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A Conspicuous Sign of a Cycle Top

Unsettled conditions have not abated in global equity markets, with technology issues coming under the most intense selling pressure. So far this week, the Dow and S&P500 have dropped 2%, while the Transports have declined 3%. The Morgan Stanley Cyclical index has declined about 1%, while the Morgan Stanley Consumer index is largely unchanged. The Utilities have jumped 4%. The small cap Russell 2000 has declined 2%, while the S&P400 Mid-Cap index has a small gain. The financial stocks have been mixed, with the S&P Bank index adding 1%, and the Bloomberg Wall Street index declining 1%. Selling pressure has been much more acute throughout the tech sector. So far this week, the NASDAQ100 and Morgan Stanley Technology indices have dropped 4%, while the Semiconductors have sunk 7%. The NASDAQ Telecommunications index has been hit for 4%, and Street.com Internet index has been pounded for 11%. Elsewhere, with bullion prices jumping $6.50, gold stocks have added about 2%.

The credit market continues to demonstrate significant crosscurrents, perhaps driven by stronger than expected economic data and, at the same time, heightened nervousness in the corporate debt market. The implied yield on December T-bills has increased 4 basis points this week, while two-year yields have declined 4 basis points. Five year Treasury yields have declined almost 6 basis points, the 10-year only 2 basis points, and the 30-year 1 basis point. The long-bond dropped three-quarters of a point today. Mortgage-backs and agencies continue to trade well, with yields declining 2 basis points so far this week. The benchmark 10-year dollar swap is unchanged at 114. The junk debt market continues to demonstrate extraordinary stress as the Bloomberg index of the spread between junk debt and the 10-year Treasuries has widened 8 basis points to 573. Currency markets continue to trade nervously, particularly ahead of tomorrow's Danish referendum on the euro. So far this week, the dollar has generally posted small declines against other major currencies.

Today, the Commerce Department reported that durable goods orders increased 2.9%, recovering part of last months 13% decline (with the volatile transportation orders sinking 32%). And while many talk as if durable goods orders have "fallen off a cliff," orders during August ran 4% above strong levels from August of 1999. Importantly, unfilled orders increased to near June's record and remain 12% above last year. Yesterday, the Conference Board reported an increase in its September consumer confidence survey from 140.8 to 141.9. September's reading is the third highest on record, surpassed only by the months of January and May. Both the Present Situations and Expectations components moved higher and remain at extreme levels. Digging into the data, 18.4% reported that business conditions were "better," the highest figure since May. Additionally, 46.2% of respondents reported that business conditions were good. This is the second highest number during this expansion (January's 47.3 is the record), and marks the second straight month of strong recovery in business conditions. Six of the nine regions reported higher confidence.

Monday, the National Association of Realtors reported that existing home sales increased by 9.3% from July, their most rapid increase since June of 1999. With expectations of a 4.95 million annualized rate, actual sales came in at 5.27 million. Sales increased in all four regions, with the West jumping 16% and the Midwest almost 11%. It appears that sales are being hampered by a lack of inventory, as the supply of unsold homes declined to 3.7 months compared to 4.3 months during July. The average (mean) price jumped $4,100 during August to $181,800, with the average price in the West surging $13,700 to an astounding $247,400. And while sales nationally were basically flat compared to a very strong August of last year, sales in the West ran 5% above year ago levels. And while the stock market may not be helping much, wealth effects are certainly alive and well in real estate markets.

The luxury housing market is definitely a key driver behind escalating average home prices. With million-dollar homes flying off the shelf, this certainly pulls up the average price. Nowhere is this more evident than in California. It is sometimes joked that the "big one" will have California falling into the Ocean. However, by looking at outrageous housing prices, it looks like it has already fallen into la-la land. Last month, Bloomberg reported that average value of a Bay Area luxury home, as calculated by First Republic, was $1,942,700 at the end of the second quarter. This was 6.4% higher than the first quarter, 16.4% higher than the beginning of the year, and an astonishing 28.8% increase from a year ago. However, California is not the only area where luxury housing is breaking records.

Here in Dallas the local real estate market was described by appraiser D. W. Skelton in a Dallas Morning News article: "Right now we are averaging a couple million-dollar appraisals a day, I've never seen anything like it, and there is no sign of a slowdown." There were 123 million-dollar homes sold in the first half 2000, compared to only 194 in all of 1999. A little further south in Austin, 58 million-dollar homes were sold in the first-half, compared to only 23 in the first-half of last year. On July 23, the Providence Journal-Bulletin reported that in Rhode Island, 34 million-dollar homes have sold during the first six months of 2000, with an average price of $2.6 million. This compares to only 32 for all of 1999, with a $1.5 million average. In 1998, there were 23 homes over the one million-dollar mark. "If the hot market continues, we may have to reconsider the definition of a luxury home," muses Catherine Finney, a Jamestown based real estate analyst. A September 2nd story upped the number of million-dollar houses sold for the year to 43. Even Minneapolis is experiencing increasing demand for million-dollar homes. In the Minneapolis Parade of Homes, fourteen million-dollar homes were on display, more than any other previous showing. Virtually endless examples could be provided from all corners of the nation.

