Special Update #26

IN THIS ISSUE:

More Good News On The Economy
Bank Credit Analyst's New Forecasts
Why The Stock Market Is Struggling
The US Dollar -- A Sinking Spell
Homeland Security Department -- Good Or Bad?
The Global Warming Snafu
Appeasing The Liberals -- A Big Bush Mistake?

INTRODUCTION

This Special Update includes a hodge-podge of issues and my thoughts, and those of others, on each. The latest issue of my Forecasts & Trends newsletter is posted on our website along with our latest 12-page Special Report on GOLD. Find them at www.profutures.com.

THE ECONOMY -- MORE GOOD NEWS

Since the beginning of the year, I have been predicting that the US economy would rebound from the recession. Actually, there wasn't a recession in technical terms -- we did not have two consecutive negative quarters in GDP, the classic definition of recession -- but it sure did feel like one. Anyway, the latest good news came out on Friday with the unemployment rate falling from 6% to 5.8% in May.

The unemployment rate is one of the last indicators to turn positive when the economy begins to expand. On Thursday, the government announced that retail sales were higher than expected in May. This economy just keeps getting stronger, despite all the negative predictions from the gloom-and-doom crowd. It looks like we will see GDP growth of at least 3-4% (annual rate) for the 2Q.

BCA's LONG-TERM FORECASTS

For our newer readers, BCA stands for The Bank Credit Analyst which is a research firm that publishes monthly forecasts on the economy, interest rates, inflation, currency trends and the major investment markets. The publication is very expensive, and each monthly report contains 40-50 pages of analysis and forecasts. I have been reading BCA continuously since 1977 and have found them to be far more accurate than any other service I've subscribed to over the years when it comes to predicting major turns in the economy and the major investment markets.

In their June issue, the BCA editors offered a number of long-term forecasts for the economy, interest rates and inflation, the US dollar and the stock and bond markets. You can read these latest long-term forecasts in my June Forecasts & Trends newsletter at www.profutures.com.

[HINT: They are still positive.]

WHAT'S WRONG WITH THE STOCK MARKETS ?

Are you as tired of this roller-coaster, go-nowhere stock market as I am? Down in January, up in February, up and down in March, down in April, up and down in May and now the Dow Jones is just a hair above 9500. This irritating (to say the least) performance is happening in an environment that historically should have stocks sizzling on the upside -- tons of liquidity, low interest rates and inflation, a recovering economy, rising confidence, etc. So why aren't they?

As usual, BCA has an interesting take on it. By studying purchases and sales of mutual funds (using the Wilshire Index), BCA has created an index of the average prices paid for stocks over the period from 1995 to the present. For example, BCA estimates that the average investor who bought a diversified portfolio of stocks (or an index fund) in 1995, and held them until now, has only about a 10% PROFIT in his/her portfolio today! This despite the greatest bull market in history.

But it gets worse, a lot worse. BCA was also able to determine that more than 50% of the capital that flowed into stocks during 1995-2000 came in the market in the years 1999 and 2000. What does this mean? Can you say, BIG LOSSES?

The fact that apprx. half the investors in the market today have losses in their portfolios is like a huge weight on the markets' shoulders. While there have not been massive redemptions from equity mutual funds, at least not yet, more and more investors are getting disillusioned. Just the opposite from the "buy the dips" mentality in the last half of the '90s, many investors have switched to a "sell the rallies" mood.

This is a big part of why the markets have not been able to sustain rallies this year. BCA believes, however, that conditions are such that the markets will overpower the "sell the rallies" mentality and trend higher in the second half of this year.

THE SAGGING US DOLLAR --IS THIS A SERIOUS PROBLEM?

In the investment world, just about everyone has turned bearish on the US dollar. The US dollar peaked in late February and has now dropped apprx. 9% against the Euro. It is down apprx. 3% against an index of major currencies. Most Americans pay little attention to the value of the dollar versus other foreign currencies.

A decline in the dollar is not necessarily a bad thing, unless it drops too far and/or too fast. A gradual drop of 10-20% in the dollar will not seriously affect the world economy; it should not cause a big rise in inflation; and it will actually help our bulging trade deficit and, therefore, many US companies. In 1985 and 1986, as the dollar gradually weakened, we actually saw the stock market rise, and the economy grow. The dollar dropped almost 13% in 1996, and the economy and the stock market rose.

Thus, the question arises, is the dollar falling too fast? Will it fall too far? What happens if the answers are (or will be shortly), YES and YES? I read something the other day that I had not seen before. The government estimates that foreigners own over $8.2 trillion of US assets, while Americans only own $5.6 trillion of assets in foreign countries. For years I have always assumed that we owned more of foreigners' stuff than they owned of ours. Not so.

Foreigners hold 24% of corporate bonds, 13% of the equity market and 22% of US corporations.

