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The Economy, The Markets & BCA’s Latest Thinking

By Gary D. Halbert
November 8, 2005


1.  The Economy – Good News & Bad News

2.  The Bank Credit Analyst’s Latest Thinking

3.  BCA Conclusions & Latest Market Advice

4.  Could The Economy Surprise Us Once Again?

5.  How To Invest In These Uncertain Times

6.  Do-It-Yourself Investors - Read This


This week, we look at the latest economic reports, including the surprising report on 3Q GDP and the continued plunge in consumer confidence.  Next, I summarize the latest forecasts from The Bank Credit Analyst, along with their latest thinking on stocks and bonds.  From there, I ponder some new studies on whether retailers will have a “Blue Christmas” or happy holidays.  We end up with my advice on what to do in these very difficult markets.

The Economy – Good News & Bad News

Economic news of late has been mixed.  The best news is that the first estimate of 3Q Gross Domestic Product came in at an annual rate of +3.8%, well above the pre-report consensus of 3.5%.  2Q GDP was 3.3%.  3Q Consumer spending increased 3.9% over the 2Q, despite the hurricanes.  The unemployment rate fell to 5.0% in October.  So, the economy held up better than most analysts expected in the 3Q, despite the hurricanes. 

While there is plenty of anecdotal evidence that the housing bubble is losing some air, it was encouraging to see that sales of new and existing homes were steady to slightly higher in September (latest data available).  Personal income rose 1.7% in September, and consumer spending increased 0.5% in September as well.  The ISM manufacturing index rose to the highest level in a year in September, but edged slightly lower in October.  That’s about where the good news ends.

At the top of the bad news list, the consumer confidence indicators worsened again in October, when most analysts had expected at least a modest bounce in confidence following the huge plunge in September.  However, the Conference Board’s Consumer Confidence Index fell further in October, as did the University of Michigan’s Consumer Sentiment Index.  In the Conference Board’s latest consumer survey, only 23.8% of respondents described business conditions as “good.”

The much-watched Index of Leading Economic Indicators (LEI) fell sharply in September, down 0.7%, thus marking the third consecutive monthly decline .  The Conference Board’s CEO Confidence Index fell from 55 to only 50 in the 3Q, which is the lowest reading in four years.  Orders for durable goods also declined another 2.7% in September.  Auto sales fell 14% in October.

While the “advance” GDP estimate of 3.8% is encouraging, there is still little doubt that the economy will slow down in the 4Q and the 1Q of 2006.  The question is, how much?  The more optimistic estimates put 4Q GDP in the 3.0-3.2% range.  The more pessimistic estimates put 4Q GDP in the 2.0-2.5% range.  

The Bank Credit Analyst’s Latest Thinking

Martin Barnes and his fellow editors at BCA have a similar view of the economy over the next 2-3 quarters.  They say:

“. . . the pace of the U.S. economy is set to weaken for two or three quarters, led by a consumer retrenchment.  A mid-cycle slowdown is in the cards, rather than a recession, because the corporate sector is in excellent financial shape, and, as noted above, there is no need for severe monetary restraint. Nonetheless, the economy should be soft enough to cause a downgrading of current overly optimistic corporate earnings expectations, creating a headwind for the equity market.”

As noted in the quotation above, the editors at BCA do not believe the US economy will experience a recession in the next year, barring any major negative surprises.  Instead, they expect 2-3 quarters when economic growth will be “below trend” (BCA-speak for below 3%).  Following that, they expect the economy to rebound in the second half of next year.

Inflation is on the rise, and this is becoming a big concern among economists and investors.  The Consumer Price Index rose 1.2% in September, and has jumped to 4.7% above the level it was one year ago, largely due to the explosion in energy and related prices.  However, the “core rate” of inflation – CPI minus food and energy – is at 2% currently, and this is the index the Fed is said to watch most closely when setting monetary policy.

Many pundits and financial analysts (and the gloom-and-doom crowd, as always) are warning of much higher inflation to come.  Yet BCA has a different view, despite continued high energy prices.  BCA’s view is that inflation will be LOWER, not higher, a year from now.  Here is their thinking.

Obviously, soaring energy prices have pushed up the CPI; however, we have not seen a similar spike in other consumer goods sectors.  And in fact, high energy prices have made many consumers cut back on other purchases, thus keeping the core inflation rate near 2%.

BCA offers several main reasons why inflation in the US is not about to soar higher, despite higher energy prices.  First, competitive pressures abroad will continue to keep prices for globally traded goods relatively low.   According to US import statistics, prices for imports coming from Asia and China are still falling overall.

