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January 2005 Issue
The latest official data we have on the economy is the December estimate
showing that 3Q GDP rose by 4.0%. 4Q numbers are not yet available from the
Commerce Department, but expectations are for another strong report for the
last quarter of 2004. On Monday, January 3, the Wall Street Journal
announced the results of its latest economic survey for 2005. The
WSJ polled 56 leading economists, and the average forecast is for GDP to
grow by 3.6% in 2005. They rated the chance of a recession by the end of
2005 at only 11%. The Bank Credit Analyst’s forecast is for 3-3½%
growth in GDP in 2005, and they also do not expect a recession this year,
barring any major negative surprises.
The stock markets rose to their highest levels in more than three years in
late 2004. While stocks have gotten off to a mixed start in the first few
trading days of January, I expect the rally to continue a bit longer. It is
clear, however, that as stock prices go up, the risks are rising also. So,
I would urge you to have a considerable portion of your equity portfolio
managed by professionals who will either get out or hedge their positions if
market conditions take a turn for the worse. The bond markets surprised on
the upside in the last half of 2004, despite the firm economy and several
rate hikes by the Fed. There are several theories on why this occurred
(normally bonds go down in recoveries), and we will discuss a bond strategy
in these pages this month. Precious metals, oil and several other commodity
markets had a great year in 2004, but these markets (especially the metals)
may be a bit overpriced now. I would await a meaningful correction before
buying these markets again.
This month, I summarize BCA’s “Outlook 2005.”
Each year at this time, BCA makes its various forecasts for the economy,
stocks, bonds, interest rates, etc. and offers its specific investment
recommendations for the New Year. For the benefit of our many new readers,
I also look back at my long history with BCA, and why I continue to believe
they are one of the best research groups on the planet.
Finally, we look at some very interesting stock market theories, including
years ending in 5 (as in 2005) and the Super Bowl phenomenon.
Introduction
In this issue, I will review the latest forecasts for the economy and the
major investment markets for 2005 from The Bank Credit Analyst. As
you know, BCA is one of the most widely followed and respected research
groups in the world. As long-time clients and subscribers also know, I have
been a continuous subscriber to BCA’s various services for many, many
years, and I have frequently summarized their forecasts in my monthly
newsletters and more recently in my weekly Forecasts &Trends
E-Letters.
BCA offers a wide range of research services covering the US and global
economies, all of the major stock markets around the world, foreign currency
trends and periodically, the energy and precious metals markets. To
subscribe to all of BCA’s various services, it will cost you well over
$10,000 per year. To learn more about BCA and its services, go to
www.bcaresearch.com.
BCA predicts that the US economy will continue to grow by 3-3½% in 2005,
with no recession likely. Beyond 2005, however, BCA says the
outlook is much less clear, and the editors warn that the US will likely
face a serious debt crisis sometime in the next few years. As a
result of this looming debt crisis, and the terrorist threat, BCA calls 2005
“A Year of Living Dangerously.”
My History With The Bank Credit Analyst
For the benefit of our many newer newsletter and E-Letter subscribers, let
me briefly review my history with BCA. In late 1977, one of my clients sent
me a copy of BCA and recommended that I subscribe in order to help with my
own forecasts for the investment markets. While BCA’s publications are
quite expensive relative to most, I subscribed and soon became a loyal
follower of their advice. I have been a continuous subscriber ever since.
In late 1977, we were in a runaway inflationary period. At that time, the
Dow Jones was around 800 and Treasury bonds were out of favor.
(Interestingly, Treasury bond futures began trading at about the same time I
first subscribed to BCA in August 1977).
At that time, BCA was predicting that the inflationary trend in the US was
going to accelerate even further. Their advice at the time was to
hold below-average investment positions in equities and bonds. BCA also
recommended that investors continue to accumulate above-average positions in
tangible assets such as real estate, precious metals and collectibles.
They also predicted that the US dollar would plunge. It did.
