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LATEST FROM THE BANK CREDIT ANALYST

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
March 2, 2004

LATEST FROM THE BANK CREDIT ANALYST

IN THIS ISSUE:

1.  The Economy Remains On A Solid Track.

2.  A Year Ago – Who Agreed With Me Then?

3.  BCA – Maybe No Interest Rate Hike In 2004. 

4.  Investing – Risks Higher, What To Do Now?

5.  The Case For Professional Money Managers.

Introduction

To hear the Democratic presidential wannabes tell it, the economy is in shambles.  But we know differently.   GDP grew at a blistering annual pace of 8.2% in the 3Q last year, and the government reported Friday that GDP rose by 4.1% in the 4Q.  Hardly an economy that is in trouble!  In fact, the Index of Leading Economic Indicators rose sharply in January, the housing industry remains strong and the manufacturing sector continues to rebound strongly as we will discuss below.

The main deterioration in the economic reports so far this year was the drop in consumer confidence in February.  In my view, this is clearly due to all the negative publicity by the Democrats in recent weeks and thus should be temporary.  In fact, consumer spending actually posted a solid gain in January (latest data available), and while it may drop off somewhat in February – in line with consumer confidence – this is no reason to conclude the economy is in any trouble.  

The Bank Credit Analyst is one of the most respected economic and market research firms in the world.   BCA continues to believe that the economy will remain strong well into 2005.  Even so, inflation remains low, slightly below a 2% rate by most indicators.  As a result, BCA believes the Fed will NOT have to raise interest rates this year.  This is a significant shift in BCA’s outlook, since they previously believed the Fed would have to raise rates at least once prior to the elections.  More on this below.

Lastly, the outlook above, one of continued firm economic growth, low inflation and low interest rates, suggests that the equity markets can continue higher.  However, it is important to keep in mind that equity prices have already spiked higher in the last year.  Thus, there is a good chance that stocks will move into a broad trading range with a slightly upward slope this year.  Once again, this argues for active, professional management that can deal with something other than a strong bull market.

The Economy Remains On A Solid Track

The US economy expanded at an annual rate of 4.1% in the 4Q, so reported the Commerce Department last Friday.  The latest report was slightly better than average expectations of 4.0%.  The main reason the latest report was higher than expected was a significant increase in business investment spending.  Capital spending expanded sharply at an annual rate of 9.6% in the 4Q, up from the pre-report expectation of only 6.9%. 

The better than expected rise in business spending reflects growing confidence among executives that the economy is on a sustainable growth path.  Higher capital spending also signals that hiring will continue to rise, and the unemployment rate should continue to fall in the months ahead.

The Index of Leading Economic Indicators rose 0.5% in the latest report and has risen at a 5% annual rate since the low a year ago.  The manufacturing sector continues to improve.  The Institute for Supply Management index rose in January for the ninth consecutive month.  Industrial production rose 0.8% in January.  And the purchasing managers index (NAPM) hit the highest level since September 2001 this month.

On the negative side, durable goods orders declined 1.8% in January, and retail sales fell 0.3%.  As noted above, consumer confidence fell somewhat sharply in the latest report, but it is important to note that this survey is about opinions and is no doubt influenced by all the Democratic rhetoric about the economy.  This must be weighed against actual consumer spending which has continued to rise for the last several months.

There are those who quickly pointed out that the 4.1% growth rate in the 4Q was only half the torrid pace of 8.2% set in the 3Q of last year.  But as I have pointed out often in the last several months, the 8.2% rate was an unusual occurrence which could not be sustained.  The latest reports confirm the economy is now on a much more stable, non-inflationary track.  This is good news for interest rates as I will discuss below.

What A Difference A Year Makes

A year ago, there was widespread skepticism about the economic outlook.  The economy only grew by 2.2% in 2002 following anemic growth of 0.5% in 2001.  There were widespread predictions, especially in late 2002, that the economy would slip back into recession in 2003.  The other prominent view a year ago was that consumers were buried in debt, and since consumer spending accounts for over two-thirds of GDP, 2003 had to be a bad year (return to recession).

