THE ECONOMY - GOOD NEWS & BAD NEWS - PLUS, A LOOK AT THE POLITICAL SCENE

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
July 8, 2003

IN THIS ISSUE:

1. BCA Predicts 3-4% Economic Growth In Second Half.

2. BCA Warns Next Recession Could Be The “Big One.”

3. See My July Newsletter For BCA’s Latest Warning.

4. Why The Democrats Are In Fear Of Howard Dean.

Introduction

If you have read my weekly E-Letters for long, you know that I am a big fan of The Bank Credit Analyst, the widely respected economic and financial forecasters based in Montreal, Canada. Although quite pricey as compared to most analytical services, I have been a continuous subscriber since 1977. Over that time, BCA has made more correct calls regarding major trends in the US economy, and the financial markets, than any other source I read.

In their latest July issue, the BCA editors predict that the US economy will rebound to a growth rate of 3-4% in the last half of this year. They also predict that the economy will grow at that rate, or possibly even better, in 2004. I will outline BCA’s latest analysis for you in the pages that follow.

While BCA is quite optimistic about the US economy in 2003 and 2004, they are very concerned about what will happen whenever we hit the next recession, perhaps in 2005 or 2006. While they rarely agree with the gloom-and-doom crowd, the BCA editors paint a very bleak picture of what will unfold when we hit the next recession and the possibility of a debt deflation.

I have analyzed BCA’s latest predictions in the July issue of my Forecasts & Trends newsletter, complete with extensive quotes. To view this latest monthly issue of my newsletter, CLICK HERE. You need to read this latest forecast from BCA.

Finally, we look at the latest developments on the political scene. Surprisingly, presidential hopeful Howard Dean has the Democrats on the ropes, at least for the moment. He wants to oust DNC chairman Terry McAuliffe and the rest of the Clinton cronies in the party leadership. Will this cause Hillary Clinton to throw her hat in the ring? I wouldn’t rule it out.

BCA’s Latest Economic Forecast

The economy is recovering slower than most economists expected, and unemployment jumped to 6.4% in June. The Commerce Department revised its estimate of 1Q GDP from 1.9% down to 1.4% (annual rate). Despite these and other disappointing reports, The Bank Credit Analyst was surprisingly optimistic in their latest July issue, at least for the next 12-18 months.

BCA believes that the US economy will recover to a 3-4% annual growth rate in GDP by the end of the year. BCA cites the Index of Leading Economic Indicators which has risen for the last four months, as well as other indicators. BCA believes the economy will continue to recover due to four primary factors:

1. Low rates & aggressive monetary policy;
2. Record deficit spending in Washington;
3. President Bush’s latest tax cuts; and
4. The falling US dollar.

BCA believes these factors, and others, will ensure that the economy recovers for at least the next 12-18 months. They say:

“Record policy reflation should ensure that economic growth moves to a 3% to 4% pace during the second half of the year and into 2004. The risks of a debilitating deflation are low… Super-stimulative monetary policy will be the driving force behind [stock] market performance during the next 6 to 12 months. The Federal Reserve plans to keep short rates at close to current levels for an extended period and this should reward those investors who have taken on some portfolio risk [in equities].” They continue:

“There continues to be a powerful tug of war between massive [monetary] policy reflation and the lingering after-effects of the various shocks that have hit the economy during the past three years. The sharp drop in interest rates and tax cuts have been successful in sustaining consumer spending, but have not yet managed to trigger a rebound in business spending. Corporate executives remain extremely cautious, focused more on cost cutting and balance sheet restructuring than on expanding. Nevertheless, business confidence should gradually revive in the second half of the year, aided by a continued improvement in profits.

Deflationary concerns may persist for several more months, but the odds that the economy will fall into a Japanese-style slump are low. It is far more likely that economic growth will surprise on the upside in the next year as the latest tax cuts take effect and the manufacturing sector responds to the competitive boost from a lower dollar.

