THE BANK CREDIT ANALYST IS UPBEAT

IN THIS ISSUE:

1. BCA’s Latest Forecast For The Economy.

2. Many Factors Now Support A Recovery.

3. BCA’s Latest Investment Recommendations.

4. The “Other” Gary Halbert (must read this).

Introduction

The latest economic news was a mixed bag – some good and some bad. The media, of course, painted a bleak picture following the latest GDP report, showing the economy grew at an annual rate of only 1.6% in the 1Q, following 1.4% in 4Q 2002. However, the widely respected Bank Credit Analyst is quite upbeat in its latest May research report. Highlights of their latest issue follow below.

Most of you, I suspect, are not familiar with The Bank Credit Analyst. BCA is a very expensive research publication which offers detailed economic forecasts and advice on the major investment markets. One of my clients turned me on to BCA back in 1977, and I have been a continuous subscriber ever since.

Over the last 25 years, I have found BCA to be more accurate in forecasting major trends in the economy and the investment markets than any other source I have followed (and I have followed many, by the way). This week, I share with you their latest thinking.

Also, just so you know, there is another GARY HALBERT out there in the investment world. I am Gary D. Halbert. The other guy is Gary C. Halbert. We are NOT related. At the end of this letter, I’ll tell you why you don’t want to get us confused.

Latest Economic News

As noted above, the latest report on 1Q GDP showed a rise of 1.6% (annual rate). Expectations had been in the 1.5-2% range, but the media made it sound like economists and market analysts were expecting a rise of 2-2.5%. Not so. And if the GDP report was so bad, as the media suggested, why were the stock markets UP STRONGLY on Monday?

The truth is, the GDP report was just OK – not bad, but not that good either. At least it was positive. You can look at economic data with a negative bias, as the media and the gloom-and-doom crowd do, if you like. You can also assume we’re headed back into a recession if you like. I happen to have a different view.

I believe it is nothing short of amazing that the US economy grew by 2.4% in 2002, on the heels of the September 11 terrorist attacks that shocked our nation and the world, and in spite of the plunge in the stock markets!

On another front, consumer confidence rose again in the last half of April. The University of Michigan’s Consumer Sentiment Index rose to 86, up from 83.2 at mid-April and 77.6 for March. This is a good indicator, even though consumer spending increased only 1.4% in the 1Q when people were worried about the war.

I continue to believe the economy will gradually improve during the course of the year, especially now that the war is over. I’m not alone in this view. As noted above, The Bank Credit Analyst was quite upbeat in their latest May research report.

BCA’s Latest Thinking

Here are some excerpts from the May issue of The Bank Credit Analyst.

“The bearish view of the economic outlook has been fully embraced by a number of Wall Street’s leading commentators. It remains an easy story to tell: heavily indebted consumers will cut back on spending, companies will have no reason to expand for the foreseeable future, and the Federal Reserve is almost out of interest rate ammunition. Meanwhile, many parts of the world are in even worse shape. Even Asia, the major bright spot in an otherwise bleak economic landscape, now faces the uncertain impact of the SARS epidemic.

Indeed, there is much to be concerned about in the economic outlook, but we are holding to our view that the gloom is overdone.

The corporate sector has been through a severe recession during the past couple of years, but that has now run its course. Meanwhile, consumers are in reasonable financial shape, and spending is not set to collapse.

The U.S. economy has displayed remarkable resilience in the face of a series of severe shocks during the past few years, and the odds are good that growth will surprise on the upside in the second half of the year. The economy is not going to boom, but growth should be strong enough to calm fears of deflation and foster increased risk-taking on the part of investors.”

The BCA editors believe that three primary factors have led to the slowdown in economic growth during the 4Q and the 1Q: 1) war worries; 2) severe winter weather; and 3) high oil prices. Of those three, the first two are gone, and oil prices are trending lower.

Consumer Debt Not A Huge Problem

The gloom-and-doom crowd would have you believe that consumers are tapped-out, and that spending is set to fall off a cliff. They most often refer to the “debt-to-income ratio” which reached a new peak of 106% at the end of 2002. However, the BCA editors point out, similar to what I have said in previous issues, that home mortgages now make up apprx. 80% of all consumer debt.

When presented with the statistic above, the pessimists then argue that home prices are in a bubble that is bound to burst, at which point consumers will stop spending. I addressed the outlook for home prices in the April 8 issue of this E-Letter and concluded that home prices are not about to implode. On this point, BCA says: “The key risk to household balance sheets would be a sharp drop in house prices, but that is not in the cards.”

Regarding consumer debt levels, BCA says, “A decline in delinquency rates [on a percentage basis] in home mortgages and other consumer loans during the past year suggests that debt burdens are not putting any undue stress on consumers. Moreover, earnings reports from major banks indicate that loan quality continued to improve in the first quarter, despite a weak labor market.”

Moreover, they say, “The ownership of both assets and debt is highly skewed toward the rich, and this means that aggregate data can give a misleading picture of the financial health of the typical consumer… The average consumer does not own much [in] equities so was not overly hurt by the stock market collapse and debt burdens have been manageable.”

