The Commerce Department reported that Gross Domestic Product increased 0.2% (annual rate) in the 4Q.  Analysts had expected a drop of at least 1%.  The latest GDP report is the "advance" estimate, so it will be revised two more times.  For now, however, we are not officially in a recession, which is defined by two consecutive quarters of negative economic growth.  Even if the GDP number is revised downward, it will not be nearly as bad as most expected.  There was considerably more good economic news released over the last month, as I will discuss inside.  Bottom line:  the economy is turning the corner. 

The Bank Credit Analyst now feels even more strongly that the US economy will be in positive territory by mid-year.  They also believe that their "long-wave upturn" forecast may still be accurate, and the economy could be stronger than expected for several more years.  They continue to recommend stocks over bonds for the next year.  Details to follow.

The Fed left interest rates unchanged at its January meeting.  It is safe to assume that the Fed knew the GDP report would be much better than was expected.  While there could still be another rate cut ahead, we should assume that the downtrend in rates is at or near the end.  This does not mean that rates will begin to move significantly higher.  That will not happen until the economy turns much stronger, and that will be a while.

The stock markets remain jittery for a variety of reasons, Enron fallout among them.  The Enron situation has serious implications for the stock markets, as I will discuss later in these pages.  However, with the economy showing clear signs of recovery, with interest rates expected to remain low, and with $4 trillion sitting in money funds earning almost nothing, the backdrop is set for the equity markets to begin to trend noticeably higher.  Those looking to get back in should probably do so just ahead.  It will be too late when it's clear the economy has turned.  I would avoid the high tech sector which is once again over-valued.

This month we will look at various strategies for stock market investing including market timing, momentum investing and buy-and-hold.  We will also look at the latest political ranglings as election season begins.

GDP Report Was A Shocker

As noted on page one, the Commerce Department surprised everyone with its latest estimate of 4Q GDP,  showing an increase of 0.2% (annual rate).  This followed the -1.3% rate for the 3Q (which was unchanged from the previous report).  The increase in the 4Q was especially surprising since the consensus estimate was for a drop of apprx. 1%.  The increase from -1.3% to +0.2% was one of the largest quarterly changes on record.  So how could this be?

The GDP report, which will be revised two more times, indicated that consumer spending, home and auto sales and government spending, among others, were all substantially above 3Q levels.

Most analysts downplayed the number and predicted that it will be adjusted downward in the subsequent revisions.  Maybe so, but this number was far above expectations.  Even if it is subsequently revised downward to -.1%, -.2% or -.3% - which is not a certainty - it will still be much stronger than virtually anyone expected.  It is clear evidence that the economy is on a comeback.

If the 4Q GDP figure is not revised to a negative number, this will mean we have not had two consecutive negative quarters in GDP.  This is the classic definition of a recession.  While most of us believe we're in a recession, technically it may not prove to be the case.

Other Good News In The Last Month

The Conference Board's Index of Leading Eco-nomic Indicators (LEI) rose for a third consecutive month in December.  The LEI rose by 1.2% in Decem-ber following +0.8% in November and +0.1% in October.  The gain in December was the largest monthly increase since February 1996, with 8 of the 10 indicators in positive territory.

Next, the Consumer Confidence Index rose again in January to 97.3 versus 94.6 in December and 84.9 in November.  These numbers explain why retail sales were surprisingly stronger than expected in December.  Salomon Brothers/Smith Barney's index of the 50 largest retailers rose by 4.5% in December.  While holiday sales started slowly, shoppers became more confident and the result was surprisingly positive.

Most analysts agree that the manufacturing sector has been among the areas hardest hit in this recession, and that it will be one of the last to rebound.  However, in December the Institute of Supply Management reported that its Manufacturing Index rose for the first time since the recession began.  The index climbed to 48.2 in December, versus 44.5 in Nov.  The Commerce Department also announced that durable goods orders rose 2% in December, another piece of good news for the manufacturing sector.

