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Trends & Surprises - What To Expect In 2007 |
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FORECASTS & TRENDS E-LETTER IN THIS ISSUE: 1. My Thanks To The Bank Credit Analyst 2. BCA’s Latest Outlook For 2007 3. BCA’s Potential Wild Card For Equities 4. To Ride, Or Not To Ride, The Equity Bubble 5. Get The Pros On Your Team Now 6. Conclusions – Time To Be My Client Introduction This week, we take a look at the latest analysis and forecasts from our old friends at The Bank Credit Analyst. I will give you a summary of BCA’s latest thinking on the economy, interest rates, inflation and what they expect in the stock and bond markets for 2007. I think you may be surprised at some of what follows. I will also share with you what I appreciate most about The Bank Credit Analyst. This is a story I have never shared with readers of this weekly E-Letter. I think you’ll find it interesting, but I must warn you, it may hit pretty close to home for some of you – especially those of you who have a tendency to be bearish most of the time. My Thanks To The Bank Credit Analyst If you are a regular reader of this E-Letter, you know that I have a great deal of respect for, and confidence in, The Bank Credit Analyst. I have been a continuous subscriber to BCA for almost 30 years. Of all the financial/investment publications I have read over the years, BCA has been by far the most accurate in forecasting the economy and the major investment markets in my opinion. This is why I continue to renew my subscription every year (which is not cheap). I am grateful to BCA for all the good information and forecasts they have published for all these years. Their advice has helped me as an Investment Advisor, and therefore my clients as well. Their advice has frequently helped me to be on the right side of trends and, more importantly, to warn me of impending recessions and bear markets. But there is one other thing for which I am most grateful to BCA. BCA changed me from a “perma-bear” to an objective observer who could be bearish or bullish many years ago. Not long after I got into the investment business in 1976, I became captivated with newsletters and books written by what I frequently call the “gloom-and-doom” crowd. By the time I decided to subscribe to BCA in late 1977, I was definitely a perma-bear (one who is always bearish). Of course, it was not hard to be a perma-bear in the late 1970s. Inflation was soaring out of control, as were federal budget deficits. Stocks were in the tank. Precious metals were soaring. The gloom-and-doom crowd promised that we were headed for a financial apocalypse and a depression (don’t they always) and frankly, I was one of them at the time. I had most of my clients loaded up with gold, silver, coins and other inflation hedges that were soaring. But in late 1979 when Paul Volcker was made chairman of the Federal Reserve with a mandate to get inflation under control, BCA warned its subscribers to liquidate inflation hedges and move to the safety of cash. In short, BCA predicted that Paul Volcker was going to crush inflation, even if it meant a recession. They were correct as usual. While I didn’t agree with BCA at the time, I fortunately took their advice and insisted that my clients liquidate all of the inflation hedges I had previously recommended to them before the end of 1979. As a result, we dodged a huge bullet as the precious metals markets collapsed in early 1980. Many people in the commodities markets were completely wiped out. As most of us can recall, Volcker ratcheted short-term interest rates to levels never seen before. The Prime Rate spiked above 20% briefly in 1980/81. 30-year Treasury bonds soared to near 16%. And the economy did go into a recession. But in late 1981, with the economy still in recession, BCA began to emphasize that the US was about to embark on a multi-year (perhaps multi-decade) economic recovery which would be highlighted by consistently stronger than expected growth, very shallow recessions and a continued decline in inflation. BCA argued that this multi-year “upwave” would be very bullish for financial assets for many years to come. They recommended that subscribers move to fully-invested positions in stocks, bonds and related mutual funds. As a perma-bear, BCA’s forecast for a multi-year economic juggernaut presented a real dilemma for me. For starters, I personally thought BCA was wrong at the time. I even spoke with the editors about my concerns. Basically the conversations ended with BCA telling me that they respectfully believed that the perma-bears were dead wrong. I even interviewed BCA editor Martin Barnes on tape and challenged BCA’s rosy view of the future. I made cassette tape copies of that interview and sent them to all my clients at the time free of charge. But the bottom line was, I had a choice to make! Because of my respect for BCA, I elected at that time to turn over a new leaf and stopped being a perma-bear. So I advised my clients – most of whom were also perma-bears – of my transformation, and shared with them BCA’s optimistic view of the future. Now, over 25 years later, we know that BCA was right on target back in 1981/82. We’ve seen the strongest economy in history, only two mild, brief recessions, inflation has come way down, interest rates have plummeted, and we’ve seen the biggest bull market in stocks in history. While I appreciate all of the great forecasts from BCA over the years, I am most appreciative of the fact that they converted me from a perma-bear to one who can be bullish or bearish. I thought this is a story you would like to know. Now let’s see what BCA is thinking for 2007 and beyond. Keep in mind that when I summarize BCA, you are reading my interpretation of what they have to say, and my interpretation may not always be completely correct. But after reading BCA for almost 30 years, I think I’m pretty adept at interpreting “BCA-speak.” BCA’s Outlook For 2007 Let’s start with the Big Picture. BCA believes that the US economy is still in the long-term “upwave” they predicted in 1981/82. But they also believe that we’re getting quite late in the game. The editors do not speculate as to exactly when the upwave comes to an end, but my guess is they believe the wheels will start to fall off after 2008.
