Cole's Market Insights - August 31, 1997

Global Financial Turbulence Intensifies

The ides of August are putting the "new era" ideologues on Wall Street to their sternest test. Currency and stock market turmoil intensified last week In Asia and the infection is spreading to Latin America, Europe, and even the U.S. Quite a few global markets already have fallen more than 10% from their highs -- raising a serious question as to whether these are merely "corrections" or the start of full fledged grizzly bears.

The public's love affair with big cap stocks seems to have ended. As global financial turmoil intensifies, heavy international exposure is now seen as a liability rather than a positive. The Dow Jones Industrial Average closed Friday down 265 points (3.4%) at 7622 after a very volatile week. By contrast the Russell 2000 index of small cap stocks rose almost 2% to a new all-time high. Smaller cap companies generally have less overseas exposure than the multinational behemoths and are more reasonably valued in most cases.

There can be little doubt that the stock market is peaking, but the market's internals have not deteriorated enough to touch off a crash in the near future. Specifically, the number of stocks hitting new 12 month lows remains minuscule. In the past, steep drops in the stock market generally were preceded by a big rise in the number of issues hitting new lows.

Watch the Greenback

The strong dollar has been the fulcrum of the unprecedented bull market in U.S. financial assets. Escalating financial difficulties overseas have attracted more private foreign capital to these shores -- further strengthening the greenback. By contrast, foreign central bank holdings of treasury securities declined slightly last week and remain modestly below last spring's peak.

How much longer the dollar can retain its perch at the top of the mount is questionable. M3 -- the broadest measure of the U.S. money supply -- has risen 9.1% over the last 12 months. This is not much below the pace of the late 1970s when price inflation was out of control. When more of these funds shift out of financial assets into real goods and services, upward pressure on prices will accelerate much faster than most expect.

With the huge U.S. trade deficits showing no signs of abating and the monetary fuel for a large rise in consumer price inflation building rapidly, a steep drop in the dollar probably is not far off.

Still No Movement in Gold

Spot gold fell from $325.75/$326.25 to $324.10/$324.60 last week despite escalating financial turmoil. Gold stocks turned down and very low trading volume suggests further declines are in the cards.

The robust dollar is key factor dampening the demand for gold and gold stocks. Until the greenback goes down for the count, the looming gold bull will remain on hold no matter how many problems develop overseas.