This issue of F&T is written on March 5, and it appears we are about to go to war with Iraq.   By the time you read this, the war could be underway, or largely over, or it may not have happened at all.   Just be advised that a lot could change from today until the time you read this.  This is why you need to be reading my weekly Forecasts &Trends E-LETTER.

The US economy grew more than previously reported in the 4Q, +1.4% versus the previous report of +0.7%   Most economists expect similar growth in the 1Q.  Yet consumer confidence continues to fall despite several encouraging economic indicators.   The Bank Credit Analyst continues to believe the economy will rebound slowly in 2003 with growth back to a 3% rate, assuming no serious negative surprises and the war goes well.

Stocks continue to drift lower on “war worries” with the Dow below 7,700 as of this writing.   I continue to believe that this is a buying opportunity, and that stocks will rebound if the war goes well.  I don’t know that this will mean the end of the bear market, or that the rally I’m expecting is simply an intermediate trend worth following.  We’ll just have to see.  

Treasury securities remain very popular and continue to rise, also due to war fears.  But if the war goes well, Treasuries could decline in value, perhaps significantly, in the months ahead.  Hopefully, you used the recent strength in Treasuries as an opportunity to lighten-up, especially if you are overweight in bonds.  Or better yet, I strongly recommend you consider Capital Management Group to direct your bond investments given the geopolitical uncertainties and the possibility of higher rates. 

This month, I focus on what could happen if we do NOT go to war with Iraq.  On pages 3-5, I reprint a fascinating article about the long-term implications if we do not remove Saddam Hussein and continue the War On Terror.  Warning: it’s troubling! 

Also, if you’re a political buff like me, you’ll definitely want to read a brilliant article by Peggy Noonan aimed at Democrats’ problems.  It is one of the best political analyses I have ever seen.  You can read it at http://www.opinionjournal.com/columnists/pnoonan/?id=110003143.

What The Anti-War Crowd Ignores

The anti-war crowd and the liberal media are obsessed with all the reasons why we should not go to war with Iraq.  But in my weekly F&TE-Letter on March 4, I pointed out some of the negative repercussions that would almost certainly occur if we do not go to war at this point.  I said:

QUOTE.  “One of the main reasons I believe we should remove Saddam, at this point, is what would happen if the US decided now to abandon the war.  There are those against the war mainly because it could spark widespread terrorist attacks in the US.  I have never believed this notion.  I believe that if al Qaeda or other terrorist groups had the ability to strike us, they would do so immediately.  They wouldn't wait and risk being caught, in my opinion.

As I will discuss below, I believe the odds for more serious terrorist attacks will INCREASE if we do NOT go to war.  Let's examine this scenario.  For whatever reasons, let's say that Bush decides in the next few days that we will NOT go to war.  Let's just imagine what would happen next.

1.  Al Qaeda is emboldened.  Al Qaeda has long believed the US is a “paper tiger.”  Yes, the US will go into limited military actions such as Bosnia, Kosovo and Somalia, largely with air power, but not a real war where large numbers of troops are actually at risk.  Even our victory in Afghanistan did not impress al Qaeda.  If Bush were to back down now, it would be cause for a grand celebration by al Qaeda and terrorists around the world.  This would be the proof, they would proclaim, that the US is indeed all talk and no action.

Let us also not forget that Iraq has weapons of mass destruction, and if Saddam is left in power, he might sell the WMDs to terrorists, if he hasn't already.  I believe if we were to back down now, the terrorists would be emboldened, and the threat of more serious attacks on the US will increase, perhaps significantly.

2.  Saddam would dominate the region.  Can you just imagine how Hussein would feel if he backed down George Bush and the United States, not to mention Tony Blair and the Brits?  Can you imagine the publicity?  He would instantly become the dominant leader in the region.  He would resume his production of weapons of mass destruction.  If the US backs down, it is all but certain that Saddam would increase the genocide, particularly against the Kurds and the Marsh Arabs, which has gone on for over 20 years.  If Saddam survives as Iraq's leader, he can be expected to significantly increase the killing, as happened after 1991.

