The US economy slowed more than expected in the 4Q.  The government reported 4Q GDP rose only at an annual rate of .7%. For the year, that means GDP rose only 2.4%, subject to subsequent revisions, and as compared to only .3% in 2001.  Consumer confidence continues to fall amidst several encouraging economic indicators.   Most of my sources, including The Bank Credit Analyst, believe the economy will rebound slowly in 2003 with growth back to a 3% rate by year-end.    This outlook assumes that there are no serious negative surprises, and that if there is a war with Iraq, it will be won relatively easily and decisively.  More analysis of the economy is included in the following pages.

Stocks declined in January as “war worries” intensified, with the Dow falling below 8,000 late in the month.  Investor confidence is waning, and money continues to flow out of mutual funds.  The current decline could continue until the US attacks Iraq, which looks very likely, but that could present perhaps the best buying opportunity of the year.  I don’t expect stocks to fall below their October lows.  Should the US have some early success in the war, stocks should begin to trend higher as in the past.

Bonds have been in a narrow trading range recently, but it looks increasingly likely that the low in rates has been seen, and that bond yields will begin to trend higher later this year.  With $300+ billion deficits staring at us for the next two years, I believe the bull market in bonds is over.  I strongly recommend you consider Capital Management Group to direct your bond investments given the outlook for higher rates.

Gold, oil and commodities have been the big winners recently.  Gold hit a seven year high of $380 this week.  Oil prices topped $34 dollars a barrel, and several other traditional commodities are trending higher.  2003 may be another good year for well-managed futures funds.  If you are an accredited investor, call us to find out how to get onboard these markets.

In this issue, we cover a variety of topics:  the economy; where to invest now; why investors under-perform the markets; Bush’s new saving/retirement accounts; and a great editorial slamming the Clintons, rightly so.

People Are Too Negative

In their February issue, the editors at The Bank Credit Analyst state that they feel the public is simply too negative about the economy and about stocks.  They believe the media has generated unwarranted worry about the economy, the war with Iraq, the equity risks, deflation, consumer balance sheets and the corporate sector in general.   They state:

“There is still pervasive gloom about the economy on the grounds that the post-bubble adjustment still has much further to run.  We believe that the pessimism is overdone, and that the economy has a good chance of   surprising on the upside once the geopolitical [Iraq] clouds lift.   Thus, we  are sticking to  our view that risky assets will outperform over the course of this year.  This means favoring stocks over bonds and corporate bonds over Treasurys on a 6-to12-month view...   Presumably, there will be a healthy relief rally in equity prices and a selloff in Treasurys when the conflict with Iraq is no longer a major issue.”

If BCA’s view is correct, then investors should consider buying stocks and selling bonds just ahead, or at least moving bonds into the hands of a market timer like Capital Management Group.  CMG, by the way, went to cash on January 28, an indication that they believe rates will move higher.  More on this later.

What Good Economic Signs?

Retail sales rose 1.2% in December and were up 4.6% over the last 12 months.  Consumer spending increased 3% in 2002.  Durable goods orders and factory orders were both up in December and above 2001 levels for the year.  ISM manufacturing index rose in January for the third consecutive month.  The housing sector broke all records in 2002 in housing starts and   sales of new and existing homes. 

We have all heard that it is business investment spending that needs to kick-in, along with consumer spending to get the economy back on a 3% path.  According to the Commerce Department, business investment spending increased 1.5% in the 4Q after plunging ever since 911.  This news was a surprise to most analysts.  While the 4Q increase was modest, it was at least a start, and it could rapidly increase significantly if there are further signs that the economy is accelerating.  Along the same line, business inventories are very low and will have to be replenished if the economy strengthens. 

The main negative in the economy at this point is consumer confidence which has declined in seven of the last eight months and is at the lowest level since November 1993.  This is despite the fact that the economy grew 2.4% in 2002.  The media and the gloom-and-doom crowd have been very effective. 

