Economic reports released over the last month were very encouraging.    The economy is gaining momentum.  GDP rose at an annual rate of 4.2% in the 1Q and will likely do even better in the second half of the year.  As discussed on page 2, several of the latest economic reports were much stronger than expected.  The recovery remains on solid footing.

With the latest good news on the employment front, discussions have shifted once again to the question of when the Fed will raise interest rates.    The odds have clearly increased that the Fed will raise short-term rates before the election.  If they do, it will most likely happen at the June 29/30 FOMC meetings.  If the Fed does make a move, it will likely be only a quarter-point or half-point increase in the Fed funds rate.

Despite worries about higher interest rates and inflation, the stock markets rebounded in April as I suggested last month.  I continue to believe that stocks will perform well for the balance of this year based on the strong economy, and despite an interest rate hike or two along the way, should that actually happen.  Bonds are a different story.  Treasuries have been hammered over the last month, and the decline very likely has further to go.  BCA continues to believe that stocks will outperform bonds for the rest of this year and perhaps longer.

While stocks may perform well during the rest of the year, volatility will remain high.  With interest rates already on the rise, bonds will continue to be very volatile as well.  This argues for active management by professional Advisors who can move out of the market or hedge their positions if need be.  That is why I continue to recommend Niemann Capital Management and Potomac Fund Management for your equity investments and Capital Management Group for high yield bonds.

On pages 6-8, I handicap the presidential election race along with some very interesting quotes you may not have seen in the press.  Also, there is the question of Bill and Hillary Clinton and what their plans may be with Kerry sagging in the polls.  Will Bill’s new book suck all the air out of the Kerry campaign?  Will Hillary decide to get in the race?  It’s gonna be a very interesting election season, folks!

The Economy Is Booming

Despite what you hear from the gloom-and-doom crowd and John Kerry, the US economy is booming.  On April 29, the Commerce Department reported that GDP expanded at an annual rate of 4.2% in the 1Q.  The latest GDP report was slightly below expectations because businesses did not increase inventories as much as expected.  That is actually good news for the economy going forward, especially in light of the economic reports discussed below.

The Index of Leading Economic Indicators rose 0.3% in March and is signaling continued strong economic growth.  Durable goods orders jumped 3.4% in March versus estimates of only a 1% increase. That followed a similar rise of 3.8% in February, and for the 12 months ended March, orders for big-ticket items are up a whopping 16%.  The Institute for Supply Management’s manufacturing index rose again in March to 62.5.  ISM says this equates to a 6% overall growth rate in the economy.

The Commerce Department also reported that businesses boosted their inventories by 0.7 percent in February (latest data available) - the biggest increase since August 2000- a sign that companies are feeling better about the recovery’s staying power.  Despite the latest increase, inventories remain very low, and this suggests strong hiring growth in the months to come.  This also means we should see a significant increase in capital spending during the rest of 2004 as businesses ramp-up to rebuild inventories.

On the consumer side, retail sales jumped 1.8% in March even though advance estimates suggested less than half that amount.  For the 12 months ended March, retail sales are up 8.2% over yearago levels.  Shoppers treated themselves to a wide range of goods in March, spending on cars, clothes, furniture and building and garden supplies.

New home sales surged 8.9% in March, the largest monthly increase in nine months.  This occurred despite the fact that mortgage rates have been on the rise recently.  Freddie Mac reported in late April that the national average 30-year fixed mortgage rate rose to 5.94%.  

Consumer spending accounts for over two-thirds of all economic activity (GDP) in the US.  Despite the constant warnings from the gloom-and-doom crowd and the Democrats, consumers continue to spend, and this is good news for the economy.  Economists said the improved job climate, tax refunds and continued low borrowing costs made shoppers feel more inclined to indulge in March.

While the official unemployment rate edged higher from 5.6% in February to 5.7% in March, over 308,000 new jobs were added, hitting a four-year high.   While many doubt that employment growth will continue at this pace, the latest reports suggest that this economy will continue to surprise on the upside.