Second, the investment technology revolution is still unfolding.  While prices for computers and software are not falling as they did over the past two decades, continued advances in technology help companies boost productivity, reduce costs and thereby absorb much of the increased cost of energy.  Corporate profit margins have hit a post-WWII high, despite the spike in oil prices.

Third, one of the largest factors affecting the inflation rate is labor costs.  BCA points out that wage increases have not kept pace with the inflation rate over the last two years.  Furthermore, in today’s very competitive global market, labor has little bargaining power for higher wages.  Thus, the labor component of the inflation rate is not in a position to rise significantly.

Fourth, while BCA remains bullish on energy prices over the long-run, they believe that oil and gasoline prices will continue to fall over the next 6-12 months or so. 

Fifth, BCA expects the Fed to continue raising short-term rates two or three more times, which will continue to keep a lid on inflation.

And lastly, BCA believes that the global war on inflation over the last 20-25 years has largely succeeded in eliminating the “inflationary psychology” of companies around the world.  BCA contends that when companies are faced with higher costs, they now first look to boost efficiency internally, rather than automatically raise prices.

While the University of Michigan consumer survey has shown a big spike up in inflation expectations over the last two months, BCA believes – for the reasons cited above and others – that inflation will actually be lower a year from now.  This may explain why the rise in gold prices has stalled in the $460-$480 range recently.  It may also explain why bonds have not broken out of their two-year trading range to the downside.

BCA Conclusions & Latest Market Advice

In summary, BCA expects 2-3 quarters of “below trend” growth in the economy, with GDP in the 2-3% range, and no recession, barring some major negative surprises.  They expect the Fed to continue its inflation fighting policy with 2-3 more quarter-point hikes in the Fed Funds rate, and then go to a neutral policy early next year under new Fed chairman Ben Bernanke.  The BCA editors expect the US economy to strengthen again in the second half of 2006.

As for the investment markets, BCA is not optimistic about the equity markets.  This is not surprising given their outlook for an economic slowdown over the next 2-3 quarters, and the continued rise in short-term interest rates.  Most notable, however, BCA believes that earnings forecasts for 2006 are significantly overstated.  They say:

“Analysts are rashly assuming that nothing will harm corporate profitability, and that is bound to lead to disappointment.  The bottom-up consensus of analysts’ projections implies that S&P 500 operating earnings will rise by 12.4% in 2006, only slightly down from this year’s expected growth of 14.8%.  Our earnings model paints a very different picture, with earnings growth expected to slow to around zero [in 2006].  The trend in the leading economic indicator also supports the case for slower earnings growth.” [Emphasis added, GH.]

This is a significant departure from the current thinking on Wall Street.  If BCA is correct that we face a major contraction in corporate earnings next year, the equity markets are almost certain to move lower.  BCA is NOT predicting a new bear market in equities, but they do believe that stock prices in general will move somewhat lower over the next several months.  As a result, BCA continues to recommend below-average positions in equities.

While BCA remains long-term bullish on stocks, they believe there will definitely be a better (cheaper) opportunity to move back to a fully-invested position in equities over the next few months.  This suggests that, at the least, the Dow Jones will move back to the low end of the two-year trading range (9,700-10,900) or lower.  If so, the S&P 500 would do likewise (1,160-1,240) or lower.

As for bonds, the BCA editors believe that medium and long-term rates will remain in the trading range of the last two years.  While most analysts are predicting that yields on the 10-year Treasury Note will rise to at least 5% from the current level of 4.5% - due to inflationary expectations – BCA believes that the 10-year Note will remain in the recent trading range of 4%-4.6%.  In short, they believe that bonds will be a “boring asset class” in the next 3-6 months.

To subscribe to The Bank Credit Analyst, go to - I highly recommend it!

Could The Economy Surprise Us Once Again?

I have been a continuous subscriber to The Bank Credit Analyst for the last 28 years.  Over that time, I have found BCA to be the most accurate forecaster of major economic trends, major inflation trends and major market trends of any source I have found.  But BCA is not perfect, and forecasting short to medium-term trends is very difficult for all analysts.

The current situation is indeed complicated, what with soaring energy prices and three national disasters (Katrina, Rita and Wilma).  Immediately after Katrina and Rita, many analysts predicted that a recession would follow.  Likewise, many analysts predicted that stocks would plunge and interest rates would soar.  The gold bugs were ecstatic.

Yet the fact is, the economy and the markets have held up much better than initially expected in the wake of $70 oil and three devastating hurricanes.  Could it be that the next 3-6 months will not be as bad as expected?