3.  The message to North Korea.  As a member of Bush's “Axis of Evil,” North Korea is another major threat.  In recent months, we have learned they have nuclear weapons.  On February 24, the day Colin Powell visited South Korea, North Korea test-fired a new "surface-to-ship" missile.  Clearly, this was a message from Kim Jong Il that North Korea intends to continue developing such weapons.  On Monday, there was a mid-air confrontation with a North Korean jet and one of our military aircraft.  Should the US back down on Iraq, the North Korean leadership would also be emboldened.  They would conclude, "If the US backs down from Iraq, they certainly won't come knocking on our door."

4.  Political implications for Bush.  If Bush were to call off the war at this point, he would alienate much of his conservative base.  It could cost him the presidency. Would his opponents who are currently criticizing him on the war sing his praises if he backs off?  Certainly not!  They would just intensify the "dumb cowboy" refrain.

I think these and other implications of not going to war with Iraq are at least as compelling as the reasons to go to war.”  ENDQUOTE.

Shortly after Ihit the “send” button on that E-Letter, I ran across the very troubling editorial which is reprinted on the following pages.  It takes a much longer-term view of what might happen if we do not take out Saddam Hussein.  Read it.  Think about it.

by Stuart Taylor, Jr. of National Journal

QUOTE:  “Imagine President Bush responding as follows to the latest rebuffs from France, Germany, South Korea and others and to the stunning surge of anti-Americanism around the world:

‘Enough. The American people are weary of holding the world's rogue regimes and barbarians at bay in the face of sneers and obstructionism from faithless 'allies' such as France, Germany and South Korea, who owe their freedom to America. So I have decided, with a heavy heart, to acquiesce in the profoundly misguided but implacable demands of world opinion and to end our efforts to disarm Iraq and liberate its oppressed people.

‘From this point forward, my policy will be to defend the United States and our true friends. We will pull our troops out of Germany, the Persian Gulf, and South Korea. We will disengage from NATO and the United Nations. I will urge Congress to invest the savings in airtight border controls and missile defense. And I will begin a crash program to end U.S. reliance on Persian Gulf oil.’

‘We will leave our critics to deal as best they can with nuclear-armed North Korea; with soon-to-be-nuclear-armed Iraq, Iran, and maybe Libya, Syria, and Indonesia; and with the nascent black market in doomsday weapons for terrorists. It has become clear that the United States and our friends cannot long prevent the spread of such weapons while nations such as France and Germany undermine our efforts and trade with our enemies.’

How would the French, Germans, Arabs, South Koreans, Chinese and other America-bashers like that? It would be only a matter of time until Iraq or Iran, or both, took over the entire Persian Gulf region. That would send oil prices to unprecedented levels and drag European, Arab, African and Asian economies into recession or depression -- and it would mean the bloody subjugation of the region's Arab peoples.

Islamist terrorists, bent on destroying Western civilization, would find it far easier to attack targets in Europe than in the newly fortified United States. With North Korea's million-man army poised to sweep through Seoul and beyond, South Korea would face blackmail to unite on terms dictated by the North's Stalinist regime. China would soon find itself facing two nearby nuclear threats, as Japan would rapidly go nuclear to defend itself against North Korea.

The point of this exercise is not to suggest that the time for such a lurch into isolationism has arrived. Not yet, at least. Pique is not a policy. And an unpoliced, anarchic world would be an economic and national security disaster for the United States as well as others. The point is to underscore how the Europeans, South Koreans and others who have become so anti-American depend on American power -- unthinkingly, ungratefully, and completely -- for their well-being.

Abdicating their own responsibilities to help maintain world order, they are free riding, as my colleague Clive Crook noted last week, on the same U.S. polices that they publicly denounce. Like a spoiled teenager who expects her parents to support her even though she refuses to do any work around the house and constantly mouths off to them, these nations enjoy the benefits of U.S. global policing while refusing to share in the costs and trashing the policeman.

Take the views of many anti-war Europeans that Iraq should not be invaded but ‘contained.’ By whom? France? Germany? Belgium? They could not contain the two-bit Serbian tyrant, Slobodan Milosevic. And they have been no help -- indeed, they have been a great hindrance -- in containing Iraq. They want the U.S. to do it, through a costly, draining, long-term commitment of American forces. At the same time, they bash the U.S. for the military pressure and economic sanctions -- ‘starving Iraqi babies’ -- that undergird containment.

