Stockscom Report for Sunday Sep 21 2003

Publisher: Colin Alexander     Editor: Ken Wilson

Subscriptions and Administration: Pierre Fichaud (toll-free: 866-487-9711)

 

• Nervousness in the markets – use stops!
• US$ dropping – Dubai Accord

 

Market Synopsis

 

We are nervous.

 

The newest equity bubble, led once again by the almighty Nasdaq index with its predominance in tech and biotech issues, is quite possibly on the verge of bursting.

 

To clarify: this weekend, finance ministers from the G-7 met in Dubai and currency rate exchange was high on the agenda. After the meeting, it was made abundantly clear with its statement,

“In this context, we emphasize that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustments in the international financial system, based on market mechanisms,”

 

Rightly or wrongly, analysts and traders took this message to believe that the yen would be permitted to appreciate without intervention by the BOJ (Bank of Japan). And just why is the yen appreciating anyway if the country is still perceived as an economic basket case?

 

Data from the past few months have indicated that Japan is recovering and investors have bought into the idea and bought massively into what might have been vastly underpriced shares. By purchasing shares, the need to pay with yen meant that the yen was in demand. Despite the efforts of the BOJ to sell yen and buy US$, an effort that has cost the Japanese some $78 billion in 2003 alone, yen refuses to take a substantial drop. The US$ purchased are subsequently used to buy US treasuries, thus propping up US bonds and the value of the US$ concomitantly.

 

It's already Monday morning in Japan and with a rising yen (the US$ is falling against all major currencies), the Nikkei stock exchange is down sharply with large losses sustained by Japanese companies most dependent on exports. Companies such as Sony, Canon, Matsushita, Honda, and Toyota have all fallen several percent as the threat of higher yen promises to translate into sharply lower profits.

 

Related or not to the Japanese story, the stock indexes on this side of the Pacific ocean are reacting in the same manner with both the Nasdaq and the S&P 500 down sharply and setting up for a rude awakening tomorrow.

 

Below are two points taken from a G-7 agreement:

The U.S. current account deficit, together with other factors is now contributing to protectionist pressures which, if not resisted, could lead to mutually destructive retaliation with serious damage to the world economy: world trade would shrink, real growth rates could even turn negative, unemployment would rise still higher, and debt-burdened developing countries would be unable to secure the export earnings they vitally need.

 

The Ministers and Governors agreed that exchange rates should play a role in adjusting external imbalances. In order to do this, exchange rates should better reflect fundamental economic conditions than has been the case. They believe that agreed policy actions must be implemented and reinforced to improve the fundamentals further, and that in view of the present and prospective changes in fundamentals, some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to cooperate more closely to encourage this when to do so would be helpful.

While these statements appear to be current affairs and possibly part of the communiqué from Dubai, one may be surprised to learn that these were, in fact, points 11 and the beginning preamble to 18 of the Plaza Accord of Sept 22, 1985. The Plaza Accord was important for it triggered the fall of the overvalued US$ and likewise today, we have the Dubai Accord and in similar fashion, this accord puts into action, a concerted effort to lower the value of the US$

 

But with the US running a federal budget deficit and a current account deficit, is the engineering of a lower US$ in its best interests? To answer that question, we have to look at how the value of the US$ is propped up.

 

In order for Japan to control the appreciating yen, it has been forced to sell yen and purchase US dollars. It takes the US$ raised and purchases US treasuries primarily short-term, which in the case of Japan has accumulated to a grand total of $443.8 billion by July. China is another large buyer of US treasuries having accumulated $126.1 billion through July.

 

If Japan (and possibly China) is willing to let the US$ fall in relation to yen and not purchase US$, this translates directly to fewer US treasuries purchased. But the US government doesn't print more US treasuries just to satisfy demand by foreigners – they print more because they need to import capital to fund the budget deficit. If fewer buyers line up to purchase US treasuries, the US government, needing the money, is forced to increase the interest rate granted in order to attract the buyers. Already with few purchasers, the US$ would have fallen and now the interest rates would be moving higher.

 

This is the part that equity markets don't like. An increase in interest rates due to competition for capital would greatly reduce mortgage applications and put a halt to the boom in the housing market. And just as importantly, a rising interest rate would cripple a nascent economic recovery forcing consumers to shut their wallets and businesses to defer capital investment.

 

Some economists believed that the US would muddle through this problem and that the day of reckoning would never occur. They may be right but the most recent calls by Treasury Secretary Snow for China and Japan to stop supporting their currencies, a call one would have to believe is supported by the US administration, is tantamount to shooting oneself in the foot. The Far East has been happily feeding the twin deficits for many months now and if the US were to cut that channel, then the scenario given above is triggered and higher interest rates result.

 

The Federal Reserve's policy of low interest rates has also created another monster that would come crashing home in the event of a rise in rates. Margin debt on Nasdaq equities has soared from $7.3 billion in May to $26 billion in July. To put this into perspective, at the height of madness in February 2000, margin debt amounted to roughly $21 billion. Thus right now, we are looking at about 25% more margin debt than at Nasdaq's peak in 2000. If interest rates crept higher, investors would begin to scale back their use of margin debt and in doing so would lessen the buying pressure on equities thus virtually guaranteeing that the indexes drop, probably generating a substantial fall at that.

 

With our own stocks, no one should be surprised when we say that stops need to be enforced. As mentioned above, this day of reckoning might not even come, but publicly, the US administration is maintaining an aggressive stance vis-à-vis the Far East that is far too dangerous to ignore.

 

New Buy Recommendations:

 

None.

 

New Short Sales

None.

 

Stock Positions to Sell/Exit:

 

TRP – We managed to stay in this trade but only by the thinnest of margins. At this point, the retracement appears to have completed its move and the share price is now recovering. We will keep the stop however at $17.40.

 

We applied several stops and these are now listed as part of the table below. Additionally, we change the stop on ABB from 5.23 to 5.50, on CHU from 6.85 to 7.45, on SAPE from 3.15 to 3.40, on SCLD from 3.75 to 4.15. We are also initiating stops on PFSW at 2.20 and COT at 22.45. At this point, we see no reason to apply a stop on BGO – in fact, this may be one recommended company that one could consider adding to as the price of gold is up sharply this evening.

 

SCLD appeared particularly weak at Friday's close and for those investors holding shares, you should consider exiting this position if it gaps lower to open and stays below 4.50 for the first hour of trading. The CEO announced on Thursday, his plan to sell 800K of his family's shares as part of an estate planning exercise, however this has not gone unnoticed by investors.

 

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

Stocks marked # are eligible as Canadian content in Canadian RSP funds. Otherwise there is a 30 percent restriction on foreign stocks held in these accounts.

Date of Entry	Name	Symbol	Entry Price	Current Price	Stop	Action Rating
08/25/03	ABB	ABB	5.43	5.88	5.50	H
08/25/03	Bema Gold	BGO #	2.15	2.29		H
08/25/03	China Unicom	CHU	7.63	8.00	7.45	H
05/12/03	Cott Corp	COT #	20.02	22.98	22.40	H
08/11/03	Crystallex	KRY #	2.28	2.35	2.35	SOLD
08/25/03	PFSweb Inc	PFSW	1.64	2.47	2.20	H
09/08/03	Sapient	SAPE	3.72	3.96	3.40	H
08/11/03	Steelcloud	SCLD	3.55	4.51	4.15	H
04/28/03	TransCanada Pipe	TRP #	15.85	18.60	17.40	H