When the government reported that 4Q GDP rose only .7%, we were told that had it not been for increased defense spending, the economy would have been negative for the period.  But what they didn’t say was that the longshoremen’s strike on the West Coast cost the economy tens of billions of dollars in the 4Q.

Things Could Look A Lot Better Soon

The next 60 days could bring a significant change in the pessimistic view that prevails today.  This newsletter is written on the day that Secretary of State Colin Powell addressed the United Nations with his evidence that Iraq has weapons of mass destruction.  I watched his speech and found it very compelling.  This suggests that the US will initiate the war on Iraq very soon.  The military sources I read believe that within the first 2-3 weeks of the war, it will be clear that the US will succeed in bringing regime change to Iraq.

If this proves to be the case, consumer confidence should shoot higher, giving a significant boost to the economy.  If stock prices hold above their October lows, and the war goes well, we could see a new uptrend develop quickly in equities.  Let us not forget that there is a sea of cash out there that could drive equities significantly higher if the public decides things aren’t so bad after all. 

Falling oil prices would be another positive development.  Oil prices have spiked not only because of the supply problems in Venezuela, but also because of war worries.  If the US is successful in Iraq, oil prices should begin to fall, and especially if it turns out that a new Iraq could begin producing and exporting at full capacity before long.

The point is, while sentiment and confidence are low at this point, that could change quickly.  US success in Iraq this time around will be far more uplifting than in the Gulf War because this is part of the War On Terror.  I could see the public turning euphoric over a victory in Iraq.  If so, the economy could indeed “surprise on the upside” as BCA suggests.

What About Negative Surprises?

While I have suggested a better economy and rising equity prices in the scenario above, there is certainly the threat of negative surprises.  That could come in the form of more major terrorist attacks in the US.  Some believe that if we go to war with Iraq, that may be the trigger for more terrorist attacks in the US.    Obviously, if there are more major attacks, that would send confidence into a black hole, and my optimistic scenario out the window.

Certainly, if the war on Iraq goes badly, then all bets are off.  While most military sources believe it will go very well, there is always the threat that the unexpected could happen.  While it is thought to be doubtful that Saddam Hussein will use weapons of mass destruction against our troops, it can’t be categorically ruled out.  If there are large casualties, morale in the US will sink like a rock.

Others believe that the war in Iraq will spark chaos all across the Middle East.  Some feel that the presence of US troops in the heart of the region will spark a major new Mid-East war involving Saudi Arabia, Egypt, Syria, Iran and, of course, Israel.  While this cannot be ruled out, it does not seem likely.

Finally, there’s the North Korea/China question.  Might North Korea take military action against South Korea while the US is tied-up in Iraq?  Might China move against Taiwan?  Some think that N. Korea feels it doesn’t have anything to lose since it is a member of the Axis of Evil and may be next in the War On Terror.  Then again, a move against S. Korea would insure that N. Korea is next on the list.  So, while these things can’t be ruled out, they seem very unlikely.

How To Invest Now

As suggested earlier, the best buying opportunity of the year may occur just ahead in equities.  The question is when.  That depends on the war.  If the markets react as they have in the past, you will want to get onboard before it is clear that the US is in full control.  I suggest you use one of our recommended market timers to make that decision.  All of our recommended Advisors beat the equities market in 2002.  Consider Hallman &McQuinn, Niemann and Potomac. 

As for bonds, BCA believes that Treasury bonds will go down this year, especially when (and if) it is clear that the US has prevailed in Iraq.  BCA believes that corporate bonds are the place to be this year.  This is why I believe that Capital Management Group (CMG) is a great choice.  CMG invests in high-yield bond funds that are highly diversified.  High-yield bonds historically benefit during economic recoveries.  CMG has an outstanding 10-year record, averaging 10.5% with a worst-ever losing period of only 3.3% (non-leveraged program).  This could be a very good time to invest, especially if you are in Treasury bonds.

