Happy New Year everyone!  I hope your holidays were as pleasant as mine.  I do believe it will be another happy New Year for most of us.   As discussed in this issue, 2004 should be another good year for the economy and most of the investment markets.  About the only thing that could derail that outlook would be another major terrorist attack on our soil.  Otherwise, expect another good year.

In its final report on 3Q GDP on December 23, the Commerce Department confirmed that the economy rose at a blistering annual rate of 8.2%.  Consumer spending was stronger than expected in the 3Q.  In the December report, the manufacturing sector surged ahead with the largest monthly increase in 20 years.  This will lead to additional improvement in employment.  While a growth rate of 8% is not sustainable, most economists expect growth of 4-5% in 2004.

In their annual forecast for the new year, The Bank Credit Analyst predicts that the economic recovery should continue until 2006.  This is a significant improvement from their previous forecasts in 2003.  Details inside.

The stock markets have started the new year on a strong note.   The equity market should continue to advance in 2004, but probably not at the rates we saw last year.  2004 will very likely be a good year for market timers such as those we recommend.  The bond market, on the other hand, will likely continue to struggle, with the exception of high-yield bonds which could continue to benefit from the economic recovery.   Gold hit new highs in the first week of the new year, while the US dollar hit new lows (down over 30% against the Euro).  Both of these trends could continue.

This month, we look at all of the major market trends.  We will review my advice in 2003 and look ahead to what I think you should do in 2004 and why.  I will also announce a new website we are building that will focus on privately offered investments that, unfortunately, are only available to “accredited investors.”  If you are an accredited investor, you need to let us know so we can give you access to the new website when it’s ready to go.  Finally, we will look at the real story on Mad Cow Disease.

A Big Change In Their Outlook

During most of 2003, the editors at BCA emphasized that the USeconomy would “surprise on the upside.”  Now, in retrospect, that call was dead-on, especially given the GDP growth surged to an 8.2% annual rate in the 3Q.  However, for most of 2003, BCA maintained a very cautious outlook for the period beyond 2004.  Not that they were negative or bearish beyond 2004, they simply admitted that their economic models were not clear beyond that point.

Yet in their latest New Year forecasts, the editors have become much more confident that the economic recovery will continue beyond 2004.  They say:

“We have a high degree of confidence. The [monetary] policy environment should remain conducive to growth in all the major regions and leading economic indicators are pointing north. Barring some unforeseen shock, the current impetus toward stronger growth should continue.

As a rule, economic trends do not change on a dime. There is a general rhythm to the economic cycle in the sense that once an upturn takes hold, it sets in motion a chain of events that becomes self-sustaining. The business cycle has averaged four to five years in recent years, which means the current one should be safe until at least 2006. The cycle typically comes to an end when increased inflationary pressures force policy to become restrictive. While we expect inflation to edge higher, it will not become enough of a problem to create the need for a monetary squeeze during the next year or two. We are particularly encouraged by the broad-based nature of the economic upturn.”

This is actually a very bold move by the editors at BCA.  They could have easily said only that they expect the recovery to extend beyond 2004.  Suggesting that  the recovery should continue for another two years, at least, is a much riskier position.  But then, offering longer-term forecasts is nothing new for BCA, and their track record in doing so is enviable.

The Usual Caveats

BCA includes the usual caveats that could render their forecast too optimistic.  Among those are a collapse in the US dollar, which they do not expect, a major banking crisis, which they do not expect, or a  major war which, to them, also seems unlikely.  BCA’s major concern regarding their outlook for the next two years is another serious terrorist attack in the US.  Of all the surprise events that could derail their positive outlook, the terrorist issue is the most serious in their eyes.  Of course, this is a major concern to all of us in the forecasting business.

Storm Clouds Are Still Brewing

While BCA’s outlook for the next two years is upbeat and positive - both in terms of the economy and the stock markets - they continue to have very serious concerns about the next recession, whenever that occurs.  They continue to believe that the next recession could be very, very serious.  In fact, they state that the long-term economic upwave that they predicted back in the early 1980s could unravel in a potentially dangerous fashion whenever we hit the next recession.  But they also emphasize that they don’t believe we are there yet, and maybe not for a couple years or more.