The ignorance and hypocrisy of the European free-riders is perhaps best illustrated by their clamoring that Bush is bent on a greed-driven ‘war for oil.’ But Bush could get a lot more cheap oil, a lot sooner, by joining the long-standing French-Russian push to lift the sanctions on Iraqi exports than by spending vast sums and betting his presidency on an invasion and occupation of Iraq. No American leader would dream of invading but for Saddam's persistence in seeking weapons of mass destruction. If Bush's goal were to grab an oil-rich colony for his corporate buddies, Venezuela would be a much easier target.

It's true that the vast oil reserves in and near Iraq help drive U.S. policy -- but not in a way that justifies European or Arab sneers. It is oil that brings Saddam enough money to buy and build weapons of mass destruction. And the regional hegemony he seeks would enable him to raise prices to extortionate levels. Every other nation in the world has at least as strong an interest as the United States does in denying Saddam such a stranglehold on the global economy.

The tidal wave of anti-Americanism has multiple wellsprings, of course. Critics are understandably resentful of the Bush administration's arrogant demeanor; its disdain for international institutions, agreements, and diplomatic niceties; and its unqualified support of Israel's Ariel Sharon and his expansionist settlement polices. And they're understandably attached to a U.N.-centered vision of international law that has worked well enough in Western Europe -- ever since America liberated and rebuilt the place -- but is useless against terrorists and rogue regimes with weapons of mass destruction. Mix in German pacifism; Russian insecurity; French ego and cynicism; Arab self-pity, paranoia, and envy; and near-universal resentment of the world's only superpower.

But underlying them all is the implicit calculation that the safest course for European nations (and others) is to obstruct American policies while free riding on American power. This calculation rests on two assumptions that may prove to be catastrophically wrong. The first is that as long as Paris and Berlin appease the Arab world and Europe's own militant Muslims, it will be New York and Washington -- not Paris or Berlin -- that are targeted for destruction by any weapons of mass destruction that jihadists obtain from Iraq or other rogue regimes. The second is that Europe need not share in the costs and risks of keeping rogue regimes in check, because Uncle Sam will do it for them.

Similarly, most South Koreans have lulled themselves into assuming that the North will not attack them and that its nuclear buildup is America's problem. They seem to have forgotten that the main reason they are not under the boot of the Stalinist North already is that the United States rescued them 50 years ago and still protects them with 37,000 troops and the nuclear umbrella. Or perhaps they assume the U.S. will protect them no matter how much they spit on us.

This assumption may be correct in the short run. Viscerally satisfying as it might be for the United States to offer North Korea a trade -- you abandon nukes, we abandon South Korea -- the North would no doubt sign the deal, do its best to take over South Korea and then resume its nuclear buildup.

All of this is somewhat analogous to the American public's isolationism while Hitler's armies were marching through Europe. Not our problem, Americans thought. Let England and the Soviet Union fight Germany. That seemed the best way to stay out of the war. But only in the short term. As President Franklin Roosevelt understood long before Pearl Harbor, German (and Japanese) aggression would eventually threaten America too. So FDR did all he could to change public opinion and help Britain fight the war.

European or South Korean leaders with a long view would likewise see their own nations' interest in standing with America against the rogue states and barbarians. The reason is that even the American ‘hyperpower’ probably lacks the will or the strength to carry the burden of world security for much longer, with little help from anyone but Britain, and in the face of increasingly widespread anti-Americanism. And unless someone stops the spread of doomsday weapons, anti-Western jihadists are probably within five to 15 years of obtaining enough of them -- from Iraq, North Korea, or elsewhere -- to endanger civilization as we know it.

Jacques Chirac and Gerhard Schroeder should ask themselves: After New York and Washington and London have been destroyed or depopulated, how long before Paris and Berlin meet similar fates?

It may be too much to expect the European and Arab publics, who are fed grotesque caricatures of Bush and America by their media and intelligentsia, to grasp their own interests in helping the United States defang Iraq. But wise leadership is about seeing one's national interest in the long term, and educating public opinion instead of pandering to it. The superficially clever Chirac and Schroeder are not wise leaders. They are fools. And they are helping to bring the world closer to a dark era of nuclear anarchy.”  ENDQUOTE.  [Emphasis added, GH.]