In late 2005, BCA predicted that the US economy would experience a “mid-course correction” in the last half of 2006 and extend into the first half of 2007. The first half of that forecast has come true. GDP was 2.0% (annual rate) in the 3Q, down from 2.6% in the 2Q and 5.6% in the 1Q. BCA expects the 4Q GDP number to be below 3% as well, and looks for similarly soft figures for the 1Q of 2007, with a recovery emerging by mid-next year. BCA has been very consistent in their view that the most likely scenario is that this mid-course correction will not devolve into a recession, barring any major negative surprises. So far, there is no reason to believe they are wrong, or that we will hit another mild recession this year. Beyond the first half of 2007, BCA sees another economic rebound – they don’t speculate how strong, other than a return to GDP growth of 3% or above. BCA believes that inflation will continue to trend lower in 2007, and that should give the Fed the flexibility to halt its interest rate hiking cycle, if it hasn’t already. Furthermore, the editors believe that inflation will tame to the point that the Fed will be able to lower short-term interest rates a couple of times in the first half of 2007. As for stocks, BCA believes that the bull market will continue in 2007. Their most likely scenario is that stocks will have another year like 2006 in 2007, with decent gains on the upside, but with continued high volatility on the upside and downside. BCA also believes there is apotential WILD CARD looming in the US equity markets this year. I will discuss this below. As for interest rates, BCA believes that rates – both long and short – will be in a trading range in 2007. This is not particularly good news for bond investors, but it is what it is – more of the same. Likewise, BCA expects the US dollar to remain in a trading range for 2007. As for markets such as oil and energy, precious and base metals, and other resource commodities, BCA continues to believe that we are in a long-term, demand-driven bull market that will see these commodity prices move higher than the highs seen in 2006. However, in the short-term, BCA warns that precious and base metals could get hit more on the downside – thus providing some good buying opportunities sometime this year. BCA’s Potential Wild Card For Equities In the world we live in today, almost any forecast has to include some potential wildcards, caveats and risk factors. Typically such wildcards and caveats are on the negative side: terror attacks, new wars, major government defaults, currency crises, financial/banking breakdowns, hedge fund debacles, market meltdowns, etc., etc. All of these risk factors are a part of our world every day. For most of these risks, the odds are fairly low of them happening, or at least it would seem. Yet each of these risks is factored into market prices and investment valuations on a continual basis, at least as best as possible. In all of BCA’s forecasts, they also include all of the caveats noted above, as they cannot be ruled out. But BCA has always been good about suggesting what they consider to be the “most likely scenario” in case no major negative surprises occur. BCA’s most likely scenario is what I have summarized above for 2007 and beyond. However, BCA subtly makes a point regarding yet another Wild Card that could rear its head in 2007, and this is a point I have seen no other market research group make, at least among those I follow. Read this carefully. There is currently a flood of global liquidity. Space does not allow me to elaborate at length, but suffice it to say that a combination of windfall oil profits and the excess savings rate in Asia and elsewhere has created a monumental level of global cash looking for a place to invest. BCA believes there is the potential for a huge influx of this global cash to the US this year, when it is clear we have avoided a recession, and thus there is the real possibility that this potential tidal wave of cash could drive US equity prices into yet another bubble on the upside. This may or may not happen. BCA is just warning us not to be surprised if it does. If it does, it could mean another potentially huge leg up in the ongoing bull market in US equities. Just something to think about. To Ride, Or Not To Ride, The Equity Bubble Many analysts, and most investors I talk to, were surprised by the strength in the equity markets in 2006 – even though BCA predicted that stocks would rise all year. What with oil prices soaring and the Fed raising interest rates in the first half of the year, and with the economy slowing down in the second half of the year, most people did not expect the market indexes to take off on an upward rampage in the last half of 2006 that sent the Dow Jones to a new all-time high. The 2006 bull market in equities also occurred at a time when the war in Iraq turned deadlier and public opinion on the war turned negative, so much so that the Democrats swept both houses of Congress in the November mid-term elections. Even that didn’t phase the equity markets. So, despite a lot of real and perceived negatives, stocks moved higher than most anyone expected in 2006. The Dow Jones Industrial Average gained over 16%, and the S&P 500 climbed over 15% in 2006. While some analysts argue that US stocks are overdue for a downward correction, BCA believes that such a correction would likely be limited, in large part due to the continued influx of global capital to these same markets. And as discussed just above, BCA also believes that we could see the influx of global capital accelerate this year, especially if it becomes clear the US will avoid a recession. Most of the investors I talk to are under-weighted in stocks and equity mutual funds. Most have been in this position for the last several years, in many cases having never gotten fully back into stocks and equity mutual funds since the bear market of 2000-2002. Investors in this position have left a great deal of money on the table since the current bull market began in 2003. This brings up a difficult decision for many investors, especially in light of BCA’s forecast for another positive year in equities, and the possibility that we could see another equity bubble in 2007. Yet despite that forecast and BCA’s long and enviable history, many investors are likely to conclude that it’s just too late and too risky to move back to a fully-invested position in equities. A major reason for this hesitance, I believe, is the memory of how many nest eggs were wiped out in the tech bubble