Inflation Fears Arise, Interest Rates To Rise

Strong economies almost always give rise to inflation, and this one will be no different.  In March, the Consumer Price Index rose 0.6%, and the Producer Price Index rose 0.5%, both higher than expected.  For the three months ended March, the CPI rose at an annual rate of 5.1% versus only 1.9% for all of 2003.  A big reason is the surge in energy prices over the last several months.  Yet  inflation is not likely to get out of control and will likely average 2½-3% for all of 2004. Actually, the Fed has wanted to see inflation increase somewhat to be sure that the deflationary threat has passed.

While the Fed has been happy to see the economy growing strongly and inflation rising slightly, this does mean that interest rates will be heading higher.  In fact, they already have.  The yield on 30-year T-bonds has risen from near 4.75% to 5.25% in the last month, while the 10-year T-Note rose from 3.75% to near 4.5%.  This has meant big losses for investors in most bond funds.

For months now, I have warned that yields on long-term bonds were going to rise, and I have recommended that investors reduce positions in Treasury bonds specifically.  I hope you took that advice.  While these inflation-sensitive markets may have over-reacted a bit in the last month, I believe long-term rates will be even higher over the next six months to a year.

On numerous occasions in this newsletter, I have recommended that investors consider my favorite professional bond manager - Capital Management Group.   I am happy to report that CMG has managed to avoid the carnage in the bond markets over the last month or so. I'll come back to CMG later on.

Will The Fed Raise Rates?
The Question Is When.

As noted above, I am in the camp that believes interest rates are headed higher, including short-term rates.  Virtually everyone agrees that the current 1% Fed Funds rate is too low.  Even at 2% - double the current rate - the Fed funds rate may be too low.  In fact, the rate is likely headed back to 3-4% over the next 12-18 months, especially if the economic recovery continues.

Earlier this year, I predicted that the Fed would not hike the short-term Fed funds rate before the election.  However, the latest surprisingly strong economic data and the March inflation numbers clearly increase the odds that the Fed will raise rates once before the election.  It still won’t surprise me if the Fed waits until after the election; on the other hand, a modest increase (quarter or half point) before then won't surprise me either.

Everyone is speculating about when the Fed will raise rates.  Here is the schedule of Fed Open Market Committee meetings: June 29/30, August 10, September 21, November 10 and December 14.  Most analysts think that the Fed will move rates up at the June FOMC meeting, or they will wait until after the election.  Clearly, the Fed would prefer not to make a move at the August or September meetings, since the election campaign will be in full swing by that time.  Greenspan would prefer to remain apolitical.   

Actually, it may not matter much whether they raise rates at the June meeting.  As noted above, the bond markets have already reacted sharply to the growing likelihood of a rate hike before the election.  Some analysts argue that the bond markets actually over-reacted in April to the possibility of a rate hike.  Assuming we see only a quarter-point or half-point increase in the Fed funds rate, the bond markets may already be priced accordingly.  Even so, rates will be trending even higher later on, and that is bad news for bonds.

BCA’s Latest Thinking On Bonds

The Bank Credit Analyst continues to be bearish on bonds, especially Treasuries.  Here are some excerpts from the latest issue of BCA :

“The cyclical outlook for bonds is bearish. Inflation is headed higher, monetary policy will tighten over the coming year and real yields will increase from current low levels. We continue to recommend below-average weightings in Treasurys. 

The Federal Reserve has downgraded the inflation threat. However, inflation has clearly turned and the prospect of tighter monetary policy will continue to weigh on the [bond] markets. The fed funds rate is headed above 4% over the next couple of years.  Ten-year Treasury yields will likely reach 6% or higher before a cyclical peak is reached. The upturn will be more dragged out than in the past.  [Emphasis added, GH.]

Real yields seem low given the strength of economic activity and a sharp rise in the corporate sector'’ return on capital. The Fed’s low interest rate policy, weak business credit demand and large-scale purchases of bonds by foreign central banks are largely responsible. These bullish supports will diminish going forward.

