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December 2002 Issue
The economy grew even
faster than expected in the 3Q. The Commerce Department reported that GDP
rose at an annual rate of 4.0% in the 3Q, up from its previous estimate of
3.1%. Most of the other economic news was positive last month as well.
However, on December 6, the government reported that unemployment jumped back
up to 6% in November. This is typical of an economy that is recovering slowly
with ups and downs along the way.
The Bank Credit
Analyst has
released its forecasts for the next year. They are more optimistic now than
they have been in several months. They now believe the Fed is taking the
deflationary threat seriously enough, and they believe Greenspan will do
everything in his power to keep deflation at bay. They also expect more
fiscal stimulus from the Bush administration early next year. All of this
should be good for the economy, but BCA still expects only slow growth next
year. More details inside.
Stocks rallied for
eight consecutive weeks, before closing slightly lower in the first week of
December. The S&P 500 gained apprx. 20% and the Nasdaq over 30% from their
October lows. BCA recommends adding to equity positions on setbacks just
ahead, but they advise doing so only using “market-timing” strategies.
Icontinue to recommend Neimann, Potomac and Hallman &McQuinn -
all of which are market-timers - for your equity portfolio. They have
all beaten the market significantly this year.
Bonds have taken it on
the chin over the last few weeks as interest rates inched higher. BCA
continues to recommend below average holdings of bonds, especially Treasury
bonds. Despite the recent shake-up in bonds, Capital Management Group
, our high-yield bond timing Advisor, is up almost 9% this year in their
unleveraged program. I continue to highly recommend CMG for your bond
holdings.
I have prepared a new
SPECIALREPORT on Market-Timing. In the new 12-page Report, I discuss
the basic methodologies behind market-timing, ways you can use market-timing
and the market-timing strategies I prefer. You can get the Report at
www.profutures.com or call 800-348-3601.
[Editor’s Note
: This summary
of BCA’s latest forecasts is a repeat of the information contained in my
Forecasts &Trends E-Letter dated December 3. Since not all of our
clients read the weekly E-Letters, I am including BCA’s latest thinking in the
next several pages. If you have already read this, you may want to skip to
page 5.]
Introduction
In 1977, one of the
smartest clients I've ever had introduced me to a research publication called
The Bank Credit Analyst (BCA) www.bcaresearch.com. BCA is a Canadian
research firm which publishes forecasts on the US and global economy, the
stock markets, interest rates and bonds, the US dollar and other major
currencies, gold and periodically real estate. Over the last 25
years, I have found BCA to be the most accurate of all the sources I follow
when it comes to predicting major turns in the economy and the investment
markets. That is why I have been a continuous subscriber since 1977, even
though their research is quite expensive.
BCA's original monthly
research report (apprx. 40-50 pages) costs $995 per year. BCA offers
over a dozen other publications, ranging from monthly to weekly to even daily,
and the cost to subscribe to all of their regular services is over $10,000
per year. Despite the cost, for the last 25 years I have kept my clients
abreast of BCA's latest thinking and forecasts in my monthly Forecasts &
Trends newsletter and more recently, in these weekly F&T
E-Letters.
BCA caters to large,
sophisticated investors and institutions. As such, they assume that their
clients and subscribers are always invested in US stocks and bonds, as well as
other investments from time to time. As a result, they have only three
investment positions in stocks and bonds: “above average”
holdings, “average” holdings or “below average”
holdings. They assume that most investors have “core”
holdings of stocks and bonds that they never sell. This is true of most
large investors and institutions. A portion of their assets is essentially in
a buy-and-hold mode, while another portion may be switched from one asset
class to another as market trends dictate.
In this issue, we look
at BCA's latest forecasts provided in their early December publications.
While BCA has been the most accurate research source I have followed over the
years, when it comes to calling major turns in the economy and the markets,
they are not perfect. With that caveat said, here is their latest thinking.
BCA's Prior Forecasts
For the benefit of our
many newer subscribers who may not be familiar with BCA, let me quickly
summarize their forecasts and investment recommendations over the last couple
of years to bring us up to the present. BCA predicted the economic slowdown
that has been upon us since mid-2000. Yet unlike the gloom-and-doom
crowd, BCA did not expect the economic slowdown to turn into a severe
recession. Even after the terrorist attacks of September 11, the BCA
editors did not believe the US economy was headed into a severe recession. In
fact, quickly after 911, the BCA editors suggested that the US economy might
surprise on the upside. It has.
