.

Stock Update:

Update of stocks mention in this page:

Stock	Date Mentioned	Price Then	Price Now	Comment
PUMA	11/23/99	42	46.75	Still Bullish

Return to Stock Commentary Page.
(c) Copyright Ya-Gui Wei 1999, 2000.

11.29.99

Hello Again

My previous website, www.perpetualbear.com, has been off line for a while. I am going to repost some of the articles from the website to here.

This will be done gradually.