As long-time clients will remember, I was a “perma-bear”
back in those days, meaning that I had a very negative bias toward stocks,
so I welcomed BCA’s advice to load up on tangible assets. Gold, for
example, was well below $200 per ounce at the time, on its way ultimately to
$850; silver was around $5 per ounce, on its way ultimately to over $35.
Most of my clients loaded up on precious metals and other inflation-sensitive
commodities. Many also shorted the US dollar. From an investment
perspective, it was a grand old time in that these inflation-sensitive
markets soared. We thought it would never end.
But then something happened. In October 1979, a relatively unknown man,
Paul Volcker, was appointed as the new Federal Reserve chairman.
Volcker announced that he was going to take bold new steps to stop the
runaway inflation in the US. Few people took him seriously at
first. I didn't. Precious metals and tangible assets continued to
skyrocket. My clients thought I was a hero.
But in November and December of 1979, BCA issued a stern warning. They very
much believed that Paul Volcker was serious, and that he was prepared
to raise interest rates, dramatically if necessary, in order to reverse the
runaway inflation in the US. They recommended immediately
liquidating positions in precious metals and tangible assets. They also
predicted that a recession would unfold as a result of the interest rate
hikes.
I will tell you that I agonized over what to do. I thought BCA was wrong
and that inflation would continue higher. I very much believed that
precious metals and tangible assets would continue higher for at least
another year. Most of the newsletter writers in the so-called “
hard money” world were predicting that gold was going to $2,000 or higher.
Yet by this time, my respect for BCA had grown to a point that I could not
ignore their warnings. So in late 1979, I insisted that all of my
clients follow BCA’s advice and liquidate all of their precious metals and
other inflation-sensitive investments that I had put them in over the two
previous years.
Many clients were unhappy with me, even though they had made huge profits.
Some clients closed their accounts. A few refused to take my advice, and in
few those cases, we transferred their accounts to other brokers, and in one
case, to another investment firm. Meanwhile, inflation continued and
precious metals prices continued to explode on the upside. But by
mid-December 1979, all of my clients were out of the precious metals markets
and their US dollar short positions.
As noted above, gold skyrocketed above $800 per ounce in late December, and
silver soared above $35 an ounce. More than a few clients reminded me that
I had gotten them out too early. To some, I was no longer a hero.
The Great Metals Market Collapse
Most of you will remember what happened next. Paul Volcker made good on his
promise to ratchet up short-term interest rates. The explosive bull market
in precious metals peaked at the end of 1979 and an even more historic
collapse followed. Gold plunged from above $800 to below $500 by the end of
January 1980. In silver, the crash was even worse with prices collapsing
from above $35 an ounce to below $12 by the end of March 1980. Many
investors were completely wiped out.
But thanks to BCA, my clients and I avoided one of the worst market
debacles in history.
As most of you will remember, short-term rates eventually went above 16%,
and Treasury bond yields soared to near 14% as Volcker continued his war on
inflation. By the end of 1980, we were in the recession that BCA
had predicted. The Dow Jones fell from 1,000 to near 700 by the end of
1981. Things were bad in the investment world.
Yet in early 1982, BCA had yet another monumental forecast. While most
analysts in the investment world were bearish, BCA predicted that: 1) the
recession would end in 1982; 2) the economy would begin a strong, long-term
recovery; and 3) stocks would begin a powerful, multi-year run on the upside.
They also predicted that interest rates would continue to fall. They
recommended above-average positions in equities and bonds.
BCA described their bullish long-term outlook in 1982 as the “Long-wave
Supercycle of Debt.” In that analysis, they predicted that
the US would amass record-breaking amounts of debt over the next decade or
more in an attempt to avoid painful recessions in the future. This was
indeed one of the most insightful calls BCA ever made! Look at where we are
now.
In early 1987, BCA warned subscribers that the equity and bond markets had
become overheated on the upside and recommended that investors scale back
their holdings of stocks and bonds. As it turned out, the bond market
turned sharply lower in mid-1987, and we had the October crash in the stock
markets. BCA subscribers who followed their advice side-stepped
much of the damage. Thank goodness, I followed that advice once
again, and most of my clients were out of the equity markets before October
‘87, at least in their positions with me.