Spurred by low mortgage rates, Americans pushed sales of new homes up by 5.7 percent in December.   Sales of existing homes also set an all-time record in 2001 with 5.25 million homes sold.  The average existing home price rose by 6.5% in 2001 to $190,100.  This helped make 2001 the best year on record for home sales, despite 911 and a struggling economy.

Even the latest unemployment number was very encouraging.  After rising to 5.8% in December, unemployment dropped to 5.6% in January.

The Recession Is Ending

The latest encouraging reports support The Bank Credit Analyst's forecast that the recession would be relatively mild, and that the economy would be in positive territory by mid-year.  Now the question becomes,  how strong will the economic recovery be?  BCA maintains that the most likely course is for the recovery to be slow over the next year.  They continue to emphasize that the record levels of consumer and corporate debt will limit spending and prevent the economy from returning to the growth levels we saw in the last half of the '90s.  However, BCA says that if there is a surprise in the economy, it will be stronger than expected, not weaker than expected (provided there are no more major terrorist attacks, of course).

I actually traded e-mails with Martin Barnes,  BCA's managing editor, in January.  Because BCA made such a big deal out of the debt problem in their January double-issue, I wondered if the editors had abandoned their 1995 forecast for a "long-wave upturn."  If you recall, BCA predicted in 1995 that the US economy would continue in a strong uptrend until at least 2005 and perhaps even longer, but not without some brief setbacks along the way.  So I asked Mr. Barnes directly if the massive buildup in debt had caused BCA to cut short its long-term forecast.  Surprisingly, he said no:

"The fact that productivity growth has held up well this cycle and that the recession is turning out to be mild imply that the long-wave upturn is still intact. Debt may become a problem at some point, but indicators of financial stress still seem OK."

The still-prevailing view of most economists and analysts is that the economic recovery will be very slow, that it will take most of 2002 for the economy to get back on its feet, and that anything more than 1-1½% growth won't return until 2003.  This may well prove to be true.  Or, BCA's somewhat more optimistic scenario may prove to be true.  Either way, the economy is turning around and the recession is ending.

Gloom & Doom Still Sells

The gloom-and-doom crowd doesn't want to hear that the economy is turning around.  Most of these people are still warning that this recession (if we can call it that) will turn into a depression, and that the stock markets will fall to half their current levels by year-end.  Yet this is their same old broken record; they say this no matter what, in good times or bad.  Here's just one example I got in the mail last week:

"URGENT!!  There are facts and forecasts on terrorism that our government will not and cannot tell you.  It's absolutely vital to your safety, your financial security and your future that you take a few moments to read this letter NOW.

In it you will learn what terrorists have in store. . . why America's 'Second Great Depression' is just 4-6 months away. . . AND how  XXX's [name] smart step-by-step 'Survival & Profit' strategy can arm you to protect yourself and safeguard your assets!" 

I happen to know this guy.  He' been a non-stop gloom-and-doomer for as long as I've known him (mid-1970s).  He's been predicting the same "Second Great Depression in just 4-6 months" for the last 25 years that I know of.  He's also predicted that the stock markets would fall by at least 50% for the last 25 years.

And what is his "step-by-step Survival & Profit strategy"?  He's a gold and precious metals dealer!  For the last 25 years, that I know of, he has been telling people to buy gold and precious metals bullion and coins and stay away from stocks and bonds.  Those who followed him may have lost a bundle on precious metals, and they probably also missed out on the greatest bull market in the history of stocks.

Oh, and it gets even better.  This same guy has also recently become a self-proclaimed health expert!  I got another direct-mail promotion from him touting his own line of vitamins and supplements to cure all that ails.  I wonder if he has a cure for gold market losses!

I won't mention his name.  A wise man down here in Texas once told me, "Don't get into a p***ing contest with someone who buys ink by the barrel!"  If you're on his mailing list or those he rents, you know who he is; if you're not, consider yourself lucky. 

The sad fact is, gloom-and-doom still sells, even after all these years of prosperity and falling gold prices.  If it didn't, these people couldn't afford to mail millions and millions of pieces of junk mail every year.

