For the second month in a row there was good economic news along with the bad.  First, the bad news.  The Commerce Department revised 3Q GDP to an annual rate of -1.3%.  Industrial production fell 3.6% in Novem-ber and has now fallen in 13 of the last 14 months.  Everyone talks about this number, and as bad as it may seem, industrial production is only 5.9% below where it was in November of 2000.  Durable goods orders fell 4.8% in November as compared to +12.5% in October.  Retail sales fell 3.7% in November after rising 6.4% in October.  Unemployment jumped to 5.7% in November.  That's the worst of the bad news.

The good news was that the Index of Leading Economic Indicators rose 0.5% in November following the gain in October.  Consumer confidence rose sharply in November, both in the government's report and the University of Michigan Sentiment Index.  Sales of new and existing homes were once again stronger in November and are running 5.9% above year-ago levels.  Holiday sales were lower for some retailers but were stronger than expected at the discount stores.

Clearly we are still in a recession, but the economy is turning the corner.  If we were in a severe recession, the news would be much worse at this stage.  In this issue, I will share with you the highlights of The Bank Credit Analyst's latest double issue (66 pages total) "OUTLOOK 2002."  You can read for yourself what they expect for the new year.

The stock markets are signaling an economic recovery in 2002. Yet there is still a record $3 trillion in money market funds.  If stocks have recovered better than you had expected, imagine what will happen if much of that cash parked in money funds decides to get back in the market.  I have a suggestion if you want to beat the herd back in the market.

I think 2002 will be a good year, especially after reading BCA's assessment of the economy and the markets.  There are some serious problems to address, but they don't believe these problems will thwart the economic recovery or bring down the stock markets for at least a couple more years.

Introduction

Over the last two months, the economic news has turned from all bad to mixed.  Let me boil it down to this.  If this recession was going to be very deep and long-lasting, as some promise, the economic news would be much worse than what we have seen over the last couple of months. 

Many of us have a strong tendency to expect the worst.  That, of course, is what the gloom-and-doom crowd has told us for many years.  Yet the US economy has continually surprised on the upside for the last 20 years, barring a few relatively minor interruptions.

The stock markets have also surprised on the upside recently and for the last two decades, some relatively minor interruptions not withstanding, despite the gloom-and-doomer forecasts for their demise.

With that in mind, here are BCA's latest forecasts for 2002, both from its regular January issue and from a Special Report - "OUTLOOK 2002" - that I received at the end of the year.  Let us not forget that BCA has been the most accurate source for major economic trends that I have read over the last 25 years.

BCA's Latest Forecasts

Here's what BCA had to say in its January issue which arrived just before Christmas:

1.  "The news on the U.S. economy is starting to improve, consistent with a recovery starting in the first half of 2002.  The odds support a moderate upturn, which will be good for equities by ensuring that monetary policy stays very easy."

2.  "Even a moderate economic recovery should trigger a rebound in corporate profits from their current very depressed level.  Slower wage growth holds the key to improved [profit] margins."

3.  "The recent vicious sell-off in bonds may be partly retraced in the near run, but the lows in yields [interest rates] have been made.  Bonds will underperform stocks in the next twelve months and a move to below-average positions is warranted.  Bond portfolios should emphasize corporates rather than Treasuries."

4.  "The [U.S.] dollar has been resilient in the past year, but the bull market may be running out of steam.  While further gains against the yen are probable, the dollar will likely stay in a trading range versus the Euro during the coming months.  Longer-run, the dollar should drift lower."

5.  "The technical backdrop suggests that gold prices are poised to fall in the months ahead."

Again, unlike the gloom-and-doom crowd, BCA believes the economy is turning around.  They also believe the recent upturn in equities is for real, and that stocks, generally speaking, will trend higher in 2002.

In BCA's January Special Report - "OUTLOOK 2002" - which I received at the end of the year, the editors expanded upon their forecasts above.  Here are the highlights:

1.  "A moderate recovery in the U.S. economy should begin in the first half of next year, with the other regions [of the world, except Japan] following soon thereafter.  The fragile nature of the upturn will encourage the Fed to maintain a very easy monetary stance during most of the year.  Falling inflation will give the Fed and other central banks plenty of room to maneuver."

2.  "Super-easy monetary conditions create a very potent background to the stock market.  Investors  are sitting on a huge mountain of cash that is delivering paltry returns and that money will be put to work in stocks as confidence in the economy and earnings recovers.  It is very possible that we will see a mini-bubble environment [ie - strong upturn] reappear."