Not Always Right, But Rarely Ever Dead Wrong
I could go on with more examples of timely forecasts by BCA. They were
generally very accurate in their predictions on the economy and the major
investment markets during the 1990s as well. I should point out, however,
that BCA does not have a crystal ball. While they are absolutely the
best source I have ever found over the years for forecasting major trends in
the US and world economies, they do not catch all the major trends in the
markets.
In early 2002, for example, BCA advised investors to reduce holdings of
Treasury bonds to below-average positions. They believed that Treasury
yields would remain high and thus saw little potential for bonds to advance.
As it turned out, however, bond yields peaked in March/April of 2002,
rates fell significantly for the rest of the year and into 2003, and bonds
appreciated significantly in value.
This example illustrates that BCA will miss some market movements from
time to time, but they are rarely ever outright wrong in predicting the
major direction of the economy and the investment markets. I might add,
however, that the bond market collapsed in early to mid-2003, and reversed
most of the gains made over the prior year.
The point is, BCA is not perfect (no one is) but they have a better record
overall than any source I have found in the last 28 years.
BCA’s Outlook For 2005
In late December each year, BCA issues its various forecasts for the New
Year, and I will summarize their latest thinking for you below. Like
everyone, BCA qualifies its forecasts for 2005 with the caution that if
there are more serious terrorist attacks in the US, then everything could
change. That’s a given.
Before getting into BCA’s forecasts for 2005, let’s briefly look back at
their outlook for 2004. In December 2003, BCA predicted that: 1) the global
economic recovery would continue; 2) the Fed would raise short-term rates
several times; 3) stocks would rise but probably only modestly; 4) the US
dollar would continue to fall, but not crash; and 5) commodity prices would
remain in an uptrend. Other than missing the nice move in
Treasuries last year, their advice was right on.
In their latest “Outlook 2005,” the editors are actually
optimistic that the economy will continue to expand all year. As you may
know, there are many in the forecasting business who believe that the
recovery will stall out this year, and that a recession will unfold sometime
in the second half. The BCA editors predict that US GDP will
average 3-3½% this year. Short of a major negative surprise, BCA
does not believe we will see a recession unfold this year.
BCA’s forecast of 3-3½% is slightly less than the latest Wall Street Journal
economic survey released on Monday, January 3. The WSJ polled 56
leading economists, and the average forecast is for GDP to grow by 3.6% in
2005. This group, on average, put the chance of a recession by the
end of 2005 at only 11%. Several other economic surveys in late December
yielded similarly optimistic results.
Yet many analysts continue to argue that consumer spending, which makes up
over two-thirds of GDP, will decline in 2005. They point to the new high in
consumer debt and very low savings rate in the US. BCA argues,
however, that the economy will produce real income growth of apprx. 3% in
2005, and that this will lead to an increase in personal consumption
spending by about the same amount (3%) this year. In short,
consumers can hang in there.
The BCA editors also see the decline in the US dollar continuing this year,
although they also expect there to be some occasional upward corrections
from time to time as we’ve seen recently. Unlike some forecasters who see
the dollar decline turning into a currency crisis, BCA expects the decline
to be generally gradual again this year.
Many analysts worry that the dollar decline will cause foreign governments
to sharply reduce their large purchases of US Treasury debt, as compared to
the last several years. This, they contend, will lead to a global financial
crisis.
BCA very much believes that such a global financial crisis is coming at some
point, but they don’t believe we are near that point just yet, barring any
major negative surprise (such as another terrorist attack). For
2005, BCA believes foreign governments will continue to buy large amounts of
US debt, and that this will keep medium and long-term interest rates
relatively low. They say:
“The painless nature of the dollar's drop indicates that there is
plenty of global capital available to finance the U.S. current account
deficit. Weak demand in the global economy means that there are excess
savings, and these inevitably find their way into U.S. assets. Thus, major
problems should not erupt until demand improves in the rest of the world to
the point where the pool of excess savings dries up, forcing the U.S. to
compete for capital. That could then push up U.S. interest rates and trigger
problems in the debt-heavy consumer sector.”
