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The Economy, The Stock Markets & Hillary In 2008

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
February 1, 2005

The Economy, The Stock Markets & Hillary In 2008

IN THIS ISSUE:

1.  GDP Rose Only 3.1% In The 4Q, But…

2.  2004 Was The Strongest Year Since 1999

3.  How High Will The Fed Take Rates?

4.  Stocks Facing Some Strong Headwinds

5.  Hillary Makes It Clear – 2008 Is A Go

Introduction

This week, we start off by analyzing the latest economic data released last Friday, which was both disappointing and encouraging at the same time.  Despite last week’s disappointing GDP report, The Bank Credit Analyst still predicts growth of 3½% this year.

Forecasting the economy this year depends a lot on how high the Fed intends to raise short-term interest rates.  Most analysts on Wall Street believe the Fed Funds rate will go to 3% and stop.  Yet BCA believes the rate is going to 4% in order to keep inflation in check.

Then we take a look at the stock markets where my optimism is fading fast.  With interest rates on the rise and with corporate profits slowing down this year, the equity markets are facing some stiff headwinds.  If you are over-weighted in equities, I suggest you reduce exposure just ahead.

Finally, I wasn’t going to include anything on politics this week, but Hillary Clinton made it crystal clear last week that she is running for president in 2008.  “Crystal,” as Tom Cruise said in the movie 'A Few Good Men. '

And it now appears that Howard Dean has the lock on the DNC chairmanship.  Political analysts on both sides are trying to figure out why the Clintons are going to let this happen.  Let me give you a clue: they want it to happen.  Read on and I’ll tell you why.

The Economy – 4Q GDP Disappoints

The government released its first estimate on 4Q Gross Domestic Product on Friday, and it was well below expectations.  The Commerce Department reported that GDP rose only 3.1% (annual rate) in the 4Q following the gain of 4% in the 3Q of last year.  For all of 2004, based on this latest report, the economy grew at the rate of 4.4% last year, the best year since 1999.

Personal consumption spending rose by 4.6% in the 4Q, so consumers continue to spend.  For all of 2004, consumer spending was up 3.8% as compared to 3.3% in 2003.  Government statistics continue to show that consumers have record debt levels, but these figures do not consider home equity or gains in securities and other investments.  The bottom line is that consumers are likely to continue spending and keep the economy reasonably firm again this year.

Business investment spending continued to be robust in the 4Q.  The government reported that capital investment rose 10.3% in the 4Q versus 13% in the 3Q.  Business investment spending is expected to remain strong all this year.

A Bloomberg survey of economists and market analysts conducted in early January found a consensus estimate of 3.6% growth in GDP for 2005.  This is consistent with The Bank Credit Analyst which forecasts GDP growth of 3.5% for this year.  BCA continues to believe there will not be a recession in late 2005 barring some unexpected negative surprise such as another terrorist attack in the US.

In summary, the US economy will remain in positive territory again this year, barring some major negative development. Growth is not likely to match last year’s 4.4% pace, but a recession does not appear to be in the cards as the gloom-and-doom crowd promises (over and over again).  Consumers have high debt levels, but the overall net worth picture is much more positive.

Will The Fed Tighten Too Much?

The Fed has made it no secret that they plan to continue hiking short-term interest rates this year.  Since last June, the Fed has raised the short-term borrowing rate from 1% to 2.25% as this is written.  The Fed is expected to raise the key rate another 25 basis points to 2.5% at the next FOMC meeting scheduled for later this week.

So far, the interest rate increases have not caused any serious damage to the economy.  Actually, the bond markets held up quite well last year despite the short-term rate hikes by the Fed.  However, analysts all over the world are trying to gauge just how far the Fed intends to take short rates.  The consensus seems to be that the Fed will raise rates to 3%.  If so, this round of monetary tightening could be over by mid-year.

The Bank Credit Analyst, on the other hand, believes the Fed is targeting a 4% level in the Fed Funds rate.  If correct, that would mean the Fed will continue to ratchet up short-term rates pretty much all year, and that will not be good news for the equity markets and possibly bonds as well.  Obviously, the Fed will continue to monitor the economy and what’s happening in the stock and bond markets.  Policy will be set accordingly. 

Given that this is Alan Greenspan’s last year as Fed chairman, he does not want to go out with the economy in a recession or the equity markets in the tank.  So, as he puts it, the rate hikes will be “measured.”   Even so, BCA predicts that the Fed Funds rate is likely headed for 4%, and this is above what Wall Street is currently expecting.

Are Stocks Set To Trend Lower?

If you have been reading this weekly E-Letter for long, you know that I have been generally positive on the outlook for equities over the last year.  In fact, I have been bullish since just before the war in Iraq began in March of 2003.  If you followed my advice back then and moved to a fully invested position in stocks and/or equity mutual funds, you have done very well. 

But if you have watched the market at all, you know that January was NOT a good month for the stock markets.  My optimism is fading fast.

While the economy is expected to remain solid again this year, the equity markets are facing some stiff headwinds.  The interest rate environment is not friendly as discussed above, and the Fed Funds rate is likely to rise more than Wall Street expects. 

The US dollar is likely to be lower later this year, and this is also not positive for US equities.  Oil prices remain high and there is still the risk of another spike up again this year.  Corporate profit growth will not match 2004’s heady pace.

Equity prices churned mostly sideways in 2004, ending the year with only modest gains in what was clearly a more positive environment than we see for this year.   Also, this is the third year after the bear market which ended in 2002.  Historically, the S&P 500 only gains about 3% in the third year after a bear market low.

