Japan Between A Rock and A Hard Spot Part -V

"He who knows nothing, doubts nothing"

An old Italian proverb which accurately describes today's credulous believers that STOCKS NOT TOO HIGH, inflation is dead, and we are in a new economics era - devoid of cycles - where stocks will continue to outperform as in recent years. The only perception of risk is that of not being fully invested in the financial markets.

AD NAUSEUM we have heard Fed Chairman's now infamous statement of IRRATIONAL EXUBERANCE afflicting Wall Street. But that was a couple of thousand points ago. No body seemed to care then - and they care less today.

Alan Greenspan's warning of excessively high financial values was not the first cautioned signalled by the Federal Reserve Board. A report was published more than a year earlier than Greenspan's admonition. THIS WAS 3500 POINTS LOWER THAN THE DOW'S LEVEL TODAY. Appreciate the exaggerated absurdity of the current situation: The DOW was too high at 4700 at the time of the FRB's report in September 1995,... so what does that say for today's DOW in the neighborhood of 8300???! Is this writer missing something... or is something wrong in a draconian measure?? The report goes on to conclude that stock values were way out of line with historical precedent and simple investment common-sense. A synopsis of this FRB report is the topic of this essay.

Before we start with the FRB's report, one might ask how this relates to the series, "Japan Between a Rock and a Hard Spot." It is all inter-related. Once Wall Street's Tulip Craze is recognized, stocks and the U.S. Treasury markets will be decimated by soaring interest rates. Consequently, the land of the Rising Sun will indeed suffer the pressure squeeze of a falling dollar and plummeting T-Bond prices... to say about the Nikkei going to HELL in a hand-basket.

Japan's Prime Minister, Ryutaro Hashimoto will be put on the spot,... and forced to make a monumentally difficult decision: To sell or hold the $200 billion in U.S. T-Bonds.

Mr. Hashimoto can succumb to U.S. Treasury Secretary, Robert Rubin's relentless pressure - and continue to hold U.S. Treasuries, suffering horrenduous losses. However, this decision would be tantamount to committing political harikari. It will be interpreted by his opposition and the world that he backed down from his Columbia University threat to sell T-Bonds and buy gold... he will have acquiesced to the powerfully rich Americans. Mr. Hashimoto will have lost face before his nation - and most likely be forced to resign.

On the other hand if hard-driving Ryutaro Hashimoto's Trade-Talks perfornance a couple of years ago is testament to his samurai spirit, he most probably will not back down from his duty to ensure the economic well-being of his country,... and will do what is expected and demanded of him as the nation's Prime Minister: namely, sell or swap the T-Bonds for gold and other hard cirrencies.

In essence it boils down to this:

Hashimoto-san: Okubyomono ka busho ka....toki ga tsutaeru

Hashimoto: Coward or Samurai... time will tell

Federal Reserve Bank of New York

RESEARCH PAPER #9520 -- September 1995

by Jean Helwege, David Laster and Kevin Cole

The following is not an original study by this writer, but rather a product of the Federal Reserve Bank of New York. I will only present excerpts from the study - and bring the market data up to date where appropriate. Nonetheless, for those conscientious students who wish to read the original in its entirety: Federal Reserve Bank of New York RESEARCH PAPER: "Stock market Valuation Indicators: IS THIS TIME DIFFERENT?" Research Paper #9520, dated September 1995 by Jean Helwege, David Laster and Kevin Cole. Incidentally, it is FREE for the asking.

The very first page - conveniently - has an Executive Summary of Conclusion. Most that follows are verbatim quotes - except for my occasional comments.

STOCK MARKET VALUATION INDICATORS: Is This Time Different?

"Record low dividend yields and record high market-to-book ratios in recent months have led many market watchers to conclude that these indicators now behave differently from how they have in the past. This paper examines the relationship between traditional market indicators and stock performance, and then addresses two popular claims that the meaning of these indicators has changed in recent years. The first is that dividend yields are permanently lower now than in the past because firms have increased their use of share repurchase as tax-advantaged substitutes for dividends. The second claim is that the implementation of the Financial Accounting Standard (FAS) 106 for retiree health liabilities has seriously depressed the reported book values of many companies since the early 1990s, artificially raising their market-to-book ratios. WE CONCLUDE THAT, EVEN AFTER ADJUSTING FOR THESE FACTORS, THE CURRENT LEVEL OF MARKET INDICATORS IS A CAUSE FOR CONCERN."

Writer's comment: Please note the S&P 500 continued to inflate values by an additional 71% from the publication of this report to this year's high (about 960) -- driving the traditional market indicators to even more unsustainable heights. This would be funny, if it were not so pathetic and sad! In September 1995 the FRB's report states that stocks were too high with the S&P 500 at about 560,... and just last week it hit 960! WHAT, NO OUTCRY OF IMMINENT DANGER FROM THE FRB?! What is going on in Washington?!

"The dividend yield hit an all-time low of 2.5% in the summer of 1995, substantially below the levels generally associated with excessively high markets." The market is said to be in equilibrium when the dividend yield is around 4%. Please note that since publication of this study the dividend yields have been driven exorbitantly lower - in fact lower than the ultimate days of great illusion of 1929! Recently, the dividend yield reached an all-time low of only 1.8%. Furthermore, market-to-book values in September 1995 had zoomed to levels in excess of 50% of the historic normal range. To further exaggerate the extreme excess in the last few weeks, the Dow's market-to-book established an all-time astronomical high of greater than SIX times.

C O N C L U S I O N

"We conclude that, even adjusted for share purchases and FAS 106, the indicators are in a danger zone that points to an overheated market. If history is any indication, the immediate prospects for the stock market are modest at best." !!!!!!!!!!!!!!!!!!!!!!

This writer shudders to think what the prospects would be AT WORST! But then... what does the Fed know? And who cares what the Fed thinks...? The Fed wouldn't dare take away the punch-bowl... or would it?