Stuart Taylor Jr. is a senior writer for National Journal magazine, http://nationaljournal.com, where the “Opening Argument” editorial above appears.

WOW!

This is one of the most powerful and well-written analyses that I have ever read.   There are those on the left, of course, who will say that Mr. Taylor is using the  post-911 environment simply to whip-up unsubstantiated and overblown nuclear war fears.  He will be called a “kook” by many.   I happen to think he is DEADON!

I must point out, however, that when it comes to our current state of affairs, the United States is not completely without fault.  US foreign policy over the last 20-30 years certainly has not been without its problems.  But even with those mis-steps, look at all we’ve accomplished for the world.  Europe is free; many other countries are free; the Berlin Wall is gone; the Soviet Union is gone; and hopefully, Saddam Hussein will soon be gone (if he isn’t by the time you read this).

The worst part, for me at least, is that I don’t think that any American leader would do what Mr. Taylor suggests: simply tell our so-called allies to “kiss-off” and tell the United Nations to go somewhere else.  We have let this go on too long.

Will we continue the War On Terror after Iraq?  I don’t know.  Will we continue with Iran and/or North Korea?  I don’t know.  Will we stop the proliferation of nuclear weapons?  Again, I don’t know.  The whole issue that Mr. Taylor brings up is something we should all think about and pray about very seriously.  

*      *      *      *      *

THE  ECONOMY

Latest Data Still Support A Recovery

Most analysts Iread remain pessimistic about the economy this year.  As always, you can find reports and statistics to support either an optimistic or a pessimistic view.  Regardless of your outlook, there are some unusual risks for any forecast, given the likelihood of war, more terrorist attacks, etc.?

The base numbers on the economy, however, continue to point to a mild recovery.  As noted earlier, GDP rose more than expected in the 4Q, a +1.4% annual rate of growth(up from 0.7%).  For all of 2002, the economy grew by over 2.5%.  The key pieces are in place for a continued recovery this year.  Among those are: 1) low interest rates; 2) accommodative monetary policy; 3) a rebound in manufacturing; 4) an upturn in business investment spending; 5) record home sales; and 6) a falling US dollar.

I have also discussed in recent months that the consumer debt problem is not nearly as bad as the pessimists would have us believe.  The pessimists ignore the fact that 70% of consumer debt is in home mortgages that are well collateralized.  Meanwhile, household disposable income has risen sharply over the last year.  Consumers have plenty of money, relatively speaking, to continue to spend.

The problem, as discussed at length last month, is that most consumers are worried and pessimistic.  Consumer confidence continued to drop in February.  With uncertainties and concerns about war with Iraq, along with the liberal media which drones on and on about how bad this economy is, people are understandably reluctant to spend.

What Will Change After The War?

As noted earlier, this letter is written on March 5.  I am assuming we will either be at war with Iraq when you read this, or possibly the war is largely over.  I am also assuming we will be successful in the war.  If these assumptions prove to be correct, I believe we will see a nice recovery in the economy this year.

If the war effort is very successful, I would expect consumer confidence to jump quickly.  As discussed below, I believe the stock markets could mount a meaningful move on the upside.  And this could lead to a better than expected economy.

The Bank Credit Analyst continues to be optimistic as well, based on the same assumptions I made in the previous paragraph:  “The  economy should grow by at least 3% this year, warranting increased exposure to equities and reduced exposure to Treasurys. . .  we expect equity prices to end the year above current levels as an improving economy encourages investors to shift some of their cash mountain back into the market.

I should add that BCA has NOT yet recommended moving from “average” holding of equities to “above average.”  Like everyone, they want to wait and see what happens in the war on Iraq.  Like everyone, they caution that if the war goes badly, consumers will go into a funk, the economy could sink back into recession and stocks could fall significantly lower.

A Buying Opportunity?

I have been suggesting in my weekly F&T E-Letter  that we will see an excellent buying opportunity in equities just as the war begins in Iraq.   That buying opportunity may have come and gone by the time you read this, assuming of course that I am correct.  While I don’t expect a roaring bull market, I could see the major market indexes rising 20-30% in a post-war rebound in confidence and the economy.

