Economy Sputters, Stocks Plunge What To Do Now

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
May 3, 2005

IN THIS ISSUE:

1.  The Economy Disappoints In The First Quarter 

2.  Another “Soft Patch” Or Is A Recession Looming?

3.  Fed Expected To Raise Rates Again Today… But

4.  Another Good Buying Opportunity In Stocks

5.  Knowing When To Get Back In The Market

6.  Two Money Managers Who Can Do It For You

The Economy Disappoints In The First Quarter 

Economic growth was a bit slower than expected in the first three months of this year.  The Commerce Department reported last week that GDP rose at an annual rate of 3.1% in the 1Q.  Economists had expected a rise of 3.5% or better, so the latest report was a bit of a disappointment.  The latest GDP report followed a 3.8% annual rate in the 4Q and a 3.6% gain for all of 2004. 

Keep in mind that the GDP report last week was the first of three reports on 1Q economic growth.  It will be adjusted higher or lower in two subsequent reports, but it is apparent that the economy is slowing a bit so far this year, which is consistent with higher interest rates and soaring energy prices.

The latest Commerce Department report also showed that consumer spending remained buoyant in the 1Q, rising 3.5% versus 4.2% in the 4Q of last year.  Exports and housing activity remained strong in the 1Q, while business investment spending fell significantly and inventories rose in the first three months of the year.  Durable goods orders were unchanged in the 1Q.

The report also placed domestic inflation at a 3% annual rate in the 1Q as compared to 2.9% in the 4Q.  The year over year rate of domestic inflation still remains around 2%, however.  The latest inflation data in the GDP report has to concern Fed chairman Alan Greenspan, but there are reasons to believe the Fed will not have to raise interest rates as high as previously expected, as I will discuss below.

Just Another “Soft Patch” Or Is A Recession Looming?

The gloom-and-doom crowd no doubt relished the latest disappointing GDP report, and I’m sure they are already preparing new materials warning of the impending recession and a crash in the investment markets.  But the latest economic report should not come as any surprise for readers of this weekly E-Letter.  In the February 1 E-Letter, I stated:

“Growth is not likely to match last year’s pace, but a recession does not appear to be in the cards as the gloom-and-doom crowd promises (over and over again).” 

As noted above, consumer spending remains strong, although not as strong as in the 4Q.  New home sales set another new record high in March.  Retail sales were up 0.3% in March and were up 5.8% over March 2004 according to the Conference Board.  Durable goods orders rose 2.8% in March (latest data available), and personal income was up 0.5% last month.

On the negative side, consumer confidence in April dropped for the third consecutive month.  The Index of Leading Economic Indicators fell 0.4% in March.  The ISM Index which measures manufacturing activity declined from 55.2 in March to 53.3 in April.  This was the fifth consecutive decline in the ISM Index, but keep in mind that any reading above 50 indicates a growing manufacturing sector.

Of course, the economy continues to face stiff headwinds in the form of rising interest rates and soaring energy prices.  Still, the Conference Board’s CEO Confidence Index rose in the 1Q, indicating that they expect economic growth to remain favorable this year.

The bottom line is that the economy should continue to grow this year with no recession in sight.  GDP growth should average around 3%. The latest data merely suggests we’ve hit another “soft patch.”  Yet as discussed below, the latest softness in the economy may be good news with regard to interest rates.

Fed Expected To Raise Rates Again Today… But

By the time you read this, you may have heard that the Fed raised interest rates an eighth consecutive time today, putting the Federal Funds rate at 3%.   Recent statements by several Fed governors indicate that the Fed is not going to stop raising short rates anytime soon.  The minutes from the March 22 FOMC (Fed Open Market Committee) meeting indicated that the governors intend to continue raising rates at a “measured” pace – mostly likely quarter-point increments at each meeting this year.

However, with the latest disappointing economic news, there is a good chance that the Fed will not have to raise rates as much as is currently expected.  The minutes from the March FOMC meeting indicate that the Fed governors anticipated stronger growth than we actually experienced in the 1Q, and they will no doubt be considering the latest economic reports at the meeting today.

While the Fed may not show its hand in its public statement after the meeting today, there may be a very good chance that the Fed Funds rate could top out at 3½% later this year.

That could be very good news for the stock markets as I will discuss below.