What if they decide to sell? According to the Commerce Department, foreign direct investment in the US fell by 60.4% in 2001 from 2000 levels. This is not good!

What would make a significant chunk of that $8.2 trillion foreign investment go away? There are several possibilities. The stock markets have been ugly for the last two years. Bonds have also been ugly this year. The fact that America is clearly the terrorists' target is also a concern of foreign investors.

BCA predicts that the US dollar will fall by 10-20% over the next 12-18 months. With the economy clearly in recovery mode, one would reasonably expect the decline to be gradual. But this market is one that definitely "bears" watching!

HOMELAND SECURITY DEPARTMENT --GOOD IDEA OR ANOTHER BOONDOGGLE?

According to the latest USA TODAY/CNN/Gallup poll, 72% of Americans support President Bush's plan to establish the Homeland Security Department (HSD). I guess it should not surprise me that a whopping majority of Americans are all for enlarging the government and creating another huge bureaucracy. But does anyone but me question if it will work?

As proposed, the new department will be one humongous bureaucracy, uniting 22 government agencies into the third-largest cabinet agency after Defense and Veterans Affairs. According to the President, it will have a staff of 169,000 and a budget of $37.5 billion. I'll bet you these numbers are way too low! I'll bet you it will end up with at least twice that many employees and at least double or triple the $37.5 billion budget. Government is always bigger than we are led to believe.

The good news is that many of these initial employees will be relocated to HSD from other existing agencies. It would also seem to make good sense to have more of our security agencies under one roof, so to speak. This "might" help cure some of the communications breakdowns among the security agencies, except that the FBI and the CIA will continue to act independently from the HSD.

The bad news is, we're creating yet another cabinet level government bureaucracy. If I were the president, I would put in a new rule: the only way you can add a new cabinet level department is to get rid of an existing one. But, frogs don't fly and I'm not the president.

I would love nothing more than to be optimistic about this new move to consolidate over 100 federal agencies. After all, I consider President Bush and Tom Ridge to be very intelligent leaders. They'll make it work, right? I wish it were that simple.

Consider congressional oversight, for example. Currently, there are 88 congressional committees and subcommittees that have jurisdiction over the 100-plus federal organizations that will comprise the new HSD. Will any of those congressional committees give up oversight authority? Don't bet on it! In fact, the pork barreling is already beginning. This could be another huge government boondoggle.

Turf wars among the various agencies are already starting. In fact, there are reports that some agencies are already lobbying Congress. If they can't get out of joining HSD, they will certainly want their agency to dominate. Can you say, too many chiefs and not enough Indians?

Bush has called for quick congressional action on HSD, but don't look for this issue to be resolved anytime soon.

I don't want to rain on the HSD parade. No, actually I do, but I will at least give the idea more time. Some smart people I know, including some good conservatives, think HSD is a good idea. I hope so, but I must say I have serious doubts about how well it will work.

HAS BUSH CROSSED THE LINE WITH HIS CONSERVATIVE BASE ?

. . . . LET ME COUNT THE WAYS.

Over the past few months, I have seriously questioned why President Bush seemed to be caving in to the liberal agenda on so many issues, as well as making some foreign policy blunders. Here is the list of things I seriously questioned:

Steel import quotas;
Campaign finance reform;
Double standard on Israel -- we can fight terrorism, but they can't, and
Bush's refusal to call Arafat a "terrorist" -- Israel must deal with him;
Red carpet treatment for the Saudi Crown Prince, the ruler of a known terrorist state; and
Signing the huge pork barrel farm bill.

My first reaction to these actions was that Bush had abandoned his conservative principles. Yet my colleague, Spencer Wright, had a different take on Bush's recent actions. Spencer argued (in the latest issue of our "Between The Lines" newsletter) that Bush had made the decisions and taken the actions described above for the greater cause of winning a Senate majority later this year and his own re-election in 2004.

Spencer argued that by signing onto these liberal bills and his other actions noted above, Bush was gaining the necessary votes in key states to retake the Senate in November. Once that happens, so Spencer opined, the "real" Bush, the true conservative Bush, will be back. You can read Spencer's analysis, if you haven't already, by clicking on the following link:

http://www.profutures.com/BushMissteps.pdf

I tried to buy into Spencer's argument and hoped it were true. But then, last week, came the clincher, at least for me. The Environmental Protection Agency, a part of the Bush administration, delivered an astounding report to the United Nations last week. In the report, the EPA stated that global warming is indeed occurring, and that it is caused by the actions of humans. This is the first time that a conservative administration has taken such a position.

The scientific community is still very divided on the question of whether global warming is really occurring, or not. For the Bush administration, or at least the EPA (a part of the Bush administration), to take such a position was a real blow for many conservatives, myself included.

