(From John Mauldin's August issue:)

Information Center

Expect a massive, worldwide flight to quality driven by fears of Y2K and recession.

Already, millions of investors are beginning to anticipate the turn of the millennium ... dumping stocks ... rushing to the safety of Treasuries ... and causing turmoil in markets worldwide. Heres how to start profiting from the Y2K flight to quality right now.

After months of widespread complacency and ignorance about Y2K, the crisis is now bursting onto the scene with a vengeance ...

In Washington, the US State Department says that about half of the 161 countries they assessed are incurring "medium to high risk of Y2K-related failures in their telecommunications, energy, and/or transportation sectors."

Brazil, China and Russia, the three largest countries in the world and major US trading partners, are among the most vulnerable, according to a State Department witness before Congress.

In corporate headquarters throughout America, some major firms are discovering new Y2K computer bugs for every one they fix. The result is dramatic increases in their Y2K budgets disclosed to the SEC.

America Online jacked up its Y2K budget FOUR-fold, to $20 million at March 31, from $5 million six months earlier.

Apple Computer, Commonwealth Energy System, Costco, Kroger, Lear, Owens-Illinois, Tenet Healthcare, and Texas Utilities are among the other major firms raising their budgets by 40% or more.

In Asia and Europe, stock markets  which, until now, had been enjoying dramatic recoveries from last years deflation  are coming unglued: Tokyo has fallen 1,132 points, or 6.1%; Korea has been whacked for 171 points, or a whopping 16.4%. Germany, France and the UK are down as much as 8.9%. Brazil is down 14.2% ... Argentina, 23.3% ... Mexico, 10.1%.

On Wall Street, the high-flying tech stocks, among the most vulnerable to a Y2K disaster, are reeling:

 The NASDAQ has plunged 243 points in the last 10 trading days, losing 8% of its value.

 Just recently, AOL, which has a Weiss Y2K Rating of "low," plunged 33 1/4 points, losing 26% of its value ... IBM, which has failed to disclose its Y2K expenditures, fell $14 in the last week, shedding 10% of its value ... and Amazon.com, which weve dubbed "Amazon.bomb," lost 31% of its value in the last week, dropping over $44 per share!

Everywhere, we see blatant signs of an absolutely massive, worldwide flight to quality looming on the horizon. Robin Hubbard, director of European fixed income research at Chase Manhattan in London, predicts that the flight to quality before year-end "will damage foreign markets." Callum Henderson, emerging market strategist at Citibank in London, warns "that by the end of December, the market will be dead in the water."

Sure enough, right here in the US, our own Treasury market ( the largest and most liquid market in the world! ) is already suffering distortions never before witnessed in history  all due to a Y2K-driven flight to quality for the turn-of-the-millennium Treasury bills. ( See the New York Times, July 27, 1999 for details. )

I told you this was going to happen. Now its here.

I told you that the stock market could hold up until about mid-year as investors largely ignored Y2K warnings.

But I also told you that in the second half of the year, all hell could break loose when Y2K would emerge as a dominant force in the marketplace.

That is exactly what is getting ready to happen. And soon.

Thats also why Ive been stressing safety and caution ... and why now the time has come to be more aggressive with Y2K investment strategies.

No one can predict the timing of major market turns with precision, or tell you the exact instant to open fire. But we can now almost begin "to see the whites of their eyes."

One of the biggest and broadest plays of all is to ride this just-emerging, potentially huge, flight to quality.

First, to profit from the resulting fall in high-risk investments, Ive been  and will continue to be  recommending LEAPS put options.

Second, to profit from the resulting rise in safe investments, Im going to recommend increased investment in zero-coupon bonds.

Third, I have a mutual fund for you that will perform consistently for you whether the market goes up or down.

Fourth, if you are a speculator with risk capital you can afford to lose, now is the time to actually sell short individual companies that could be among the greatest victims to Y2K disruptions in transportation and telecommunications. Ive found two companies that could be hit hard.

Y2K may cause the auto industry to slam on the brakes!

One of the key factors during the flight to quality will be the collapse of infrastructure in key countries overseas  and the growing fear of such collapses as we approach year-end.

But that collapse will also disrupt key industries right here in the US that depend on resources from overseas that they cannot get domestically.

Graphite  an essential material for every brake in every car, bus and truck in America  is a prime example.

The US simply does not produce graphite  we import all of it. That makes us entirely dependent on Y2K laggards like China, Mexico, and Madagascar, which collectively produce 63% of the graphite we use.

China alone provides 27% of the mineral for our domestic use; and yet, as I mentioned above, China was just identified by the US State Department as one of the worst laggards in preparing for Y2K.