The editors believe that inflation will remain low this year. Nevertheless,
they do expect the Fed to continue to raise short rates several more times
in 2005. They say:
“The Fed will keep raising [the Fed Funds] rates to at least 4% as
long as the economy is growing at a steady pace and inflation is stable or
drifting higher. Policy will go on hold if the economy clearly weakens
and/or inflation heads lower.”
One of BCA’s concerns is that the Fed could raise short-term rates too high
late this year or in 2006 and thus, short-circuit the economic recovery.
While the Fed would not intentionally do so, it has made such mistakes in
the past. So far, the Fed has moved cautiously in raising rates; each rate
hike so far has only been a quarter-point (0.25%). Given that, BCA believes
the odds of the Fed overshooting short-term rates on the upside in 2005 are
low.
BCA On The Investment Markets
With those predictions for the economy and interest rates, what do the
editors have to say about the investment markets? It is safe to say that
the BCA editors are not in love with with either US stocks or US bonds at
this time. They believe US equities will move higher in 2005, but
they expect returns to be in the single digits again, while volatility is
likely to remain high.
The editors caution investors to keep a close eye on the Fed. Their concern
is that if the Fed begins to raise rates more aggressively, this could be
negative for equity prices in general. But as noted just above, they do not
see this as very likely.
As noted on page one, I still feel that stock prices have more potential
on the upside - not huge, mind you, but worth participating in - especially
if under the direction of professional Advisors that can move out of the
market, or hedge their positions, if market conditions so warrant.
BCA’s Specific Recommendations On Stocks &Bonds At This Time
Even though the BCA editors are only mildly positive on equities, they did
make some specific recommendations on which markets to be in now.
First, they recommend that investors increase weightings of large cap stocks
and reduce holdings of small cap stocks. They argue that large cap
stocks will benefit more from the falling dollar, and small cap stocks will
be hurt more by rising short-term interest rates.
Second, they also favor European stocks over US equities.
Specifically, they recommend buying high quality stocks of the UK and France
on dips in those markets (or mutual funds that focus on same).
They also feel there is better potential (than in the US) in certain of the
emerging markets overseas. As a general emerging strategy, they like
countries that provide goods and services to China, as opposed to countries
who buy goods and services from China. Some of the emerging areas they
like include Latin America, South Africa and Russia (although they are
increasingly concerned about the heavy-handed political situation in
Russia). In Asia, they like South Korea and Taiwan. I would
caution, however, that many of the emerging markets have already made big
moves on the upside, so the risks are greater at this time.
As for the US bond markets (Treasuries and high quality corporate bonds),
BCA sees a trading range as the most likely scenario in 2005. As noted
above, they believe there is plenty of foreign capital available to purchase
Treasury debt and thus keep yields relatively low. Yet at the same time,
the strong economy and the Fed raising short-term rates create pressure for
higher yields. In the end, and barring any major negative
surprises, the editors seem to think bonds will be in a trading range for
most of this year. Here, too, the editors favor Euro zone bonds
over US bonds, at least for the first half of 2005.
[Editor’s Note: Keep in mind that BCA has a
subscriber base that includes thousands of large institutions and high net
worth, sophisticated individuals all over the world. But for many of us,
buying and selling securities overseas is not so simple a matter. There are
plenty of pitfalls in trading the foreign markets, and you should only do so
if you have experience in these areas.]
BCA On Selected Commodities
As for the commodities markets, the BCA editors believe that oil prices have
now moved to a new and likely permanent price plateau, with a floor of
around $40 and ceiling that is very uncertain. BCA says we should
not be surprised if there are more upward spikes in the price of oil and
energy related commodities. This is consistent with the views of many
other analysts in the energy markets.