I must admit that the economy and the markets have held up much better than I expected after Hurricane Rita in late September.  The 3.8% increase in 3Q GDP was a big surprise, as discussed above.  The US economy is extremely resilient, despite our massive trade and budget deficits and the zero savings rate among Americans.  The US economy has consistently surprised on the upside for over two decades now. 

While there will no doubt be a painful time of reckoning for our deficits and pitiful savings rate sometime in the next few years (ie – a severe recession or worse), there is a chance that the next 3-6 months will not be as bad as we expect, especially if oil and gasoline prices continue to fall.

While I have predicted a disappointing holiday shopping season for retailers, several new studies suggest just the opposite.  The National Federation of Retailers projects that holiday retail sales will rise 5% this year, as compared with a 6.7% increase in 2004. 

Two independent economic research firms – Jupiter Research and Forrester Research – project that holiday sales on the Internet will jump by 18% to 25%, respectively, this year, despite the hurricanes and high gasoline and heating oil prices.  Keep in mind that more and more people are getting comfortable shopping on the Internet every day, so these numbers may not be a good barometer of consumer spending habits for the holidays.

Are these forecasts too rosy?  I think so, especially with consumer confidence in the tank and a negative savings rate.  But the point is, the economy may not weaken as much as we expect over the next 3-6 months.  This assumes, of course, that there are no major negative surprises, terrorist attacks, etc.

How To Invest In These Uncertain Times

If you have read my latest Special Report on “ABSOLUTE RETURNS,” you know that I believe there are two critical issues when it comes to investing, especially in the trading range markets we find ourselves in today:

First is AVOIDING LARGE LOSSES by using active management strategies that can “hedge” or move to cash in downward market trends. Second is seeking ABSOLUTE RETURNS by using strategies and programs that have the potential to do well in up or down markets

If you study the stock markets at all, you are no doubt aware that return expectations have come down significantly over the last couple of years.  Even most bullish forecasters have come to the conclusion that equity prices, as measured by the S&P 500 Index, will not live up to the Index’s historical average annual return of just under 11%.

More and more stock market analysts are now predicting that the S&P 500 will average only 5-7% annually at best over the next 10 years or longer.  The Bank Credit Analyst has been saying this for over a year now.

Yet what many investors do not realize is that while average upside returns will likely be lower over the next 10 years, the downside risks are still as large as ever.  I’m not predicting that the S&P 500 is going to plummet 44% as it did in 2000-2002 (although it can’t be ruled out), but I fully expect we will see some declines of 25% or more over the next decade.

If you’re only making 5-7% on average in the good times, you absolutely need to protect your downside in the bad times.

All of the active management strategies that I recommend have capital preservation at their core.  They have built-in systems to “hedge” during market downturns, or move partially or fully to cash (money market) if market conditions so dictate.

The goal of the programs and the Investment Advisors I recommend is to generally deliver market rates of returns in the good times, and lose half or less what the market does in the bad times.

While past performance is not necessarily indicative of future results, the programs I recommend have been quite successful in limiting losses during the bad times in the stock markets.  You can CLICK HERE to view the programs and Advisors I recommend and their past performance records.  Pay particular attention to their “drawdowns” (losing periods) as compared to the losses in the broad market indices.

Do-It-Yourself Investors: Read This

In our READER SURVEY which we sent on September 27, we asked why you haven’t invested with us.  One of the highest responses was, “I manage my investments myself.”  Frankly, we were surprised at how many of you handle all of your own investments, especially given that we had a bear market in stocks during 2000-2002, a modest recovery in 2003, and we’ve been in a generally sideways market ever since.

Likewise, the bond market has been in a generally sideways trading range since mid-2003.

Almost all of the prospective clients I talk to, who do their own investment management, are at this point very frustrated.  Most admit that they lost a lot of money in the equity bear market of 2000-2002 when the S&P 500 Index fell 44%.

More often than not, prospective clients tell me that they actually bailed out of the stock market near the end of the bear market in late 2002 and have never gotten back in.  They missed the recovery in 2003.  These folks are very frustrated!

For these reasons and others, more and more investors are looking for professionals to manage a portion of their portfolios.  More and more investors are embracing active management strategies, such as those I recommend, specifically because: 1) they don’t know how long the markets will remain in these broad trading ranges; and 2) they want the potential for limited losses during down periods in the markets.

If any of the above observations relate to you, maybe it’s time to check out the professional Advisors I recommend.

Aside from being surprised at the number of investors handling their own portfolios, I was also surprised that this was listed as a reason for not investigating any of the actively managed programs I recommend.  Based on many of the responses, a fairly large number of readers assume that I want you to turn over ALL of your money to my care and that of the Advisors I recommend.  This is hardly the case.

