The Dow bubbles and the bears rumble

By Gerard Jackson
web posted May 1999

For sometime now I have thought of myself as a voice in the wilderness, not because I predicted a market correction -- many others have been doing that for as long I have -- but because I stated the the correction would first emerge in "real terms" before it finally struck the market. By real terms I mean profit squeezes, layoffs, shutdowns, declining investment. I explained why this would happen and why these forces could not be permanently arrested once they were set in motion, despite booming consumption. In fact, I even explained that booming consumption was part of the problem and not a cure, that promoting consumption would only aggravate the situation by tightening the squeeze while diverting more and more resources from investment in activities that raised future living standards.

On does not need any Wall Street experience to realise that what ultimately matters to companies is profit. If profits are squeezed share prices will fall. The realisation that this is now happening across the board is having a very sobering effect on some analysts' market predictions, to the extent that some now privately express the view that the end is here rather than just 'nigh.' A fact that I never tired of pointing out is that the symptoms of a coming recession are first felt in those lines of production furthest removed from the final stages of production. This is hidden from us by figures that concentrate on total spending and employment so that any fall in spending on equipment can, statistically speaking, be more than offset by consumer spending. This is basically why people tend to see recessions as sudden occurrences, much like lightening, rather than a process that has been gathering speed for sometime.

That more and more bears are coming out of hibernation as more bellboys buy into the market should be a worrying sign for those deeply concerned with their savings and pension schemes. That the rise in stocks is narrowly based is finally causing widespread concern. The more I think of these high-flying tech stocks the more I think of 'Tulip Mania.' Just as this sorry episode in Dutch economic history was fuelled by insane expectations, credit expansion and capital inflows, so are our hi-tech stocks. Even though about 66 per cent of NASDAQ hi-tech stock have fallen in the last 12 months and 50 per cent of shares quoted on the New York exchange are down 30 per cent in the same period, some commentators are still predicting plain sailing. No way. The same thing is happening with the Standard & Poor 500 index and the Russell 2000 index of company stock has also fallen. And this is not a bear market?

These shares didn't just fall for no reason. This trend is not an act of God and there is nothing mysterious about it. Shares are falling because earnings are falling or are expected to fall. I suspect this is one of the reasons that Warren Buffet publicly questioned the fundamentals of corporate America. When the likes of Warren make statement like that then one should sit up and listen very carefully. This man is talking from within corporate America. Perhaps the announcement by the famed Caterpillar company that its predicted first quarter profits had been slashed by 50 per cent and that it was planning to close US and foreign plants has finally prompted some investors, including Buffet, into reassessing the market risk factor. That bulls have been quietly withdrawing for some months while bears have been moving in may have motivated Martin Armstrong to argue that many investors have become more risk averse. If so, then the market is being driven by "bubbleheads".

Caterpillar is just one of the capital goods companies that is feeling the pinch of a slowly emerging profits squeeze. Eventually the profit squeeze works its way down the production structure where if finally strikes at companies located at the consumption stage. Once this happens, things really begin to look bleak. But has it happened? Coca Cola's profits are now falling and it has been reported that other corporations whose products more or less go straight to the public find themselves in a similar situation. If correct, this suggests that the profit squeeze has now spread through the economy meaning that it has already entered the bust phase. At which point this will become pronounced cannot be determined at this stage.

It has to be understood that the profit squeeze is actually part of the purgative process; it is part of the means by which malinvestments are liquidated. Of course, there would by no such process if the Fed did not use monetary policy to force down interest rates. Regardless of what Ralph Acampora of Prudential Securities claims, the Fed's policy of using the money supply to keep interest rates down is the real reason why a major correction is unavoidable. I'm not impressed by his so-called view of "mega-markets" either.

Depressing as this will sound to some: if the data I have seen is accurate and the anecdotal evidence correct then I believe this year will see a major correction and the blame can be squarely laid at the feet of the Federal Reserve.

Note: The profit squeeze is a general process and does not hit every company to the same extent. Companies heavily in debt will obviously be hit extremely hard, no matter at which stage of the production process they are operating. However, that companies at the consumption stage suffer less than those in the higher stages of production is a well-noted phenomenon.

Gerard Jackson is the editor of the peerless The New Australian. This article is reprinted with his permission.

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