I was trying to buy into Spencer's argument that the recent cave-in's were a part of a larger plan to win enough votes to hold the House and regain the Senate. I was hoping Spencer's scenario was true. Yet this latest policy position on global warming BLOWS IT, at least for me.

Why? Think about it. The environmentalists are thrilled over the latest EPA report acknowledging that global warming really is happening. They are even more giddy over the admission in the report that global warming is the result of human actions.

HOW MANY ENVIRONMENTAL

VOTES WILL REPUBLICANS GET ?

Publicly, after the EPA report, the Bush team waffled. Maybe yes, maybe no, on global warming, but there was no flat out denial. All that President Bush said was it was "a report put out by the bureaucracy." More importantly, nobody at the EPA was fired or even reprimanded, at least as far as we know. So what gives? Why would the Bush team do this?

I don't know the answers, but I do know this. Steel import quotas will probably win votes in the steel states. Campaign finance reform will probably win votes in several states, mainly because voters don't understand the real implications of CFR. The farm bill will win votes in numerous farming states. And probably most voters were not turned off, as I was, by the double-standard for Israel and terrorism, or the red carpet treatment for the Saudi Crown Prince. But I must ask you:

What environmentalist is going to vote for Bush as a result of the latest EPA report to the UN stating that global warming is real, and that it is the fault of humans? ANSWER: NONE! They would never vote for a Republican.

IS IT POLITICS AS USUAL ?

At this point, I have to say YES. George W. Bush has done a great job, so far, in the war on terror, in my opinion. His job approval ratings are back up to 75-80% in the polls. But he has caved on so many issues, when he didn't have to.

How do we explain this? At this point, I do not know. The global warming cave-in will produce ZERO VOTES from the environmentalist crowd, I can assure you. So why? I don't have a clue. My colleague, Spencer Wright, always the Republican advocate, is even scratching his head. Even he can't defend this global warming position, try as he might.

Remember that Karen Hughes, one of President Bush's closest advisors for many years, recently stepped down and returned to Texas. The official explanation was that Hughes wanted her son to finish high school in Texas and be closer to her husband.

I never bought that explanation, and neither did many in the media. All sorts of stories have been suggested for the real reason Hughes stepped down and returned home. Some have argued that Bush requested she return to Texas to shore-up Republican chances in the fall elections. That seems a stretch for me. One report claimed that Hughes' husband demanded she and their son come home due to the terrorist threat in Washington, DC. I have no idea about that one.

Given that so many theories about Hughes' departure have been put out there, I'll add one of my own. I would not be surprised if Karen Hughes was simply FED UP with the series of cave-in's by the Bush administration, and as a result, she decided to get out. Obviously, I don't know if this is the case, and we may never know the real story, but this could be the explanation.

BUSH BETS BIG -- REVISITED

In previous Updates and newsletters, I have argued that the Bush administration is making a HUGE POLITICAL BET in caving-in on so many issues in order to garner votes in liberal states. Some political analysts believe this strategy will be successful, and that the Republicans will retake the Senate. If so, they suggest, the real Bush will re-emerge, and maybe some of the legislation he has signed will be repealed or scaled back. I wouldn't bet on it.

But the real question is, what if the Republicans don't retake the Senate? If they don't, Bush will have squandered an enormous amount of political capital! If the Dems hang onto the Senate, we can only wonder how much more liberal legislation Bush might have to, or feel he has to, sign into law.

I still do not understand why Bush hasn't used the bully pulpit to go before the American people in prime time, to tell us how he felt about these pieces of legislation and then vetoed them. With his approval ratings and the public's strong support of him as the leader of the war on terror, most of the American people would have agreed with him. Yet for whatever reasons, he and his advisors decided to go along with steel tariffs, campaign finance reform and the farm bill.

All conservatives can do is HOPE that this huge political bet pays off, that the Republicans do retake the Senate in November, and that the real George W. Bush returns.

If the Dems win and retain control of the Senate, Bush will be in a much weaker position than he is today. If that is the case, Karl Rove's head needs to roll! Several others need to roll as well.

All the best,

Gary D. Halbert

SPECIAL ARTICLES

The dirty bomb scenario.

http://politics.slate.msn.com/?id=2066819

Bush developing new policy of striking first.

http://www.washingtonpost.com/ac2/wp-dyn/A22374-2002Jun9?language=printer

The road to Baghdad.

http://www.usnews.com/usnews/issue/020617/opinion/17pol.htm

The challenge for the Homeland Security Department.

http://www.opinionjournal.com/columnists/bminiter/?id=110001822

Real homeland defense requires DC to think differently.

http://www.opinionjournal.com/editorial/feature.html?id=110001824

Why Hillary will run for president.

http://www.csmonitor.com/2002/0611/p09s01-cogs.html