The Latest Stock Market Baloney

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
April 12, 2005

IN THIS ISSUE:

1. The Economy Should Cool Off A Bit

2. The Fed Will Continue To Hike Rates

3. High Energy Prices Here To Stay?

4. Don’t Become A Stock Speculator

5. A Better Way To Invest In Stocks

Introduction

The US economy continues to grow at a healthy pace, despite non-stop warnings by the gloom-and-doom crowd to the contrary. Yet the major stock market indices have been in a generally sideways trading range for over a year now. Over the last couple of months, it seems that the talking heads on the financial channels have concluded that this sideways trading range is likely to continue for some time to come. Even the cheerleaders on Wall Street seem to be coming around to this view that the major stock markets may continue to go generally sideways.

So what do they recommend now? That we all need to become individual stock pickers. If the stock market is going to continue to go sideways in a broad trading range, then about the only way you can make money is by selecting those certain stocks that will do well even in a sideways market, or so we are told. So forget trying to figure out which way the market is going, and just pick stocks that are currently out of favor but are likely to become the next darlings of Wall Street. In other words, we all need to become short-term stock traders.

This advice is so flawed! If we want to be perfectly honest about it, most of us are not good at determining the stock markets’ overall direction (up or down), and most of us are even less capable of selecting the next “hot” stocks. Even if we knew which stocks are likely to become the next winners, we wouldn’t know when to sell them. So the bottom line is, the latest market advice from Wall Street and the financial show talking heads – that you need to become a short-term stock trader - is a disaster for most of us. Don’t go there.

Since the beginning of the year, I have introduced you to two professional money managers who have demonstrated that they can make money and avoid large losses even in the sideways stock markets we have seen over the last year and a half. In my January 18 E-Letter, I introduced you to Third Day Advisors, LLC, and in my April 5 E-Letter last week, I introduced you to Scott Daly’s Asset Enhancement Program. Both of these equity managers have produced outstanding returns, even in the sideways market we’ve seen for the last year and a half or so.

So I beg to differ with the latest advice from Wall Street and the talking heads on cable TV. Do not fall into the trap of trying to be a short-term stock trader. Don’t line the brokers’ pockets with all those commissions. It’s a losing proposition for most of us. And the losses can be large. My advice is to put your money with professionals such as those I recommend who have time-tested systems in place to deal with any kind of stock market scenario – up, down or sideways.

In this week’s E-Letter, we will briefly look at the economy and why it is likely to slow down somewhat during the rest of the year; we will look at why the Fed is likely to continue to raise short-term interest rates; and we will look at why this may not be good for stocks. There is certainly the possibility that stocks may break out of the current trading range to the downside, in which case becoming a short-term stock trader could be a disaster.

The Economy Is Solid, But May Slow A Bit

The US economy just keeps rolling along. 4Q GDP rose 3.8% according to the Commerce Department, following the gain of 4% in the 3Q. Personal consumption spending rose by 4.2% in the 4Q, indicating that consumers are still in buying mode. Reports so far this year confirm that core retail sales (excluding autos and gasoline) are still rising at an 8% annual rate.

The Index of Leading Economic Indicators has risen in three of the last four months, although in small increments. Housing activity remains buoyant. Capital goods orders continue to rise strongly. The unemployment rate fell to 5.2% in March. These and other reports suggest that the US economy should continue to grow during the balance of the year.

However, several factors suggest that the economy will not continue to grow at a 3½-4% rate in the second half of this year. First, consumer confidence fell in February and March. Second, oil prices look to remain very high for the rest of this year. And as discussed below, the Fed is likely to continue to raise short-term rates until the Fed Funds rate nears 4%.

All this suggests that economic growth has slowed a bit from last year’s 4% level but should manage a 3% pace for the rest of the year. No recession is in sight.

Fed Says It Will Keep Raising Interest Rates

The Fed raised interest rates for the seventh time at the latest FOMC meeting, putting the Fed Funds rate at 2.75%. Many analysts had expected the Fed to stop raising rates at the 3% level in Fed Funds, but in recent weeks the Fed has made it clear that it intends to go further. Recent statements from the Fed indicate that the monetary authorities are now more worried about checking inflation than growing the economy.

