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.

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04/08/2000