3.  "Stock prices are likely to move higher, but it will be a speculative and high-risk trend because the earnings outlook is not very bright and investor expectations are inflated.  More generally, we expect a return to a more cyclical stock market environment, such as occurred in the second half of the 1960s."

4.  "The equity market displayed major cycles between the mid-1960s and early 1970s, and a buy-and-hold strategy would have significantly under-performed a market timing strategy. . . In other words, it [the markets just ahead] will not be a buy-and-hold environment and market timing will pay off."  [Emphasis added.]

5.  "Wall Street will outperform other major equity markets [ie - the foreign markets] in the next six months or so because the U.S. will lead the global economy out of the recession.  However, the Asian emerging markets will be the star performers [among the foreign markets] because they are cheap and highly leveraged to the economic and liquidity cycles."

6.  "U.S. Treasuries will underperform stocks as the economy recovers.  A trading range of 5¼%  to 6% is likely for the 10-year yield during the coming twelve months.  You should have below-average bond weightings and focus your holdings on [high quality] corporate bonds rather than Treasuries."

7.  "The [U.S.] dollar may be forming a major top, but we do not expect a major decline in the coming year given lingering economic problems in Japan and Europe."

8.  "Commodity plays [especially those highly correlated with the economy] should perform better in the coming year [gold excluded, as noted above]." 

There you have it, the latest from BCA.  Obviously, the editors have a more optimistic outlook than most forecasters I read, but quite a number of mainstream economists agree, generally, with their latest forecasts.

Risks To This Scenario

The quotes above are "conclusions" reached by BCA in its two lengthy publications it sent to subscribers over the last week or so.  However, the editors did go to great lengths to point out the possible risks that could render their forecasts inaccurate.  Above all, the BCA editors are concerned about the very high levels of debt held by US consumers and corporations.  In nearly all past recessions, the rate of debt growth fell sharply as both consumers and companies retrenched and restructured their balance sheets.  This time, however, the rate of debt growth has not retrenched and, in fact, stands at or very near record highs.  Meanwhile, the personal saving rate is at or very near a record low.

While very much aware of this troubling structural debt problem, the BCA editors believe that the extremely stimulative monetary environment will overpower the "drag effect" of high debt levels, and that the economy and the equity markets will turn around  in 2002 (albeit not back to the go-go days of the late 90s).

The Bottom Line:

Not THIS Time

As you are probably aware, the gloom-and-doom crowd is now more rabid than I have ever seen them.  The events of 911 have made them more convinced than ever that the US economy is headed for a depression, and that the stock markets will surely collapse.

BCA, as noted above, spent a great deal of time analyzing some of the long-term problems we now face.  And the editors made it clear that they believe we will have to face these structural problems in the future.

However, the BCA editors believe that the time we have to "pay the piper" will be in the NEXT recession, NOT the current one.

As you will recall, BCA predicted back in 1995 that the US economy was embarked on a "long-term economic upwave" that should last until at least 2005 and perhaps even longer.  However, in making that forecast, the editors made it clear that they expected one or two relatively mild recessions along the way. 

Yet in reading these two latest reports, I got the feeling that perhaps they think we will be lucky if the "upwave"makes it to 2005.  Please understand, they did NOT say this; it was just the feeling I got in the tone of their latest analysis.  I will be sending Martin Barnes, the Managing Editor, an e-mail asking him for BCA's current feeling on the status of the long-term "upwave."  I suspect he is already planning to address this in their February issue.  I will, of course, let you know what they say.

What Kind Of Equity Markets Should We Expect in 2002?

As noted in the conclusions reprinted above, the BCA editors do NOT rule out a "mini-bubble" in stocks in 2002.  Put differently, they would not be surprised if the markets soar on the upside, at least during temporary periods.  They say:

"Other than valuation, most of the pieces are in place for a classic cyclical bull market:  liquidity is explosive, many measures of sentiment reached depressed levels, and there are some hints that the economy and earnings are set to recover within the next three to six months."

"Survey evidence indicates that many investors still expect stocks to deliver double-digit returns on a long-term basis.  By comparison, money market funds are yielding close to zero, after fees.  Thus, investors may not need much persuading to start moving their cash pile into stocks."

"Of course, it is one thing for the market to move higher and quite another for there to be a new bubble.  But with the Federal Reserve likely to keep monetary policy very easy for an extended period, it is not difficult to imagine a renewed stock market frenzy.  Easy money is a very potent force and our liquidity indicators are very bullish."

Let me emphasize that the editors are NOT predicting a stock market frenzy and a new equity bubble.  Rather, they are advising us that it could happen, especially if economic and earnings reports happen to be a little better than is currently expected.