The question is, how high do short rates have to go for the Fed to be comfortable that inflation is in check? The Fed is not going to tell us, of course, but several of my best sources believe that the Fed Funds rate will be raised again at each of the next several FOMC meetings. My sources now believe that the Fed Funds rate is headed for the 4% area, give or take a quarter-point.

That is higher than the stock and bond markets are currently anticipating. That probably explains why both markets have turned lower in the last several weeks.

High Energy Prices May Be Here To Stay

Crude oil prices hit a new record high of $58.28 last week. Gasoline prices are at new highs also (unleaded is $2.10-$2.20 here in Austin – today, that is – and much higher elsewhere around the country). There is an old saying in the commodities markets: “The solution to higher prices is higher prices.” In a supply/demand world, high prices normally result in a reduction in demand, which eventually leads to lower prices.

However, the sharp rise in crude oil prices over the last year and a half has not resulted in a significant decline in demand or usage around the world. The freeways are still congested, airline flights are still full, etc., etc. Meanwhile, demand for energy continues to explode in China, India and elsewhere.

The question is, how high do oil prices have to rise to curb demand? No one knows for sure. Goldman Sachs released a new research report recently which suggests that oil prices could rise to over $100 a barrel in the next few years. While I’m not ready to embrace such a forecast, I do believe it is fair to say that oil prices have reached a new plateau, and higher energy prices are here to stay. We just don’t know how high.

Wall Street Says Stocks Are In A “Trading Range”

As you know, most Wall Street analysts and the talking heads on financial programs are inherently bullish on stock prices. However, the combination of rising interest rates and surging oil prices has led many normally bullish analysts to concede that the major stock markets are now in a “trading range.” And that is true for the most part. The Dow Jones, for example, has been in a roughly 1000-point range (9,800-10,800) since the beginning of 2004.

I have actually been optimistic in my view of the stock markets’ direction over the last couple of years, until just recently. I have felt that the broad equity indices (Dow, S&P, etc.) have held up quite well given the sharp increase in energy prices and the seven rate hikes by the Fed. And in fact, in late February and early March, it looked like the Dow and the S&P 500 were going to break out above the recent trading range.

Since then, however, all of the broad indices have fallen significantly. And there is a good chance this trend will continue in the months just ahead. As discussed above, stocks may have to move lower in order to adequately reflect a slowing economy, higher interest rates still to come and continued high energy prices.

I am not predicting a bear market, but the major indices could well break out of the trading range to the downside. If this happens, expect the gloom-and-doom crowd to go wild. However, if stocks fall as I expect, this could very well result in an excellent buying opportunity later on this year. I will have more to say about that in the weeks to come.

Don’t Become A Stock Speculator

I watched several so-called financial and investment programs over the weekend. Almost without exception, the argument went more or less as follows:

The stock markets are in a broad trading range, and they’re likely to stay that way. As a result, you can’t simply buy a basket of stocks or an index fund and just sit on them for the long run. No, the market has changed and you have to seek out under-valued stocks that are likely to go up more than the major averages, and then sell them when they come into favor.

Sounds good, right? No problem. We all know how to do that, don’t we? Of course not!

Now, after almost a year and a half of telling us we should be fully invested in equities – because the market was going to go up – the talking heads now tell us we need to sell the stocks we bought on their former advice and become stock speculators. We are now advised to go out there and find under-valued stocks that are likely to get over-valued sometime in the reasonably near future.

We are supposed to be able to identify such under-valued stocks that are likely to go up sometime fairly soon, AND we are supposed to know when to sell them if they do go up. Most people aren’t good at doing either!

Of course, most of these talking heads have several stocks that they recommend, but my experience is that, as a group, they are usually wrong about as often as right with their particular stock picks. Interestingly, they almost never tell you what to do with their losers. Losers are conveniently just forgotten about on most of these financial programs.

