Dow 8000 Fails

Today the DJIA broke below the psychologically critical 8000 mark on heavy volume in association with a growing Asian financial crisis.

(Also note how today the NYSE fell below 500, the Paris CAC 30 reversed below 3000, the London FTSE 100 dropped below 5000, the Frankfurt DAX plunged below 4000, and the Canadian TSE 300 neared a drop below 7000.)

The DJIA dropped around 200 points in response to a 10% plunge in Hong Kong stock prices and sharp drops in stock markets around the world.

What is developing is probably the worst financial crisis in world history. The S&P500 charted out an Elliott Wave "diagonal triangle" from September into a "Spiral Calendar" peak near the 1000 mark around mid-October (Chris Carolan, who developed the Spiral Calendar, indicated that mid-October of 1997 was a likely time for a major U.S. stock market top years in advance- contact Elliott Wave International for more information).

As was pointed out in an earlier Stock Market Update article, the diagonal triangle pattern is usually observed into a culmination point, i.e., an Elliott Wave "fifth of a fifth".

See http://www.elliottwave.com/basics2.htm

In this case, a potential fifth of a fifth of a fifth....so on and so forth....into a Grand Supercycle top formed.

As was also noted earlier, an important characteristic of the diagonal triangle is that such patterns are usually followed by sharp reversals- i.e., a crash (an example of such a reversal is the recent peak and plunge in the Malaysian stock market that marked the onset of Asia's financial crisis).

What was critical about today was the fact that the DJIA's powerful break below 8000 coincided with a growing Asian financial panic. The implication seems to be that a much larger drop in the DJIA is going to occur, probably in connection with a global financial panic and economic debacle stemming from developments in, at the least, Asia. In other words, an Asian crisis is the initial "shock" that is associated with a full-fledged reversal from the psychologically important 8000 mark.

When the DJIA reversed from 1000 several times between 1966 and the early-1980's, there were all kinds of crises that shocked investors and led to major stock market drops, around 30% each time. These crises ranged from currency crises, to oil-shocks, to stagflation and economic recessions.

When the Dow plunged 20% after reaching the 3000 mark in July of 1990 (the DJIA closed at 2999.75 two days in a row), this reversal was associated with Iraq's invasion of Kuwait and a Persian Gulf crisis.

In 1994, soon after the DJIA got to 4000 for the first time, the Fed hiked interest rates and stock prices fell 10 percent.

The Japanese economy is simply incapable of recovering. The reason the economy can't recover is due to problems such as the one revealed in today's news. In most economies, the events of the last few years would have caused banks to pursue radically different strategies. They should have diversified their holdings out of traditional securities, and in particular away from cross-holdings in other financial institutions and major borrowers. Japanese banks have been unable to achieve this diversification to anywhere near the extent required, because they have been unable to break free from the web of socially and politically required business relationships. If these linked companies suffer failures, banks suffer double failures: bad loans and eroded equity positions. Thus, like a virus, banking problems multiply themselves throughout the banking system.

In the midst of the tremendous prosperity of the 1990s, the fact that the world's second largest economy is incapable of drawing back from the brink of disaster is frightening. Japan's normal solution, increasing nearly profitless exports in order to generate cash, is meeting growing resistance from the markets and increasing political opposition. Last week's crisis over Japanese ships in U.S. ports was one symptom. The demand by ASEAN countries, including, it is interesting to note, Malaysia, that Japan open its markets to their exports, is another dimension of the problem. With ASEAN itself scrambling for solutions to its problems, Japan is unable to take the leadership role that its size and position would normally dictate.

The Japanese economy is lurching from crisis to crisis, sustained by the remarkable cooperation shown by all sectors in fabricating short-term solutions. This is the core problem. The Japanese have become masters of short-term solutions that make a genuine, long-term solution impossible. With Japanese loans in Asia becoming increasingly vulnerable and Japanese banks unable to recover from their own internal problems, we are becoming increasingly concerned about the potential effects of ASEAN defaults on the Japanese banking system, which is heavily exposed in that region. We must also remember that even the robust American economy would have trouble maintaining momentum in the face of a generalized Asian economic crisis.

Others may remain confident, but we are becoming more concerned daily about the ability of Asia to avoid a major financial crack-up. Normally Japan, as the region's leading economy, would be the stabilizing force in ASEAN's crisis. Unfortunately, Japan is sicker than its pupils. This leaves only Singapore to impose order and discipline, and we expect the task to be too large for them to handle. This leaves, as the stabilizer of last resort, the United States. Of course, it is not clear that the U.S. either could or should assume this burden.

In the meantime, as the bad news from Asia keeps accumulating, the general position among policy makers seems to be: don't worry, be happy. We certainly hope that the optimists are right, but we just can't figure out why they are so confident.

So, a question to our readers: With bankruptcies sweeping Asia, a barely contained currency crisis throughout the region, and Japanese banks facing calamity if they have to deal with another huge set of non-performing loans in southeast Asia, why do so many intelligent people feel that there is no major problem that can't be handily managed by the national governments involved? This problem seems to us massive and extremely dangerous. What are we missing here?