Special Update #16

IN THIS ISSUE:

1. The Economy - More Signs of Recovery

2. The Latest from The Bank Credit Analyst

3. Three Scenarios for What Lies Ahead

4. Enron - Bush/Cheney & the Media;

Terry McAuliffe's Enron

5. Terrorists Profit from Stock Decline?

IS THE ECONOMY TURNING AROUND?

I believe the answer is YES. Economic reports released so far in January have been mostly positive. Although these reports are for the month of December, they are the most current info we have.

The most encouraging news we have is the Conference Board's Index of Leading Economic Indicators (LEI) which rose for a third consecutive month in December. The LEI rose by 1.2% in December following +0.8% in Nov and 0.1% in Oct. The gain in December was the largest monthly increase since February 1996, with 8 of the 10 indicators in positive territory.

Next, the Conference Board's Consumer Confidence Index rose again in January to 97.3 versus 94.6 in Dec and 84.9 in Nov. These numbers explain why retail sales were surprisingly stronger than expected in December. Salomon Brothers/Smith Barney's index of the 50 largest retailers rose by 4.5% in December. While holiday sales started slowly, shoppers became more confident and the result was surprisingly positive.

Most analysts agree that the manufacturing sector has been among the areas hardest hit in this recession, and that it will be one of the last to rebound. However, in December the Institute of Supply Management reported that its Manufacturing Index rose for the first time since the recession began. The index climbed to 48.2 in December, versus 44.5 in Nov. The Commerce Department announced late yesterday that durable goods orders rose 2% in December, another piece of good news for the manufacturing sector.

Spurred by low mortgage rates, Americans pushed sales of new homes up by 5.7 percent in December. That helped to make 2001 the best year on record for home sales, even as the country suffered through a recession. Sales of existing homes also set an all-time record in 2001, 5.25 million homes sold. The average existing home price rose by 6.5% in 2001 to $190,100.

Those are the highlights from the good news department. The bad news was that unemployment continued to rise in December to 5.8%, up from 5.6% in Nov. This was expected and most analysts expect the unemployment rate to reach at least 6% before this recession is over. The other bad news is that consumer debt levels are even worse after the better than expected holiday spending.

GREENSPAN SOUNDS ENCOURAGING

The release of the economic reports noted above, and others, apparently has made the Fed chairman more optimistic that the economy is turning the corner than he was earlier in the month. In testimony before the Senate Banking Committee last week, Greenspan said he is now more optimistic that the worst is behind us. While he stopped short of predicting a strong rebound, he did hint that the economy may not need any more interest rate cuts, or a further stimulus package from Congress.

The Fed Open Market Committee (FOMC) meets this week to decide whether to cut rates an unprecedented 12th time, or to leave them unchanged for now. Based on Greenspan's latest remarks, most analysts expect the FOMC to leave rates unchanged.

BCA REMAINS POSITIVE

In Special Update #13 (and in my January newsletter), I gave you The BANK CREDIT ANALYST'S forecasts for 2002. If you recall, BCA predicted that the recession would be over by mid-year, and that stocks would outperform bonds in 2002. However, the BCA editors voiced some serious concerns about the record-large levels of consumer and corporate debt.

The debt problem, they opined, would cause the economic recovery to be slower than normal in 2002 and 2003. They also cautioned, that the dangerously high debt burden could be the catalyst for a much deeper recession in the future, although they did not say when.

As long-time clients will recall, back in 1995 BCA predicted a "long-term economic upwave" for the US that would last at least until 2005 and maybe even longer. Yet upon reading the 60+ pages of research in their January reports, I wondered if the editors might be abandoning their optimistic long-term forecast. Having spoken with MARTIN BARNES, the Managing Editor of BCA on numerous occasions in the past, I sent him the following e-mail:

"Mr. Barnes,

We have spoken on several occasions over the years, and I have a question after reading your January issue and the Outlook 2002. In those issues, you referred to the alarming levels of public and private debt and warned that the piper will have to be paid at some point (but probably not this time around). My question is, how does this serious concern about debt levels affect your long-term economic "upwave" forecast that you first made in 1995? That forecast has been amazingly accurate, but are we nearing the end?

Thank you in advance for a response. Best wishes for continued success!