If it were true that it is easy to pick under-valued stocks that are going to get over-valued sometime reasonably soon, then why aren’t mutual fund managers making tubloads of money in this trading range market? After all, they are supposedly the brightest of the bright, right?

Yet according to Morningstar (the large mutual fund data service), the average large cap “value” and “growth” mutual funds were only up single digits for the 12 months ended March of this year. So far in 2005 (as of April 8), the average large cap value fund was actually down slightly for the year according to Morningstar. So even the experts have not been particularly good at picking those stocks that are under-valued and likely to go up significantly in the reasonably near future in this trading range market.

Nevertheless, the talking heads now tell us that we need to become stock traders.

[Don’t get me wrong – I am a fan of value investing. The point is, even value investing is difficult in a trading range environment. And the type of stock trading suggested by some of the talking heads doesn’t qualify as value investing in the first place.]

There Is A Better Way To Invest

If you have read this E-Letter for long, you know that I believe most investors would be much better served if they used professional Investment Advisors and active money management strategies. The money managers I recommend have time-tested systems that have been through up markets, down markets and trading range markets like we have seen over the last year or so.

These professional managers decide which mutual funds to be in, out of the more than 10,000 funds out there. They decide when to be in the market and whether you should be fully or partially invested or out of the market. Increasingly, these managers are using so-called short funds to “hedge” their mutual fund long positions when they get a signal to exit the market, rather than selling out their positions and going to cash.

[Some reading this may not be aware that there are specialized mutual funds that actually go up when the stock market goes down. These funds can be purchased as a way to offset or hedge losses in a downward market.]

No doubt there are some people reading this who are in fact astute at buying and selling individual stocks. If you are one of these few, then maybe you don’t need professional management. But for the rest of us, professional money managers can at times mean the difference between success and failure.

As noted at the beginning, I have introduced you to two outstanding mutual fund money managers just so far this year. Third Day Advisors has been very popular with our clients mainly because their program will go long OR short depending on market conditions. We have already received a great deal of interest in Scott Daly’s program since I wrote about it last week, mainly because of how well it performed during the bear market of 2000-2002. Past results are not necessarily indicative of future results.

For most investors, I recommend placing money with both Third Day and Scott Daly’s Asset Enhancement program. Their respective performance returns have virtually no correlation historically, so they complement each other very well based on past performance. If you have $100,000 to invest, you can have both of these outstanding managers on your team.

Some clients and prospective clients have noted concerns about the fact that Third Day only has a three-year performance record. We completely understand this concern. This is another reason I recommend opening accounts with both Third Day and Scott Daly. Daly has an outstanding 10-year record, and with virtually no correlation between the two, the net result of the two accounts could be very impressive. Again, past results are not necessarily indicative of future results.

For the record, I have my own money with every money manager we recommend at my company. I am in the process of opening my account with Scott Daly’s back-office administrator as this is written.

I also invite you to go to our website and look at the other money managers we recommend. All of these managers have sophisticated systems in place that are designed in an attempt to reduce market risks during downtrends.

As I discussed earlier, there is a good chance that the major stock markets will break out of the recent trading range to the downside. A softening of the economy, more rate hikes by the Fed and soaring energy prices may prove too much for the equity markets to handle. Given that, you would certainly want some of your money with an active manager that can reduce or hedge their positions. But as I also wrote above, if there is a significant selloff in stocks later this year, I believe that will present another excellent buying opportunity – if you know when to do so.

In closing, I think that right now is an excellent time to place money with any of the equity managers I recommend. The same is true for the bond manager I recommend. Bond rates are likely to peak later this year, and this should also be a good buying opportunity.

I invite you to call us at 800-348-3601 and let us help you get started. It doesn’t matter where you live in the US – we have clients in all 50 states.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES

Iraq: How the media got it wrong.
http://www.opinionjournal.com/editorial/feature.html?id=110006547

Three signs of the impending Asian century.
http://www.newsday.com/news/opinion/ny-oppin124214185apr12,0,2929512.column?coll=ny-viewpoints-headlines

The New York Times-Democrat.
http://www.nypress.com/18/14/news&columns/russsmith.cfm