Could the pre-war low in equities be the bottom of the bear market and the beginning of a new bull market?  Actually, most analysts don’t believe so.  The bearish consensus has gotten quite high recently, even on Wall Street, if you can believe that.

There is no way to know if the rally I expect will begin a meaningful new trend to the upside, or if it will merely be another intermediate rally such as we saw last October--November.  But if the war goes well, I think both the stock markets and the economy may surprise on the upside for the rest of the year.

Because of this, and because stocks have declined so hard since last December (oversold), I think it’s worth adding some money to your equity portfolio, especially if it is managed by a professional that can get out of the market if need be.

As usual, I’m putting my money where my mouth is.  I am increasing my equity holdings at this time.  If you feel the same, give us a call for more specific advice about where best to invest at this time.

What To Do In Bonds

Even if you aren’t inclined to put some money in equities now, there is a good opportunity in bonds.  BCA believes that corporate bonds will outperform Treasuries this year, especially when (and if) it is clear that the US has prevailed in Iraq.  That is why I believe that Capital Management Group (CMG) is a great choice at this time.  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%.  (Past results are not necessarily indicative of future results.)

I have been surprised at the relatively low level of interest in CMG we have seen from our clients.  Some tell us it’s because CMG invests in high-yield bonds, and they don’t like “junk bonds.”  I should point out that CMG only invests in highly diversified high-yield bond funds, not individual issues of junk bonds.  They also invest in large, well-known fund families such as Goldman Sachs, Putnam, Pimco and others you would recognize.  As noted above, these funds are highly diversified, and even if some of their issuers have problems, which happens from time to time, it should not have a significant effect on returns.  Otherwise, CMG would not have such a stellar record with a worst-ever losing period of only -3.3%.

Also, some people just don’t like bonds, period.  I used to be in this group.  However, in this market environment, with equities in a bear trend, there aren’t that many places to earn 10% returns with very limited drawdowns.   Remember, CMG is a bond timing program, not buy-and-hold.  Check them out.

Please Read This Very Carefully

How much will it cost you to maintain health insurance coverage and pay out-of-pocket medical expenses after you retire?  You had better sit down for the answer .  According to a report recently issued by the Employee Benefit Research Institute (“EBRI”), post-retirement health care costs could run up to $1.5 million, depending upon your situation!

Fortunately, the high end of this range is somewhat inflated, as I will discuss later on.  However, this report does bring up a subject that many pre-retirees are not fully considering when they look at their nest eggs to see if it is possible for them to retire.

EBRI is a non-profit, non-partisan organization committed to research and education on topics involving employee benefits.  In its February 2003 Issue Brief entitled “Retiree Health Benefits: Savings Needed to Fund Health Care in Retirement,” they illustrate the potentially huge amounts of money a retired person may need to save to pay for health insurance and out-of-pocket health care costs during retirement.  This issue is also very timely considering the current debate in Washington concerning Medicare and prescription drug coverage.  However, I was surprised that I did not see this story make more of the major newspapers and news broadcasts.

The full report is 28 pages long and can be found on the Internet at www.ebri.org.  Prepare yourself; this report is tedious reading and a sure cure for insomnia.   However, the implications of this report are extremely important, especially for someone who is considering retirement.

Employers Cutting Back On Benefits

We’ll get to some of the individual cost estimates a little later.  First, I’d like to bring out another important finding from the report.  Currently, two-thirds of employees have no post-retirement insurance coverage from their employer, and the number of employers offering such coverage is getting smaller and smaller.

Typically, only larger corporations are able to provide post-retirement health insurance benefits to their former employees.  Many private-sector employers also have been either limiting the amount the employer will pay for the coverage or doing away with it entirely.  A 2001 national survey of employers with 500 or more employees showed that those expecting to continue offering post-retirement health benefits was only 29%, compared to 46% in 1993.  Another survey of larger employers also showed a decline in the percentage planning to offer post-retirement benefits. 