What this means to us as investors is that the good times may well last longer than many people currently expect.  We should therefore keep our money largely invested, rather than largely on the sidelines expecting the worst. 

I continue to believe that having a significant portion of your money with market timing programs, like those we recommend, makes the most sense especially in light of the continued terrorist threat.  You want your Advisors to have the ability to move to the safety of money market funds should conditions change. 

In the meantime, there is still the potential to profit from market moves, especially in stocks and related mutual funds, that should continue to benefit from the improvement in the economy.

The Rear View  Mirror

Let’s think back to late 2002 and early last year.  The gloom-and-doom crowd was riding high.  We had a recession in late 2000 and 2001.  Never mind that it was the mildest recession in the post-War period, despite the serious effects of the 9/11 terrorist attacks.  Yet the gloom-and-doomers maintained throughout 2002 and early 2003 that we were headed into a “double-dip” recession.  They were absolutely convinced that US consumers were tapped-out financially and dangerously overloaded with debt.  Therefore, there was no way that consumers could lead us into a new economic recovery, much less a recovery in stocks.

The naysayers were also convinced that we were headed into a deflationary spiral that would lead us into the “big one” (depression).   This, they promised, would lead to a major decline in home prices - “the next great bubble to burst!”  They also predicted that the USdollar would collapse in the world currency markets.  The US dollar has fallen apprx. 30% against the Euro, but it could hardly be described as a collapse.  It has declined in a very orderly fashion that has not disrupted the financial markets.

As for stocks, the naysayers were convinced that the bear market would resume in earnest in 2003.  They wouldn’t touch stocks with a ten foot pole, and most encouraged investors to “short” the markets.  What a disaster that was! 

Finally, the gloom-and-doom crowd argued that the Fed was out of bullets, and that all of the aggressive rates cuts would not be enough to pull the economy out of its dive.  The problem is, the economy never was in a dive!  Again, the recession was very mild by historical standards.  Yet to the gloom-and-doom crowd, the US was finally headed over the proverbial cliff.

Some of you are probably thinking, “Okay, but at least they correctly predicted the new bull market in gold.”  Let’s analyze that for a moment.  Almost all of the gloom-and-doomers I know or read have been continually bullish on gold for the last 25+ years I have been in the investment business.  This, despite the fact that gold has been a LOUSY investment since its glory days in the late 1970s.  So to say that the naysayers correctly predicted the latest bull market in gold gives them way too much credit in my opinion.  You know the saying, even a stopped clock is right twice a day.  Most of these people haven’t been right about gold for  over 20 years in many cases, until recently!

Fear has always been a great motivator.  We’ve all heard the term, “fear and greed.”  Those in the marketing business tend to agree that fear is the stronger motivator of the two.  That’s why you see so much negative, fear-oriented advertising in the financial world.  Unfortunately, many investors continue to buy into it and miss many opportunities as a result.

What Were We Saying?

Now, let’s compare the above to what we have been saying in these pages over the same period.  And before I do, let me say that the purpose here is not to toot my own horn.  Candidly, if you have been reading this newsletter for long, you know that I take most of my cues from The Bank Credit Analyst.  While I disagree with them once in a while, that has become increasingly rare in recent years.  And for good reason.  BCA has consistently had the best track record for calling major turns in the economy and the major investment markets of anyone I have read over the last 25+ years.  They’re not perfect, but they’re very very good.

In early 2002, BCA did voice some serious concerns regarding the possibility of deflation, but they were confident that the Fed was well aware of this threat and would deal with it accordingly.  A little later in 2002, BCA became increasingly concerned that consumer debt levels were getting dangerously high.  As a result, they began to focus more attention and research on consumer debt levels and reached very different  conclusions from those in the gloom-and-doom crowd, and even many in the mainstream.  BCA determined from numerous sources that 70-80% of all household debt was made up of home mortgage debt, which in most cases is fully collateralized and therefore secure.