The next FOMC meeting is on June 29/30, and the meeting following that is on August 9.  If in fact the Fed stops raising rates at 3½%, the upward rate cycle could be over before the end of summer.  That, of course, will depend on how the economy is faring at that time and the level of inflation.

Ideally, the Fed would like to see the economy continue to grow at a rate of 3% or better, with inflation around 2% or below.  It remains to be seen if the Fed can make that happen, but recent action in the bond market is encouraging.  Treasury bond prices have been rising steadily since mid-March.  If inflation was poised to move significantly higher, we would not be seeing this kind of strength in the bond market.

Another Good Buying Opportunity In Stocks

Stocks have taken a beating since early March.  While the Dow Jones is still at the low end of the trading range over the last year and a half, the S&P 500 fell below its trading range.  The Nasdaq has been in a downtrend since the first of the year.  The Dow and the S&P have actually held up very well given the multitude of negative news in recent months – soaring oil prices, rising interest rates, higher inflation and the gradual slowdown in the economy.

But investors can only take so much bad news, and many decided to throw in the towel during the latest sharp decline.  Given that the S&P 500 has broken out of its trading range to the downside, I would expect the Dow to follow suit sometime over the next few weeks.  If the Dow falls below 9,700, the next level of good support is around 8,000.  The next level of good support for the S&P 500 is in the 1,050-1,100 range.

Should we get a selloff down to those levels later this summer, I believe that will present another good buying opportunity, especially if the Fed decides to lay off the interest rate increases once they reach 3½% in August.

We should be able to glean more insights into the Fed’s intentions after the meeting today and again after the meeting on June 29/30. 

If my line of thinking proves to be correct, the stock markets should bottom well before the August 9 FOMC meeting.  Stocks could have the potential for a meaningful recovery once the bottom is in. 

The news could be a lot more positive by August.  The economy may be coming out of the soft patch by then.  Oil prices could be lower as we near the end of the peak summer demand period.  The current concerns over rising inflation could be subdued by then.  The environment could be quite positive for stocks by the end of this summer.  

For those of you who are out of the market, or are under-invested in equities, you may want to pay more attention to the stock markets this summer in case the buying opportunity I envision develops.  Sadly, if I am correct, many investors will miss the buying opportunity this summer – more on this below.

If you are overweight in equities now (which you shouldn’t be if you’ve followed my advice), you may want to reduce your exposure now that the trend has turned lower.

Knowing When To Get Back In The Market

If you have read this E-Letter for long, you know that one of my biggest issues is avoiding large losses in your investment portfolio.  I ‘preach’ on this issue at length and frequently (too frequently, some might say) but it is the key to investment success.  A few large losses in your portfolio can ruin your chances for reaching your retirement goals.

As I’ve also probably written too often, following Wall Street’s “buy-and-hold” strategy virtually assures that you will suffer large losses from time to time.  The stock markets go down periodically as we’ve seen in recent years (and in recent weeks).

While avoiding large losses is the #1 goal, in my opinion, there is another part of the equation – knowing when to get back in the markets and be fully invested.

A number of years ago, I was in Philadelphia conducting a due diligence visit on a professional money manager we were considering for recommendation to our clients.  I was in the office of the president and founder of the firm, asking my usual list of questions, when he related the following to me.  His point went as follows:

Investors think they pay us management fees to get them out of the market and avoid major declines.  But that’s the easy part.  Anyone can get out of the market.  The hardest part – and what investors really pay us for – is to get them back in the market so that they participate in the good times.  It’s much easier to design a system to get you out and avoid the bad times, and it is much more difficult to create a system that gets you back in the market for the good times.

This is such an excellent point, and for several reasons!  Over my 28 years in the investment business, I have consistently found that most investors tend to be overly cautious and frequently expect bad things – rather than good things – to happen in the markets.  In following, they tend to be much more attuned to jumping OUT of the market rather than focusing on when to be IN.

The buy-and-hold crowd loves to refute the “active management” strategies I recommend by touting various studies which show that if you miss some of the good (up) days in the stock market, your returns will suffer dramatically.  This is the cornerstone of their buy-and-hold argument, and many investors buy it hook-line-and-sinker – at least until a bear market comes along and they lose 20-30-40% or more.