The sharp selloff in U.S. Treasurys during the past month has not created a buying opportunity because the fundamental backdrop to the market will deteriorate further over the coming year. Inflation will edge higher, the Federal Reserve will begin to tighten its monetary stance and real yields will increase from current unusually low levels. While the Fed’s low interest rate policy may remain an anchor for bond yields in the near run, the risk/reward trade-off for Treasurys is unattractive… There is nowhere safe in long-duration fixed-income securities when interest rates are in a cyclical uptrend.”

If BCA’s forecast for 10-year Treasuries is correct, this will mean considerably more bad news for bond investors.  If you are still overweighted in Treasuries and high grade corporate bonds, Iwould consider reducing those positions as soon as possible.  However, as I will discuss below, the strong economy could actually be good for high-yield bonds.

Stocks - Another Good Year In 2004?

The stock markets should also benefit from the good economic news which is likely to continue for the balance of this year and very likely into 2005.  Corporate profits are poised to improve significantly over the next year or longer.  It is in this context that BCA continues to recommend above average holdings of equities.

There is little disagreement that higher interest rates loom as a negative for equity prices over the next couple of years, especially if rates are going to the levels suggested by BCA above.  However, interest rates are expected to rise only modestly over the next 6-12 months.  This should be more than offset by the good economic news and improved earnings, so we still have a window of time in which stocks should perform well. 

Another factor which could help push stock prices higher is new money coming in.  Inflows to equity mutual funds rose by over $88 billion in the 1Q according to AMG Data Services.  Still there is a mountain of cash sitting in money market funds that could move into stocks and stock funds.  Likewise, we may well see increasing movement from bonds and bond funds to stocks and stock funds as fixed income investors decide to cut their losses.

Keep in mind I am not predicting another year like 2003 when the S&P 500 rose over 28%.  And volatility is likely to remain high.  However, returns over the next year could be very respectable, especially if there are no major negative surprises.

Investing In A Rising Rate Environment

If the Fed funds rate is going from 1% to 4% and the 10-year Treasury from 4.5% to 6% over the next 12-24 months, as BCA predicts, Treasury bonds and high-grade corporate bonds are not the place to be.  We’ve certainly seen evidence of that over the last month.

On the other hand, a strong economy can be a very good environment for high yield bonds.  High yield bonds can do well even in a rising interest rate environment, especially if rates rise only modestly over the next 6-12 months as we expect.  As business improves, high yield bonds can see their ratings improve and increase in value, even as higher quality bonds are falling in value.

The ONLY way I recommend investing in high yield bonds is with Capital Management Group.  CMG invests in large, highly diversified high yield bond mutual funds.  These funds hold many different issues of high yield bonds so as to reduce the default risk. 

CMG may be fully invested, partially invested or 100% in cash occasionally, depending on market conditions.  CMG also uses so-called “short funds” to hedge its long positions.  This flexibility can be crucial in a rising rate environment.

CMG has one of the best risk-adjusted performance records that I have ever seen.  Yet amazingly, they still accept investments as small as $25,000.  If you are looking for an alternative to Treasuries and other bonds, take a look at CMG.  (High yield bonds are not suitable for all investors.  Past results are not necessarily indicative of future results.)

As for equities, I continue to recommend Niemann Capital Management, especially in a rising interest rate environment.  Niemann continually analyzes money flows across various market sectors and invests where they expect returns to be best.  This can be extremely important in periods when the overall market may not be sizzling on the upside or when volatility is high. 

Like CMG, Niemann may be fully invested, partially invested or 100% in cash occasionally depending on market conditions.  Niemann also uses so-called “short funds” to hedge its long positions.  This flexibility can be extremely important in a volatile market.

Niemann has an outstanding performance record.  The minimum investment is $100,000.  We also continue to recommend Potomac Fund Management, another outstanding equity fund Advisor that accepts investments as small as $25,000.  (Past results are not necessarily indicative of future results.)

The Issue Of Advisor Management Fees

As you know, I have maintained for years that most investors would be better off using professional Advisors to manage their investments.  Some investors, however, refuse to use professionals simply because of the management fees they charge.  Most successful active managers charge management fees of 2-2½% per year, and the good ones are well worth it.  

