ON THE ECONOMY, STOCKS, BONDS & GOLD

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
September 30, 2003

IN THIS ISSUE:

1. Latest Economic News Is Encouraging, Despite The Media.

2. Stocks – Should You Take Profits Before Earnings Reports?

3. Bonds – A Look At One Of The Best Bond Managers Around.

4. Gold – Can The Bull Market Continue, Or Is It Near A Top?

The Economy Continues To Improve

The Commerce Department reported last week that GDP rose at an annual rate of 3.3% in the 2Q, which was above pre-report expectations. This final report compared favorably to the previous estimate of 3.1% and is a great improvement over the 1Q rate of 1.4%. Several surveys of economists now suggest that 3Q economic growth will land in the 5% range. The recovery continues.

The government reported on Monday that consumer spending jumped a strong 0.8% in August following the gain of 0.9% in July. If this pace holds up in September, it will be the strongest quarter for consumer spending since 1985. So much for the pessimists’ warnings earlier this year that consumers were tapped-out and in the doldrums.

The media, of course, downplayed the latest good economic news and continued to focus on the weak employment situation. Even though the unemployment rate fell from 6.2% to 6.1% in August, the media continues to stress that over two million jobs have been lost in the last two years.

There is no ignoring the fact that many of the jobs which have been lost during (and since) the recent recession are permanent losses. Some have been lost to increased productivity at home and others have been moved offshore. Thus, the recovery in employment will be slow to expand, but it should start to happen by yearend.

The Bank Credit Analyst is optimistic that unemployment has peaked: “Job growth is the final and key ingredient to ensure that a self-reinforcing U.S. recovery is underway. Modest job creation could be just around the corner.”

Stocks – Can The Rally Continue?

Stocks moved lower last week, but most analysts are still optimistic that the rally can continue. For the year, the Dow is up over 11%, the S&P 500 is up over 13% and the Nasdaq is up a whopping 33%. That’s pretty impressive given all the pessimism out there. Since I recommended moving back to a fully invested position in equities in March before the Iraq war started, the S&P 500 Index has risen over 20%.

We are now entering the “earnings season” when many companies will be making announcements that will affect both individual stocks as well as the markets overall. Most analysts agree that the 3Q was a very good period for corporate earnings. Therein lies the problem, or potential problem. Analysts’ expectations for earnings are very high, and this is a big reason why stocks have rallied so strongly in recent months. So, if the actual earnings reports fail to meet (or exceed) those expectations, the result could be a further slide in the markets in the next several weeks.

So, what should you do now? I continue to believe that the major stock market indexes such as the Dow, S&P, Russell, etc. will be at least moderately higher a year from now. Given that, I would not recommend reducing holdings now ahead of the earnings reports.

On the other hand, if you took my advice in early March before the war to get fully invested in equities, and you are now sitting on some very large gains in just over six months, you may be anxious to lock-up some of those profits prior to the earnings reports. And who could blame you? Yet keep in mind, of course, that it’s easy to know when to get out, but far more difficult to know when to get back in.

If you did not take my advice back in March to get fully invested in equities, and you are still partly or fully on the sidelines in equities, you should hope for a further selloff in equities during the next few earnings weeks to get back in.

The Love Affair With Bonds

Most sophisticated investors have a blend of stocks and bonds (and other investments) in their portfolios. More aggressive investors tend to have a higher percentage of stocks versus bonds (70 stocks/30% bonds, for example), while more conservative investors typically have a larger allocation to bonds (50/50 or 60/40, for example).

In the wake of the three-year bear market in stocks, many investors have greatly increased their percentage exposure to bonds. Part of this increase occurred simply because the value of their equity portfolios declined significantly (the S&P 500 fell 22% in 2002 alone), while their bonds rose in value. Yet many other investors bailed out of stocks and moved that money into bonds, thereby greatly increasing their exposure to the risks of the bond markets.

In particular, there has been a love affair with Treasury bonds and mutual funds which invest in such government debt instruments. And why not? As measured by the Lehman Brothers Government Bond Index, Treasuries went up in all three years of the bear market in stocks. Lehman’s Government Bond Index went up 11.5% in 2002 when the S&P 500 fell 22%.

It came as no surprise that inflows of money into bond mutual funds, especially those that invest in Treasuries, began to soar in late 2002 and continued to skyrocket earlier this year. According to the Investment Company Institute (ICI), which tracks mutual fund inflows and outflows, taxable bond mutual funds (including Treasury funds) saw inflows soar by over $112 billion from December 2002 to June 2003.

The problem was that interest rates were at rock bottom levels when much of this new money poured into bond funds. Unfortunately, most investors came late to the party and are now sitting on big losses!

The Bond Bubble

If you read my monthly Forecasts & Trends print newsletter and these weekly E-Letters, you may recall that I began to warn about a “bubble” developing in the bond market in November of last year. I continued my warnings during the first several months of this year as well. I specifically warned that the bond market was becoming “overbought” and that a nasty correction (or worse) would likely follow.