If China tanks next year and supply lines are disrupted, car manufacturers could have a tough time getting the graphite they need for brake linings. Detroit could still make cars that go fast ... but theyd be hard pressed to make cars that can stop. And what about replacement parts?

( Special note to all automobile owners: Get your brakes re-lined during the last quarter of this year! )

Other key minerals are also mostly imported, with few or no operational mines in the US.

These arent exotic materials used in special processes that we could do without. Far from it. They are minerals used in hardcore steelmaking, aluminum production, glass manufacturing, electronics  vital materials and parts that affect our everyday lives.

Im talking about arsenic, manganese and bauxite ( for aluminum ) . Not to mention tin, tungsten, cobalt and chromium, where we import 80% of what we need.

For many of these critical raw materials, theres simply no substitute, no other solution. Without a steady supply, many of our manufacturing industries could grind to a halt.

Average Y2K shipping delays estimated at 12 days. But specific incidents could be much worse.

The US State Department is actually a latecomer to the task of monitoring Y2K problems overseas. For the last two years, International Monitoring, a highly respected specialist consulting firm based in London, has been meticulously gathering and analyzing data about the Y2K status of 140 countries, then assessing how severe the problems will be in each country.

Recently, International Monitoring released a comprehensive 199-page study, which they make available for $3,000 to corporations, government agencies, and others that need to be aware of the impact Y2K disruptions could cause. Theyve given me permission to summarize for you the results I found in this groundbreaking report.

If your business depends upon exports and imports, and youre interested in obtaining the full "Y2K Storm Rating" report, you can contact International Monitoring at 235 Earls Court Road, Suite 105, London, SW5 9FE, UK. Tel: 44-171-373-2856. Or email them at inform@intl-monitoring.com.

International Monitoring analysts placed each country on their proprietary Y2K "Storm Rating" scale, ranging from 1 to 6 ( 6 is the worst case and 1 is the best ) . Each number corresponds to a Y2K scenario involving transportation delays, utility outages, political instability, and telecommunications disruptions. Their conclusions:

Seaports could be tied up: Focusing on countries that are home to the worlds 20 largest seaports, they calculated that the average Storm Rating of these countries was 2.6, corresponding to the scenario in which the average transportation delay is 12 days.

That may not sound like a huge delay to you. But in todays just-in-time manufacturing world, where parts often arrive on the very day they are needed for the assembly line, a 12-day delay can cause a nightmare of slowdowns. Moreover, 12 days is just the average predicted delay. In some ports, it could be much worse.

Airport bottlenecks: The countries with the worlds 30 largest airports rated an average of 1.8 on International Monitorings scale.

Thats actually pretty good by international standards, but it still means transportation delays of 7 days  on average. Air passengers could be stranded for a week or more in some very big countries. And the air cargo bottlenecks could be devastating.

Even if a countrys airports are in good shape, never forget the complex links that interconnect nearly all flights. As International Monitoring explains 

"International air travel works like a giant network with an estimated half of all planes on long haul flights in the air at any one time. Delays in one part of the global air traffic network may cause delays in other sections as planes miss connections, landing slots and other time-sensitive windows."

Large international carriers are dependent upon smooth operations to maintain their already razor thin profit margins. They have no room for major, protracted delays. Their profits could be wiped out. Many will bleed red ink.

Telecom outages could last up to 31 days.

Telecommunications is the lifeblood of most businesses. Without it, business is virtually impossible. Even if postal services are 100% operational, theres just no way we could continue doing business without phones, faxes and modem links.

But International Monitoring predicts that, while the US shouldnt experience extended problems, many countries around the world could suffer severe outages  an average of 12 days without telecommunication ... up to 31 days in some countries!

I have tried to identify the one industry that is most sensitive to these disruptions. My answer: International banking.

It may seem easy to send money from one country to another, but the transaction is actually quite complex  currency exchange calculations, custodian-to-custodian transfers, accurate record keeping, electronic order transmission, settlement and accounting of transactions, etc.

Just one glitch in any one of those functions  and you could have a thoroughly messed up transaction.

In fact, large portions of todays global financial transactions could very well come to a standstill for several days ... or even weeks.

Without phone, fax, telex or email, companies cant easily take orders for goods, communicate with customers and shippers, or even run day-to-day business operations. Theyre stuck.

Massive supply problems could emerge worldwide, continually driving investors from unsafe to safe investments.

The Problems with Stockpiling 

I can hear the "bump-in-the-road" crowd saying, "John, its no big deal. Companies will just increase their inventories of critical parts and materials. Not to worry."

Wrong. Corporate America long ago transformed its entire inventory management system to the Japanese model called "just-in-time" inventory. They did it because of huge financial benefits  less inventory costs, reduced costs for storage, lower interest expenses, plus a host of other benefits.