Along the same lines, BCA studied housing trends and other related factors and concluded that home prices were not likely to fall significantly anytime soon.  Independent of BCA’s research, Ifound additional support for this view.  For example, a major Harvard study released last year looked at housing demographics and concluded that, other than possible short-term dips, home prices would steadily rise over the next 10-20 years.  I summarized that study in these pages. 

On the basis of BCA's research, the editors concluded by late 2002 that consumers were not tapped-out financially, and that consumer spending might well be able to support a further recovery in the economy.  This led BCA to forecast that the economy would “surprise on the upside” in 2003. 

As the year came to a close, BCA became increasingly positive on stocks and increasingly negative on bonds, especially Treasury bonds.  BCA was hesitant to recommend “fully invested” positions in stocks in late 2002 for several reasons.  First, the stock markets were still in a clear downtrend, and BCA has never been one to “bottom pick.”  Second, there were already clear indications that we were going to war with Iraq.  So, BCA did not formally recommend that investors go back into stocks in a big way.

BCA Recommends Market Timing Strategies

Due to the uncertainties in the markets, BCA - for the first time ever in my 27 years of reading them - recommended “market timing” strategies for stock market investors.  Market timing strategies, as you know, allow for moving among different market sectors (rotational timing) and even moving partly or fully out of the markets if conditions so warrant.

[Market timing in this context has nothing to do with the “rapid-fire” trading of mutual funds that has come under so much scrutiny this year.]

Iwas very pleased to see BCA endorse market timing strategies because, as you know, I have strongly recommended professional Advisors who practice traditional market timing for almost a decade now.  It was nice to see a highly respected, mainstream research group like BCA embrace this style of investing.

A Great Call On Bonds

While BCAwas still reluctant to recommend fully invested positions in stocks and mutual funds in late 2002, the editors made clear their concerns about bonds, and Treasury bonds in particular.  The editors were increasingly convinced that they were right about the economy surprising on the upside in 2003.  They were also convinced that if the economy surprised on the upside, bonds - especially longer maturity bonds - would surprise on the downside.

Thus, at the beginning of 2003, BCA’s strongest advice was to reduce holdings of bonds, especially Treasury bonds.  This was precisely at a time when T-bonds were becoming increasingly the darlings of the financial media and the investment public.  This love affair with T-bonds continued right up until the major top in June of last year.

As BCA recommended reducing positions in T-bonds and longer maturity bonds, they advised investors to look at shorter-term maturities and, to my surprise, high-yield (junk) bonds.  I don’t recall BCA ever recommending high-yield bonds in the past.  Iwas again pleased to see BCA take this position, for as you know, we have been recommending a high-yield bond program since August 2002.

For several years prior to 2002, we had recommended a bond program that invested only in Treasury mutual funds.  While this particular program had a good long-term record, the manager and I had a fundamental difference over the economy in 2002.  As a result, we intensified our search for an alternative to this program, and our timing on finding the high-yield bond program noted above couldn’t have been better.  More on this below.

My War Call On Stocks

As discussed above, my views are usually in-line with BCA’s.  However, by late February of last year, it was clear we were going to war in Iraq.  I was completely convinced that we would prevail in that war, and that both the economy and the stock markets would rebound strongly in the wake of the war.  Yet BCA was still reluctant to advise fully invested positions in stocks.  Nevertheless, in late February and early March, I predicted that this would be “the best buying opportunity of the year” in stocks.  Just prior to the war, Irecommended that investors get fully back into the equity markets. 

This probably seemed like an overly risky recommendation to make, especially given that the stock markets were still in a clear downtrend.  Yet I was very comfortable making that recommendation based on: 1) my confidence in a quick military victory in Iraq; and 2) the fact that most of our clients are invested in market timing programs that can get out of the market if things don’t go as planned.  For these reasons, Ididn’t think it was a reckless recommendation, even though it was more aggressive than BCA’s advice at the time.

In hindsight, that was one of the best market calls I’ve ever made.  As we all soon learned, Iraq put up limited resistance, and our troops quickly marched all  the way to Baghdad.  The stock markets immediately reversed sharply higher and have not looked back since.  As this is written, the S&P 500 Index has risen 40% from its low just before the war.