that burst as we entered the new millennium. I think investors do see the potential for participating in up markets, but fear that they may not get out in time if the markets start to decline. Thus, some will decide to just stay on the sidelines. Others, however, might get in the market, but have their finger on the trigger so they can jump out at the first sign of a market decline. This could, in turn, lead to investors hopping in and out of the market on their own, which is hardly ever a winning game. Buying and selling on emotion often leads to buying high and selling low, especially in a volatile market such as the one BCA expects to see in 2007. Neither of these two alternatives is prudent, in my opinion. Fortunately, there is another alternative for investors who want the potential to participate in up markets, but with the flexibility to move to cash or hedge positions should the market turn down significantly for some reason, or should surprises occur. Get The Pros On Your Team Now If you have read this E-Letter for long, you know that I am a big fan of “active management” strategies that have the potential to exit the market or hedge long positions should market conditions change significantly. Active management strategies attempt to reduce risk by being under-invested or hedged during periods when the markets decline significantly. At Halbert Wealth Management, we continually search for professional money managers that use active management strategies and have successful performance records. While there are plenty of active managers that aren’t worth their salt, there are those who have been very successful at delivering their clients very attractive returns with limited drawdowns, although this is no guarantee of future results. These are the kind of active managers I recommend to my clients. In light of the current market environment, and BCA’s latest forecast, now may be the time to consider getting these successful professionals on your team. Last year, I wrote about two of the active managers I recommend – Potomac Fund Management and Third Day Advisors. I am happy to report that both had excellent performance last year. Of course, past performance is no guarantee of future results, and these programs are not suitable for all investors. You can view their updated performance by going to my website, along with the performance of the other professional money managers I recommend. Be sure to read all of the important disclosures. If you have at least $50,000 to invest, you can get started with one of the active management programs I recommend. Which one(s) will depend on your investment experience, your goals and your risk tolerance. We can help you select a program that is suitable for you. Many of my clients have money with more than one of the money managers I recommend. I highly recommend diversifying with multiple managers if possible, as you not only diversify the risks but also the types of strategies employed. Conclusions – Time To Be My Client As I noted above, BCA has been my most trusted source of economic and market analysis over the years. While not perfect, BCA has been more accurate at predicting major trends in the economy and the major investment markets than any other source I have followed over the last 30 years. BCA believes that the most likely scenario for 2007 is a couple more quarters of slow growth, but that the US economy will not fall into a recession this year, as many now predict. BCA forecasts that the economy will rebound in the second half of this year and into 2008. BCA also predicts that the US and global stock markets will continue to rise this year, with the possibility that US stocks could surge on the upside, if and when it becomes clear that the US has dodged a recession. While there’s no guarantee that their forecast of a continued bull market in stocks will come to pass, I have learned that it is usually better to bet with BCA than against them. Even if BCA is correct as usual, I don’t see a smooth road ahead for the equity markets. There are plenty of real and potential negatives that could cause an emotional response on the part of investors. So, even if stocks are going to rise this year – perhaps significantly as BCA suggests – it could well be a roller-coaster ride, with lots of ups and downs along the way. Keep in mind that memories of the bear market of 2000-2002 are still fresh on the minds of investors, and might result in “knee-jerk” reactions to market declines. During the bear market of 2000-2002, many investors in “index funds” suffered losses of 40% or more, and many investors in Nasdaq stocks and related index funds lost 60-70% or more. Thus, any market declines or corrections this year could be exaggerated by investor emotion. The bottom line is that 2007 looks to be a challenging year for stock market investors. If BCA is correct, US stocks will turn in another positive year, with the possibility that we could see another bubble on the upside. But it is likely to be a rocky ride along the way. If you are under-invested in equities, or even if you are fully-invested and doing it on your own, I believe that now is the time to consider professional management for a part of your portfolio. Consider “active management” strategies that have the flexibility to move to cash or hedge positions should economic or market conditions warrant. Finally, if you have been hesitant to invest with my company because we are in Texas and you live in some other state – and we have never met – that should not concern you. We are in the “Internet Age” where people do business all around the globe without ever meeting the party on the other end of the transaction. Investing in today’s complicated markets should be no different. In fact, I have clients all around the country in all 50 states, most of whom I have never met. But I am always happy to speak with clients personally. So maybe it’s time for you to become one of them, especially given the outlook I have described above for 2007 and beyond. To learn more about the money managers I recommend and the services we offer, go to my website at www.halbertwealth.com or call us at 800-348-3601 and talk to one of my experienced Investment Consultants. You can even e-mail us at info@halbertwealth.com to get the ball rolling. The sooner you do so, the sooner you can learn about these investment programs with the potential to manage the risks of being in the market. Wishing you profits in 2007,
Gary D. Halbert SPECIAL ARTICLES
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