Today, we simply dont have the capacity to turn on a dime and start stockpiling like we used to in the old days.

And for many small- to mid-sized firms, it is questionable if financing would be available for such a sudden build-up throughout the country.

For those that do have access to short-term money to finance inventory, the costs will inevitably eat into profits.

Besides, if every buyer suddenly wanted to acquire an extra one-month supply, we estimate that mines and plants throughout the world would have to increase production by about 50% for two months or 25% for four months.

Very few are doing that now before year-end. And with Y2K disruptions, they certainly wont have the ability to do it after year-end. So it just isnt going to happen.

The key is productivity losses. All these delays will not end the world, but they will make us far less productive. In recent years, productivity growth has picked up to more than 2%, with the past year averaging about 2 1/2%. Almost everyone agrees that technology has been the reason.

What happens if we suddenly lose access to 10% or 20% of our technology? The damage to productivity will be devastating.

And what happens if some countries lose 80% or more of their access to technology, as the International Monitoring group is predicting? It will make productivity declines in the US pale by comparison.

Yes, we will muddle through  BUT AT WHAT PRICE? The normal balance of supply and demand is going to take a huge beating. Some products may be plentiful ... but with few buyers, causing huge supply overflows.

Other products will suffer acute supply shortages with a mad scramble by buyers to grab whatever they can, whenever they can. Prices could go haywire.

Second, any build-up in inventory this year means reduced orders and purchases next year as companies use up the extra inventory.

If inventories somehow do get stockpiled in the next few months, it almost locks in a slowdown in the first part of 2000. Thats Economics 101, plain and simple.

Oil exporting countries could suffer devastating transportation delays.

If I told you our oil imports depended on Africa, this would make you nervous. The average rating for Africa is 4.5, which is not good.

Well, I went through the International Monitoring report and added up the average rating for OPEC nations.

I was shocked to learn that OPECs rating is exactly the same as Africas  a pitiful 4.5. That corresponds to transportation delays of over 30 days ... telecommunications outages of 10-21 days ... electric utility outages of 10-20 days ... and a "moderate to high" strain on their political system.

We know that the US has been stockpiling oil. But as Peter Bogin of Cambridge Energy Research Associates observes, "It wouldnt take more than a two percent cut in output  1.5 million barrels per day  to dramatically alter oil market fundamentals and lead to a significant price increase."

And imagine what would happen if everyone tries to top off their gas tanks in the last few days of 1999. It would wipe out our gasoline reserves overnight.

Larry Goldstein, president of the Petroleum Industry Research Foundation in New York, puts it this way: "A couple of extra gallons in every car on the road could drain the system. It doesnt take a lot of buying to have an impact on spot prices."

How high could prices go in the very short term? It is impossible to predict, but in the kind of circumstances International Monitoring is forecasting, $30 per barrel would not be unreasonable at all.

A Constant Flow of Bad News

Almost every day I read or hear troubling reports about the Y2K situation overseas.

And yet, the traditional brokerage community ignores this news and prefers to believe the press releases, which say everything is fine.

Mark Mobius of Templeton funds, for example, recently said developing countries will be hurt less by Y2K than developed countries because they have less technology.

Hes apparently not heeding the 160-page report by the US Senate  the ratings by the World Bank  the latest Congressional testimony by the US State Department  or the new report by the International Monitoring Group.

The conclusions of all these groups are virtually unanimous:

Internally, developing nations will be hurt far more severely by Y2K than modern nations. Their exporting companies will get hammered. Their banks will have serious difficulties collecting from domestic borrowers  and paying overseas creditors.

Their interest rates will soar. And again, you will see a massive flight of capital  from high risk domestic investments to the safest investments in the US, leaving in its wake a vacuum of cash.

Many governments could respond with exchange controls. Political unrest will be the norm. And the flight of capital will accelerate, despite exchange controls.

Sell. Dont wait!

Despite all this, are you still holding on to some of your favorite stocks? Trying to play the game until the last moment? Please dont.

Dont be like a skydiver waiting until the last minute to pull the safety cord. Pull that cord now, and you can still enjoy a safe, soft landing.

Start by liquidating the stocks we have identified as the most vulnerable to Y2K disruptions and the ones most likely to be on the wrong side of the flight to quality.

That includes automakers, airlines and other transportation companies ... telecommunications, banking and any area vulnerable to telecom breakdowns.

Plus, of course, any business directly or indirectly linked to overseas. And dont forget international mutual funds, multinational businesses and any company reliant on foreign supplies.

Then follow my instructions on page 8 to get on the right side of this flight to quality.

Dont wait.

-- Andy (2000EOD@prodigy.net), August 23, 1999