By the way, these people do NOT get your name or address from me.  I have never sold, rented, traded or in any way shared the names of my clients and subscribers with anyone - even though a "virgin" list like mine would fetch a pretty penny.  If you get a lot of junk mail, it's because you're on someone's list who does rent their names, often frequently.

Fortunately, we have The Bank Credit Analyst and dozens of other credible sources to keep us on the right track, at least most of the time.  I will continue to bring you their forecasts as I have for all these years.

The Blame Game

As we have all seen for too long now, the media has tried to make Enron President Bush's Whitewater or Watergate.  It hasn't worked.  If Enron asked for a bailout, they didn't get it.  Nevertheless, this debate will continue.  I expect the Bush administration will release the relevant information about its meetings with Enron and other energy companies, but only after it is sure it has preserved the right to have private meetings where attendees can speak off the record.

In the meantime, investigations will go on to determine: 1) who was primarily responsible for the Enron debacle; 2) were laws broken and, if so, who should go to jail; and 3) how much was the fault of Arthur Andersen which was both the accountant and consultant to Enron?

I also hope that the public learns that Enron was exempted from certain provisions of the Investment Company Act of 1940 and amendments thereunder by the SEC in 1997.  Enron specifically tried to avoid complying with new Investment Company Act amendments passed in 1996 to further safeguard investor protection.  While Congress turned down Enron's exemption in 1996, Clinton's SEC granted it a year later. 

It's About Accounting, Not Politics

While we, as investors in the stock markets, can tune-out the political rhetoric over Enron if we so choose, we cannot ignore the possibility that many companies may have to significantly revise their accounting practices and possibly reduce their stated earnings in the months ahead. 

Arthur Andersen has admitted that serious mistakes were made in Enron's accounting, mistakes that may have allowed Enron to hide losses and report profits that did not exist.  There can be a conflict of interest when the accounting/auditing firm is also acting as a consultant to the company.  In the case of Enron, it appears that the accounting/consulting pendulum swung too far.

As a result, virtually all major corporations are now reviewing their accounting practices, reporting practices and consulting relationships to see if they need revision.  Analysts fear that such revisions could be substantial and could mean that a LOT of bad news for stocks may be coming in the months ahead.

How Much Bad News?

Everyone is looking for "the next Enron."  We have already seen share prices of some companies swing wildly simply on rumors of questionable accounting practices.  Some fear that we are going to see widespread and substantial adjustments to companies' profits, losses, earning, debt levels, etc. in the months ahead.  As this is written, the stock market is falling due to fears of more Enron-like  problems with other companies.

The question is, how widespread are Enron-like practices?  First of all, Enron lost most of its money trading derivatives, billions and billions worth of risky derivatives.  This story has yet to be made public in full.  Second, from what we have seen, it appears that numerous high level executives at Enron were more than willing to break the law.  And third, as we have learned, Arthur Andersen made some serious mistakes in allowing Enron to hide losses.

While there may well be more Enrons out there, I will be surprised if these types of practices are widespread.  Most corporate executives, especially those making 6-figure salaries, are NOT willing to break the law and risk going to jail.  And most accounting firms are NOT willing to "look the other way."

Hopefully, Enron-like practices are very limited and there will not be a massive write-down of earnings as some are predicting (especially the gloom-and-doom crowd).  If so, the stock markets should begin to rebound as the economy improves.  As dicussed later, however,  market volatility will almost certainly remain high.  As a result, market timing strategies have become more important than ever as BCA suggested last month.  Let's take a further look into that issue.

BCA Clarification

Last month, I quoted extensively from BCA's 60+ page forecast for 2002.  As you will recall, BCA suggested, for the first time ever, that investors should consider "market timing" strategies for their equity investments, due to the expectation for continued high volatility in the stock markets.  This month, I would like to expand on, and clarify, that advice.