The Outlook For Unemployment

The unemployment rate stands at 5.8% (February and March). The pessimists argue that this number will only go higher. As usual, BCA has a different take: “Labor market indicators have been weak recently, but we assume that this largely reflects the combination of temporary headwinds [war, weather and oil] noted above. With the war now over and corporate profits staging a modest recovery, there is no obvious reason why companies should embark on an accelerated pace of cost cutting [layoffs]. More likely, employment should gradually improve over the remainder of the year, helping real wages to grow by around 3%.

Even if the saving rate rises, real consumer spending growth should still comfortably exceed 2% in the coming year. That will be consistent with a decent pace of economic growth, assuming that there is also a modest recovery in business spending.”

What About Business Spending?

In its GDP report, the Commerce Department estimated that business spending decreased 4.2% in the 1Q after rising in the 4Q. Here, too, BCA believes the 1Q decline was very likely the result of war worries, weather and oil prices. The editors believe that business spending will improve, perhaps significantly, over the next year.

One of the pessimists’ favorite arguments is that business spending is not going to increase because the factory operating rate (capacity utilization) is only at 72%. BCA points out, however, the capacity utilization rate of 72% refers only to the manufacturing sector, which accounts for less than 25% of private sector investment in equipment and software.

As for business spending, BCA sums it up this way: “The bottom line is that the conditions are in place for a revival in business spending… There is also potential for increased company spending on inventories. The ratio of inventories to sales is at a secular low, and there is even a risk of shortages when demand picks up. The missing ingredient is confidence: companies will not expand if they fear a downturn in the economy, and that clearly has been an issue in recent months. Hopefully, confidence will now show an improvement, encouraging companies to abandon their retrenchment mindset.”

Other Reasons To Be Positive

BCA believes that the monetary environment will remain very accommodative. They expect the Fed to cut interest rates at the upcoming FOMC meeting on May 7-8. In addition, they believe the economy will benefit from increased government spending and whatever tax cuts the Bush administration may be able to wrestle out of Congress. They also point to the falling dollar as another positive for the US economy.

In conclusion, the BCA editors say, “The bottom line is that it is quite easy to generate a forecast of real GDP growth in a 3% to 4% range in the second half of the year. All it requires would be real growth rates of 2% to 2½% in consumer spending, 5% to 10% in [business] investment, 5% in government spending, modest inventory building, and a reduced drag from trade. None of these are extreme forecasts. One has to make rather pessimistic assumptions to have growth below 3%, and this would probably require some new shock to confidence.”

Investment Recommendations

Like many of us, BCA is not entirely sure if the long-term bear market in stocks is over or not. However, the editors believe that conditions are right for at least a cyclical upturn in equities over the next 6-12 months. They recommend average holdings of equities.

FYI, BCA does not subscribe to the belief that P/E ratios have to bottom at 7-8. They believe that the market reached fair valuation at the lows in October when the S&P 500 “Forward P/E” fell to near 14. Their analysis of equities includes many indicators besides P/E ratios. On a technical basis, they believe the next milestone is the 960 level in the S&P 500. If the market can close above that heavy resistance level, I suspect they will move from “average” to “above average” holdings of equities.

The BCA editors continue to believe that bonds, especially Treasuries, are overvalued and subject to losses, particularly if the economy continues to recover. As a result, they recommend corporate bonds over Treasuries.

We know that many investors have moved into Treasuries and bond mutual funds over the last couple of years, due to the decline in stocks. Unfortunately, many believe they are “safe” in bonds and bond funds. The fact is, bonds can be just as risky as stocks, or even more so. We will look at this issue in more detail next week.

Conclusions

BCA believes the economy will continue to recover, and that growth in the second half of the year could well be in the 3-4% range, absent any major negative surprises. They believe that both consumer and business confidence will improve slowly now that the war is behind us. And they believe that stocks could have a cyclical upturn that could last for 6-12 months.

I realize this forecast flies in the face of what you may read from the pessimists and the gloom-and-doom crowd who are (always) predicting deflation and recession. And I must state for the record, there is no guarantee that BCA’s latest forecast will prove to be accurate. All I can say is that they have been more accurate (not perfect, mind you) than any other source I have followed over the last 25 years.

If you would like more information on BCA’s various publications, visit their website at www.bcaresearch.com . I highly recommend it!

Lastly, I might also note that Stratfor.com has just turned much more positive about the economy and the equity markets.

The Other Gary Halbert

As noted in the Introduction, there is another Gary Halbert in the investment world, and you might assume I am him. I am not. I am Gary D. Halbert. The other guy is Gary C. Halbert. We are NOT related, by the way. I have never even met him.

If you do a search on the Internet for Gary Halbert, you will find out a LOT about the other Gary Halbert. He claims to be a marketing expert. He also apparently has some kind of stock picking system that he promotes. I have no first-hand knowledge about Mr. Halbert’s abilities or services, and as such, I could not recommend them.

I did a search today on Google.com for “Gary Halbert.” The first 21 “finds” that came up for Gary Halbert were for the other Gary Halbert, not me. Not until I got down to the 22nd “find” did I see one about me.

Ever since I learned about the other Gary Halbert, I began using my middle initial, D, in all our publications and all business correspondence. Just keep this in mind whenever you see anything from Gary Halbert.

Talk to you next week.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Morris warns that Bush could lose in 2004…. but

John Podhoretz argues that the Dems can’t win anyway.

Wall Street firms fined for giving conflicted advice.

Wall Street Journal’s view of the fines on securities firms.