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Latest Forecasts From The Bank Credit Analyst
& Lastly, My Parting Thoughts On The Election

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
November 2, 2004

IN THIS ISSUE:

1.  The Economy – Solid Growth But Below Expectations

2.  Leading Indicators & Confidence Fall For 4th Month

3.  The Bank Credit Analyst’s Outlook For The Economy

4.  BCA Suggests “Market Timing” & “Sector Selection”

5.  BCA Predicts Multi-Year Bull Market In Commodities

6.  The Election Came & Went, Or Did It?  Yes, It Did.

Introduction

The recent economic reports suggest that the economy remains in a “soft spot” as it’s being called.  Growth is still solid, and should remain so, but it is still somewhat below the level needed to create large numbers of new jobs.  The government estimated 3Q GDP growth at +3.7% (annual rate).  We will look at this report and others this week.

We will also look at the latest economic and market forecasts from the widely respected editors at The Bank Credit Analyst.  The editors downgraded their economic forecast for 2005 to 2½-3%, largely due to the effects of soaring oil and energy prices.  You can read some of BCA’s latest thinking in the excerpts below.

BCA also suggests that the broad trading range in stocks could continue well into 2005.  The editors recommend that investors consider “market timing” and “sector selection” (rotation) strategies in the current market environment.  We will look at these strategies and how to make them work in this issue.

BCA also predicts a multi-year bull market in commodities.  The editors believe that exploding demand from China, India and other regions will push most commodity prices, and energy related markets in particular, much higher over the next several years.   I will be writing more about this in the weeks ahead.

The Economy – Solid Growth, But Below Expectations

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 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 & 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 Bank Credit Analyst’s Outlook For The Economy   

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:

QUOTE: “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. [Emphasis added, GH.] 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. 
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. [Emphasis added, GH.] 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.” END QUOTE

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.    

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.  As usual, I tend to agree with them, especially depending on the outcome of the election.

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 rally.

The editors continue to recommend “below average” holdings of Treasury bonds and other high quality bonds, even though they believe that bond yields may remain low until the economy comes out of the current soft spot.  While Treasuries and other high quality bonds have done well this year, the editors believe the risks are too high at this point.

The editors conclude:

“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” 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.

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.  At my company, we look at hundreds of money managers on a continual basis.  For every one truly successful money manager we find, we see over a dozen that we reject – usually on the basis of performance.

If you have been reading this E-Letter for long, you know that I recommend a 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.

Given that market timing and sector rotation strategies may be among the only approaches that work in this kind of market, I will be writing more about these strategies in the coming weeks.

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 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

It is 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.

I actually began my career in the investment business in the commodity futures markets in 1975.  I was a “hedging” specialist for one of the largest grain companies in the world.  In the late 1980s, I introduced a highly diversified, multi-Advisor futures fund that allowed individual investors to participate in the commodities markets under the direction of professional Advisors.  That fund continues to operate to this day, although it is no longer open to new investment.

In the 1990s, my company introduced several other commodity futures funds which also continue to operate today.  We continue to track and monitor the universe of Commodity Trading Advisors (CTAs) and select those we consider to be the best to manage our various funds.

The point is, I do NOT recommend that readers try to invest in the highly volatile commodity futures markets on their own.  I only recommend it under the direction of proven Commodity Trading Advisors.  Usually, that means by investing in established commodity futures funds, due to the normally very high minimum investments required to invest with the most successful CTAs directly. 

Due to the rapidly growing interest in the commodities markets, and given BCA’s prediction for a multi-year bull market, I will be writing more about these markets and ways to invest in the weeks ahead.  If you need specific advice in the meantime, feel free to call our office at 800-348-3601. 

The Election Came & Went, Or Did It?

Yes, it did.  President Bush won a clear majority (51%) of the popular vote, the first time that has happened since 1988.  The Electoral College vote is not completely clear yet.  As this is written, Bush has 249 Electoral votes locked up.  By the end of today, he is expected to add Iowa, Nevada and New Mexico to his column, thus putting him up to 266 Electoral votes.

If so, then it comes down to Ohio (20 Electoral votes) and Wisconsin (10 Electoral votes).  If Bush wins Wisconsin, putting him up to 276, then he surpasses the magic 270 Electoral votes required to win.  In that case, Ohio doesn’t matter.  But if Kerry wins Wisconsin, then it all comes down to Ohio, as many had predicted.

Bush won the popular vote in Ohio by apprx. 136,000 votes we are told.  Yet we are also told that there are between 131,000 and 157,000 “provisional ballots” (cast by persons who had some sort of problem when they went to vote) in Ohio, which have not been counted.  If it’s 131,000, then Kerry has no chance to win Ohio.

If the number of provisional ballots is 157,000, then Kerry has a slim chance – or does he?  Ohio’s Secretary of State says they expect that roughly 90% of these ballots will be verified as being legitimate.  It could be less.  But if 90% are legitimate, that leaves apprx. 141,000 provisional ballots to be counted. 

This means that apprx. 96% of the provisional ballots must be for Kerry for him to win Ohio - assuming there really are 141,000 or so that are legitimate.  Based on the national vote (Bush 51/Kerry 48), Kerry will do well to get half of the provisional votes in Ohio. 

Bush wins.  End of story.

Late Note: As I hit the “send” button on this E-Letter, it is being reported that Kerry has just called President Bush and conceded the election.  It’s over.

In the end, it came down to what I said last week:

“Will the War On Terror trump anti-incumbency and the ‘Hate Bush’ crowd?”

It did.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Michael Barone on Election Day, the Bush win & a second term.
http://www.usnews.com/usnews/opinion/baroneweb/mb_041103_2.htm

NY Times editorial on Election Day, the Bush win & a second term.
http://www.nytimes.com/2004/11/03/politics/campaign/03assess.html?hp&ex=1099544400&en=ef7a4aead2f32959&ei=5094&partner=homepage


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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