Recent gains in the stock market suggest that investors are already discounting an improvement in economic activity and earnings. Nonetheless, the rally has further to go on a cyclical basis given that monetary conditions will stay extremely easy for an extended period. The Federal Reserve wants to encourage risk-taking and it will be worth playing its game [being in the market] for a while longer…

There is a tendency to assume that policy has been ineffective given the economy’s softness during the first half of 2003. Some have argued that if the economy is still growing sluggishly after all this monetary and fiscal stimulus, why should we expect any improvement in the months and quarters ahead? This argument could be turned on its head.

The U.S. economy has endured an extraordinary barrage of negative shocks in recent years, beginning with the bursting of one of the past century’s greatest asset bubbles. This was followed by the 9/11 terrorist attacks, a damaging spate of corporate scandals, two wars and a spike in energy prices.

Yet, the economy suffered its mildest recession on record in 2000/2001. The economy’s performance in the face of so many adverse events reflects the effects of powerful monetary and fiscal stimulus as well as the economy’s underlying resilience.

It is true that the mild nature of the downturn means that there has not been the pent-up demand for consumer durables and housing that typically occurs in a recession. That is why there will not be vigorous growth in these areas in the coming year. However, business spending did suffer a vicious cutback and there is pent-up demand in this area. The building blocks for increased spending are in place: inventories are low, net investment (capital spending minus depreciation) as a share of GDP is as weak as it has been in the post-WWII period, and profits are recovering. Business confidence is still depressed, but the small business survey carried out by the National Federation of Independent Business suggests that sentiment may have bottomed...

We expect that economic growth will move to an above-trend pace during the second half of the year and the momentum should carry into 2004. The Conference Board’s leading economic indicator has moved back above the boom/bust line, implying that the economy’s soft spot has run its course…

There are reasons to be concerned about the longer-run outlook in terms of rising financial imbalances. Nevertheless, that should not prevent investors from taking advantage of the current hyper-stimulative environment that should persist for at least another year.”

BCA’s analysis gets much more technical, but you get the drift. They believe the Fed will prevail in turning the economy around, that business spending will begin to increase, that the economy will move back to a 3-4% growth rate over the next six months, and that the recovery will continue in 2004.

They recommend slightly above-average holdings of equities. BCA continues to favor “market timing” strategies over a buy-and-hold approach. They also recommend slightly below-average holdings of bonds. They believe investors should be reducing exposure to Treasuries and increasing exposure to corporate bonds, high-yield bonds in particular. In addition, they are still bearish on the US dollar and bullish on gold.

If BCA’s outlook is correct, the next year or year and a half should offer some very good investment opportunities. In my view, this environment should be very good for the market timers we recommend. If you have money sitting on the sidelines, maybe now is the time to get back into the market.

Now For The BAD News

The BCA editors have never been in the gloom-and-doom camp. While they have correctly predicted several recessions, they have more often been more positive about the economy than just about anyone I have read over the years. However, in their July issue, the editors devoted a section to looking down the road at what may happen whenever we hit the next recession.

The editors do not predict when the next recession will hit, but they do point to a pattern in the business cycle where there has been a recession about every 4-5 years, generally speaking, over the last three decades. As such, they suggest the next most likely time for a recession would be in 2005-2006 or soon thereafter. The editors paint a picture of what things might be like when we hit the next recession, and it isn’t pretty!

BCA believes that because of the massive effort being made to reflate the economy now, the Fed and policymakers in Washington will have little ammunition to pull us out of the next recession. They say:

“The dark side of current reflationary efforts is that they are leading to increased financial imbalances that will cause problems down the road. Consumers are taking on more leverage, government finances are deteriorating dramatically and the bloated current account deficit is continuing to increase. None of these trends are sustainable over the long term…

There has been a fairly regular four to five-year business cycle in the U.S. in recent decades. This suggests that the next economic downturn could occur in 2005 or 2006. The problem is that the authorities may have limited ammunition in their policy arsenal with which to try and rekindle growth.

Fiscal options will be limited given current trends in the deficit, the dollar will have already fallen significantly, and interest rates may still be below equilibrium levels. Thus, the threat of a debt deflation will be even greater in the next recession than it is today.”

