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November 2004 Issue
The government’s advance estimate showed that 3Q GDP rose at an annual rate
of 3.7%. While 3.7% is a strong number, it was below expectations. Most
economists agree that growth must be 4% or above in order to create large
numbers of new jobs. Meanwhile, the Index of Leading Economic Indicators
and consumer confidence fell for the fourth month in a row in the latest
reports.
So, does this mean that the economic recovery has peaked, or that we are
headed for a recession? Probably not. Growth above 3% is solid, even if it
is not as robust as we would like to see it. In this issue, we will look at
the latest economic forecasts for 2005 from The Bank Credit Analyst.
We will also look at their latest forecasts for the investment markets.
The stock markets rallied immediately after the election and Bush’s win. I
continue to look for the stock markets to break out of the recent trading
range to the upside, but that remains to be seen. With the economy expected
to remain firm for the next year or so, stocks should benefit, especially if
oil prices cool off.
The Treasury bond market has done well this year as long-term rates have
moved lower once again. However, rates are likely about as low as they are
going in this cycle, and the next move may be up. High yield bonds, on the
other hand, still have the potential to do well in this growing economy.
This month, the editors at BCA predict a multi-year bull market in
commodities. The commodities markets, led by the explosion in oil
prices, have been rising briskly. BCA believes this trend will continue for
several more years. More details inside.
The election is over, finally, Bush won decidedly and Republicans picked up
seats in the House and Senate. I’m happy about that, but Ialso know we have
serious problems to face in the next four years.
The Latest GDP Report
Most economists believe that the US economy has been in a “soft spot” for
the last few months. Yet in its advance report, the government estimated
that Gross Domestic Product grew at an annual rate of 3.7% in the 3Q
following 3.3% in the 2Q. While the report shows the economy still on a
strong growth path, it was disappointing in that most economists had
expected a number above 4%. Some are now revising their 4Q estimates down
to 3.0-3.5%.
There is general agreement that the economy must grow by 3.0-3.5% just to
keep the unemployment rate steady. Anything below that range indicates that
the unemployment rate will begin to rise again. Likewise, it is believed
that we need growth of 4% or more if we are to create new jobs and see the
jobless rate continue to fall.
The government also reported that consumer spending rose by a surprising
4.6% in the 3Q following 1.6% in the 2Q. Despite that, analysts continue to
predict that consumer spending, which makes up over two-thirds of the
economy, will fall off significantly any day now. Yet the government
reported on Monday that consumer spending rose 0.6% in October, well above
expectations.
The government also reported that durable goods orders rose a surprising
16.8% in the 3Q after being unchanged in the 2Q. In the same report, the
Commerce Department reported that consumer prices rose at an annual rate of
only 1.8% in the 3Q versus 3.5% in the 2Q.
The ISM manufacturing index fell slightly in October to 56.8 following 58.5
in September. While the latest report is disappointing, any number above
50% indicates that the manufacturing sector is expanding. The ISM index has
been above 50 for 17 consecutive months.
Leading Indicators & Consumer Confidence Fall For 4th Month
The Conference Board reported that its Index of Leading Economic Indicators
fell 0.1% in September for the fourth consecutive month. While the Index is
still in positive territory, the trend is not encouraging. Fortunately, the
string of monthly declines has been very modest.
The Conference Board also reported that its Consumer Confidence Index fell
in October for the fourth consecutive month as well. The latest household
survey found that consumers are most concerned about the economy and what
happens six months from now, more so than today.
Yet despite falling confidence, Americans continue to buy homes at a
near-record pace. New home sales rose 3.5% in September, while sales of
existing homes were the third highest on record, up 3.1% in September.
The Next Recession
Now that the election is behind us, you will begin to read and hear more
analysts speculating about when we will hit the next recession. Unless
there is a major negative surprise, it is safe to say that we will not see a
recession in the next six months, and maybe not until late 2005 or even
2006. Yet I believe it is also safe to say that we will hit a
recession sometime in President Bush’s second term.
I happen to believe that the next recession, whenever it comes around, will
be a serious one. Record budget deficits, trade deficit, falling dollar,
etc. will all make the next recession a bad one. How bad, I don’t know. I
will be writing more on this subject in the months just ahead, as well as in
my weekly E-Letters. But for now, let’s take a look at the latest forecasts
from The Bank Credit Analyst.
