Asia The Weekly Toyo-Keizai – August 5, 1995

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August 5, 1995

An Interview

between Martin A. Armstrong, Chairman of Princeton Economics International, Ltd. and Mr. Atsuo Mihara, an economic commentator

To take aim is at the US stocks, gold, and the Australian natural resource related stocks. Distrust on governments has globally become prominent due to the increases in the interest expenditures for the national debts. Inside Japan, both real estates and stocks are full of uneasiness. Where should we make our investment to now when it is under “deflation?” An investment professional who is active globally provides you now with his “prescription.”

Princeton Economics International, Ltd., is an influential investment advisory company that gives advice on fund management, from a global point of view, for governmental agencies and institutional investors globally.

Mr. Martin A. Armstrong, chairman of the company, is a leading technical analyst who has been making good use of the latest artificial brain of a computer. He has been successful in forecasting major changes in various capital markets like the 1989 high of the Tokyo stock market, its following sharp decline and the big fall of the Hong Kong stock market in 1994. In addition, his forecast in November 1994, at Mr. Atsuo Mihara’s interview meeting with him for this magazine, that the Japanese Yen would mark a new high in early 1995 against the US currency at the first half of Japanese Yen 80s (the exchange rate at that time was around Japanese Yen 97) and the Nikkei 225 Average would decline sharply as the Yen hike would progress came true so beautifully. Taking the opportunity of Mr. Martin A. Armstrong’s visit to Japan this time, an interview meeting between Mr. Martin A. Armstrong and Mr. Atsuo Mihara was again realized and they made a discussion in depth narrowing their argument to two themes, “the present situation of confusing world markets” and “an investment strategy for a period under deflation.”

Canada may Default!?

Mihara: First of all, may I ask you to point out something noteworthy in the recent market developments?

Armstrong: Discontent and distrust against governments is increasing everywhere in the world. This phenomenon has become clearer since last year and its background exists in both increasing national debts and sharp increases in interest expenditures due to rise of short-term interest rates after governments’ shifting to short-term funding of their debts. At the latest G7 meeting (composed by the finance ministers and the central bank governors of the seven most developed countries), a bail-out fund of US dollars 50 billion was discussed for establishment. A country eligible for the fund assistance was said to be one with a critical financial situation similar to that of Mexico and it was Canada which insisted on founding the fund most aggressively. Canada which shifted to short-term funding of its debts, like the US, aiming to control the interest expenditure burden now suffer from the rise of short-term interest rates since the beginning of last year. Its interest expenditures accounted for 42% of its existing debts next year. If things come to the worst, we may not be able to exclude a possibility that Canada will default next year.

Even in Europe—Belgium, Sweden and Italy are in a similar situation. The problem is that interest expenditures grow faster than other expenditures are cut. It is very serious as we foresee upward pressure on interest rates in coming days. International capital is beginning to recognize the problem and the recognition has appeared as a decline of bond markets (especially government bond markets) and as fund inflow to stock markets (especially to that of the US). Many people, however, still think that AAA rating for government bonds is reasonable. Therefore, possible realization of a state default would leave chaos behind it.

M: If is really surprising to know that only interest expenditures occupy 40% – 50% of the total ones. I have not trusted the administrative capabilities of governments but the fact that they are so stupid disgusts me very badly.

A: Every country has made a big mistake of a short-term funding for a long-term investment. The US has shifted to short-term funding as well and 33% of its outstanding debts are going to mature within twelve months from now. People normally tend to think that governments will realize each situation well and take appropriate measures but their investment judgements are actually the most stupid and worst ones. People may regard the problem as a matter of no concern to them but need to realize the reality that the ratio of interest expenditures to total ones is 15% in the US, 18% in Japan and above 20% in all the European countries.

M: Once confidence on governments sways, various influences like softening of government bonds, appearance of currency instability and so on can be expected.

A: Swaying confidence on governments means improved confidence on the private sector and, in that sense, capital inflow to stock markets which we now see in the US occurs and international flow of capital becomes active as well. When a currency will decline, inflation will appear so that domestic prices will get close to international ones on nominal basis. This sort of development is seen remarkably in real estate markets especially. The American’s purchase of British real estates and the Japanese’s rush into the US properties on the occasion of the currency crisis after the Plaza agreement are still fresh in our memory..

M: I keenly realize that it is important to perceive such a change in trend as soon as possible.

A: A change in trend takes place slowly, keeps moving and gets suddenly perceived at a certain point and, then, people get surprised or panic. It is possible to get wind of a change in trend to some extend by keeping at watchful eye, learning from our history and so on. It is important to have the understanding that the only one who is always right is the marketplace.

What will be Able to Change the Trend of Japan is a Tax Reduction?

M: Some people say that current situation of Japanese economy is deflation and others say it is dis-inflation. May I know what your recognition is and would you please provide us with your prescription for our economy?

A: It is neither dis-inflation nor depression but deflation at its final stage, I believe. A lot of deterioration in economic activities and a lowering of economic standards like price destruction is now seen. I understand that there are strong requests for an economic stimulus by increased public expenditure which will be available upon an issuance of so called “deficit (covering) bonds (of government).” This, however, will just increase the budget deficit and enlarge the interest expenditure burden. The other request is for a discount rate cut. It is possible even to introduce the official discount rate of zero percent which Switzerland once put into practice but this is not so effective and may worsen the situation, I think.

M: Your points are really appealing to me. Mistakes in policy which distorted the principle of a market gave Japan a large bill. What sort of measures do you think Japan should take now?