Our futures funds are off to a great start so far this year, following a very good year in 2002.  All of our funds are up 7-8% so far this year.  Unfortunately, our older funds are no longer open to new investment.  We do have one fund that is open to accredited investors.  You can call us for more information.

We’re getting a lot of questions about gold.  Gold has had an exciting run-up, especially recently.  Prices hit $380/ounce this week, the highest in seven years.  Yet I would NOT chase gold at this point.  Part of the reason for the advance is war worries.  If the US gains quick control of Iraq, gold could fall significantly.  If you believe in the bullish case for gold, I would wait to buy it until there is a meaningful correction, most likely whenever it’s clear the US will prevail in Iraq.

The Dalbar Studies

Since the mid-1990s, I have been writing about the studies published by Dalbar, Inc., the Boston-based market research firm.  If you recall, Dalbar studies mutual fund inflows and outflows and uses that information to estimate what the “average investor” made in any given time period, versus what the funds actually made.  The results are not pretty.

If you buy a mutual fund and hold it for the long-term, you will make exactly what the fund makes (assuming no additions or withdrawals).  If a fund makes 50% in three years, and you hold it for the same three years, you will make exactly what the fund made.   But most investors don’t do that.  Instead, they jump from fund to fund, hoping for the best performance.  Unfortunately, they often sell their funds when they are under-performing to buy the latest hot funds, only to see them under-perform.  The results are disturbing! 

The latest Dalbar study looks at the results during the period from 1984 to 2000, during the greatest bull market in history.  The following numbers from Dalbar represent investors who bought diversified stock mutual funds, which tend to track very closely on average with the S&P 500 Index, and bond/fixed income funds, which tend to track closely with the long-term Government Bond Index.  Read the numbers closely.

In the period from 1984 to 2000, the S&P 500 Index gained 16.3% on average per year; however, the average investor in stock mutual funds gained only 5.3% on average during that same period.  Surprised??

In the same period, 1984-2000, the long-term Government Bond Index gained 11.8% on average per year; however, the average investor in bond mutual funds gained only 6.1% on average.  

The problem is, most investors jumped around from fund to fund during that period, often buying high and selling low.  Yes, the investors who bought the average stock fund(s) and/or bond fund(s), and held them for that entire period, made roughly what the market indexes made: 16.3% on average for stock funds and 11.8% on average for bond funds.  But most investors didn't.  Due to bad timing, they didn't make nearly as much as the average funds. 

In the case of stock mutual funds, the average investor made less than a third of what the funds made on average.  And this was in the hottest stock market in history!  In the case of bond funds, the average investor made only about half what the funds made. 

I don't know about you, but I was shocked when I first began to look at Dalbar's (and others') numbers on this in the early 1990s!  I had no idea that investors, as a group, were jumping from fund to fund to fund so frequently, and with such disastrous results. 

My observation in dealing with thousands of investors over the last 25 years is that most people (including me) do not have good timing when it comes to the markets.  We have a tendency to buy things when they are hot, not when they are cold.  In most cases, it should be the other way around.  While the media is certainly a willing accomplice along this line, with the constant barrage of advice, we are all influenced by greed and fear, at least to some extent.  We want to be in the  hot funds or hot sectors.  But this strategy simply doesn’t work for most investors.

The Dalbar numbers have consistently shown that if investors simply picked the “average” stock mutual funds, and held on for the long-term, they would have made about what the S&P 500 made.  Yet this is very hard for most investors.

As you know, I am a firm believer that most people would be better off if they used professional money managers to direct most of their investments.   The Dalbar numbers above, and similar studies, certainly back me up.  Today we have more uncertainties than ever before, especially with the increased terrorism threat.  This is why I have 100% of my investment portfolio in the hands of professionals.  I don’t manage any of it myself. 

Bush Spends With The Best Of ‘Em!

President Bush released his new budget proposal for fiscal 2004 this week, and it’s a whopper at $2.23 trillion in total.  The new budget is 4.2% higher than the fiscal 2003 budget.  The new budget has a projected record deficit of $307 billion next year (and another $300+ billion in 2005).  The estimate of $307 billion does not include the cost of war with Iraq, which is estimated to run $50-$100 billion.  So the deficit next year could actually top $400 billion!