Treasury Bonds Take ABeating

The runup to the war in Iraq only intensified the feeding frenzy in the Treasury markets.  Long-term rates continued to fall as investors sought the safety of government bonds and related bond mutual funds.  Bond prices continued to rise even after the initial success in the war in March.  In fact, Treasury bond prices continued to spike higher, and yields lower, until June of last year when the bottom fell out. 

By June, it was abundantly clear that the war had been won, despite the localized guerrilla attacks on our troops.  It was also abundantly clear that the economy was on the rise.  Bond prices had overshot on the upside, with nowhere to go but down at that point.  Just as BCA predicted, Treasury bonds were the hardest hit, plunging seven straight weeks after the peak in June.  The 30-year bond fell over 16% in that brief period, and many Treasury mutual funds lost a lot more. 

Meanwhile, high-yield bonds enjoyed a great year in 2003.  Unlike Treasuries and high-grade corporate bonds, high-yield bonds tend to do well during economic recoveries.  2003 was no exception!  According to Morningstar, in 2003 the average high-yield bond mutual fund gained 21%, through November.  The Credit Suisse/First Boston High-Yield Bond Index gained over 25% in the same period. Capital Management Group (CMG), our recommended high-yield bond Advisor, had one of its best years ever.  (Past results are not necessarily indicative of future results, and high-yield bonds are not suitable for all investors.)

I will be the first to admit that I have promoted CMG aggressively this year for three primary reasons.  First, Ivery much agreed with BCA’s analysis indicating that Treasury bonds would get hammered, and I wanted clients to move out of this market.  Second, it is no secret that high-yield bonds, despite their higher risks, have a history of doing very well when the economy moves into a recovery phase.  And third, I have great confidence in Steve Blumenthal and his team at CMG in being able to move in and out of this market.   This is why Isent subscribers of F&T detailed information on this program, along with your newsletter, earlier this year.

Going forward, I don’t expect high-yield bonds will match their 2003 results in the new year.  However, I do expect them to continue to do well, especially when managed by a professional who can move to the safety of money market funds should that outlook change.  So, Icontinue to recommend Capital Management Group, if this type of investment is suitable for you.

Stocks - What To Do Now

I continue to recommend fully invested positions in stocks and/or mutual funds.  Stocks have advanced to new recent highs just in the first few trading days of the year.  While I don’t expect the equity markets to perform as well as they did last year, these markets could continue to surprise on the upside.  BCA agrees that stocks will move higher this year, and they also continue to recommend fully invested positions.  Actually, in light of BCA’s more optimistic outlook that   the economy should improve until at least 2006, that makes the case for being fully invested in the stock markets even more compelling, even at current levels.

While I do expect the stock market averages to be higher a year from now, it’s likely to be a bumpy ride.  There will almost certainly be some potentially nasty corrections along the way to higher prices.  For that reason, I continue to recommend that you use professional advisors to manage most of your equity investments.  Among others, I continue to recommend Niemann Capital Management, which had one of its best years ever in 2003.  I sent you detailed information on Niemann earlier this year.  (Past performance is not necessarily indicative of future results.)

Niemann’s minimum investment is $100,000.  They no longer allow us to open accounts for $50,000 as they did in 2003.  If that minimum, is too large, then consider Potomac Fund Management.  Potomac’s “Conservative Growth” program also had an excellent year in 2003 and accepts accounts as small as $25,000.

A Buy-And-Hold Solution

We are often contacted by investors who want to have a “buy-and-hold” exposure, but no longer trust their brokerage firms to give them solid investment advice, and also do not want to take on the job themselves.  In many cases, these investors are in cash or low-yielding money market investments and need to have an equity exposure to meet their financial goals.

While I am convinced that most investors need to have a significant portion of their investments in actively managed programs such as those offered by  Niemann, Potomac, CMG and other programs we recommend, I believe that investors should also include other investment strategies for maximum diversification.  An “asset allocation” strategy can provide exposure to not only US stock and bond mutual funds, but also to international stocks, real estate and other asset classes not represented in the actively managed programs offered by the market timers we recommend in  our ADVISORLINK Program.