BCA's clients and subscribers are primarily institutional investors, pension fund managers, chief financial officers, bankers, financial analysts, etc.  (This is one reason they can charge almost $1,000 a year for BCA and even more for some of their other publications.)  In all my years in the investment business, I have never run into anyone else who works for individual investors (like me) that subscribes to BCA (at least on a continual basis).

Because most of BCA's subscribers are institutions, their advice is geared toward very large investors.  They correctly assume that these large players are fully invested, or nearly fully invested, at all times.  They assume that their subscribers have a certain "core" investment in equities, a certain "core" investment in bonds and other fixed income instruments, and then a "flexible" portion of their portfolio that can shift to "above average" or "below average" positions in stocks and bonds based on BCA's forecast.  As stated earlier, their current advice is above average holdings of stocks and below average holdings of bonds.

Because they believe the stock markets will continue to be very volatile, they advised (for the first time) that investors consider market timing strategies for their equity investments.  What I wish to clarify is that BCA's definition of "market timing" is probably different from yours or mine.

BCA's view of market timing would probably be more appropriately called "momentum investing."  Rather than getting partially or fully out of the market from time to time, the momentum investor looks to move, or rotate, among different market sectors.  Momentum investors try to be in the hottest sectors at any given time.  The point is, they are generally fully invested at all times and rarely, if ever, do they go partially or fully to cash.

Among true market timers, there are two basic types.  So-called "asset allocators" are market timers who are also generally fully invested.  Some asset allocators use the same few mutual funds most of the time,  while others may have a large stable of mutual funds, of various types and sectors, that they move within.  These market timers that move among different sectors are actually quite similar to momentum investors.  The point is that asset allocators, like momentum investors,   are generally fully invested at all times.

Market timers who actually get partially or fully out of the market from time to time are called "tactical asset allocators."  This group varies from those who are rarely out of the market, and sometimes never 100% out, to those who are out of the market very frequently and are often 100% in cash.  Some tactical asset allocators even "short" the market from time to time by using the Rydex Ursa fund and others like it that go up in value when the market goes down.

A Balanced Portfolio

Most sophisticated investors have a buy-and-hold component in their equity allocation.  This is usually made up of certain mutual funds that have performed very well over time, and they only occasionally make adjustments to this component.  This is consistent with what BCA calls "core" holdings.  But in addition to one's buy-and-hold core positions, there should also be a component of momentum investing and/or market timing. 

It is my opinion, with all the potential adversities and volatility we face today, one should have more money allocated to momentum and/or marketing timing strategies and less money in buy-and-hold positions.  Additionally, within the allocation to momentum/market timing, I want a significant portion in programs that can go partially or fully to cash.

How Market Timing Can Enhance A Buy-And-Hold Portfolio

Mike Posey, a vice-president here at ProFutures, has prepared an excellent illustration of how a good market timing program can enhance the returns over a strictly buy-and-hold portfolio, especially over the last five years.  You can read Mike's article and see the analysis in this month's issue of Professional Investing.

Niemann Capital Management

For the last two months, I have suggested that you  look at Niemann's "Risk Managed" program.  What I like most about Niemann is that they combine momentum investing with market timing.  Most of the time, they are fully invested in whatever sectors of the market they determine to be the strongest.  They use the Fidelity funds network, so they have many different types of funds to choose from.  At other times, however, Niemann will get out of the market and sit either partially or fully in cash.  This is important to me.

Actually, a lot of market timers are moving toward Niemann's approach.  Over the last two years, we have seen several market timers that previously used only one (or a few) mutual funds adding new sector funds to their list of choices.  When the markets are more difficult, having more choices is important.

Niemann has done this from the beginning, and their results have been impressive.  Best of all, they averaged over 20% per year (net of all fees) over the last three extremely difficult years when the S&P 500 averaged less than 1%.

If you have been thinking about looking at Niemann, you need to get going now.  At the end of February, the minimum account size doubles from $50,000 to $100,000.  As long as we get the account paperwork in process this month, Niemann will accept the account even if the funds arrive after the end of the month.  If you haven't, call us for information today.