I am disappointed that Bush didn’t push for lower spending, especially with Republicans in control of the White House and Congress.  This proves that Bush can spend with the best of ‘em! 

The big spending next year will be good for the economy, but I expect it will be bad news for the bond market.  Big deficits usually lead to higher interest rates and in this case, a lower dollar.

New Savings/Retirement Accounts

There was some good news along with Bush’s new budget.  The president is proposing sweeping new changes that would allow many people to sock away far more money tax-deferred than before.

Anyone who has tried to accumulate some money for retirement, college educations for their kids, or for a new home has run into a myriad of regulations, forms, restrictions and confusion.  Should you do a traditional IRA, 403(b), 401(k), medical savings account, 529 college savings plan, or just give up and just sock the money away in your mattress?

Along with the new budget, President Bush has proposed new tax-free savings plans that would not only increase the amount you can put back for various needs, but would also simplify the maze of different types of accounts and regulations governing each.  The three new plans are called Employer Retirement Savings Accounts, Lifetime Savings Accounts, and Retirement Savings Accounts.

Employer Retirement Savings Accounts

One of the major reasons that more employers do not provide retirement benefits is the current regulatory maze surrounding qualified retirement plans.  It seems that every time Congress meets, new laws are passed that add another layer of complexity or reporting to these plans.  This makes the administrative costs of providing such a plan prohibitive for many employers.

The Bush proposal would consolidate 401(k), thrift, 403(b), and governmental 457 plans, as well as employer-sponsored SARSEP and SIMPLE IRA programs into Employer Retirement Savings Accounts, or ERSAs.  Contributions to these plans would still be tax-deductible and earnings would continue to grow tax-deferred.  Withdrawals at retirement would continue to be taxed as ordinary income.

Administration of the new ERSA plans would be similar to current 401(k) administrative requirements, but greatly simplified.  Like 401(k) plans, employees would be allowed to contribute up to $12,000, increasing to $15,000 by 2006.  Employers will also be able to continue to match employees' contributions as in the past.

Lifetime Savings Accounts

Lifetime Savings Accounts (LSAs) could be established for any purpose, including children's or grandchildren's education, a new home, healthcare needs, or funds to start a new business.  Individuals will be able to make non-deductible contributions of up to $7,500 per year (indexed for inflation), or $15,000 per married couple.  There is no age or income cap on the ability to participate in these programs, so many parents may actually set up LSAs for their children to accumulate funds for college.  Best of all, funds can be withdrawn from an LSA for any purpose at any time with no penalties or taxes on the earnings.

Retirement Savings Accounts

The final type of new account is called a Retirement Savings Account (RSA).  This will allow individuals to salt away another $7,500 per year ($15,000 per couple) into an account that is set-aside for retirement.  RSAs would be governed by rules similar to those for current Roth IRAs, in that contributions would not be tax-deductible, but individuals will be able to participate regardless of their income.  Currently, high-income individuals cannot contribute to a Roth IRA.

Earnings will grow tax-deferred, and can be withdrawn tax-free after age 58, or upon the death or disability of the account holder.  Existing Roth IRAs would simply be converted into the new RSA.  Existing traditional IRAs could be converted into an RSA, again without any income limitations.  Any traditional IRA not converted to an RSA would not be able to accept new deductible contributions, but would be able to accept rollovers from another plan.

Examples Of The New Savings Plans

Here are some examples of how much you can set aside under the new savings plans proposed by President Bush.   For this example, we'll assume a single taxpayer less than 50 years of age:

For a married couple, the amounts could be doubled ($54,000), assuming that both participate in an Employer Retirement Savings Account.  Individuals over age 50 are permitted to make "catch-up" contributions of $2,000 per year to an Employer Retirement Savings Account, making the total allowable contribution $29,000.