The more likely scenario, the editors believe, is one where the equity markets trend higher in spurts with a lot of volatility in between.  They say:

"It could be a very dangerous environment and would be much more fragile than the bubble market of the late 1990s.  Then, the mania was fueled by the excitement about technology and the Internet, the economy was booming and there were repeated bouts of monetary easing that provided fuel for the market to move higher."

"The current easy money environment is very different because it is a response to a deep recession in the corporate sector and the Fed's fears that a prolonged slump could take hold. . . All of this means we should not expect the bull market to become as frenzied as it was between 1996 and 2000."

"Given that the economic recovery is likely to be moderate, it is quite possible that stocks could suffer sudden downdrafts as investors respond to occasional pieces of disappointing news that cause fears of renewed recession.  Of course, these same fears will help to keep monetary policy easy and this should limit the stock market's downside."

Basically, BCA expects stocks to trend higher in 2002 in a very volatile fashion due to 1) economic uncertainty and 2) the nervousness of the investment public.  They also believe it could be another "momentum" environment in which investors rotate from sector to sector in search of higher or steadier returns.  Finally, they do not rule out another mini-bubble.

BCA Advises "Market Timing" - This Is New & Different For Them

In the 25 years I have been reading BCA, I don't ever remember them embracing market timing.  Their approach has always been buy-and-hold with only the allocations between stocks and bonds changing periodically.  However, a couple of issues ago when they predicted that the economy and the stock markets would recover in 2002, they suggested the use of market timing strategies, for the first time I can remember.  Now, in their latest two reports, BCA says buy-and-hold is not the best strategy, at least for the next year or so.  [Notice again their point #4 on page 3.]

Yet in the volatile scenario they envision, I can certainly understand why they would switch to this position.  First off, investors who buy individual stocks are going to have to be very adept at selecting those stocks where the valuations are not still dangerously high.  Most investors are not good at this.  Second, even investors who buy only mutual funds are going to have to be flexible and able to switch among sectors from time to time. 

Third, and most important, investors will have to be much more watchful of economic developments and may need to get partly or fully out of the markets from time to time.  That is the definition of market timing.

Obviously, most investors are not good at momentum investing, much less market timing strategies, even in the best of markets.  Thus, a lot of BCA subscribers will be looking for market timing strategies and/or professional advisors to manage their money in the stock markets in the new year.

Frustration Is High As Investors Don't Like Their Options

I have talked to many people in recent weeks who are very frustrated.  Most are coming to believe that  the economy will turn around, but they still have reservations.  Ditto for stocks.  Here is how the story usually goes:

What the **** am I supposed to do!?  I think the economy probably will turn around, but I'm just not sure.  The stock markets are acting much better than I expected, but I'm uneasy about going back in.  Also, it looks like long-term interest rates have bottomed, so now I have to lighten-up on bonds.  I can't stay mostly in cash because rates have fallen to next to nothing.  There's just no place for me to go.

This is the position millions of Americans find themselves in today.  That's why there is over $3 trillion parked in money market funds in the wake of 911. 

Some people should just stay in cash even though the rates are paltry.  This would be especially true for older retired persons who should not put their assets at risk, assuming they have enough money to live out their lives.  However, for tens of millions of Baby Boomers, sitting in cash earning 1½% indefinitely is NOT an option.

Most Baby Boomers were behind schedule in saving for their retirement even before the stock markets began to trend lower last year.  Now they are even further behind.  For this reason, I believe the investment public, and especially Baby Boomers, will come back into the equity markets in a big way as soon as there is more encouraging news about the economy.  If I am correct, this alone could drive equity prices high enough to make even the bears reconsider their positions.  Not the gloom-and-doom crowd, though; they will, as always be bearish no matter how high the markets go.

[Side Note:  I heard a great line this week!  A friend of mine who is also in the investment business called this week and asked if I would like him to send me the latest newsletter from Dr. Kurt Richebacher.  Richebacher is a German economist who has been in the gloom-and-doom crowd for as long as I can remember.  I told my friend I didn't think I could bring myself to read 12 pages of broken record.  My friend replied, "I know, I know, Richebacher has predicted at least 12 of the last 4 recessions, but maybe this time he'll be right!"  Get it?  He's predicted 12 recessions but we only had four.  How funny!  I wish I had thought of that line.  I can think of at least a dozen or more gloom-and-doom newsletter writers it would apply to.]

Decision Time For Most Investors

Most investors are under-invested in equities.  Bonds may be headed lower; even if they don't BCA believes they will under-perform stocks in 2002.  Gold doesn't look interesting either, unless you are a trader.  And money market rates will almost certainly remain paltry throughout 2002 and until the Fed starts raising short-term rates again.  There are no easy choices.