BCA has recommended
below average holdings of US equities consistently over the last couple of
years. They were among those that warned in 2000 that the Nasdaq was a
bubble waiting to be burst. During that same period and up until the middle
of this year, BCA recommended above average holdings of bonds. In
June of this year, BCA recommended that investors move from above average
holdings of bonds to below average holdings. They particularly warned
that Treasury bond yields could be near a bottom and recommended that
investors switch from Treasuries to high-quality corporate bonds for core
holdings. This latest call on bonds was arguably a few months early, but bond
investors have certainly taken some hits in the last several months.
Also since the middle
of this year, BCA has been warning that US monetary authorities were not
taking sufficient actions to head-off growing deflationary pressures.
They warned repeatedly that the Fed needed to cut interest rates further, or
else global deflation could spread to the US. They actually called on the Fed
to cut interest rates by 50 basis-points at the November FOMC meeting. It is
believed that several of the Fed governors (and perhaps even Alan Greenspan)
read BCA regularly, and it appears they took BCA's advice when the Fed Funds
rate was slashed 50 basis-points last month.
With that bit of
background out of the way, let's now see what BCA believes is ahead for the US
economy and the major investment markets.
BCA's Latest Thinking
I am pleased to report
that the BCA editors had a more positive tone in their latest publications.
While the editors did not categorically rule out a second recession earlier
this year, they never believed it was the most likely outcome. Rather, they
believed that the US economy would manage to stay in positive territory with
slow growth throughout the year. That has proven to be the case. Now, they
expect the moderate recovery to continue over the next year. They say:
“A double-dip
recession in the U.S. was never the most likely scenario, and recent data
suggest that the odds [of a recession] have dimmed even further. The Federal
Reserve's aggressive pump-priming is sustaining buoyant housing activity, the
corporate sector continues to gradually heal, the labor market is showing
tentative signs of improvement and our estimates point to a rise in the
composite leading indicators in November. Meanwhile, the Republican sweep in
the mid-term elections clears the way for additional fiscal stimulus next year.
The big issue for
the U.S. economy in recent months has been whether or not the consumer would
run out of steam before the corporate sector was ready to start spending.
Recent data support a moderately positive view.”
Specifically, BCA
believes that unemployment may have peaked and will begin to decline slowly.
They also believe that the housing market will remain stable to buoyant and is
not a bubble about to burst. They believe that the worst of the corporate
retrenchment has been seen, and that companies will slowly begin to increase
investment spending. Their proprietary advance indicators suggest a
significant rise in the Index of Leading Economic Indicators for November.
That report will be released on December 19.
While the BCA editors
were more positive in their latest reports, they are not expecting a robust
economic recovery over the next year. In fact, they believe it will be a
slow, “sub-par” recovery, meaning that GDP growth will
likely be in the 2-3% annual range in the next year.
Deflation Is Still A
Concern
As noted above, the BCA
editors have repeatedly warned US monetary authorities to pay close attention
to the deflationary threat over the past several months. They cautioned that
if deflationary forces were to set in, they would be very hard to reverse, as
has been the case in Japan for a decade.
In their latest issue,
the BCA editors say they believe Alan Greenspan and a majority of the Fed
governors have gotten the message on deflation, and that they will not
hesitate to slash rates further - even to zero if necessary - to prevent a
deflationary trend. While most market analysts predict that interest
rates will be higher a year from now, BCA predicts that the Fed Funds rate a
year from now will be either the same as today, or lower.
Alan Greenspan actually
said recently that the Fed would even resort to buying up longer-dated
Treasury securities if needed to get the economy growing and stave-off
deflation. For now at least, the BCA editors seem to believe that the
deflationary threat in the US has subsided somewhat. Of course, this assumes
there are no more major terrorist attacks in the US; if that were to occur,
then all bets are off.
Time To Increase
Equity Positions
Probably a surprise to
most of their subscribers, the BCA editors recommended moving from below
average to average holdings of stocks and equity mutual funds in their
early December issue. However, rather than jumping in the market immediately,
or all at once, the editors suggest buying on weakness during the days and
weeks ahead.
The S&P 500 has gained
apprx. 20% from its October low, while the Nasdaq is up apprx. 33% in the same
period. There have been three previous rally attempts since the markets
peaked in 2000. Each time, the rallies failed when the S&P gained apprx.