So the question is, will stocks churn sideways again in 2005, and maybe edge slightly higher, or could we be seeing another major top in equities?  Obviously, I don’t know the definitive answer, but price action so far this year is NOT encouraging. 

At the very least, the downside risk in equities is higher now than it was in 2004, and last year was not a banner year.  Given this outlook, readers who are over-weighted in equities are advised to reduce holdings just ahead, especially if prices recover somewhat after the beating in January.

BCA’s forecast is that the equity markets will continue to be choppy for most of this year and ease moderately lower.  They do not expect a major bear market.  They believe some sectors will do reasonably well, even in a choppy to lower market environment.  Their favorite sectors are energy, health care, consumer staples and telecom services.  Sectors they recommend you avoid are technology, financials and consumer discretionaries.

The Argument For Active Management

Given where we are in the economic cycle and the interest rate cycle, there are no really attractive asset classes to buy.  Stocks are vulnerable, bonds are vulnerable, real estate is frothy, metals have topped out and currencies are very volatile.  It is precisely these kinds of uncertain times when active, professional management is in order.

“Active” management, in this case, refers to professional Advisors that have time-tested systems that will move them partly or fully to cash if market conditions so dictate.  Some of the managers we recommend will “hedge” their positions using short funds, rather than sell out positions.  If the equity markets turn lower this year, you need that kind of active management.

Two weeks ago, I introduced you to Third Day Advisors, a money manager with an outstanding performance record in up, down and sideways periods in the stock markets.  During down periods, Third Day uses certain Rydex funds which go up in value when the stock market goes down. 

While shorting the market is an aggressive strategy, and therefore not suitable for everyone, I believe Third Day is an excellent choice for sophisticated investors who want the potential to make money in both upward and downward trends in equity prices. (As always, past results are not necessarily indicative of future results.)

If you are a sophisticated investor, I highly recommend you check into Third Day for a portion of your equity portfolio.  Call us at 800-348-3601 for more details and account paperwork.  You can also see information on Third Day and all of the Advisors we recommend at my website.

Hillary Makes It Clear

For anyone who may have been doubting, there is now NO QUESTION that Hillary Clinton is running for president in 2008.  In a series of speeches last week, she unofficially declared her candidacy.  She did so by moderating her position on abortion and suggesting we teach abstinence; she condemned illegal immigration; she emphasized the importance of prayer in her life; and in each speech, she reminded her audiences that she supported the war in Iraq.

All of these positions are foreign to Ms. Clinton’s far left political passions over the years.  There is no way she would swerve toward the center in this way unless she is running for president.  No way.  Next, I suppose she’ll be talking about how to strengthen the military even though she has despised it in the past.  She will say anything.

While Hillary is busy moving to the center, the Democratic Party is about to move to the left.  It now looks all but certain that Howard Dean will be elected the DNC chairman on February 12.  Here’s how political analyst Dick Morris feels about it:

What kind of chairman will Dean make? He will probably be as bad for the party’s prospects as Nancy Pelosi has been as Democratic leader in the House. He will dig a deeper and deeper hole for the party, alienating its moderate donors and holding it hostage to the likes of Michael Moore and the Hollywood left.

Interestingly, the Clintons have not mounted much of a fight to stop him, and political analysts in both parties are trying to figure out why.  Why would they give up control of the party they’ve dominated for the last 12 years? 

I have a suggestion.  I believe it is just fine with the Clintons to see the Democratic Party veer to the left and essentially self-destruct.  I think it is fine with the Clintons that many of the Dems in Congress remain intent on being obstructionists, even though the voting public is sick of it.   Hillary, of course, will remain above the fray as she shifts toward the center.

I think it will be fine with the Clintons if the Democrats get spanked once again in the 2006 mid-term elections.  If the Republicans gain even more seats in Congress in 2006, that will put the Democratic Party into a full-fledged crisis.

That sets the stage perfectly for Hillary, the centrist, to ride in on the proverbial white horse and save the party from the liberals.  That’s the plan as I see it.  Sadly, it might just work.

Hillary ranked far above any of the Democrats who ran for president last year, including John Kerry.  So, she is popular.  The question is, how many people will believe Hillary’s new centrist positions?  How many will it turn off?  I don’t know.

Certainly some voters will believe that by electing Hillary president, they will get Bill back in the White House.  I suppose that is possible, but one wonders what Bill would have to gain by moving back to Washington and being under the microscope and Hillary’s thumb.  Maybe he stays in New York.

Obviously, I could be wrong about the scenario laid out above.  But when I hear Hillary soften her position on abortion and recommend teaching abstinence, no other scenario comes to mind but a run for the White House in 2008 as her party implodes in the meantime.

Finally, some of my Republican friends who are involved in politics believe that Hillary is “unelectable” because of all the skeletons in her past.   I hope I’m wrong, but I don’t agree – for two reasons.   First, by 2008, how many voters are really going to remember Hillary’s questionable past?  And second, who are the Republicans going to run in 2008?  The GOP bench is pretty much empty.

I think Hillary can win the Democratic nomination in a cakewalk.  And with Bill out there on the stump for her, she could win it all.  Again, I hope I’m wrong!

Very best regards,

Gary D. Halbert

 

SPECIAL ARTICLES 

Novak on why Dean is bad for the Dems.
http://www.suntimes.com/output/novak/cst-edt-novak31.html

Mort Kondracke defends Hillary, sort of.
http://www.realclearpolitics.com/Commentary/com-2_1_05_MK.html

Reinventing Hillary Clinton, again.
http://www.washtimes.com/op-ed/20050130-094527-2313r.htm

An interesting read from a liberal on the Social Security dilemma.
http://www.opinionjournal.com/editorial/feature.html?id=110006234


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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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