To make matters worse, BCA believes that the buy-and-hold strategy is obsolete, at least for the time being.  The fad of "index investing" worked exceedingly well in the late 1990s.  People could just blindly buy an index fund and forget about it.  Not in 2002, according to BCA.

Market timing may at last have its day in the spotlight.  BCA certainly thinks so for the first time that I can ever remember.

Changing Times

During the late 1990s, market timers were criticized for not keeping pace with the dazzling returns of index funds and high tech Nasdaq stocks.  For four years straight, stocks returned over 20%, as measured by the S&P 500, and two of those years saw returns over 30%.  Market timers in general failed to match  those returns because it rarely paid to be out of the market when it was in a vertical ascent.

Market timers in general were again criticized in 2000 for not delivering great returns.  Yet if you look at a chart of the S&P 500, for example, you will see that there were no pronounced trends in 2000.  The broad markets were in a choppy, topping-out phase.  The downward trend didn't really unfold until late in 2000.

In 2001, market timers were again criticized for not being out of the market (or short) as the downtrend intensified.  The vast majority of market timing systems use interest rates, monetary policy and liquidity as significant indicators of market direction.  Historically, these have been very reliable indicators.  We've all heard the old saying, "lower interest rates are good for stocks."

Well, in 2001 interest rates plunged as we all know.  The Fed slashed short-term rates 11 times, the most in any year in history.  Short-term rates fell from 6½% to 1¾% in 2001.  Monetary policy was obviously very easy all year, and liquidity was enormous.  With these prominent indicators so bullish, most market timers got few signals to go to cash (or short).

Investors, including many of our clients, were frustrated last year.  After all, the most important reason you hire a timer is to get you out when the market goes into a downtrend.  Most market timers did not get their clients out last year, or if they did, it was after losses had already occurred. 

Then there was September 11th and the market crash immediately thereafter.  Of course, we all know that this event could not have been predicted.

2002 Should Be Different

I believe that 2002 and the next couple of years thereafter could be the time for carefully selected market timers to shine.  Here are the reasons why:

1.  Market timers should not have to compete with 20%-30% or even higher stock market returns as they did in the late 1990s.  I don't think that any of us believe the equity markets are going back to the go-go days of the late 1990s anytime soon.  The economic recovery will be slow; corporate earnings will take time to rebound; and the high tech/Internet boom has been badly wounded.

2.  If BCA is correct, there should be sustained moves in both directions in 2002, unlike 2000 when the markets were choppy almost all year.  With so much money idled in money market funds, and with Baby Boomers desperately needing to get back in the markets, I can see multiple strong periods for equities every time there is good economic news.  These strong periods could well be followed by disappointments and downturns.  Unlike 2000, market timers should have plenty of opportunities.

3.  Interest rates cannot plunge in 2002 as they did last year, thereby tripping-up the market timers' systems.  Short-term rates can't go much lower from current levels.

4.  Most market timers have made adjustments to their systems in the wake of the last couple of years.  Whenever there are unprecedented events, such as the plunge in short-term interest rates this year, most market timers make refinements to their systems in the hopes of recognizing such conditions in the future.

5.  Most importantly, there are a few market timers that performed very well in 2000 and 2001 despite the many market challenges and unpredictable events.  Many markets timers, including those with 10-20 years of performance history in many different kinds of markets, faltered in 2002 and 2001.  Yet a select few did very well.  The key is how to find them.

One Of The Few

Niemann Capital is one of the very few market timers that delivered impressive results in recent years despite market adversities and unpredictable events.  Take a look at the following comparison.  Niemann's numbers are actual (not hypothetical) results in real accounts, net of all fees, for their "Risk Managed Program" versus the S&P 500. 

Period Niemann S&P 500

2001 *6.40 % *12.06 %

2000 28.75 % -9.10 %

3 Year Avg. 22.49 % 0.54 %

5 Year Avg. 21.41 % 10.07 %

Worst Drawdown -9.93 % -30.49 %

*12-30 estimates subject to minor revision

Obviously, Niemann beat the pants off the major market indexes in all time periods noted above.  I don't know which is more impressive - Niemann's whopping 28.75% return in 2000 or its 6.40% return in 2001.  In percentage terms, versus the S&P, its 28.75% return in 2000 was more impressive.  On the other hand, Niemann's return of 6.40% in 2001 may be more impressive since Niemann was actually fully invested on September 11th.  The market action just after 911 resulted in Niemann's worst-ever losing period, -9.93% as noted above.  Yet despite this loss, Niemann battled back to end the year up 6.40%.  (Past performance is not necessarily indicative of future results.)