Some investors insist only on so-called “index” funds simply because they tend to have the lowest fees.  Index funds are just fine if we are in a roaring bull market such as stocks in the late 1990s, or in a steadily falling interest rate environment such as we’ve had since 2000.  But we’re not in a roaring bull market, and we have already entered a rising interest rate environment.  Index funds will only do what the market does, much like riding a roller coaster.

Market risks are higher now and having the ability to reduce positions, hedge or move to the safety of a money market fund is very important now.

Successful professional Advisors can more than justify the management fees they charge by reducing the risks, often missing some of the worst periods in the markets.

Even though I am an investment professional myself, with 28 years experience, I rely on professional Advisors for my own portfolio.  With the exception of some real estate interests I own, virtually all of my investment portfolio is managed by the professional Advisors and the professionally managed funds we recommend.  I have my own money with every manager and every program we recommend.

If you have not invested with the professionals we recommend simply because of the fees they charge, I suggest you reconsider - especially now that we are beginning a trend of higher interest rates.  If you look at their performance records - all of which are illustrated after all fees and expenses are deducted - you will see that they more than made up for the fees they charge.  And I believe this will be especially true now that we are ina rising interest rate trend.

For more information on these Advisors - including their actual past performance records -  you can go to our website at www.profutures.com or you can call us at 800-348-3601.  I believe you will be glad you did.                                                                                      

Introduction - Buyer’s Remorse

John Kerry’s presidential stock has sagged recently amidst numerous gaffs in his campaign.  Among them, there’s the controversy over whether he did, or didn’t, throw away his Vietnam war medals or ribbons.  Kerry got so frustrated over the media frenzy about the medals that he stooped to questioning whether President Bush actually served his time in the National Guard, which Kerry previously promised he would not do.  

The Kerry campaign is clearly floundering.  While some polls still show the race to be neck and neck, others show President Bush pulling ahead.  In most of the so-called “battleground” states - Pennsylvania, Missouri, Michigan, Wisconsin, Ohio and Florida - Bush is either ahead or is gaining ground.  More on this below.

The Democrats are understandably having “buyer’s remorse” at this point.  As you will read below, some liberals are actually calling for Kerry to step aside.  While that is not likely to happen, there are those who are quietly (or not so quietly) urging Hillary Clinton to get in to the race. 

Could it really happen?  Would Kerry’s delegates jump ship at the August convention?  Would Kerry step aside, for anyone?  Would Hillary actually take the risk of running against Bush, rather than waiting until 2008?  These are all very interesting questions.  But before I tackle them, let’s see what some liberals are actually saying these days.

On April 27, liberal columnist James Ridgeway, in the liberal New York newspaper the Village Voice, made a case for just such a scenario.  His article began, “With the air gushing out of John Kerry’s balloon” and referred to the Democrats as “arrogant and out of touch.” He goes on, “With growing issues over his wealth (which makes fellow plutocrat Bush seem a charity case by comparison), the miasma over his medals and ribbons (or ribbons and medals), his uninspiring record in the Senate (yes war, no war), and wishy-washy efforts to mimic Bill Clinton’s triangulation gimmickry ... Kerry sinks day by day. The pros all know that a candidate who starts each morning having to explain himself is a goner.”

Ridgeway urged, “Democrat biggies, whoever they are these days, to sit down with the rich and arrogant presumptive nominee and try to persuade him to take a hike.”

The Village Voice column concluded: “If things proceed as they are the dim-bulb Dem leaders are going to be very sorry they [kicked] Howard Dean.”

This is amazing stuff, especially coming from a liberal newspaper!  That they would even allow such an editorial to see the light of day is indicative of how much trouble the Kerry campaign is in.

Hillary To The Rescue?

The question, really, is who could replace Kerry if he falls far behind President Bush?  John Edwards?  Howard Dean?  I don’t think so.  In my view, the only Democrat that could replace Kerry would be (drum roll, please) Hillary Clinton.