BCA Downgrades 2005 Forecast
As you know, The Bank Credit Analyst is one of the most widely followed and
respected research groups out there. Here are some excerpts from their
latest November issue:
“The recent rise in crude oil prices has been unambiguously bearish
for the economy and the stock market. Consumer spending power and confidence
have been undermined and profit margins have been squeezed, adding to the
business sector's already cautious mood. On a more positive note, the oil
shock does not yet seem large enough to induce a recession.
The economic drag from higher oil prices is being partly offset by the
stimulative effects of lower bond yields and a weaker dollar. However, the
core problem facing the economy is that consumer spending will not be
sustained unless there is a marked pickup in employment. In turn, that will
require businesses to adopt a more expansionist mindset.
It is easy to understand why many businesses are still cautious. The
rise in oil prices has fueled worries about the economy and profits, the
geopolitical news is unremittingly gloomy, and there is uncertainty about
the result of the forthcoming elections.
The economy has actually performed quite strongly this year, but it is
hard to see where future momentum will come from without a stronger job
market. Low mortgage rates are sustaining a high level of housing activity,
but affordability has eroded in response to rising prices, and the level of
home sales and construction have probably hit a plateau… A further drop in
mortgage rates could unleash a new wave of mortgage refinancing, giving a
lift to consumer spending, but the impact would be temporary.
Again, the key to sustained spending growth must be more jobs and the
picture here has been disappointing. Unemployment claims have stopped
falling in recent months and small business job openings and hiring plans
appear to be flattening out.
The conditions are in place for employment growth to improve [once we
get through this soft spot] and our models continue to predict a pickup over
the coming year. However, the longer that hiring stays weak in the near
term, the greater the danger of a consumer retrenchment [recession].
The decline in the Conference Board leading indicator suggests that
economic activity will remain on the soft side for at least another few
months. However, it is premature to worry about a recession developing in
the coming year. The overall [monetary] policy environment is still
relatively accommodative and although high oil prices are hurting, financial
indicators do not point to any major problems. [Emphasis
added, GH.]
We had thought that growth next year would average between 3% and 3½%,
but that now looks optimistic unless there is an early and sustained retreat
in oil prices. Growth in the range of 2½% to 3% seems more likely for 2005
, assuming oil prices drop back to around $40 in the first half of the year.
Economic growth of less than 3% would be below potential, implying that
inflation would stay muted. It would also ensure that the Fed puts its
tightening policy on hold.” [Emphasis added, GH.]
BCA Moves From Optimistic To Cautious
As recently as a few months ago, the editors at BCA expected the economy to
grow by 3½-4% in 2005. Then they lowered their forecast to 3-3½% due to the
spike in oil prices. Now, they have lowered that forecast again to 2½-3% -
if oil prices fall back to the $40 area. And of course, there is no
guarantee that oil will fall to $40 or lower.
The BCA editors make it clear that they do not expect a recession in 2005.
However, having been a continuous subscriber to BCA for the last 27 years,
I can tell that Martin Barnes and his fellow editors are becoming more
cautious in their outlook for next year. Like me, I sense that the
editors are beginning to think about the next recession.
BCA On Stocks &Bonds
In light of the downward revision in BCA’s economic forecast for next year,
the editors continue to recommend “neutral” positions in
equities. Neutral, in their case, means average holdings of
stocks and mutual funds, not above or below average. Unfortunately, the
editors do suggest that the equity markets may well continue in a fairly
broad trading range for the next several months if not longer, unless oil
prices fall to the $40 area or lower. In that case, they believe stocks can
stage a meaningful rally.
I agree. I still believe there is a window of opportunity for stocks to
surprise on the upside in the next several months, and especially if oil
prices move somewhat lower. This is why I believe investors should be in
the market today, especially if you use professional Advisors who can move
out of the market if conditions change for the worse.
The BCA editors continue to recommend “below average”
holdings of Treasury bonds and other high quality bonds. The editors do
expect bond yields to remain low in the months ahead, but they do not see
rates moving significantly lower from current levels. And they believe
there is the potential for rates to move higher next year. While Treasuries
and other high quality bonds have done well this year, the editors believe
the risks are too high at this point.
I agree with BCA on Treasuries and other high grade corporate bonds.
However, I continue to believe that there is more upside potential in high
yield bonds this year and into next year. Remember that high yield bonds
tend to do well when the economy is recovering. This is why I continue to
recommend Capital Management Group for those who are comfortable with
this market.