As for gold and precious metals, the editors believe these markets will
continue to benefit from the falling dollar, but they also believe the bull
market may be overextended at this point. They feel that gold, for
example, could correct down to the $380-$400 area where it would be a good
buy again.
I agree with BCA’s caution regarding chasing precious metals at this point.
I have warned often in the past, and most recently in my November 30
E-Letter (when I discussed the new Exchange-Traded Gold Mutual Fund (ETF),
that gold has a long history of plunging after major advances:
“As noted above, gold prices in the US have risen almost 80% since the
low, and prices have moved virtually straight up since September. That
means the market is ripe for a pullback at any time. Furthermore, gold has
heavy overhead resistance (a technical term for selling pressure) from $450
to $500. Gold prices spiked to near $500 in 1982 and 1987, and both times,
the market then cratered.
And that’s another negative. Gold prices typically fall off a cliff
after a sharp run-up, rather than gently trending downward. This extreme
volatility can be disconcerting to many investors.”
Days later, gold prices plunged from above $455 to below $435. As this is
written, gold is down to below $425. While this may not be a big deal to
investors who own gold from lower levels, it does demonstrate once again
that gold (and other precious metals) tend to fall hard whenever they
correct or the trend changes from up to down.
While I still believe that gold is in a bull market, keep in mind that one
of the main drivers is the decline in the US dollar. Even if the dollar is
headed lower, it will be a volatile ride in precious metals.
Trouble Looms In The Coming Years
While BCA predicts that the economic expansion will continue in 2005, they
also warn that some very difficult economic and financial times lie ahead in
the not-too-distant future. They warn that whenever the next serious
recession occurs, it could lead to a global financial meltdown.
While the editors believe that Asia and other foreign countries will
continue to purchase large amounts of Treasury debt for another year or
longer, they also believe the day is coming when this excess global
liquidity will evaporate. When that happens, the US will face very
difficult choices.
The problem is, no one knows when the next serious recession will hit. It
could occur in 2006 or 2007, or it could unfold at any time if there are
more serious terrorist attacks in the US. We just don't know. This
explains why BCA subtitled its Outlook 2005 as “A Year of Living
Dangerously.”
Conclusions
In the space of a week or so, we have BCA predicting 3-3.5% GDP growth in
2005, and no recession, plus the Wall Street Journal economic survey with a
consensus 3.6% increase in GDP this year. That’s the good news.
BCA predicts that stocks will trend higher but probably at only single-digit
returns with continued high volatility. If this forecast proves to be true,
that means most “buy-and-hold” stock market investors will be taking a LOT
of risk to make disappointing returns.
The bond market could remain in a broad trading range for much of the year,
worrying along the way about the Fed raising short-term rates and the
falling US dollar. Here, too, buy-and-hold bond investors will be taking a
LOT of risk for what could be low returns or no returns.
BCA believes investors might see better returns by investing in European
stocks and bonds, but let’s face it - most Americans aren’t going to buy
European stocks or bonds (especially not France).
Other than the economy, BCA’s latest forecasts may seem
disappointing/discouraging to most investors, especially those who use only
buy-and-hold strategies or are accustomed to investing in “index funds”
which only do what the markets do. In my opinion, these traditional
strategies are going to be disappointing in the markets we are likely to see
over the next couple of years.
Active, Professional Management
At the risk of sounding like a broken record, these forecasts speak to the
need to have professional managers with time-tested systems that can move
into or out of the markets periodically as market conditions warrant. Even
better would be professional managers that have systems in place to “hedge”
their long positions by using the various “short” funds. The successful
managers that use these strategies have the potential to increase returns
while at the same time reducing risk.
For many years we have looked for managers who can not only move in or out
of the market, or hedge, but who also can take outright “short” positions
. I am pleased to announce that we have found a very successful Advisor
who trades both long and short in mutual funds. We are in
the final stage of our due diligence review on this new Advisor, and I
expect to bring you more detailed information later in January.