One reason for the decline is an accounting rule that forces employers to recognize the long-term liability of post-retirement health benefits in their current financial reports.  This negative factor can decrease profits and affect stock prices.  With the recent additional changes in accounting rules brought about by the Enron and Worldcomm scandals, we may even see a greater percentage of employers abandoning post-retirement health benefits.  If we combine the trend of fewer employers providing post-retirement health insurance, rapidly rising health care costs, and extended life expectancies, the result is that the majority of future retirees will have to fend for themselves for health related expenses.

So, What's The Bottom Line?

The amount of savings required to cover health related costs after retirement depends upon a number of different assumptions.  Obviously, those employees who are lucky enough to have employer-sponsoredpost-retirement coverage have to accumulate less than those who do not have it.  However, other variables such as assumed life expectancy, health status, insurance premium levels, rates of return on investments and age at retirement also factor into the equation. 

For someone who has access to standard employer-sponsored group insurance coverage (where the premium is calculated based on a group rate) the amount of savings required to cover post-retirement health care costs range from $37,000 to $216,000 , depending upon the age at death and the amount the employer contributes toward the premium.  The numbers above are based on an annual premium increase of 7%.  If the premium growth rate is doubled to 14%, the range of savings required increases substantially, ranging from $56,000 to $750,000. 

As noted earlier, most employees do not have  employer-sponsored group insurance after retirement.   Therefore, the numbers for most future retirees are much worse than those listed above.  For a fairly standard private “Medigap” coverage with a premium that increases 7% per year, the amount of savings necessary to cover post-retirement health costs ranges from $116,000 to $354,000.  If we again assume a 14% annual increase in premium, this range becomes $194,000 to $1,458,000.

The numbers for both of the illustrations above assume an after-tax growth rate of 4% on money saved.   However, note that EBRI used the premium for the most comprehensive Medigap coverage in the state of Florida, where such coverage is the most expensive in the US.  Hopefully, your situation will be different.  I would assume that EBRI used the highest possible premiums so that their numbers would be conservative - not wanting to understate the need for saving for post-retirement health costs.  However, I would also be willing to bet they were not disappointed to see that one set of assumptions produced a present value savings requirement over $1 million (ie - good press release).

To estimate the amount of money you need to save for retirement to cover your health-related costs, EBRI recommends a “retiree health savings calculator.”  You input information about yourself and assumptions about the future, and the calculator will tell you how much you should save by the time you retire.  You can find the retiree health savings calculator on the Internet at www.choosetosave.org/tools/rethlth/htm.    I highly recommend you check this out.

Implications

Even if the EBRI tends to overstate the savings requirements, its conclusions are quite alarming:

1. The majority of workers today do not have employer-sponsored health coverage of any kind.  Therefore, it is imperative that workers start to save on their own for future health related expenses;

2. Savings for health-related expenses are over-and-above that necessary to fund other retirement expenses such as housing, food, clothing, etc.  Unfortunately, most workers are not doing a good job of saving for retirement, much less health care costs. Government statistics indicate that roughly one-half of current retirees rely exclusively on Social Security benefits to cover their living expenses, and more than two-thirds rely primarily upon it.   Unless future retirees begin to save more, this trend may get worse.

3. Lack of savings to cover post-retirement health costs means that retirement behavior patterns will change.  The percentage of men age 60 - 64 in the labor force has been increasing since the mid-1990s, and is expected to continue to do so as workers seek ways to obtain affordable health insurance coverage; and

4. Remember that the savings requirements illustrated in the EBRI report are present values based on health care costs as they exist NOW.   Future increases in health care insurance premiums and related costs will just serve to increase the amount of savings necessary at retirement.

Predictably, there are already those who want to call upon the government to step in and fix this problem.  Even the EBRI report lists government intervention as one of the possible solutions.  However, the report also recommends that policymakers undertake a public education campaign to highlight the expenses to be expected after retirement, and the need to save for them personally. Unfortunately, we seem to have bypassed the time when men and women were expected to save money to provide for their expenses after retirement.  For many, personal responsibility has been replaced by government dependence.

However, I think there is hope on the horizon.  The savings incentives recently proposed by President Bush are a step in the right direction, in my opinion.  Though they have been largely ignored or reviled by the liberal press, these savings vehicles could provide the mechanism for a return to structured savings by Americans.

Even if they do not pass, I think it is important for you to not only look at your own personal situation, but also to help to educate your children and grandchildren on the importance of saving