The luxury home market is just one example of the current conspicuous consumption binge, which reminds us of the "glory days" that marked major tops in the markets as diverse as Japan, Thailand, and Russia. During boom-time periods of rising confidence, income, and particularly with extraordinary asset inflation, consumers develop quite different buying habits. The current luxury goods market not only provides bewildering stories, but evidence of the gross misallocation of resources that we continually discuss.

Well bargain shoppers, no more procrastinating. The Neiman-Marcus Christmas catalog came out Monday. Unless you were quick you won't to be among the 200 giving your loved one a $42,000 Thunderbird. The car sold-out within two hours. But don't worry, last we heard the $20 million submarine is still available. For the next time your spouse tells you to "go fly a kite," Neiman's "His and Hers" gift is a pair of kites for only $2,000.

By looking at the how well the luxury market has done so far this year, we bet Neiman-Marcus will be able to move several of these items. Last week LVMH Group, parent company to such brands as Moët & Chandon champagne, Christian Dior, and Louis Vuitton, posted a 40 percent increase in sales for the first half of 2000. Gucci also reported earnings last week, which were nothing less than spectacular. Sales for the division increased 28%, led by strong leather and jewelry sales, both up over 49%. Sales for Richemont Group, whose stable of brands includes Cartier,and Baume & Mercier, increased 26% over last year. To increase its presence in the luxury watch buisess, Richemont recently agreed to purchase Les Manufactures Horloge`res, Mannesmann's watchmaking business, for almost nine times revenue.

While nine times revenue seems extremely pricey for a watch company, timepieces have been a big driver for the luxury jewelry industry. Swiss watchmakers have benefited from the exceptional consumer spending and the weak Swiss franc. Swiss exports of watches increased 17% in the first half of 2000. Swatch, the world's largest watchmaker, saw it's profits rise 77% for the first half of 2000 as operating margins widened to 15.7% from 10.8% in the year ago period. Business is so good that Swiss watchmakers have not been able to keep up with demand. But to give it a try, Swatch is investing 2 billion francs ($1.2 billion) over the next four years to boost production. Another watchmaker, Patek Philippe recently introduced a $6,250 ladies' watch. The Washington Post reported that the watch immediately sold out in the U.S. and 2000 orders are backlogged. The article quoted Tania Edwards, a spokesperson for Patek, "We've never gotten that many orders before."

Diamonds are still an attraction for the rich. Last month, De Beers, the largest diamond seller in the world, reported sales increased 44% for the first half of 2000 to $3.5 billion. No doubt Tiffany & Co. has sold its share. Sales have increased more than 20% for each of the last seven quarters. Also benefiting Tiffany is the increase of conspicuous consumption. Notable illustrations include engaged couples registering for $1,500 place settings from Tiffany's Private Stock. Custom jewelry designer, Renee Lewis, who works in New York, discloses "I'm having one hell of a year. It's the best year ever and I haven't seen any signs of a slowdown."

The biggest bottleneck among luxury goods is the Porsche 911 Turbo. Most, if not all, dealerships have waiting lists for Porsche's most expensive car. Even in Munich, there is a three-year waiting list. To help ease the pain of the waiting, Porsche is shifting production of its Boxter to another factory. This will enable Porsche to increase production of the 911 Turbo by 60%, to 4,000 cars. Porsche admits current sales are beyond its most optimistic projections. One amazing story involves a Ferrari buyer that had his $225,000 car delivered and parked in his living room. Conspicuous consumption at its finest! Rolls-Royce has always been synonymous with luxury. Its has completely sold out all 107 of it latest Corniche convertibles allocated to the U.S. The $360,000 car is the most expensive car Rolls-Royce has ever sold. With all the luxury cars on the road, police officers in the Washington area are complaining that the $50 tickets issued for driving in the high-occupancy-vehicle lanes is no deterrent for those needing to save time.

These anecdotes are interesting, and most articles about luxury goods stress the wonders of wealth and give the rest of us a glimmer of the rich and some wishful thinking. What is missed is how the economy suffers from credit excesses and an endemic misallocation of resources. During boom times, like we are currently experiencing, capital is allocated based on clouded projections. Currently, there is plenty of capital available to expand Swatch's factory, or a chip plant as discussed two weeks ago. But, to build a new refinery requires $35 barrel oil to even think of the idea.

These anecdotes are interesting, and most articles about luxury goods stress the wonders of wealth and give the rest of us a glimmer of the rich and some wishful thinking. What is missed is how the economy suffers from credit excesses and an endemic misallocation of resources. During boom times, like we are currently experiencing, capital is allocated based on clouded projections. Currently, there is plenty of capital available to expand Swatch's factory, or a chip plant as discussed two weeks ago. But, to build a new refinery requires $35 barrel oil to even think of the idea.

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