Back in 2000, we developed our Dynamic Allocation Program to meet the needs of the buy-and-hold portion of our clients’ portfolios.  Using an asset allocation strategy based on “Modern Portfolio Theory”, the Dynamic Allocation Program takes your individual financial goals, investment expectations, and risk tolerance and recommends a custom-tailored portfolio of mutual fund investments.  These investments are put in place with the expectation that they will be held for the long-term (although periodic adjustments may be made along the way).

It is very important to understand that we are truly independent.  We are not tied in any way to any brokerage firm, or any mutual fund family, and we can recommend any funds that we consider to be worthy.  Also, we are not swayed by the financial media’s lists of the “latest hot funds” or “top performers” for short periods of time.  Instead, we search out funds that have consistent absolute returns over time.

Best of all, you have the knowledge that all of the funds recommended in the Dynamic Allocation Program have been selected using ProFutures’ strict due diligence criteria.  The funds are also closely monitored to insure that they continue to meet our standards and the expectations of our clients. 

The Dynamic Allocation Program normally has a minimum investment of $50,000.   However, since many investors are currently timid about getting back into the market, we have lowered the minimum investment to $25,000 until March 31.  I firmly believe that you will regain your confidence in this market if you can take a small amount of money off of the sidelines and see how it performs.

Given BCA’s latest outlook suggesting the economic recovery could last until 2006, perhaps now is the time to get started.

Call one of our Investor Representatives at 800-348-3601 to learn more about how the Dynamic Allocation Program can fit into your equity portfolio.

Finally, if you do manage your own equity investments, rather then use professional Advisors, I would recommend that you move largely to “value” stocks and value oriented mutual funds at this point.

Gold & The US Dollar

Gold hit new highs above $420 in the first week of the new year on Monday, and I expect it to move even higher, especially if the US dollar continues to fall.  The dollar is down apprx. 30% against the Euro.  So far, the drop in the dollar has not derailed the rise in the equity markets, nor has it led to a significant slowdown in foreign purchases of dollar-denominated assets.

The Bush administration and the Fed seem content to let the dollar drop further, so long as it does not lead to problems in the financial markets.  While the bull market in gold and the bear market in the US dollar may well continue, I still believe it is too risky to try to take advantage of these trends at this point, except in professionally managed accounts or funds.

Along this line, we continue to search for a successful gold/precious metals mutual fund timer.  Some of you will recall that in December 2001 we first recommended Dorset Financial Services, which was a gold fund timer.  Dorset had an impressive performance record prior to that time.  However, when gold broke out of its long trading range and began to trend higher, Dorset’s performance faltered.  Apparently, Dorset’s system only worked well in a trading range environment and, to our disappointment, could not adjust to a bull market.  As a result, we advised clients to exit the program.

So, if anyone knows of a good gold/precious metals timing program, with an actual, verifiable performance record, we would certainly like to know about it.  We just haven’t been able to find a good one.

Futures Funds Still Have A Place

Well-managed futures funds still deserve a place in a diversified portfolio for investors who are suitable.  The futures markets have been especially active over the last two years, and many commodities that have been depressed for several years have finally come to life in the last year or so.

The main reason for having managed futures in your portfolio is their low correlation with traditional investments such as stocks and bonds.  The hope is that the managed futures will do well when stocks and/or bonds are performing poorly.  At least in regard to the futures funds we offer, they certainly did their job in 2002 when stocks were in a bear market.  All four of the domestic futures funds we manage were up double digits in 2002.   Once again in 2003, even during a powerful bull market in stocks,all of our futures funds were profitable, although not all performed as well as in 2002.  (Past performance is not necessarily indicative of future results, and futures funds are not suitable for all investors.)

Presently, the only futures investment we have that is open to new investment is available only to “accredited investors.”  Accredited investors must have a net worth of at least $1 million (or $1.5 for certain investments) or annual income of $200,000 for the last two years.  You are welcome to contact us for more information about futures funds.