As discussed above, the $12,000 contribution to the ERSA is tax-deductible, but contributions to the LSA and RSA are not.

When announcing the new plans, the Treasury Department said that these accounts would "make saving simple for everyone and for every purpose…No longer will people have to worry about the endless maze of confusing rules.  The two simple accounts will have one powerful goal making saving for everyday life and retirement security easier and more attractive."

I'm for anything that makes saving simpler and easier!  Of course, it remains to be seen if these new proposals will be adopted.  The Democrats are likely to attack them as more benefits to the rich.

Who Are "The Rich" Anyway?

The following statistics from the IRS may surprise you.  They certainly surprised a lot of people when I put them in my weekly E-Letter in January.

If you make $28,000 a year, do you consider yourself rich?  What if you make $55,000 a year, are you rich?  Okay then, what if you make $92,000 a year, are you rich?  I doubt that many in any of these income brackets consider themselves rich, especially if they have kids.

However, if you make $28,000 a year, you are in the top 50% of taxpayers; $55,000 puts you in the top 25%; and $92,000 puts you in the top 10%, the so-called "super-rich."  

The liberals NEVER quote these figures either.  They know that most people making $28,000-$55,000 do NOT consider themselves remotely to be rich, nor do many who make $92,000.  These folks would be appalled if the liberals were to call them rich people, so they don't.

Also from the IRS, the top 50% of taxpayers pay 96% of all income taxes.  Only 4% of income taxes are paid by the bottom 50%. (This from tax data for 2000.)     You rarely see this data reported by the media either.  Are you surprised?

Editor’s Note

I haven’t written much about politics in the last year.  I must admit that politics has been somewhat less interesting since Bill Clinton left office.  But unlike most presidents before him, Bill Clinton has denied tradition by openly and shamelessly criticizing President Bush ever since he took office.  Hillary Clinton has also been vocally critical, but this would be expected of a liberal Democrat Senator.  Yet despite my  inclinations, I have not chosen to write about the Clintons in some time.

In the last few weeks, however, the Clintons have made some statements that I simply can’t ignore.  Rather than address those statements in my own words, I have chosen to reprint a recent editorial by none other than Dick Morris, the long-time Clinton political advisor.  Morris has undergone a major transition in his life (for the better) in recent years, and he has come out swinging at the Clintons on numerous occasions.  He is a regular columnist for the New York Post and other media sources, as well as a popular  guest on TV talk shows.  Morris knows more about the Clintons than just about anyone.

The following Morris column appeared on January 29 in The Hill, a very old, widely-circulated newspaper that focuses on politics in Washington.

“Even by Clinton Standards,
 It's Sheer Chutzpah.

When Sen. Hillary Clinton (D-N.Y.) complains that it is a ‘myth’ that the Bush administration is enhancing homeland security, and her husband says that he is the reason North Korea does not now have 50 nuclear weapons, they enter realms of hypocrisy and chutzpah new even by their exalted standards. Both of their comments smack of killing your parents and then pleading for clemency on the ground of your orphanhood.

Just why is our homeland security, in particular our air security system, flawed and vulnerable to terrorists? Because in 1996, her husband, the president, refused to take tough measures to strengthen it. Instead he punted by appointing a commission, under Vice President Al Gore, to make recommendations.

They make pathetic reading after Sept.11. As Sean Hannity notes in his book Let Freedom Ring, the failure of this commission to embrace truly important air security measures left America vulnerable and exposed.

The Gore Commission's focus was on making sure that all luggage put onboard a plane be matched to passengers actually on the flight, a step which would enhance security only if terrorists were obliging enough never to commit suicide in their attacks.

Indeed, its only recommendation that might have helped avert Sept.11 was for ‘automated passenger profiling’ which would identify ‘a small minority of passengers who merit additional attention. … based on information that is already in computer databases.’’ After civil liberties groups raised hell and called the idea ‘racial profiling,’ it was dropped by the politically correct administration.