Gary Halbert"

Here was his response:

"Hi Gary:

Thanks for the message. I will be updating my long wave views in detail at some point in the next few months. The fact that productivity growth has held up well this cycle and that the recession is turning out to be mild imply that the long-wave upturn is still intact. Debt may become a problem at some point, but indicators of financial stress still seem OK.

Regards,

Martin"

As you can see, even in the brief response, BCA now feels that: 1) the recession is even milder than they had anticipated back in late September and October; 2) that the economy is turning around now; and 3) that the long-term economic outlook is still positive.

Let me expound on that a little. When BCA first made its long-term forecast back in 1995, the editors warned that while the US economy would be generally strong for the next decade, they also cautioned that there would almost certainly be a mild recession or two along the way.

The US economy really began this slowdown in the last half of 2000. Gross Domestic Product (GDP) growth slowed to only 1.3% and 1.9% (annual rate), respectively, in the 3Q and 4Q of 2000. In 1Q 2001, growth slowed to 1.3%; in 2Q 2001, it slowed to only 0.3%; and in the 3Q, GDP went negative for the first time at -1.3%. Most analysts now expect the 4Q GDP number to be in the range of -1.5 to -2.0%.

The point is, the US economy was already slowing down dramatically from the go-go years of the late 90s. The events of September 11th, however, turned what had been a rather normal, cyclical slowdown into a real recession. Yet even with the tragic events of 911, and their enormous effects on many parts of the economy, the current recession may prove to be no worse than the 1990-91 recession.

THREE SCENARIOS

As you have probably seen, everyone in the economic forecasting business and the market predicting game has put out their forecasts for the new year. They basically fall in to three camps.

The first is the gloom-and-doom crowd. Because my name is on so many mailing lists (due to subscribing to so many publications over the years), I get a ton of unwanted stuff from the gloom-and-doom crowd. If you don't, consider yourself LUCKY!

[By the way, I have NEVER rented, traded or in any way shared the names of my clients, my newsletter subscribers, or those who receive these Updates. If you receive a lot of junk mail, it's not because of me; it's due to other publications selling your name.]

Fortunately, you don't have to read the gloom-and-doomers because they almost NEVER CHANGE. There's always a recession just around the corner. If we're in a recession, it's going to turn into a depression. Throughout the 80s and 90s, they predicted a huge bear market in stocks, which means those who followed their advice missed out on the greatest bull market in history! Many lost a bundle trying to short the market as many of the doomers suggested.

Yet right now, the gloom-and-doomers are having a field-day. They promise that we are only in the early stages of the recession; a depression is coming; the Dow Jones will be below (maybe much below) 5,000 a year from now; etc. The ONLY thing that will save you and your assets is whatever THEY ARE SELLING! Often it is precious metals or coins, which have been terrible investments for the last 20 years, or some "super-secret" short-selling strategy for stocks, which was a disaster until only recently.

The next camp I will simply call the "optimists." While not nearly as animated as the gloom-and-doom crowd, the optimists tend to always be positive. They typically do not anticipate economic slowdowns or recessions; when such slowdowns occur, they expect them to be mild and short-lived; and they are almost always bullish on the stock markets. Most people who work on Wall Street, or are in the investment business, tend to be in this camp, as are most of the talking heads on the financial channels. For most of these folks, there's never a bad time to buy stocks!

Only over the last couple of months have I noticed a third camp emerging, and I don't know what to call them. This group tends to have the following outlook: 1) yes, the recession is going to end in a few months; 2) the economy will manage a couple of mildly positive quarters in the second half of the year; 3) but after that, we hit another slowdown. 2003 will see a new recession usher in, and this time the Fed will be able to stop it. It will last however long it takes to reverse the massive buildup of debt held by US consumers and corporations, which could be years. Some of those who predict deflation are in this third camp.

WHO TO BELIEVE?

Right now, BCA is in the optimists' camp. As I have written in the past, BCA has been the MOST ACCURATE source I have ever read for predicting economic trends and major trends in the investment markets. That is NOT to say they are perfect. In the past 25 years that I have read BCA, they have at times been a bit early or late with their predictions (but not often). Most importantly, they have been correct on all of the major turns in the economy since I became a subscriber in 1977.

As noted above and in Special Update #13, BCA believes the economy is turning the corner and will be in positive territory around mid-year. Again, they could be a little early, or late, as to the exact timing, but they believe we will see a modest economic rebound in the second half of the year and on into 2003.

