August 1998

Is the bull getting tired? – Conflicts turning violent

Is the bull getting tired?

The Asian crisis turned all emerging markets, Russia and South America, moving south. Currencies got under pressure and markets disappeared. The solution of the Asian crisis is largely dependent on the economic recovery of Japan. And as long as Japan is not seriously solving their economic problems, clean up the bad loans, restructure their financial system, eliminate the connections between business, government and crime and restore confidence into the government, Asia and the other emerging markets will not be able to stem the tide.

The European and U.S. economies on the other hand are doing allright. The Asian crisis forestalled the threatening ghost of inflation in the booming U.S. and the recovering Europe. The stock markets on the old and new continent have reached in the mean time new records. The Dow broke the 9300, the Dax the 6000 and also the smaller markets like the Dutch AEX broke trough the 1300 level.

How long can the Western markets continue this growth? If Asia would return to their former might everything would be OK but this will take another two or three years at least. The growth of the western markets has also to be carried by the home markets and the markets in Eastern Europe which are less influenced by Asia then the other emerging markets. The economic fundamentals are thereby not that bad for the majority of the companies but there are a number of buts which could have a negative effect on the development of the stock market.

One of those buts is the price/earnings ratio. The market valuation is becoming very expensive. The Standard and Poor 500 index is traded at 20 times earnings, the best performers of the S&P even 35 times earnings and the profit expectations for 1999 are just a mere 1,5 till 1,9 %. The weak position of the U.S. stock market becomes more clear by a look on the advance-decline line of a combination of the NYSE and the Nasdaq, it is dropping. There are reported fewer new highs but more new lows. The booming stock markets are builded on the just a few strong stocks, the breadth is very small. And finally money is moving out ot the stock market and into the money and bond market.

The European valuation situation is not yet that worse as in the U.S. but the earning forecasts are just as disappointing as in the U.S. Disappointing is not the right word, they just not that impressive as before. The economic performance in especially the manufacturing sector will deliver single digit growth where as the financial, telecommunication and some tech stocks are however still able to deliver double digit growth. This small breadth of high performing stocks will disappoint the analysts and the investors.

This will result in a lost of trust in the strenght of the market. A lot of people will take profits and wait to re-enter the market at a better price. And more dangerously the stock community will react very harshly on most of the earnings warnings which might be given by companies. Consequently there will be some ups and downs but the year to date growth will remain positive for the quality stocks.

The earnings growth of several companies will be less then in the preceding years and this will limit the growth of the market. The volatility of the stock market will continue till the end the year. It can be described as a slow down but to call it the beginning of the bear cycle might be a little premature. The overall economic position is still to positive. The economic outlook on the world economy for 1999 is despite the Asian crisis promising, especially the U.S. and European economies are responsible for the well being of the economy. The last quarter of 1998 or the first quarter of 1999 will show some improvement to the market. The earnings situation will get better at that time. The improved market/economy with a cheaper stock price because of the slow-down/correction will improve the valuations and this will boost further growth in 1999. The bull will continue in 1999, it is only taking a little break in the second half of 1998.

The third quarter and possibly the fourth quarter will bring some volatility. This could include a correction of 10-15 %. This will not have a lasting impact. But if you want to be on the save side and have good night sleep you could consider to protect the profits you have gained till now by the use of a put-call option combination. This will protect you to any losses and it will keep your portfolio unimpaired. This can be done at little cost because the majority of the costs will be covered by the earnings of the put. This little exciting operation will protect your holdings but will limit the growth chances of the second part of 1998, there are however some more exotic derivative combinations which could increase your gains even more. But this is attached with a higher risk.

Conflicts turning violent

The world in 1998 is still not a peacefull place. There are several regions where people, organisations, groups, religions and sometimes even states have differences with eachother. Some of those problems can be solved by mediation but some will use violence as a way to improve their position. In Kosovo most of the above mentioned differences are present , included the preferred way to solve it.

Kosovo, bushfire or war

The conflict in Kosovo gets worser by the time. Both groups, the Kosovo-Albanians and the Serbian security forces increase the use of violence towards eachother but also against the civilian population.

The Serbs and the Albanians are getting far away from a diplomatic solution. The demands of both sides essentially rules out a diplomatic solution. The Serbians want to keep Kosovo part of Yugoslavia with no special position. The Albanians are insisting on independence or a possible link up with Albania proper and a part of Macedonia to create a Greater Albania.