After the ValuJet crash in Florida and after TWA 800 plunged into the Atlantic, there was a clamor for a tough crackdown on air terrorism. I polled the issue on Aug. 1, 1996, and advised the Clintons and Gore that voters supported X-ray of luggage by a 90-to-7 margin, federalizing security personnel by 92-to-6, and requiring photo IDs for all passengers by 92-to-6. Yet, despite these wide margins of public approval, none of these key recommendations made their way into the Gore report.  [Emphasis added, GH.]

Both Hillary and Bill have also stepped way over the line on their criticism of Bush on North Korea. Hillary said Bush had ‘mishandled’ the matter. President Clinton said that it was his policies that stopped the rogue nation from having ‘50’ nuclear weapons.

Wait a minute: It was Clinton who negotiated the 1994 Framework Agreement with Pyongyang in which North Korea agreed to stop diverting plutonium from its nuclear plant in Yongbyon in return for the delivery of 500,000 metric tons of fuel annually and the construction of two light water nuclear power plants costing $4 billion.

By mid-August of 1998, newspaper reports indicated that the U.S. intelligence agencies had detected a ‘huge secret underground complex in North Korea’ that they suspected was ‘the centerpiece of an effort to revive the country's … nuclear weapons program.’The United States asked to inspect the underground caverns. North Korea demanded a cash payment of $300 million to permit the inspectors to go there and the matter was dropped.

Now, intelligence sources estimate that North Korea has one or two nuclear weapons and has had them since the mid-'90s. So why didn't Clinton demand that North Korea disarm? Why didn't he insist on access to the caverns? Why did he keep funding, fuel and food flowing while Pyongyang broke its word?

At the time, Clinton assured Congress that North Korea wasn't violating the deal because the Yongbyon plant had not been reactivated, whatever was happening in the caverns. In fact, the administration insisted that the 1994 deal wasn't an agreement at all, but an ‘agreed framework that does not bind any party to specific actions or hold parties in noncompliance if given objectives are not met. Failure of the (so-called) agreed framework, consequently, is very much in the mind of the beholder.’ Presumably the two atomic bombs North Korea is thought to have are in our minds as well.

When the Senate voted, 80-11, in late 1998 ‘to condition funding (of the '94 deal) on a presidential certification that North Korea has halted all nuclear activities,’ Clinton continued to wink at North Korean noncompliance.

And now, Bill and Hillary are attacking Bush for the twin legacies they left him: inadequate air security and a broken deal with North Korea .

It's a good thing those two are sociopaths. Otherwise their consciences might bother them when they say things like that.”  [Emphasis added, GH.]

Dick Morris is a former consultant to President Clinton, Sen. Trent Lott (R-Miss.) and other political figures.”  ENDQUOTE.

The Clintons Won’t Go Away

While shunned in some venues, Bill Clinton continues to be very popular on the lecture circuit.  He typically packs the house wherever he speaks.  In Austin, for example, they are going to have to move Clinton to a larger auditorium because he more than sold out the original venue.  But then, Austin is a fairly liberal city, I hate to admit. The media everywhere still fawn over Clinton, despite the outrageous things he says about Bush and the Republicans.

Meanwhile, Hillary Clinton is carefully paving the way for her run for the presidency in 2008.  As a matter of fact, she could easily win the Democrat nomination for president in 2004, based on her poll numbers.    Various recent polls have shown her to be twice as popular with voters than any of today’s leading contenders for the Democrat nomination.  But apparently, Hillary won’t make a run in 2004 because they fear that President Bush is unbeatable.  Of course, that could change, especially if the war on Iraq goes badly.

This is bad news for the Republicans.  There is no clear leader to succeed Bush in 2008.  Some speculate (and I agree) that Bush needs to choose a new running mate in 2004, and publicly groom him (or her), since Dick Cheney is not likely to run for president in 2008.

If things are not going exceedingly well in 2007-2008, we could very well see the Clintons - at least Hillary - return to the White House.  That’s a chilling thought, at least among conservatives!