Investment Comment Bull market in late stages: Analyst

During a week when a number of prominent gold issues were rocked by a sudden drop in the price of gold bullion (from $460(US) to $454.90), a prominent investment publication had some more bad news.

In its monthly forecast on world economic developments and currency movements, The Bank Credit Analyst is predicting the demise of the current bull market.

There is growing evidence, it says, that the underpinnings of this phase of the bull market — low and falling inflation, high real interest rates, falling nominal interest rates, a more stable dollar and strong foreign stock markets — may be weakening, particularly as interest rates rise.

“Investors should recognize that the market is vulnerable and that the proba bility of a serious negative shock is high, even though the timing remains very uncertain,” it warns.

The Montreal-based Bank Credit Analyst is not the first to draw attention to the likelihood of an end to the current bull market. Sparked by the massive U.S. deficit and an expected end to the current stock market boom, economist and business writers have been talking about a possible collapse for quite some time.

Nevertheless it comes as a timely reminder — indicated by a market pullback which started in August and continued through September — that the good times may be coming to an end. Cyclical Upturn

The Bank Analyst says that while there are no definite signs indicating an end to the cyclical upturn in interest rates and no weakness in either the leading economic indicator or its own composite economic indicator, potential investors should adopt a more defensive stance.

“I don’t believe the uptrend in gold is over yet but we are getting pretty close to a ceiling in price,” said Francis Scotland, editor of the Bank Credit Analyst’s interest rate, forecast. For that reason, he says investors should consider reducing their exposure to golds.

“Last week’s drop in the price of gold bullion is not decisive enough to market a permanent decrease in gold prices but it’s not wise to keep building up your gold portfolio,” said Mr Scotland.

“People should be turning to cash.”

While he was unwilling to pinpoint a precise turning point in the current economic cycle, there are a number of factors to look out for. A drop in the price of gold is one of the first indicators that the bear cycle is starting to work.

However, the event which is most likely to trigger a stock market collapse, he says, is a big enough dollar crisis to force the Federal Reserve Board to raise interest rates. “That would kill not only inflation expectations but the economy as well.” Monetary Policy

Based in Washington, the Federal Reserve Board sets reserve requirements for U.S. banks, sets interest rates and controls the production of currency.

Although it has moved during the past several months to tighten its monetary policy, causing the economy to slow down and inflation to moderate, it has been criticized for making no attempt to reduce some of the massive imbalances in the economy which underlie prospects for a dollar crisis.

Combined with the massive stock market boom since 1982, forecasters like Mr Scotland are saying that the swelling of the U.S. deficit makes an economic downturn almost a certainty. “If the budget is not put on a corrective path soon, an economic calamity is inevitable,” adds the Bank Credit Analyst.

But not everyone agrees. In a recent interview with the Toronto Globe and Mail, Dominion Securities vice-president Leon Tuey said a stock market collapse will only occur if “the economy gets so overheated that the Federal Reserve has to tighten its monetary policy enough to choke off growth altogether.”

An eternal optimist, he predicts that the Dow Jones industrial average, which measures the performance of 30 blue chip stocks on the New York Stock Exchange will rise from 2,600 to 3,500 next year. Resource Industry

Powered by the Canadian resource industry, he says the 300-stock composite index on the Toronto Stock Exchange will go above 5,000 next year and rise to 7,000 in 1989. That represents a major increase from the current 3,900 level.

Nevertheless, until the Federal Reserve acts to rest credit market confidence by raising short-term interest rates aggressively, as did the Bank of England last month, the bond market will not likely rally, said Mr Scotland.

“Concern over the lack of resolve of the U.S. to push inflation lower will continue to cause periodic flareups in the dollar. Action to stabilize the currency will, in turn, push interest rates up.”

For now, despite indications of an oversold market, The Bank Credit Analyst says rallies in the bond market to interest rate levels below 8.75% should be used to reduce maturity and accumulate cash.

According to the publication, evidence does not suggest that a stock market collapse is about to happen, but clearly a dollar crisis is an accident waiting to happen.

“Should it occur, foreign investors would probably react violently, pulling funds out of the U.S. in panic fashion,” the publication says.

If all of this doesn’t signal a return to the hungry 1930s, it seems to indicate that investors who are considering taking out a second mortgage to load up on their favorite mining stock, should perhaps think again.