Yet if you have been reading this E-Letter for a year or more, you know that I had a very different outlook on the economy and the markets for 2003.  In late 2002, I predicted that the economy would rebound, probably strongly, in 2003.  I also emphasized that over 70% of consumer debt was in the form of well-secured home mortgages, suggesting that consumer spending would continue to be very strong in 2003.

Along with my prediction for a strong economy in 2003, I also suggested that investors consider switching from Treasury bonds to high-yield bonds.  High yield bonds tend to outperform Treasuries and other investment-grade bonds during economic recoveries, and that certainly proved to be the case last year.  High yield bonds had one of their strongest years ever in 2003, while Treasury bonds were largely disappointing.

A year ago, the equity markets were struggling just above their bear market lows, and the gloom-and-doom crowd promised another losing year in 2003 (as always).  Yet prior to the war in Iraq, I predicted a new bull market in stocks and recommended that readers move back to a fully invested position.  While my prediction was seen as somewhat aggressive at the time, we all know what has happened since.  Stocks had a bull run reminiscent of the late 1990s in 2003.

Now, a year later, there is widespread optimism about the economy, despite what we hear from the Democrats running for president.  The Blue Chip Indicators is a service which tracks the views of 50 leading economists, and their latest survey suggests growth of 4.2% for all of 2004.  This is consistent with the latest economic outlook from the Fed which suggests growth of 4½-5% for 2004.   Likewise, there is widespread optimism that the equity markets will continue higher. 

What a difference a year makes!  My hope is that many of you took advantage of my advice over the last year or longer and have profited handsomely from the bull market in stocks and high yield bonds.

BCA Alters View – No Interest Rate Hike In 2004

The editors of The Bank Credit Analyst have predicted for several months that the Fed will have to raise interest rates at least once this year due to the strong economy and the need to keep inflation in check.  However, in their latest March issue, the editors suggest that interest rates may not be increased until at least after the election and maybe not until next year.  Here’s why.  

As noted above, the economy slowed to a non-inflationary rate of 4.1% in the 4Q, down from the 8.2% pace in the 3Q.   Economic data so far this year indicate that while the economy is on solid footing, it is not likely to return to the ozone level in 3Q 2003.  BCA now forecasts that the economy will grow by 4-5% in 2004.  It is generally agreed that growth of 4-5% will not result in a significant increase in inflation.  Thus, the editors believe that this gives the Fed the opportunity to avoid having to raise rates in an election year.  They say:

“The odds of a mid-year monetary tightening [rate hike] have diminished. It will take three or more months of solid employment gains and a rise in inflation before the Federal Reserve raises rates.” 

Alan Greenspan does not want to raise interest rates this year.  He does not want to open himself up to political criticism.  Unless there is reason to think inflation is likely to rise more than expected, Greenspan has the luxury of doing nothing.   Fortunately for him, the inflation data in the latest GDP report look fairly benign. 

According to the Commerce Department’s 4Q GDP report, inflation increased 1.9% in 2003, versus 1.4% in 2002.  Likewise, the Consumer Price Index rose 1.9% for the 12 months ended January.   [We can all argue about the accuracy of these government reports on inflation, but these are the figures that policymakers and the markets key on. 

BCA and others believe that so long as inflation remains around 2% or less, the Fed has the luxury of keeping interest rates at or near the current extremely low levels.   As a result, BCA believes the odds are now good that the Fed will not raise interest rates this year.

Investing – What To Do Now

As noted above, I hope you took advantage of my investment advice in the last year.  In the last 12 months, the Dow Jones climbed 34% while the S&P 500 gained 36%.  It has been an exciting bull market which began just as we attacked Iraq.  High yield bonds, which I touted during that same period, have turned in stellar results.  The average high yield bond fund gained over 23% in the last year, while most other bonds funds were disappointing.

The question is, what to do now?  If you took my advice over the last year, the answer is probably NOTHING, just stay where you are now – fully invested in equities and, to the extent suitable, high yield bonds.  If you did not take my advice in the last year, and you are still on the sidelines or are under-invested in these markets, then the answer is a bit more complicated.