BCA’s Conclusions
“The bottom line is that we are in a frustrating period where no major
U.S. asset looks very appealing. Stocks should outperform bonds in the
coming year, but neither asset is likely to deliver outsized returns.
As we discuss in this month's Special Feature, there are better
opportunities outside the U.S., such as European and emerging market
equities. Also, there is a strong case for focusing on countries and sectors
that offer a high dividend yield. From a longer-term perspective, the
conditions seem ripe for a mania to develop in energy and commodity-related
assets and in China-related investment plays.
Thus far, we have not mentioned the forthcoming U.S. elections… We
tend to believe that whoever occupies the White House, policy will be
severely constrained by the large fiscal deficit, and neither George Bush
nor John Kerry will be able to carry out their election promises. The trends
in the economy and oil will be a more important influence on how the markets
move in the months ahead.”
BCA Suggests “Market Timing” & “Sector Selection” In
This Environment
BCA’s latest forecasts and recommendations are no doubt frustrating for most
investors. However, the editors at BCA suggest in their latest issue that
investors consider using “market timing” and “sector
selection” (rotation) strategies to take advantage of intermediate
swings in the equity markets. The editors compare the current equity
environment with that of 1965 to 1973 when the major markets went basically
nowhere, but there were numerous large moves in prices in the interim.
The type of market timing recommended by BCA is not the mis-named illegal
market timing that was uncovered by New York Attorney General Elliott
Spitzer earlier this year. Traditional market timing and sector rotation
strategies are nothing new. Both have been around for as long as I've been
in the investment business (28 years).
Traditional market timing involves moving into and out of the markets
from time to time (either partially or fully) with the goal of missing the
bear markets and serious downward corrections.
Sector rotation involves moving from industry group to industry group, or
sectors, with the goal of being in the hottest sectors and avoiding those
that are out of favor.
Again, both of these strategies have been around for a long time.
The problem is, most individual investors who try to use these strategies on
their own are not successful. Both strategies require close monitoring of
market activity, and most investors do not have the time or the inclination
to do so. Also, it is very difficult to use these strategies successfully
by simply watching the financial shows or reading the newspapers.
You need a sophisticated, time-tested system, which most investors do not
have.
As you probably know, there are hundreds of money managers around the
country that claim to have successful market timing systems and sector
rotation strategies. I must warn you, however, that the vast majority of
professional money managers that use these strategies are NOT very
successful.
As you know, we are constantly looking at hundreds of money managers around
the country. For every one truly successful money manager we find,
we see over a dozen that we reject - usually on the basis of performance.
Out of the hundreds of managers we have looked at, we only recommend a very
small, very select group of professional money managers that have
successfully used market timing and sector rotation strategies for years.
Given that we may be in this broad trading range market for an extended
period of time, you may want to take a look at the long-term performance of
these professional Advisors.
BCA Predicts A Multi-Year Bull Market In Commodities
In this latest issue, the BCA editors predict that the commodities markets
will continue in a bull market for several more years at least. While
commodity prices have been rising steadily since early 2002, the editors at
BCA believe this trend still has a long way to go.
“This year’s run-up in oil and commodity prices has intensified the
focus on China as a growing force in the global economy and financial
markets. China's rapid economic growth has fueled a voracious appetite for
raw materials and energy. Yet, China’s per capita consumption of most
commodities is still extremely small compared with more developed economies,
suggesting continued strong growth in demand, and thus prices.
The case for oil is particularly compelling because of the limited
potential for large increases in supply in the next few years. There is no
shortage of oil in the ground, but there have been many years of
underinvestment in developing new production. Current prices make it
attractive to develop new fields, but the time lags are long. Thus, in the
absence of a decline in demand, the market is likely to stay tight for some
time.
The share prices of oil and commodity companies have already risen a
lot over the past year. As noted above, oil shares in particular are
vulnerable to a nearterm setback if oil prices suffer a long-awaited
correction. However, that could prove to be a temporary interlude as the
conditions for a mania in energy and commodity plays and/or China-related
assets are in place.
[A] precondition for a mania is abundant money and credit in order to
provide the fuel for asset speculation. That is clearly the case at the
moment with historically low interest rates and global liquidity growing at
a record pace.”
In short, BCA believes that commodity prices in general will continue to
rise for several more years. The editors point out that they still believe
oil prices could retreat to the $35-$40 level in the near-term, but they
also believe that prices will move even higher in the intermediate-term.