They also believe the stock markets will trend generally higher over the next year or longer, but they recommend that investors stay away from most of the high-tech sectors that were hammered over the last two years (and which have been way too strong recently). While they do believe the stock markets will move generally higher, they caution that it will almost certainly be a bumpy ride. As a result, they suggest that investors consider market timing strategies that move them partly (or fully) out of the markets, and into cash (money market fund) if conditions warrant. Unfortunately, most investors are not very good at doing this.

In their February and/or March issues, I expect BCA to address more specifically how they now view their long-term forecast. When they do, I will pass that information immediately along to you.

THE CAVEAT

While I expect BCA's forecast to once again prove correct, there is one caveat that we are all aware of. That would be further terrorist attacks on the United States. Another major attack would throw the optimistic forecasts out the window again, at least temporarily.

THE ENRON DEBACLE - ARE BUSH & CHENEY

HIDING SOMETHING OR STANDING ON PRINCIPAL?

The Enron collapse has dominated the news for the last several weeks, thanks to the liberal media. As a result, I will not spend a great deal of time on it. However, there are some interesting comparisons. As you know, the issue is the Bush administration's refusal to hand over private notes and papers regarding Vice President Cheney's various meetings with Enron executives.

Given Enron's ugly collapse, it's obvious the Bush administration didn't attempt any sort of bailout. Yet the media howls on and wants the public to believe it is unthinkable that the administration would claim executive privilege over these documents. I'll let you read the Wall Street Journal editorial below for the details on why the Bush administration is taking the position they have.

What I would like to point out, however, is that the mainstream media NEVER cried fowl when the Clinton administration withheld evidence and claimed executive privilege repeatedly during his 8 years in office.

Actually, I expect the Enron/Cheney story to fade away pretty quickly. With each passing day we learn that Enron gave money to more and more Democrats, as well as Republicans.

Then late yesterday we learned that DNC chairman Terry McAuliffe turned a stock investment of $100,000 into $18 MILLION, yet the company he invested in went bankrupt on Monday. GLOBAL CROSSING became the 4th largest bankruptcy in US history this week. Shortly after McAuliffe made his huge windfall in the stock, he arranged to have Global Crossing's CEO Gary Winnick play golf with Bill Clinton in 1999. Winnick then gave $1 million for the building of the Clinton library. Yet McAuliffe has been critical of the Bush administration's handling of the Enron matter. Interestingly, McAuliffe has been silent since the news broke on his Global Crossing affair!

DID TERRORISTS PROFIT

FROM THE 911 ATTACKS?

You may remember there was speculation that terrorist groups may have reaped huge profits in stock options ("puts" which make money if the market goes down) in the wake of 911. It was initially reported that there was a large increase in option activity (puts in particular) in a variety of stocks just prior to 911. Obviously, these put options exploded in value when the stock markets plunged in September.

Shortly after 911, investigations were launched by the SEC, the FBI, US Customs and regulators at all of the world's large securities exchanges. I have not seen any information on the investigation, deemed "Operation Green Quest," until today. On page 20 of the latest BARRON'S (January 28) there is a story by Erin Arvedlund. Arvedlund quotes sources at the FBI and elsewhere who state that none of the suspicious options trades prior to 911 have been traced to any terrorist groups. Most of the really large trades, he says, have been traced back to institutional customers that were all "legit."

This issue may be far from over, however. The SEC declined to comment for the Barron's article. The US options exchanges were tight lipped as well, stating only that they are turning over any evidence they have to the SEC. I'll let you know if any more comes of this story.

SUPER BOWL SUNDAY

Here's a little info for you, even if you aren't a football fan. The game is this Sunday on FOX. According to the Wall Street Journal, a 30-second ad during the Super Bowl will cost most advertisers $1.9 million this year. Since a few spots are still unsold, that number could dip slightly later in the week. This year's price compares with $2 million in 2001 and $2.2 million in 2000. While the price is down a bit, it is another suggestion that the economy is not all that bad.

Since I don't have a team in the hunt on Sunday, let me wish good luck to whichever team you are pulling for! I just hope it's not a blowout.

That's all for today.

All the best,

Gary Halbert

SPECIAL ARTICLES

Greenspan: Economy on the rebound.

Bush/Cheney stand on Enron - why they're right.

Measuring W. after one year.

Russian oil to flood market, sabotage OPEC cuts. (You heard it here first.)