The major party which represents the Albanians have become the UCK/KLA who have more or less controlled a large part of Kosovo before the Serbian/Yugoslav forces started their operations. The military power of the UCK/KLA is limited. The numbers are relatively small and the armament beside the personal arms of the fighters is limited to heavy machine guns, mortars and grenade launchers including AT systems. This is enough to carry out a querrilla war but it is not enough to impress or defeat the Serbian security forces. Especially, what is the case, when they receive support from the Yugoslav army. The Yugoslav army will be the decisive factor. They can deliver the necessary military weight, MBTs, artillery and manpower to destroy the UCK/KLA military power. But they could, in the end, also force the Serbians politicians to accept a diplomatic solution. The Yugoslav army are not loyal supporters of Serbian president Milosevic and his policy. This could mean a chance for a diplomatic solution. But in the beginning they will support Milosevic to destroy the UCK/KLA because they pose a danger to the integrity of Yugoslavia. A strong UCK/KLA can not be tolerated by the army but a less threatening querilla force could be an acceptable negotiation partner.

The intensified fighting between the UCK/Albanians and the Serbian/Yugoslav forces pushed the former in the defensive. The Serbian military operations to regain control over the important roads between Pristina and Prizren and between Pristina and Pec proved to be a dangerous development for the UCK/KLA. Because the Serbians already controlled the border with Albania, incidentally they even followed the UCK/KLA into Albania and clashed with the Albanian border troops, the UCK/KLA got trapped in its hide out around the town of Malisevo. Malisevo is the HQ of the UCK/KLA and it is situated in the centre of the triangle Pristina-Pec-Prizren. And the line Prizren-Pec is about 10 KM of the border which is under control of the Serbian security forces. The intensed fighting in the triangle led to loss of the UCK/KLA HQ and this was a bad development. They not only lost a clear sign of their power but they also lost morally. They are not that strong as was thought and they are also not able to protect the Kosovo-Albanians from the Serbian terror. It was essentially the end of a myth.

The fighting will be in the advantage of Serbia. The military fortunes of the UCK/KLA are bad. They are pushed back by the Serbian/Yugoslav forces and they will be finished as conventional force very quickly. After that they will only be able to operate as a querilla force. The situation is further deteriorated by the fact that the logistic support of the UCK/KLA has become very difficult because the Serbian security forces control and “evacuated” the border territory with Albania. The Serbian forces are thereby willing to eliminate the Albanian support of the UCK/KLA in Albania proper. They have moved into Albania and destroyed UCK/KLA forces over there.

Time will be advantageous to the Serbian forces. The resistance of the UCK/KLA will be further undermined by the coming winter which is very harsh in those regions. The many displaced persons who fled because of the agression can be of no help to the UCK/KLA in their resistance. The resulted uninhabited villages can not be used as a hide out for the UCK/KLA. And local support is necessary in a querilla war.

The position of the UCK/KLA is finally undermined by their own policy to try to get the support of all Albanians in the region and their insistence on maximum demands. The UCK/KLA has become a powerfull force in the area and they try to rally support not only from the Albanians in Kosovo but also in Macedonia and Albania proper. This could draw three countries into Kosovo-conflict. Albania might like the idea of a greater Albania even if it would create a ungovernable country and that it is not clear who will run the country. The other involved entities, Yugoslavia, Macedonia and the international community, would however fundamentally oppose such a development.

The military operations in Kosovo has forced the UCK/KLA in the defensive. They had to give up the limited/conditional control they possessed over some areas. They are hard pressed because of the operations of the Serbian/Yugoslav forces. They even called for intervention by the international community. The UCK/KLA might be tempted to use a possible cease fire to regroup and reinforce their positions and try to save what is possible.

The demand for international intervention might be to late. The military operations in Kosovo might soon be over as the military power of the UCK/KLA is broken. The Serbian security forces can handle the querilla threat by the Kosovo-Albanians on their own with the usual terror. The political position of the Kosovo-Albanians will then be weaker then before and a low-level querilla war will be the only mean of resistance leftover.

The Serbian leaders will feel encouraged by the demand for international intervention because that is the evidence that they are stronger and can solve the Kosovo problem their way. The silence of the international community during the recent military operations will also give Milosevic the idea that the West does not object to the steps taken to keep Kosovo within Yugoslavia.

To prevent a forced military solution by the Serbians the UCK/KLA and other political organisations in Kosovo like the LDK should unite and work together. With one strong voice they should then try to get as much as international support as possible. If they at the same time are willing to accept a compromise solution of autonomy within the state Yugoslavia it could be feasible to reach it. The international community could press Milosevic to accept that compromise especially now the Yugoslav army has been involved into the conflict.

The psychology of the people in the region however encourages the choice of maximum demands and any compromise is a sign of weakness. Their thinking is black and white. You win or loose and something in between is not possible. If the Kosovo-Albanians let traditional feelings run their policy they will loose.

The Kosovo conflict will be a limited conflict. The threatened new Balkan war is very unlikely. The UCK/KLA is to small, politically and militarily, to really influence the outcome of the conflict. The Albanians in the region are thereby not in a position to create a Great Albania. They have to many internal differences and they are simply to poor. The neighbouring states have intrests in the region but they have little in common with wishes of the Albanians and they are certainly not willing to die for Pristina or a Great Albania.