More On “Accredited Investors”

Speaking of accredited investors, there are many investments that are ONLY available to such high net worth individuals. The SEC decided many years ago that if you have a lot of money ($1 million net worth or $200,000 annual income), you must be a “sophisticated” investor.  Well, we all know that not everyone who has such a high net worth is a sophisticated investor.  People who inherit a lot of money come to mind.   Yet the SEC used this standard in its “accredited investor” definition.  In doing so, SEC therefore implied that anyone who doesn’t have $1 million net worth or $200,000 in annual income must NOT be a sophisticated investor.  We also know that this is not true in many cases.  You don’t have to be a millionaire to be a sophisticated investor.  

In any event, the SEC relaxed some of the rules and regulations on investments - called “private offerings” - that are offered ONLY to accredited investors.  As a result, many companies offer investments that are available only to accredited investors.  This has become increasingly common among futures funds, “hedge” funds and other sophisticated investments (including some good ones AND some bad ones).

“Affluent Investor” Website

Because so many investments are now private offerings that are only available to accredited investors, we have decided to develop a website that focuses exclusively on privately offered investments.  The new website will, over time, expand to include information on privately offered futures funds, hedge funds, private  equity funds, offshore funds and other investment opportunities available ONLYto accredited investors.

Our Affluent Investor website is still under construction, and I don’t know just yet when it will go “live.”  What I can tell you is that we will only write about private funds and investment vehicles that we consider to be among the best in their field.

Due to regulations, the Affluent Investor website will only be available to those who will verify in writing,  online or by a phone call, that they are indeed accredited investors.

Action to take: If you are an accredited investor, and you want to access this new website, you need to call, write or e-mail us with that information.  For clients who have already identified yourself to us as an accredited investor, we will automatically send you the information on how to access the new website when it is ready to go.                                                                                                   ******   **   *

How Now, Mad Cow?

Speaking of commodities, I would like to set the record straight about the news regarding Mad Cow Disease.  Immediately after the announcement of the first case of Mad Cow Disease in the US, over 30 foreign countries banned imports of USbeef.  This was an overreaction, but one that is not very surprising. 

Mad Cow Disease, scientifically known as “bovine spongiform encephalopathy” (BSE), resides only in the brain and nervous system of cattle.  There is widespread disinformation about Mad Cow Disease.

First, the infected dairy cow in the US has now been proven to have come from Canada, and all of the cattle in this herd from Canada are being identified. These and any other cattle to have come into contact with them will likely be put to death (probably before you read this).  But the most important thing you need to know is what follows.

Mad Cow Disease can only be spread to humans or other cattle by consuming the brains or spinal cord remains of an infected animal.  Eating a steak from an infected cow is perfectly safe if slaughtered in accordance with USDA regulations.

The consumption of cattle brains, much less spinal cord remains, is very uncommon among people in the US.  The USbanned the use of ground cattle remains and blood meal as ingredients in cattle feed in North America in 1997.  That was six years ago.  Most, but not all, beef cattle are slaughtered by the age of three years, so most of the US herd, and certainly the feedlot population, has not been exposed to feed contaminated with BSE.  This explains why the cases of Mad Cow, both here and abroad, have occurred almost exclusively in dairy cows.  Dairy cows typically are not slaughtered before the age of six years, and many were born prior to the ban on blood meal.

Given these facts, along with the growing ability to track the whereabouts of imported cattle, the likelihood of Mad Cow Disease spreading widely in the US is next to impossible.

The Mad Cow case that emerged December 23 in Washington state is the first in the United States. Yet  health fears - mixed with blatant opportunism - have led to the exclusion of U.S. beef in more than 90% of our beef export markets.  These bans on US beef are not likely to be lifted soon, even if they prove that the US herd - other than this one case - is Mad Cow free.

Fortunately, for cattlemen that is, the US consumes 90% of all the beef we produce.  Only 10% is exported.  However, that did not stop cattle futures from plunging sharply lower for several days after the announcement of the diseased cow in Washington.