This is serious stuff, especially coming from BCA! While they are optimistic in the near-term (12-18 months), they are very concerned that the next recession could usher in a possible financial crisis. This is a very troubling forecast. Due to space limitations, I cannot go into detail regarding BCA’s latest longer-term forecast, but you can read more of this analysis on the next recession in my latest monthly newsletter ( CLICK HERE).

I will have more to say about BCA’s latest forecast in upcoming issues of this E-Letter, especially as the editors elaborate on their forecast in subsequent reports. If you would like to subscribe to BCA, go to www.bcaresearch.com. I highly recommend it!

On the Political Grapevine

In politics, as well as history, you should expect the unexpected. What could be more unexpected than liberal Vermont Governor Howard Dean’s rise to the top of the Democratic pack? And, how about our former First Lady turned Senator, Hillary Clinton, who is reportedly now hinting at a run for the White House in 2004? Surprised? Don’t be - these two events are probably not unrelated, as I will explain.

To the absolute shock and horror of the DNC and the utterly nondescript Democratic field of candidates, Howard Dean is coming on strong. The feisty, personable and approachable populist doctor from Vermont is in the process of upsetting the Democratic Party’s collective applecart. Unlike his would-be rivals, Dean has flair and spark; there is an actual twinkle in his eye; and he is passionate and not some dull, plodding policy wonk. He is, dare I say, “Clintonian” in his campaigning.

I should also mention that he is the “darling” of the Hollywood elites and has raised more money in the past quarter than the other Democrat contenders, and mostly over the Internet. Even still, Dean is treated as the “flavor of the month” by the Kerry campaign, dismissed as an “amusement park ride” that will soon come to an end when people get serious. Apparently the Democrats don’t know it, but people are serious now!

So why is this a bad thing for the Democrats? Simple, Dean is a liberal’s liberal. He is a true believer in big government, social relativism and a “one-worlder.” He was/is very much against the war in Iraq, opposes the use of the military and is seen as weak on national security. In some ways he must be admired for having the courage of his convictions. As Dean is fond of saying, he is from the “Democratic wing of the Democratic Party.” For all these reasons, Dean is seen as a danger to the Democratic Party, and some believe to the political future of Hillary Clinton.

Despite Dean’s recent successes, he would be trounced by George W. Bush if the election were held today. He would be a ‘49er’ in that he would likely lose 49 states in the general election, again if the election were today. I don’t believe he is electable in the post-911 era. While Dean has little chance of winning the election, he could snake the nomination away from another more centrist contender.

Hillary To The Rescue?

While promoting her new book in the UK, Hillary gave an interview with the BBC. Here is a quote from that interview. Appearing Friday on BBC Channel 4’s “Richard and Judy
Show,” Mrs. Clinton was pressed on whether she might challenge President Bush as early as next year. She reportedly said, “You never know what might happen.”

This has not been widely reported in the media. I only read about it this morning. So what does this have to do with Howard Dean? Well, as you may or may not know, Dean despises Terry McAuliffe, the chairman of the DNC. Dean has blasted him for the 2002 off-year election route and believes that he is, in general, moving the party in the exact wrong direction.

The trouble is, McAuliffe is the Clintons’ handpicked front man to retain control over the Democratic Party. If Dean gets the Democratic nomination, McAuliffe could be toast, along with some other Clinton cronies. If Dean gets the nod, not only would he be trounced in the 2004 election, but he could also obliterate the party apparatus set in place to support Hillary in 2008. And so, apparently, Hillary has started to change her tune ever so slightly.

The Clintons don’t care who gets the nomination; they know that (at least at the moment) no one can beat Bush. But spoil Hillary’s chances in 2008… no way! So, if the Howard Dean juggernaut continues to roll along, and if it looks like he can actually win in Iowa and/or New Hampshire, Hillary’s announcement may not be far behind. Stranger things have happened.

In closing, I must add the following caveat. I read of Hillary’s hint about running in 2004 on NewsMax.com, which has had its share of inaccuracies in reporting. So, it is possible that Mrs. Clinton’s remarks were taken out of context. But if my speculation above actually proves to be accurate, you can say you read it here first.

Wishing you well,

Gary D. Halbert

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