As you will also recall, I have consistently been positive about the economy over this same period, and it doesn’t take a genius to know that interest rates historically rise when the economy comes out of a recession and begins to expand. Coupling the improving economic outlook with the stampede by investors into bonds and bond funds, it also didn’t take a genius to predict a “train wreck” in the bond market.

Actually, the bond market bubble lasted a little longer than I expected. The market didn’t peak until mid-June this year. Because long rates continued to fall, in large part due to the stampede into bonds, the bubble just got larger and larger. But as you may recall, I stuck to my recommendation to reduce your holdings of bonds, especially Treasuries.

As we all know now, the bond market collapsed in June of this year and most bond funds that specialize in Treasuries plunged 20-30% or more by mid-August. Those who came late to the bond party are believed to be sitting on large losses at this point.

Capital Management Group Revisited

Since late last year, I have consistently recommended that investors consider Capital Management Group (CMG), our recommended bond timing program, in lieu of holding actual bonds or bond mutual funds. CMG has an impressive 10-year actual performance record. I am happy to report that they side-stepped the bond market carnage in June-August and are having another outstanding, double-digit year.

This week, I have included our “Advisor Profile” on CMG, complete with the actual performance record, background on the company and the various disclosures. If you want to look at an outstanding bond manager, simply CLICK HERE. (Past results are not necessarily indicative of future results.)

Out of all the bond timing programs we’ve looked at, CMG is our hands-down favorite. If you have not taken my advice and looked at CMG before, you have left some serious profits on the table, but it’s not too late to get started.

We also recommend several other professional money managers who specialize in equity mutual funds. I am happy to report that all of our recommended equity programs are also nicely profitable this year. If you would like more information on CMG or our equity programs, call us at 800-348-3601.

Gold – Will The Bull Market Continue?

One of the most frequent questions I get from readers is what is my opinion on gold prices. Gold prices bottomed in early 2001 just above $250/oz. Since then, gold has trended higher to the current level around $380/oz. That’s a 50% increase. Gold last traded at these levels back in 1993-1995.

The recent bull market in gold (and other metals to some extent) is based largely on: 1) geopolitical unrest and the threat of terrorism; 2) improving supply/demand fundamentals; 3) the weakening US dollar; and 4) increasing likelihood of inflation in our future.

Most analysts I read believe gold will continue to trend higher, and perhaps that is correct. However, gold has heavy overhead resistance (technical talk) at $380-$400. I would want to see gold close strongly above $400 and remain there for a period of time before I would be confident that the bull market will continue.

I have not been a big fan of gold since the late 1970s when the yellow metal soared briefly to $850 prior to the historic crash in metals in 1980. One of the reasons I don’t comment on gold or offer predictions very often is the fact that investing in gold (and other metals) is not easy for most investors.

Generally speaking, your choices for investing in gold are limited to the following: 1) buying mutual funds that specialize in metals; 2) buying physical bullion or numismatic coins; 3) buying shares in volatile mining companies or the XAU gold/silver index on the Philadelphia exchange; 4) gold futures or options on futures; and 5) futures funds that may trade in the metals.

As noted above, there are some mutual funds that specialize in precious metals. One such fund is Frank Holmes’ U.S. Global Gold Shares (USERX) – it’s been around for 30 years. Another is the Rydex Precious Metals Fund. There are numerous others, and I don’t have a favorite among them.

Obviously, buying gold bullion is a pain (safe storage, insurance, high commissions, etc.) and numismatic coins can be very complicated and are frequently (read: almost always) overpriced. I don’t recommend either unless you really know what you’re doing.

Mining shares are typically very speculative and volatile – ditto for the XAU Index. The mining shares and the XAU often lead the actual price of gold (both up and down). For example, the XAU Index is up over 100% since the low in 2001, while the actual price of gold bullion has risen only apprx. 50% since the low.

You have to have super-human timing skills, in my opinion, to successfully trade mining shares or the XAU. I’ve seen very few people make money in this market over a long period of time. Ditto for gold futures and options, which are perhaps the riskiest way of all to invest in gold on your own. There are a few futures funds that specialize in precious metals, but I would not recommend them. Most of the successful futures funds are diversified across numerous market sectors and are not limited to precious metals.

In conclusion, it may well be that gold and precious metals prices will move even higher. The economy is recovering, and we may well see some mild inflation in the next year or two. But I am not convinced that a mild increase in inflation will fuel a long bull market in metals. I could be wrong, of course, especially if there are more terrorist attacks. Absent that, however, gold may have trouble moving strongly above $400, and if it fails to do so, a nasty selloff could follow - especially in the high-flying mining shares.

For all these reasons, I would not recommend that you chase the gold or other precious metals markets at this point. While the gold and metals promoters are working overtime, with claims that the bull market has only just begun, I don’t recommend that you buy into their schemes. CAVEAT EMPTOR!!

Best Wishes,

Gary D. Halbert

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