20%. While they do believe there will be some corrections (downward price
movements) just ahead, the BCA editors believe that stocks have bottomed, and
that the current uptrend will be sustained this time around. They say:
“All of the above
trends suggest that the current equity market is on sounder foundations than
it was back in July/August. Another encouraging development is that the
NASDAQ has closed above the key resistance level of around 1420.
The combination of
improving economic data and more positive market signals suggest that downside
risks in equities have diminished. They have not disappeared altogether, but
a neutral [average] rather than underweight [below average] stance can now be
justified.”
Let me be perfectly
clear here. The BCA editors are NOT predicting a huge new bull market in
stocks and equity mutual funds just ahead. Rather, they are simply saying
that they believe the equity markets bottomed in October, and this warrants
increasing positions from below average to average. Specifically, they say:
“A new secular
bull market in stocks is not about to begin. More likely, the market will
churn about within a broad trading range as valuations gradually compress.
The market is no longer expensive and there is plenty of cash sitting on the
sidelines.
As we have
discussed in the past, the buy-and-hold era in the stock market has ended.
Average returns from stocks will likely be mediocre in the years ahead, and
the only way to generate excess returns will be to play the cycles. The
current cycle should be one worth playing, and we recommend using periods of
weakness to build positions back to neutral [average] levels.”
Let me clarify what
that last paragraph means. As stated earlier, BCA assumes that investors have
“core” holdings in both stocks and bonds that they never, or rarely, sell.
That is a buy-and-hold approach. (In a future issue, I will discuss
professional asset allocation strategies specifically for such core holdings.)
What BCA is saying
above is that the days of putting most of your money into an “index fund,”
like the hugely popular Vanguard S&P 500 Index Fund, and hoping to make 15-20%
or more a year, are OVER.
Specifically what
BCA is saying is that to generate attractive returns in stocks over the next
few years, it will be necessary to have a portion of your equity portfolio
that moves into and out of the market from time to time.
This Is Called
MARKET-TIMING
For years, Wall Street
types, Investment Advisors and talking heads on financial programs said
buy-and-hold was the only way to invest in stocks. They said market-timing
didn't work. Well, that was then and this is now! Ever since
the mid-1990s, I have been advising my clients to have a portion of their
equity portfolio in market-timing programs. Now even BCA, which advises
some of the most sophisticated investors in the world, agrees with me.
Conclusions
BCA expects the
economic recovery to continue with GDP growth of 2-3% in 2003, assuming there
are no more major terrorist attacks. They expect the Fed to cut rates further
in the months just ahead, in an effort to counter deflationary pressures. The
BCAeditors appear more confident than in recent months that the Fed will be
successful in heading-off deflation in the US. They believe that a
year from now, rates will still be as low as they are today, or even lower.
This is quite a departure from most mainstream forecasts which project rates
to be higher a year from now.
Despite BCA’s outlook
for rates to remain low, they continue to recommend “below average”
holdings of bonds, especially Treasury bonds. They feel there is a good
chance that T-bond yields bottomed in October.
BCA upgraded its
equity recommendation from “below average” to “average.”
They suggest that investors increase their equity holdings over the weeks
ahead by buying during periods of weakness which they expect to occur from
time to time.
BCA once again made the
case that investors should pursue market-timing strategies for most of
their equity portfolio. They believe equity returns will be muted over the
next couple of years, so to enhance returns they suggest using market-timing.
Unfortunately,
market-timing is foreign to most investors. Most investors are not good at
knowing when to get in the market or when to get out. Plus, there are lots of
different market-timing strategies and systems and dozens of professional
money management firms that employ them. Deciding which ones to use is
difficult.
A New SPECIAL REPORT
Since the stocks
markets turned sharply higher in October, we have had tons of questions and
inquiries about market-timing. A lot of people are now considering getting
back into the market or adding to their equity holdings. For that
reason, I have prepared a new 12-page SPECIAL REPORT on market-timing.
As this is written, I am putting the final touches on the new Report, and it
will be available on our website by the time you receive this newsletter. Go
to www.profutures.com and you will see the Report on our home
page.
In the new Special
Report, I walk you through the basic methodologies behind market-timing; I
discuss the various ways you can use market-timing; and I tell you the
market-timing programs that I prefer. I also help you decide if this is
something you can do on your own, or if you would be better off hiring a
professional to do it for you.
In conclusion, I agree
with BCA that the stock markets will be cyclical over the next several years.
We're not going to return to the rip-roaring, 20-30% a year markets that we
saw in the late 1990s. Reaching your retirement or other financial
goals is going to be tougher - it already is!