In fact, most of my clients would probably consider themselves “do-it-yourselfers,” in that they determine all of the investments that go into their portfolio, and they have only a portion of their investment portfolio with my company and the Advisors I recommend.  Many continue to manage a portion of their portfolio themselves; many have money in selected mutual funds and the like; and many still have money at brokerage firms.

The use of different approaches to the market goes hand-in-hand with my long-held belief that investors should diversify among investment strategies the same way they do in different asset classes .  These strategies can include active management, asset allocation, sector rotation, fundamental analysis (value investing), alternative investments, managed futures and real estate, among others.

Since no one financial services firm offers the best of all investment strategies, it just makes sense -- for even a do-it-yourselfer -- to include professional managers for different strategies within your overall portfolio.

I think, perhaps, my discussion of professional management left the impression that all investors should turn over their entire portfolios to my company to be allocated among the Investment Advisors I recommend.  That was not my intent.  I’m not aware of any client who has all of his/her money with us, nor should they.  However, I do believe that the portion of an investor’s portfolio which is allocated to active management strategies should always be professionally managed.

Another reason I recommend professional management is that in almost all cases, active management strategies require daily monitoring of the market and the ability to execute a trade on any given day.  Most investors I know don’t have the time, expertise or desire to take this on.  Most investors have better things to do with their time, whether that be in their primary occupation or spending time with family and friends.

In addition, individual investors often let emotions override their trading methodology, and this can result in being whipsawed by the market.  Successful active managers take the emotion and guesswork out of the trading and hedging techniques by way of their time-tested systems. 

The programs I recommend are for those investors who want proven professional Investment Advisors making the decisions on: 1) when to be in the market; 2) which sectors to be in at any given time; 3) which mutual funds to own; and 4) most importantly, when to be “hedged” or out of the market in the safety of cash (partially or fully). 

That’s precisely why I have the bulk of my own personal investments allocated to active management strategies managed by professionals.  Thus, even if you are a die-hard “do-it-yourselfer,” I encourage you to check out the active management programs available through my AdvisorLink ® program, if for no other reason than added diversification.

We have several recommended Advisors that specialize in equities only, and others who specialize in bonds only.  Several of the Advisors have multiple strategies that they employ.  Minimum account requirements vary from as little as $15,000 up to $100,000.

To access these recommended Advisors, you establish your own accounts at well-known custodians (trust companies or mutual fund families).  You receive regular account statements.  For do-it-yourselfers (or anyone), you can access your account daily on the Internet to see your balances and even the positions in the accounts, if you so choose.

In addition to complete transparency, you also have daily liquidity.  On any given weekday, you can call my company, or the Advisor directly, and your account can be closed out generally the same day, or the next day. 

A Manager Of Managers – “MOM”

My company is what is known as a “Manager of Managers” (MOM).  We specialize in finding successful money managers and introducing clients to them.  Each year, we spend a lot of money attending conferences and seminars where professional money managers gather.  We subscribe to several services that track large numbers of professional money managers.  We are constantly searching for successful money managers.

Before we recommend any money manager, we conduct a “due diligence ” visit to their offices.  We meet personally with the manager; we have him/her explain to us in detail just how his/her system works; and we meet the key people on the staff.

Most importantly, we look at randomly selected customer accounts to see if the performance record the manager is claiming actually is similar to the performance in actual customer accounts.  Only if everything meets with our approval do we then recommend the Advisor to our clients.

Before any client opens an account with one of our recommended Advisors, I open my own personal account.  I have my own money invested in every program we recommend.  In fact, the bulk of my net worth is invested in these programs.  This comes in handy in terms of tracking the Advisor’s performance on a daily basis.

You are probably wondering how my company gets paid in this arrangement.  Most professional money managers are willing to share a portion of their management fees with my company in return for introducing clients and maintaining the client relationship.  Typically, they share one-third to one-half of their annual management fee with us.

In summary, I think most investors should consider active management strategies, especially in these uncertain markets we face today.  I believe most investors should have some of their money with professional, time-tested managers who have the flexibility to hedge or move partially or fully to cash as the markets dictate.

If you want more information, CLICK HERE to get started.  I believe you’ll be glad you did.

[One last note: whenever I promote our own investment products and services in this E-Letter, I inevitably get complaints from a small group of readers who criticize me, and insist that I stick only to economic or general investment topics.  For those of you in this group, keep in mind: 1) that this E-Letter is free of charge; 2) that I spend hours every week researching and writing the articles; and 3) that if it were not for the success of my investment business, this E-Letter would not exist.  So I will continue to mention our investment programs and services periodically.]

Best regards,

Gary D. Halbert


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, 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, Halbert Wealth Management, 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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