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The Steve Puetz Letter

September 11, 1997

Dear Fellow Thinker:

Once again, the Dow Industrials are exhibiting signs that they may be topping. In the past several years, these warnings have been false alarms. The most recent of these repeated false alarms occurred during March and April.

Yet, I would be derelict in my duties if I did not report on the crash-potential of the current downturn. For the financial bears, the odds of a stock market crash appear greater than ever.

LEVERAGE

To create the potential for a market crash, there are several conditions that must first be present. The two most important ingredients are extreme over-valuation and massive leveraging. These two ingredients are virtually inseparable. They always seem to go hand-in-hand.

Various measures of the absurd level of valuations span the gamut from price-to-book ratios, dividend yields, price-to-earnings ratios, the capitalization-to-GDP ratio, the capitalization-to-home-prices ratio, and the ratio of the market values of all stocks-to-bonds.

On the upside, leverage is always the vehicle that pushes markets far beyond prudent levels. Of course, once a bull market reverses, leverage is the catalyst for panic selling. The panic develops when speculators and lenders see their collateral and paper-wealth vanishing rapidly with each passing day.

SHORT-INTEREST

Wall Street lore has it that once the short-sellers are forced to capitulate, a huge source of potential buying power has been eliminated, and the odds of a market decline are enhanced.

On the NYSE, short-interest declined by 50 million shares during the latest month. And the monthly contraction in OTC short-interest reached 53 million shares.

The greatest short-covering, however, has taken place on the Chicago Mercantile Exchange -- the marketplace for futures on the S&P 500 Index. From nearly 60,000 contracts short in 1994, and 40,000 contracts short in 1996, speculators have covered all of their short positions, and they have recently gone long about 5,000 contracts. See the chart below.

Speculators have a notorious record of being wrong at major turning points. The shortcovering that has taken place during the past several months is another indicator that the climax in stock prices may have been reached.

NYSE SEAT

High prices for a seat on the New York Stock Exchange have always coincided with major turning points in the stock market. In 1929, NYSE seat prices peaked at $600,000. Forty years later, at another significant turning point, the NYSE seat price reached $500,000. Just days before the 1987 peak, the price of a seat on the exchange exceeded $1 million. Less than a week before the August 6, 1997 peak, the price of seat on the NYSE reached an all-time record -just shy of $1.5 million. See the chart below.

THE TRIGGER

In a July 1997 interview with the German publication, Focus, internationally famous speculator, George Soros, said: "All sorts of new investors are popping up, who have very little experience with the markets. If this trend suddenly comes to a halt and the investors start to panic and decide to leave the market en masse, then we'll have a stock market crash. Besides that, the portfolios of the largest investors are increasingly international. If one of the large markets crashed, it would set off a domino effect. It would bring about an international stock market crash.... The present situation can continue indefinitely, until it reaches the point at which financial markets have distanced themselves too far from reality."

Soros is right about market crashes being international. That's been the case going all the way back to the 1929 stock market crash, the 1720 Mississippi Bubble crash, and the collapse of the Tulip-mania in the year 1637.

The recent financial turmoil in the Asian markets has now begun to spread to Europe and Latin America. If that chaos persists much longer, it's sure to engulf the US markets as well -- making it an international crisis.

Also, the recent break in the Dow Industrials may be attributable to the markets getting so far removed from economic and financial reality, that it had to retreat. If that's the case, the catalyst for the coming crash will probably be nothing more than extreme over-valuation -- not Federal Reserve tightening as many had guessed.