As a result, I highly
recommend that you begin to educate yourself about market-timing. I've done
my best to help you along with my new Special Report, which you can download
on our website www.profutures.com. Or, if you don’t use the Internet,
call us at 800-348-3601 and we will mail you a copy. The Special
Report will be available free of charge.
I continue to believe
that most investors will be more successful at market-timing if they engage
professional money managers, with proven track records, to do the
market-timing for them. Most of us are not good at doing this on our own.
We can provide you complete information on the market-timers we recommend.
Call us when you’re ready.
Consumer Debt Levels
US consumers are in
hock up to their eyeballs, so we are repeatedly told. For years we have been
told that the US consumer was tapped-out, and that spending was about to fall
off a cliff. Yet consumers have continued to spend, despite 911 and despite
the recession last year. Still, every time a new report comes out showing
consumer debt up, we get new predictions that consumers are going to retrench
and send us into a new recession.
Take the latest report
from the Federal Reserve, for example. The Fed reported on December 6 that
household wealth fell to its lowest level in seven years in the 3Q.
Household net worth fell 4.5% to $38.5 trillion as of the end of September.
The ratio of household net worth to disposable personal income fell to 4.9 in
the 3Q, down from 5.2 in the 2Q. This is the lowest reading since 1995.
This latest report
sparked predictions from the usual sources that consumer spending is going to
dry up and send us into a new recession. We’ve heard these same dire
predictions for years whenever these reports were released, but somehow US
consumers just keep spending.
There is no question
that consumer debt has risen significantly in recent years, which has in part
led to the fall in household net worth noted above. The question is, has the
decline in the net worth to disposable income ratio reached the point at which
consumers really have to cut back significantly? To answer that question,
let’s look at some numbers.
According to the latest
Fed report for the 3Q, US households had assets of $47 trillion, down 3.4%
from the 2Q. Most of that drop came from the 17% decline in household stock
and mutual fund holdings in the 3Q, which fell to $6.5 trillion according to
the Fed. (Stocks have since recovered apprx. half of their 3Q decline.)
Household liabilities
rose 2.2% in the 3Q to $8.5 trillion. Of that $8.5 trillion liability, $5.8
trillion is in home mortgages. Low interest rates and the surge in home
refinancing over the last year have sent the mortgage component of household
liability to the highest level since 1989. Home mortgage debt, unlike credit
card debt, is highly collateralized.
According to the Fed’s
latest report, the average household net worth was $352,000 at the end of
September, down from the peak of $412,000 in early 2000. While $352,000
represents a drop of almost 15%, it is still higher than at any time before
1998.
What’s So Ominous
About That?
Let’s see. . . $47
trillion in assets and $8.5 trillion in liabilities doesn’t sound so bad,
especially considering that $5.8 trillion of the liability is in the form of
home mortgage debt which is fully collateralized. Also, the fact that average
household net worth has dropped from $412,000 to $352,000 is actually
surprising in light of the grueling bear market in equities since the peak in
2000. It could have been a lot worse.
The Bank Credit
Analyst has
argued for several years that consumer debt levels were not a huge threat to
the economy. With a few brief exceptions over the last couple of years, BCA
has predicted that consumers would continue to spend, despite all the
gloom-and-doom forecasts by others. BCA has actually been much more concerned
about the deflationary threat than a household debt crisis and a major
retrenchment in consumer spending.
In their latest
December issue, the BCA editors once again make the case that US consumers
are not in a precarious financial position, and that there is still no reason
to expect a major retrenchment in the next year. In the paragraphs
that follow, I will attempt to summarize BCA’s latest analysis on US consumer
finances and their forecast for consumer spending in the next year or longer.
“The Democratization
Of Credit”
The BCAeditors begin
their latest analysis by stating that consumer debt levels have been rising
since the 1950s, and that commentators have expressed worries over this trend
ever since that time. They attribute this to what they call the
“democratizing of credit.” Credit has become
increasingly available to consumers over the last 30 years, now including many
who could not get credit in the past. The proliferation of credit cards has
made it easier than ever for consumers to take on debt. In more recent years,
many retailers - including those that sell durable goods - have gone to “no
interest” financing, another reason why consumer debt continues to rise.
Even automakers have gone to no interest financing.
Finally, due to low
interest rates, we have seen a record boom in home purchases in recent years.
