Action in he current market indicates the final unwinding of the market bubble of the late 1990s, according to a new report from BMO Nesbitt Burns.

“WorldCom’s admission of huge accounting irregularities has sent shock waves through financial markets, the latest in a series of revelations of fraud that continue to damage confidence in U.S. companies,” observes BMO Nesbitt’s chief economist, Dr. Sherry Cooper. “The U.S. dollar and stocks have been pummeled as investors seek the safety of government bonds and gold. The euro is rapidly approaching parity, as the yen strengthens to nearly 119. The Canadian dollar is once again above 66¢ and bond yields continue to fall sharply. A dramatic reassessment of risk is obviously well in train as equity risk premiums continue to rise. Foreigners are aggressively selling American stocks, depressing the large-cap indexes.”

Cooper says that it is particularly troubling that the U.S. dollar is falling now, amid the mounting debt woes of Latin America and broader concerns about world peace and sustained prosperity. “In the past, the dollar has attracted capital in troubled times, providing depth and liquidity, a secure place to put money when volatility rises.”

Cooper says that the economic data is no longer the driving force of stock market sentiment, nor are positive earning reports. “The U.S. recovery is evolving toward a full-fledged expansion, yet financial markets are embroiled. The fallout from this will be substantial,” says Cooper.

“Central banks all over the world are already intervening in support of the greenback for fear that their currencies will appreciate too rapidly, snuffing out their nascent export recoveries. Corporate bond spreads are high and rising, especially for lesser-quality credits. Hedge funds are dumping securities to meet margin calls. The domino effect of such dramatic declines in asset values is meaningful and troubling. Banks everywhere are exposed to rising loan losses and tanking corporate bond portfolios.”

In time, Cooper says that this will prove to be a buying opportunity, but in the near-term U.S. stocks and the U.S. dollar will remain vulnerable. “The greenback has been grossly overvalued. Given the excesses prevalent in foreign exchange markets, the pendulum will now swing too far the other way. Gold will continue to act as an alternative reserve currency — not nearly as liquid, but a haven in the stormy seas of corporate malfeasance and potential terrorism. Long bonds will rally further. The final stages of the unwinding excesses of the U.S. stock bubble are upon us.”

http://www.bmonb.com/Economics/bottomline/common/line_b.asp?issue=20020626