They also believe that many other commodities - in particular, natural
resource commodities, industrial commodities, metals and others - will also
move significantly higher in the next few years, driven by rising demand
from China, India and other emerging markets.
Don’t Invest In Commodities On Your Own
BCA’s latest forecast for a multi-year bull market in commodities might be
seen by some as a recommendation to go out and buy futures contracts in oil,
metals and other industrial and natural resource commodities. But remember,
it has long been said that “the easiest way to make a small fortune is
to invest in commodities with a large one.”
It is a fact that the vast majority of individual investors who try to play
the commodities markets lose money. The major brokerage firms that offer
commodity trading accounts rarely disclose information about the win/loss
rate of their clients. Privately, however, I have been told that the loss
rate is as high as 80-90% among individual investors.
With the commodities markets getting hot over the last year, many firms are
actively promoting commodity “option” contracts. The
allure of options is that you can never lose more than the amount you paid
to purchase them, unlike trading the futures contracts themselves where you
have unlimited risk if the market moves against you.
So, many investors are convinced to plunk down money to buy options on the
promise that, if the markets don’t go in the expected direction, they will
never lose more than what they paid. While this is true, what the
brokers don’t tell you is that the vast majority of all options contracts
expire worthless, and the investors lose everything they invested.
All option contracts have a specific expiration date. Generally speaking,
the longer the maturity, the higher the price. Because of this, many
investors buy the cheaper options with only a few months to maturity. This
lessens the odds that the market(s) will move enough to make the options
more valuable than what the investor paid.
Likewise, options with a “strike price” nearer to the current market price
are more expensive than options with strike prices further away from the
current price. If gold is at $400, for example, a “call” (buy) option with
a strike price of $420 will cost more than one with a strike price of $440.
As a result, many investors buy the cheaper options and thereby reduce the
odds that they will make money.
So who makes the big money in options? Generally speaking, the companies
that sell them. As noted above, the vast majority of commodity
options expire worthless, and the investors that bought them lose everything
they paid. The companies that underwrite the options keep all of that
money. Most of the time, they make a killing.
So in summary, I recommend that you stay away from commodity options which
are being widely touted today. Just say NO.
I continue to believe that the best way to participate in the commodities
markets is by investing in professionally managed commodity pools and funds,
as opposed to trying to do it on your own.
If BCA is correct that we are in a multi-year bull market in commodities,
that is great news for our futures funds. This should mean that there will
be strong, long-term trends for our Advisors to follow, including some
markets that have been mostly lifeless until recently.
The re-election of George W. Bush is nothing short of amazing, in my
opinion. As you know, I have written a lot about the election, and I
don't want to re-hash all of the old issues that I have previously brought
up. However, I do believe it is important to keep in mind that Bush had to
overcome some very powerful forces that allied themselves with the
Democratic Party to defeat him.
Just consider that Bush won the election despite the contributions made
by billionaires like George Soros. You will recall that Mr. Soros said
that he would spend whatever amount of money was necessary to defeat
President Bush's re-election bid. There were evidently plenty of other
millionaires and billionaires out there who felt like he did, as
contributions to the shadowy 527 organizations mushroomed in the hundreds of
millions.
Perhaps the American people did not want to see the presidency sold off to
the highest bidder. Or, perhaps the average American feared that once Mr.
Soros bought the presidency, he would start pushing Mr. Kerry to do his
bidding. I doubt that most Americans share Mr. Soros’ goals for America,
such as drug legalization and subservience to the United Nations. By the
way, Soros said he would move to a monastery if Bush won. Well, I think
it’s high time this bozo billionaire got some religion!
President Bush also won re-election despite continued attacks on his
intelligence, character, religion, and National Guard service 30 years ago.
The American people appreciate someone who is genuine, and President Bush
fills that bill. Anyone remotely following the election over the past year
or so saw John Kerry change directions with every political wind that blew
his way. President Bush stood firm, and America rewarded him for that.
I was also amused by a report that someone who actually studied the military
records of both Kerry and Bush discovered that Bush had actually scored
higher on the military intelligence tests than Kerry did. When faced with
this evidence, Kerry's response was that he must have been drinking the day
before the tests. Yeah, right.
President Bush won re-election despite the worst exercise of liberal
media bias that I have ever seen. Here’s where I could write an entire
book, if I had the time. I predicted early in this race that the liberal
media establishment wanted Kerry to be elected so bad that they would give
up any semblance of objectivity in their reporting.