Americans who never dreamed of owning a home have been able to do so in recent
years due to falling interest rates and creative financing. The boom in
housing has played a key role in the economic boom over the last 20 years, and
especially in the last few years. The strong housing market helped us avoid a
more severe recession in 2001.
The question is, has
the rise in personal debt reached a precarious level? Is it the next bubble
to burst? BCA argues that it is not a crisis. They say:
“The
democratization of credit has been a very positive force for the U.S. economy
over time. People who were denied mortgages and other loans in the past, can
now obtain credit. This is a good thing, even though some consumers
undoubtedly abuse the privilege. The rise in the ratio of household debt to
income reflects the broadening of credit availability, not simply the fact
that the same people are taking on ever-increasing debt burdens.
It is critical to
note that home mortgages account for around 70% of all household debt [see
chart at right], and these loans are fully collateralized. Home mortgages are
well collateralized. A shift from renting to owning a home has clearly
played a role in boosting mortgage debt, but this is bullish rather than
bearish for consumer finances. Mortgage payments may well be less than rent
payments (so spending power rises), and home ownership leads to forced saving
(via repayments of mortgage principal). This highlights the danger of just
looking at the debt side of the balance sheet. To the extent that the rise
in mortgage debt is matched by the purchase of an asset, it is important to
look at the consumer sector’s overall balance sheet position.
There is no magic
level of debt that represents a critical level in terms of consumer financial
fragility. The ratio of debt to income has been rising throughout most of the
post WWII period, yet consumer loan delinquency rates are currently far below
previous peaks. The Federal Reserve’s survey of consumer finances shows that
most debt is owed by those with higher incomes, the group that can most easily
afford the servicing payments.
In sum, debt
levels, while high, do not seem to be causing any major stress. Default rates
have increased sharply for sub-prime mortgages, but this is a low share of the
total (around 10%), and we have [had] a recession after all. Debt-servicing
costs as a percent of income are close to a peak, but there is no evidence
that this is a problem.”
BCA also points out
that the USsaving rate has increased over the last year. After falling to a
new record low in 2001, the personal saving rate has recovered to near a 4%
annual rate in 2002, according to the NIPA. The low saving rate is another
issue that the gloom-and-doom crowd harps on, but as predicted by BCA in May
2001, the savings trend has reversed in the right direction.
Not The Prevailing
View
I’ll bet you haven’t
heard an analysis of the consumer debt situation like the above anywhere else,
except when I have written about it in the past. Every time we see a report
on consumer debt, there is the usual clamoring that personal debt is at an
all-time high, and consumer spending is set to fall off a cliff, leading to a
new, severe recession. Obviously, BCA’s view is quite different, but
then what else is new?
BCA is quick to point
out that there is one potentially dangerous flaw in their analysis of the
consumer debt situation. If housing prices were to drop sharply, then
their relatively benign view of consumer debt would be incorrect.
With over 70% of household debt in home mortgages, a sharp drop in home
values would indeed send public confidence into a funk, and consumer spending
would indeed retrench, perhaps causing a new recession. However, the
BCAeditors do not believe that the housing market is a bubble ready to burst,
and as stated earlier, they believe interest rates will remain low for the
next year, thereby supporting home prices. Obviously, this is one key
area of the economy that we should keep a close watch on.
Conclusions
Clearly, the latest
forecasts and analysis from BCA are more optimistic than what we read and hear
in most other places, especially in the newsletter world. They expect the
economic recovery to slowly continue, interest rates to remain low and the
housing market to remain generally firm. They believe that while consumer
debt levels are high, they are not at a critical point, assuming housing
prices do not fall sharply.
As noted earlier, the
BCA editors believe the stock market has bottomed and advise adding to equity
positions on weakness. They recommend market-timing strategies, and we can
certainly help you with that.
You may, or may not,
agree with BCA’s latest analysis. There are certainly arguments to the
contrary. And I must emphasize again that BCA’s optimism assumes that there
are no more major terrorist attacks in the US. As I stated at the beginning,
BCA has been the most accurate forecaster I have followed over the last 25
years. They are not always right, but I don’t bet against them.
Let’s hope they are right again.
* * *
*
HAPPYHOLIDAYS!
On behalf of everyone
at ProFutures, let me wish you and yours a wonderful holiday season. For
those of us who are Christians, this is the most special time of the year.
Whatever your faith, I wish you a joyous holiday season and a Happy New
Year! I appreciate your continued loyalty more than you can know!!
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