This Advisor uses the Rydex Velocity (long) and Venture
(short) funds. The firm has an outstanding performance record with
limited losing periods. Past results are not necessarily indicative of
future results.
I think you are really going to like this new Advisor! We will
automatically send you complete information as soon as our due diligence
review is done very shortly. We are also looking at another new equity
manager and a new bond timing program.
If you have not invested with the professional managers I recommend, I
strongly advise you to consider doing so this month if they are suitable for
you. If you are looking for a true long/short program, I think we have one
you will like. Feel free to give us a call at 800-348-3601 and
speak to one of our Investor Representatives.
When late December and early January roll around, investment writers seem
compelled to make sweeping forecasts for the New Year, as if they have a
crystal ball. And the forecasts are all over the board. The
cheerleaders on Wall Street predictably assure us that the New Year will
bring impressive equity returns. Likewise, the gloom-and-doom crowd can be
counted on to promise a stock market debacle every single year. And then
there is every kind of forecast in between.
If that weren’t confusing enough, then we have some interesting statistical
information based more on the calendar and/or totally unrelated factors than
anything else. Just for fun, let’s look at a few.
Numerous sources document that the stock markets have a long history of
soaring in years ending in 5. For example, The Chart
Store documents that the Dow Jones has risen every year but one in years
ending in 5, with an eye-popping average return of 31.6%. The only
down year was way back in 1895 when the Dow lost 1.7%. The S&P500, a more
contemporary index, shot up an average of 30.6% in 1975, 1985 and 1995,
while the Nasdaq soared an average of 33.7% in the same years ending in 5.
Pretty impressive, eh?
Actually, there’s no economic or other clear explanation for this. Years
ending in 5 have not been consistently good for the economy. We were in the
Depression in 1935, yet stocks still managed to rise. In 1975 we were
entering the great inflationary wave, but stocks rose anyway. In both of
those bad periods, stocks gained more than in the years 1945, 1955 and 1985
when the economy was strong. Who knows why.
According to the Stock Trader’s Almanac, the equity markets
also have a pattern of strong gains in years prior to presidential election
years. In 1895, 1915, 1935, 1955, 1975 and 1995, all pre-election years,
stocks were strong. Interestingly, those are also all years ending in 5.
Again, no one knows why. What we do know is, this year is another
that ends in 5.
Again, just for fun, let’s add in the Super Bowl theory for all
you football fans. The stock markets have a strong tendency to do well
in years when an original NFL team wins, and poorly in years when an
original AFL team wins. The New England Patriots won last year’s
Super Bowl, and stocks performed poorly overall this year until a late
recovery in the 4Q.
So in theory, you should be an aggressive buyer of stocks now IF
you believe that an old NFL team like the Eagles, Packers or Colts-(formerly
NFL) or others will win this year, AND because the year ends in 5.
Or IF you believe that an old AFL team like the Patriots, Steelers or
Chargers-(formerly AFL) will win, you might want to lighten up a little, but
not too much because the year ends in 5. Clear as mud, right?
I could go on with such theories, but I trust that no one reading this will
be betting heavily on either of these two scenarios. Hopefully, you have a
portion of your equity portfolio with the professional managers I
recommend. The beauty of these successful Advisors is that if a
major uptrend develops, their systems should kick in, and they should get at
least a piece of the trend, if not most of it. Or, if the markets turn down
significantly, those same systems will likely either get them out of the
market, or at least to hedge their positions. (Of course, past
results are not necessarily indicative of future results.)
I believe this investment strategy is far superior to betting on theories
like years ending in 5 or the unpredictable outcome of the Super Bowl. I
also believe this active management strategy is critical as a complement to
a buy-and-hold approach. If the market goes down, buy-and-hold is sure to
lose. Given all the other uncertainties we face this year, now more
than ever Ibelieve you need some money in these programs. There’s still
time to get started before the Super Bowl!
Call us today (it’s 2005) at 800-348-3601 and may the best team
win! Wishing you New Year’s profits!!
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