A: The only measure which will be able to change the present trend in Japan is a tax reduction, I believe. A reduction of both income tax for individuals and corporate tax brings an increase in disposable income, which prompts consumption, and gives an incentive for business expansion. Thus, stimulus of economy will be brought in. Japan has made the same mistake of high taxation as the US did in the 1960s, when the corporate tax rate was 70% and the highest effective income tax rate for an individual was 91%. We should remember that countries with a high taxation, like European countries, generally have an extremely high rate of unemployment and suffer from a low rate of growth. Manufacturers who have moved out of their home country because of a high rate of taxation will not come back anymore.

The US could regain the vitality of its economy thanks to the large scaled tax reductions by the Reagan administration. Some people say that it only brought an increase in the budget deficit but it actually could balance national revenue with expenditure. The increase in the deficit was due to the increase in the interest expenditures.

14,000 Might be Broken in September

M: I would like to make an appointment with our Prime Minister, Mr. Murayama, if possible, to let him listen to you. Now may I have your forecast?

A: First of all, please be informed that our forecasts are all based on Princeton models. It will be possible for the Tokyo stock market to make a further rally to 18,000 – 19,000 level in the Nikkei 225 Average into September if a weekly closing in July would exceed 17,135. If it would not, the market would turn to decline and there is a possibility that the market will record a new low below 14,000 into September. If this is the case, it is unlikely to come down to a level below major support lines which lies on 12,000s not only because of the support lines but also because of what we have found in our research and analysis that most of the decline in a bear market takes place within the first 2 – 3 year period time. Even in the case of the currency, the Japanese Yen has a possibility to resume its hike against the US currency up to around Yen 73 at the maximum unless the dollar will exceed Yen 90.14 on a weekly closing basis. If the Japanese stocks and the dollar will make a simultaneous decline to cause a new low, it will lead to a turn of the major trend at 90% probability and a sharp rally thereafter is forecasted. This case suggests that the Nikkei 225 Average will rise to 32,000 level at the maximum and the US dollar goes to Yen 120 level. If the market would fail to record a new low after turning to decline, a pattern of a bear market which will continue until March 1996 is expected. Even in this case, the market will lead to a phase of a rally afterwards and 26,000 – 28,000 at the maximum would be possible into 1998.

M: It seems that a slight change is appearing in the US stock market which has kept a beautiful advance.

A: The US stock market has been rising since April 1994 and will be possible to get a phase of a strong rally into 1998 to form a bubble type of a ceiling seen in the US in the 1920s and in Japan in 1989 although it will suffer from adjustment phases like a mini-crash in the meantime. July is a month of reversal on a short-term basis and, therefore, it is possible the Tokyo stock market will have an adjustment period for about 2 months after a July high and mark a temporary low in September to October. If this is the case, we can think of the following market developments like that the market will turn to rise, then have a mini-crash with 12% – 13% decline in May to June, 1996 and, after a consolidation period, make a strong rally to a new high into 1998. When July high will be renewed in early August, a move to go up until September to October to test 600 level in S&P 500 at least is possible. In case the market will turn to decline after July to August high, a decline to 525 – 507 level in S&P is possible. In any case, unless the market will break through 470 in S&P 500, the market will move up towards a new high. Important resistance lines will be formed at around 5,000 in the Dow Jones Average but the US stock market will be the best investment target for both European and Japanese investors because a bubble type of stock price information with PER of close to 70 – 80 times is expected. If the 1996 closing will be above 5,000, a ceiling of around 7,000 is possible and if above 6,000, around 8,000. This is because we forecast fund inflows out of bond markets and foreigners’ purchase triggered by a currency tendency.

M: How about bond markets?

A: The long term outlook for the US 30-year Treasury bond market is not bright. It is now approaching a major resistance line at around 117. Unless the July closing price exceeds 117.06, it is suggested that the market has already reached a major high. The Japanese 10-year government bond market has an important bearish reversal at 118.25 and a weekly closing below it suggest a great probability of an adjustment phase to begin. If a monthly bearish reversal at 114.20 will be cleared, it will suggest confirming reversal of the long term trend and, therefore, a bear market for two years at the shortest or going into 1998 at the longest is expected.

Gold Price may Become Four Times the Current Level in Three Years

M: We recently cannot take our eyes off the commodities market due to the unseasonable weather around the world.

A: In the commodities market, gold, crude oil and some agricultural products are expected to show a big rally of nearly 300% into 1996 to 1998. Gold, especially, tends to achieve a price hike corresponding to lowering confidence upon governments but not to inflation. Gold in Japanese Yen is relatively cheap although we still cannot say that it has already reached the bottom. Gold also is not taxable. In the currency market, the Australian dollar is expected to show a stronger rise than the US currency into 1998 and, in addition, the US dollar’s rally against both Japanese Yen and European currencies and weakening of European currencies (especially Deutsch Mark) against Japanese Yen are expected.

M: Very interesting forecasts they are. I look forward to market developments to come. I think I have already got the answers but may I ask you about the investment strategy and the investment target in the period under deflation?

A: From the view point of Japanese investors, it is very interesting to make an investment in foreign market where Forex profits can be expected as well although a temporary adjustment phase is possible in the short-run from July to September. As an investment objective, the best will be the US stocks, commodities like gold and Australian natural resource related stocks. The US real estate is a promising investment objective, too from the view point that the best purchasing opportunities are at the time when no buyer appears, although it will be very hard to make a bold start when one remembers the failure in the investment in the bubble period. In fact, a property investment in Princeton yields some 10% and this is worthwhile enough for Japanese investors to study because the Forex risk involved is up to Yen 73 at the maximum and, instead, the US dollar hike into 1998 is expected. The Tokyo stock market which still remains with uneasiness of down-side risk in a short-term is eligible, too as a long-term investment objective aiming at 1998, I believe.

M: I thank you very much.