ProFutures Is Unusual

As noted earlier, ProFutures is not a firm that caters to institutional investors and pension funds.  I have always focused on helping individual investors, especially those that don't have $1,000,000+ to invest.  We have made it our goal to find successful investment programs that are available to small and medium-sized investors.  In addition, we have tried over the years to broaden our investment services to cover a diverse group of investments that can help most portfolios.

Buy-and-hold equity portfolios.  At the request of our clients, we invested in the software and expertise to develop sophisticated financial plans for our clients.   Our Dynamic Allocation Program helps clients evaluate their retirement needs, goals and objectives, and then selects a group of mutual funds they can hold for the long-term.  The financial plan is free of charge, whether clients act on the advice or not.  The minimum investment starts at only $50,000.

Mutual fund timing programs.  Over the last six years we have searched the broad community of asset allocators to find a group of Advisors we recommend to clients to manage their equity holdings that need to be more flexible.  We have programs that include traditional asset allocators and tactical asset allocators that will move partially or fully to cash as needed.  We have programs that require only $15,000 to invest.

Gold fund timing program.  For those who have special interests in gold and precious metals, we have recently found a very successful gold timing program that uses the Rydex Precious Metals fund.  DORSET FINANCIAL SERVICES is now in our stable of recommended Advisors.  Dorset has performed admirably, even in an environment when gold and precious metals have gone essentially nowhere.

In addition to these programs which involve mutual funds, we have several proprietary investment funds which are available to accredited investors including a hedge fund, a currency fund and a futures fund, which is managed by Campbell & Company.

The point is, at ProFutures we have expanded to offer our clients a diverse group of investment choices.  With our financial planning service, we can address your particular goals and risk tolerance. 

Just Six Months Ago

Six months ago, the Democrats were sitting pretty.  They, and most of the nation, saw George W. Bush as an arguably weak president who was questionably elected, who had no mandate, and had no clear agenda.  It looked clear that the Democrats would gain votes in the Senate, and possibly could even regain control of the House in the 2002 mid-term elections.

September 11th changed all that, as we all know.  President Bush's response to the 911 attacks has been met with resounding support from all Americans, despite their political persuasion.  Bush's approval ratings have remained above 80% for months.  This has the liberals wringing their hands, as well it should.

Now, as we begin the 2002 election season, it appears that the possibility of the Democrats regaining House control is slim to none.  It now looks possible that the Republicans could regain control of the Senate and perhaps gain seats in the House.  The Democrat party is in disbelief, disarray and apoplexy!

They do not dare disagree with or criticize the President on the war on terror.  They cannot stand against increases in the defense budget.  That would be un-American.  So, their defensive, anti-administration   arguments are limited.

The Democrats' plan over the last several months has been to blame George W. for the recession and stall the President's domestic agenda.  However, blaming a very popular president for an economy that was sagging even before he took office didn't go over very well.  

As a result, the Democrats tried to put the President's domestic agenda on hold, which began under the leadership of Tom Daschle.  Daschle has blocked the President's proposed stimulus package.  They have  blocked the energy package and other administration proposals.  It should also be noted that the Democrats continue to block dozens of Bush's federal appointees, including many important judges.

Bush's Strategy Of Patience

The Bush administration has been amazingly patient.  Rather than attacking the Democrats, the Bush team seems to have decided that the American people would see their shenanigans for what they were.  This strategy seems to have worked in spades.

President Bush's State of the Union speech was one of the best in many years.  He did not dodge the "R" word - recession.  In fact, he addressed it clearly in the first two minutes of his speech.  And he laid out his domestic agenda clearly and concisely.  He called on Congress to pass his economic stimulus package in addition to a $48 billion increase in defense spending.  He received standing "Os" on both points.