What the buy-and-hold crowd purposely ignores is the equally important fact that if you can miss some of the worst (down) days in the market, you can also improve your investment returns significantly.  This is precisely why I recommend that you use professional money managers that have the flexibility to move out of the market (and/or hedge their positions) periodically to limit losses during bear markets and major downward corrections.

But as the money manager noted above points out, getting OUT of the market is only part of a successful strategy.  Having a strategy to get you back IN for the good times is just as important, and in his opinion, is the more difficult part of a successful investment program.

My company serves thousands of clients all across the country.  In addition, this weekly E-Letter goes out to over 1.5 million people each week.   As a result, we are talking to clients and prospective clients all the time.  Based on those conversations, we know that there are untold numbers of investors who got OUT of the stock market during the bear market of 2000-2002 but never got back IN to enjoy the good times in 2003-2004.

Many people have been sitting on the sidelines since the bear market, earning next to nothing in money market funds, and are far behind in meeting their retirement goals with time running out.

Conclusions

The economy has hit a soft patch, but there is no reason to believe that we are headed for a recession.  GDP growth should be in the neighborhood of 3% for all of 2005.  As I am about to hit the “send” button on this E-Letter, the Fed has – as expected – announced another quarter-point hike in the Fed Funds rate to 3%, and indicated that more rate hikes are likely to follow.

Despite today’s Fed decision, I continue to believe there is a good chance the Fed will end the higher rate cycle when the Fed Funds rate gets to 3½% in August, if not before, depending on the strength of the economy and if inflationary pressures cool off as I expect.

If I’m correct, there will be another excellent buying opportunity in the stock market sometime this summer.  Unfortunately, many investors will miss it once again.  Like the money manager noted above said, it is much easier to know when to get out of the market than to know when to get back in.

The latest Barron’s includes the results of the magazine’s twice-yearly survey of leading money managers across the country – the so-called “Big Money Poll” – and their predictions for the major investment markets, interest rates, etc.  The most surprising statistic in the latest survey is that 40% of the money managers polled believe the major stock indices (Dow, S&P, Russell) are going to remain in a broad trading range for the next year or longer.  They are neutral on the markets’ direction.  A neutral number that large has never happened before.

If this proves to be true – that the major stock indices will remain in a broad trading range - then it will be more important than ever to use active management strategies, such as those I recommend, that have the flexibility to be out of the market (or hedged) from time to time.

Many Wall Street types and the buy-and-hold crowd argue that it is impossible to “time” the stock market.  THEY ARE WRONG and they know it.  It is true that it is difficult to time the stock market.   It is true that most Investment Advisors who try to time the market don’t do it very successfully.  But it is also true that there are professional money managers out there who have timed the stock markets successfully for many years.

Since the first of the year, I have introduced you to two highly successful money managers who employ active management strategies that appear well-suited to the current market environment.  In the January 18 E-Letter, I introduced you to Third Day Advisors.  In the April 5 E-Letter, I introduced you to Scott Daly’s Asset Enhancement Program. 

Both of these managers have delivered outstanding results, with limited losing periods, through various market cycles, including the current one.  If you have not considered these managers, I highly recommend you do so.  You can CLICK HERE to see their actual past performance records, net of all fees and expenses.  (Past results are not necessarily indicative of future results.)

My advice is that you consider BOTH of these managers – especially in the current market environment – since their performance records have a very low (almost zero) correlation to each other. 

Finally, we have had a surprising response from readers who took me up on my offer last week to analyze your risk tolerance level for free.  In case you missed it, you can download our Confidential Investor Profile, complete the questionnaire and send it to us (fax 512-263-3459 or mail).  When we receive your completed questionnaire, we will give you a no-obligation analysis of your answers and your personal risk tolerance level (ranging from conservative to aggressive)You may be surprised by the results.

Wishing you well in an ugly market,

Gary D. Halbert

 

SPECIAL ARTICLES

The Bush Doctrine's next test (long but interesting).
http://www.commentarymagazine.com/article.asp?aid=11905023_1

The Rock Star and the rest (political overview of 2008 campaign).
http://nationaljournal.com/about/njweekly/stories/2005/0429nj1.htm

Rush to Victory (conservative victory, that is).
http://www.opinionjournal.com/columnists/dhenninger/?id=110006626


Read Gary’s blog and join the conversation at garydhalbert.com.


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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