I was right-on. The major TV networks were little more than
cheerleaders during the Democratic Convention, presenting Kerry and Edwards
as the Democratic “dream team.” In
interviews, Kerry and Edwards were given softball questions that generally
led to their talking points. For Bush and Cheney, they were always
portrayed as more somber, mean, even reckless, and in Bush’s case, a dummy.
The press also tipped their liberal hands by instantly giving credibility to
any nut case who would provide negative information about Bush, while they
shielded Kerry from criticism as best they could by either ignoring or
attacking any Kerry critic. In other words, I think Dan Rather knew exactly
what he was doing when he used the forged National Guard documents in his
“60 Minutes” report.
Several media watchdog groups monitored the coverage of the campaigns. The
general consensus was that the media heaped at least four times more
negative news on Bush than on Kerry. Most political analysts who were
honest enough to admit it believe that the media accounted for at least a
5-point advantage to Kerry. Yet he still lost by a margin of some 3½
million votes.
President Bush won re-election despite attacks from other media outlets,
such as films (or should I say “documentaries?”), television shows, and
concerts. It seemed that every day, another actor, singer or sports
figure would make a big deal of endorsing Kerry. Perhaps the American
people put such people in their place, as pampered, overpaid spoiled brats
who think that their opinions are worth more than everyone else’s. I won’t
be listening to Bruce Springsteen in the future!
Don’t get me wrong, I do not hold it against these individuals for speaking
their mind. The Constitution grants them that right. It’s when they use
their celebrity status or their craft to influence votes by spinning,
distorting and/or ignoring the facts that I think they cross the line.
President Bush won re-election despite the lack of any meaningful
discussion in the media regarding Kerry’s 20-year liberal Senate record.
In fact, much of the liberal media refused to utter the “L” word (liberal)
when describing Kerry’s Senatorial record.
President Bush won re-election despite his disappointing performance in
the debates. While Bush isn’t the best debater, perhaps the American
people saw something there that is more important. After all, Clinton was
an eloquent speaker and great debater, yet he spent his eight years in
office trying to treat the growing terrorist threat as some kind of legal
matter. Bush, on the other hand, doesn’t speak as well, but does go into
action when the US is threatened. I like to think that the American people
saw that actions speak louder than words.
Finally, and perhaps most important, Bush won re-election despite making
some bad policy decisions. I have criticized Bush’s actions and
policies on numerous occasions when I thought he veered too far away from
conservative principles. However, on the whole, I respect what he has
accomplished, especially the War On Terror, and I believe we’re better off
than under Kerry or any Democrat.
While some argued that the election returns did not give President Bush a
so-called “mandate,” it is still clear that he won decisively. He not only
got more votes than Kerry, he got over half of all votes cast, something
that hasn’t happened since 1988. Bush’s clear victory over Senator Kerry
and the media is important both in terms of having avoided another Election
2000 fiasco, and in terms of changing the landscape of the American
electorate.
The decisive win by President Bush also underscores the fact that much of
America has been migrating from the Democratic mindset of the
post-Depression decades to the Republican mindset that was so clearly
articulated during the Reagan years. The Democrats have failed to see, or
admit, this trend. As a result, they have become little more than a
confederation of special interest groups with sometimes-conflicting goals,
all seeking a candidate who can be all things to all people. This mindset
has resulted in the loss of not only the White House, but also both Houses
of Congress.
Based on what I know about my loyal clients and readers, I can safely assume
that most of you are ecstatic about the outcome of the election. I am too.
But there are serious storm clouds gathering over our future that will blow in
regardless of who is in the White House. Historic budget and trade
deficits, the health care crisis, Social Security and the retirement of the
Baby Boomers are all troubling trends, and no one seems to have realistic
(or any) solutions to these problems. As noted earlier there is another
recession in our future, and the Fed has a scant few bullets left in its
arsenal to fight the next slump in the economy.
While I voted for President Bush and am happy he won the election
decisively, I am not at all confident that he, Congress, or anyone else in
Washington is up to the task of leveling with the American people about the
seriousness of these problems, or proposing the painful options for solving
them - if we even can.
The next 5-10 years may bring some of the most difficult and challenging
times we have faced in this country in decades. These problems will
certainly pose challenges to not only the economy, but also your
investments. While the rest of the investment world is happy to continue
adhering to the "buy-and-hope" philosophy of investing, I'm glad that we
have already have defensive investment alternatives in place that can take
you off of the investment roller coaster that is sure to come.
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