The Democrat's response to the State of the Union address was the most supportive speech I have ever heard.  They could not, of course, differ with the president on the war issues.  Surprisingly, they even agreed, at least in part, on most of the domestic issues.  Most notably, Gephardt did not even utter the Democrats mainstay - that Bush's tax cuts have thrown the budget into deficit.

Speaking of deficits, the Democrats tried to criticize the president for erasing the budget surpluses.  It is clear that the US will run deficits in at least 2002 and 2003.  Yet the newly released CBO projections show the surplus returning after 2003 and continuing to increase each year until at least 2011.  It will be interesting to see if the Dems continue to criticize the president on the deficit issue.

An even more interesting issue will be to see if the Democrats try to block the upcoming increase in the statutory debt limit.  The current debt ceiling limit is $5.95 trillion, and that number will be reached sometime in the next couple of months.  The Treasury has already asked Congress to increase the statutory limit to $6.7 trillion.  I will not be surprised if the Democrats try to block that increase and risk shutting down the government.  Actually, I kind of hope they do, as it could backfire on them big-time!

Tough Spot For The Dems

The Democrats are very frustrated, as well they should be.  The public does not appreciate them trying to diminish this very popular president.  Even the Enron debacle appears to have backfired on the Democrats.  The latest CNN/Gallup poll showed that 60% of Americans believe President Bush did no special favors for Enron, while 51% believed that Demo-crat recipients of Enron contributions would have.

Here are some additional statistics from the Weekly Standard:

Voters trust Republicans more than Democrats on issue after issue. A year ago, the issue map looked poisonous for the GOP. Now 49 percent of Americans say the Republicans will do a better job of keeping America prosperous, against only 32 percent who say the Democrats will. According to a Battleground Poll, voters prefer Republicans on foreign affairs by 57 percent to 26 percent. They think Republicans are better equipped to fight terrorism by 60 percent to 15 percent. Republicans and Democrats are trusted equally to improve education, an issue Democrats have traditionally dominated.

Republicans have a 5-point lead when voters are asked which party they would like to see control Congress after the next election. According to this most recent Battleground Poll, more people identify themselves as Republicans than Democrats, by 40 percent to 35 percent. The Ipsos-Reid survey found a similar trend toward the Republicans, though from a different starting point. According to Ipsos-Reid, Democrats had a 9-point advantage in party ID before September 11, but have only a one-point advantage now.

The question is, will these numbers hold?  It's a long way to the November elections.  A lot can change. Hopefully, President Bush and his team will continue to make the right decisions.  Hopefully, the ground-swell of support for Republican ideas and policies will continue to grow.  

E-Mail SPECIAL UPDATES Continue

I continue to write 2-3 e-mail Special Updates each month.  These Updates cover a wide range of issues including our latest thinking on the economy, and the markets, plus there are lots of links to articles and sources where you can learn more, and read other views, about the topics discussed. To receive these Special Updates, just send us your e-mail address.

Also, just as a reminder, you can get our monthly newsletters at least a WEEK earlier by going to our website at www.profutures.com.  This newsletter was posted on our website on February 5th.

Good Luck To Patrick

Patrick Watson resigned from ProFutures at the end of January to pursue a family business.  He had gone to part-time status with us in August of last year, hoping to be able to remain active on the investment side at ProFutures and in the family business.  We all knew it wouldn't be easy to be in two different fields at one time, and Patrick decided last month to move on.

Patrick will certainly be missed.  He was with us for 10 years and was the first employee to be made a vice-president.  He has made many important contributions over the years.  Several of the new services we have introduced in recent years were Patrick's ideas. We thank Patrick for all he did at ProFutures, for his loyalty and friendship, and we wish him only the BEST in his new endeavor. For those who talked to Patrick occasionally, feel free to call Phil Denney, Spencer Wright or Brad Unruh. 

These guys are all very experienced in the investment field, and they will be happy to visit with you at any time.  You can also speak with Mike Posey who is a vice-president here at ProFutures.  Be sure to read Mike's excellent article on asset allocation in PROFESSIONAL INVESTING this month. Of course, you are always welcome to call me directly as well.