Let me begin by saying while most of my best sources expect stocks and high yield bonds to continue higher this year, few if any expect these markets to match their 2003 results.  It is not out of the question, of course, as both markets could continue to surprise on the upside.  But if history is any indicator, a repeat of 2003 is probably not in the cards.  Either way, the risks are higher now than they were a year ago.

While stocks may continue to move higher for a few more months, it will not surprise me if the equity markets move into a broad trading range with a slightly upward bias late this year.  This suggests we maintain fully invested positions in equities for the time being, but realizing that returns are not likely to equal last year’s eye-popping results. 

Much the same looks to be true for high yield bonds.  With the economy on sound, non-inflationary footing for now, high yield bonds should have more potential on the upside at least in the next few months.  Yet like stocks, I would not expect to match last year’s stellar returns, and I would not be surprised to see a trading range develop in the last half of the year.   

The Case For Professional Management

Whether you have been fully invested in stocks and high yield bonds for the last year or longer as I have suggested, or if you are under-invested or sidelined in these markets, you should understand that the risks are higher now.  While the outlook for the economy remains very bright, and the outlook for interest rates and inflation remains benign, things could change.  Surprises can happen, especially in the post 9/11 world and in an election year.

All of this argues for professional management for at least a good portion of your investment portfolio.  Specifically, I mean professional Advisors that can “hedge” their positions or move to cash should market conditions change dramatically. 

Unless you are a new reader of this E-Letter, you know that my firm specializes in researching and monitoring professional money managers who use “active management” strategies.   Active management means that they can take measures to hedge (protect) their market positions if conditions change.  Or they may move partially or fully out of the market and into the safety of money market funds if need be.

In the past year in this E-Letter, I have discussed two specific money managers that I recommend – Niemann Capital Management and Capital Management Group.  Niemann is an equity mutual fund Advisor, and CMG is a high yield mutual fund Advisor.  Both had an outstanding year in 2003!  Both are off to a strong start so far in 2004 as well.

In the January 27 issue of this E-Letter, I included their actual results for 2003 along with their 3-year and 5-year average performance returns for Niemann and CMG.  To see them again, CLICK HERE.  (Past results are not necessarily indicative of future results.) 

These are just two of the professional managers we recommend.  While some managers, like Niemann, require $100,000 or more to invest, we have others who will accept as little as $25,000.  All of the professional Advisors we recommend will also manage IRAs and other types of retirement accounts.

For more details, visit our website CLICK HERE or call us at 800-348-3601.  Any of the Representatives on my staff will be happy to visit with you.  I have a strict “no pressure” policy, and your personal and financial information is strictly confidential. Our “privacy policy” is air tight. 

Very best regards, 

Gary D. Halbert

 

P.S.  For months, I have predicted that this year’s presidential election campaign would be one of the ugliest in history.  It has certainly proven to be the case.  If you have read this E-letter for a year or longer, you know that I have not been bashful about criticizing President Bush on numerous occasions when I believed it was warranted (steel tariffs, the farm bill, immigration, etc., etc.).

Yet as I have also pointed out, the “Hate Bush Crowd” is proving it will stop at nothing to ensure that Bush is banished to Crawford, Texas this fall.  The “ABB” (Anyone But Bush) movement seems to care less if his opponents have any good ideas of their own; they want Bush out at any cost to America.

Bush deserves his share of criticism, no doubt, I but would hope we will see a more honest debate now that Bush is about to take the gloves off.  The two links in Special Articles below address this issue, including the second one from an insightful liberal in Britain.

Finally, if you want to follow the media biases on the political front take a look at one of my favorite websites, the Media Research Center at www.mediaresearch.org.  Another site that offers political analysis of the media is www.spinsanity.com, but be warned that this site is often more critical of Bush than his Democratic counterparts.

SPECIAL ARTICLES

Bush-bashing – don’t read this if you are a liberal.

Dems lead the way in smear for 2004.


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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