Whichever you consider most important, Niemann is one of the most impressive market timers we have ever found.

Why Did It Take So Long To Find Them?

The answer is one of the things I like most about Niemann.  They are a very low profile firm.  In general, they don't advertise.  They have been content to grow slowly, largely by word of mouth.  They are not interested in growing so fast that it adversely affects performance.  Only through our network of contacts did we discover Niemann late last year.  As always, we conducted an on-site due diligence visit to Niemann's offices just outside Silicon Valley in California to meet their staff, check out their administrative capabilities and to verify performance.

Niemann's "Risk Managed Program" is one of three different programs they offer.  We like Risk Managed because it is not their most aggressive program.  The Risk Managed program seeks to be in the strongest group of funds at any given time, using some Fidelity funds but also many others.  This "momentum" type of investing may prove to be critical in 2002 and beyond.  The program does go partially or fully to cash periodically if market conditions warrant.

Accounts with Niemann are held at Fidelity Investments.  Niemann charges a management fee of 2.25% for accounts less than $500,000.  Fees are charged quarterly and in arrears.

Niemann's minimum account size is $100,000.  Interestingly, Niemann does allow multiple accounts within the same family - such as husband + wife or IRA -  to count toward the $100,000 in total.

Quite a number of you have requested the specific information and applications for Niemann since I wrote about them last month.  I revisit them this month: first, in case you missed it last month; second, because some of you haven't responded; and third, due to the market conditions we now expect for the new year. I cannot recommend any Advisor higher than Niemann in this market environment.

Procrastination Kills

You have now read in some detail BCA's outlook for 2002.  I have told you that, while not perfect, BCA has been my single best source for economic and investment advice for over 25 years.  As you have read, BCA is forecasting an economic recovery and a continued uptrend in stocks for the new year.  And surprisingly, BCA believes that a market timing strategy is the best way to go in this market environment.

Niemann Capital has a proven market timing strategy that has worked throughout the difficult markets of the last few years.  We have other market timing programs that have done well in the last couple of years, and I have continued confidence in them as well as Niemann.  However, if you are largely out of the market, or you are looking to add to your equity investments, I believe Niemann is your best choice at this time (subject, of course, to your particular goals and risk tolerance). 

This is my best advice for how to be invested in equities just ahead.  Now it's up to YOU!  Remember, procrastination kills.

Make Half A Decision?

Maybe you're one of those people that just can't bring yourself to get back in the stock markets.  Maybe you're one of those people who has sadly been out of the market for many years due to advice from gloom-and-doomers.  Or maybe you are convinced there will be more devastating terrorist attacks in America.

If you are one of these people, let me suggest something I have written about occasionally over the last 25 years.  If you are frozen in uncertainty, or if you know you need to get back in the market, but just can't, consider making HALF a decision.

What does this mean?  Instead of going fully back into the market, maybe you only invest half now and wait until you are more comfortable before investing more.  Maybe this will make it easier for you to do something, rather than continue to sit on the sidelines and miss out on the opportunities that lie ahead.

Most investors wait and wait until they are "sure" the time is right.  But by then, the markets have moved too far and they feel they missed the boat.  Making half a decision is at least a step in the right direction.

If You Just Can't Do Anything

There are some people who just cannot bring themselves to get back in the equity markets under any circumstances, not even half a decision.  If you are in this position, then let me remind you that you might want to consider DORSET FINANCIAL SERVICES, an Advisor who trades the Rydex Precious Metals Fund with impressive results.

Gold and precious metals prices are highly uncorrelated to the trends in the stock markets.  Gold and precious metals prices have been largely in a broad trading range for many years, going essentially nowhere, but moving up and down nonetheless.

Dorset Financial Services is a market timing service that has averaged returns in excess of 15% per annum (net of all fees) for the last several years trading precious metals mutual funds.  Past performance is not necessarily indicative of future results.

If you haven't requested specific information on this program, I strongly advise that you do - whether you invest in the equity markets or not.  Dorset's program is a great diversification alternative, especially in today's complicated markets.  With stocks expected to be quite volatile going forward, and with the real possibility that bonds may be moving lower, Dorset may be a good place to allocate some of your money now.  Call us toll free at 800-348-3601 for more details.

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SPECIAL UPDATES

I continue to write my e-mail Special Updates apprx. three times a month.  These 8-12 page e-letters contain lots of information, including detailed political and geopolitical analysis, that you may not find anywhere else, plus links to even more articles and topics of interest.  You can send us your e-mail address to receive the Special Updates automatically, as soon as they are done.  This is the best way to get them.  Or you can go to our website at www.profutures.com.