Here’s what syndicated columnist Cal Thomas had to say in the Washington Times on April 30:

“It’s hard not to see the conspiratorial hands of Bill and Hillary behind Mr. Kerry’s decline and the tumble of Howard Dean before him. Hillary Clinton could not afford to have Mr. Dean, who had a solid but not large enough base, win the nomination. Had Mr. Dean won the presidency, Hillary would not have a clear field in 2008 and she might be too old or her time might have passed by 2012.

Bill Clinton's book ‘My Life’ (it’s always about him) is to be published in June. It is certain to fire up nostalgic Democrats who would like nothing better than to return to those thrilling days when Clinton flummoxed Republicans, even while presiding over the loss of Congress and having to declare himself still 'relevant.' 

Mr. Kerry’s biggest problem is it’s apparent not too many people are for him. He flunks the ‘likability test.’ The motivation of most of his supporters seems to be their hatred of President Bush, not love for Mr. Kerry. That is probably not enough to win an election, especially when one must attract swing voters who respond more to a positive message than a negative one. 

Enter Hillary Clinton. The Democratic Party would swoon if she stepped in and replaced Mr. Kerry. Bill would campaign with her, further energizing Democrats. The media would go into orbit, treating her as a presumptive queen, who deserves the nomination and the presidency because of all Bill put her through. It would be one of the few media stories that could knock Michael Jackson and Kobe Bryant from the headlines.

Even if Hillary lost to President Bush, she would run again unopposed, and grateful Democrats would hand her the nomination four years later.”

Will Hillary Run?

Before we can speculate on that question, we must first ask if John Kerry would step down.  I believe the answer is a solid NO.  Kerry has reportedly wanted to be president ever since he played around the Kennedy compound as a teenager.  I don’t see him stepping down.  The only way the Dems get rid of John Kerry, in my opinion, is for his delegates to abandon him at the July convention in Boston.  While that is rare, it has happened before.

Now back to Hillary.  As I have written in the past, I don’t believe Hillary would allow herself to be nominated unless it is all but certain that she would defeat Bush.  Unless Bush makes some huge mistake, I believe Hillary will wait until 2008.  That let’s her keep her promise to serve her first Senate term, raise LOTS of money and run against who-knows-who will be the Republican nominee in 2008.

I could be wrong, though.  Bill, Hillary and Terry McAuliffe still run the Democrat party.  If they really want Kerry out, he will be out.  But that brings us, front and center, to the question: Do the Clintons want ANY Democrat to win in 2004, or do they prefer that Bush wins, thus leaving the door wide open for Hillary in 2008?

Bill Clinton has not been active in campaigning for Kerry.  They haven’t thrown their influential money machine behind him.  So you have to wonder if the Clintons are happy to see George Bush re-elected in November.  Maybe that is the plan.

Kerry’s VP Dilemma

Kerry’s best hope, short of a major blunder by Bush, is his choice for Vice President.  He desperately needs a running mate who can recharge the Democratic base and deliver a swing state or two.  As I wrote in my weekly E-Letter in February, the leading contenders still are Dick Gephardt, John Edwards, Iowa governor Tom Vilsac and Hillary.

As I wrote in February, Dick Gephardt remains the safest choice.  He might be able to deliver his home state of Missouri; he has credentials; but let's face it, Gephardt is not exactly Mr. Charisma (yawn).  John Edwards, who is very charismatic, would likely upstage Kerry; and Bush will very likely win Edwards’ home state of North Carolina, handily.

For the same reasons I cited in February, I don’t believe Hillary would accept the nod for VP.  Kerry doesn’t want her anyway, but he could become so desperate that he makes the offer.  In any event, I still believe that if Hillary is on this ticket, she will want to be at the top and not the bottom.

So, Kerry is now said to be seriously leaning toward Tom Vilsac who is also very liberal.  But Vilsac is not well-known, and Kerry already has a beyond the margin-of-error lead in Iowa.   Gephardt still looks like the safest choice to me.  In any event, we should know before the end of this month.

Clinton’s Book Due Out In June

Bill Clinton has reportedly been working on his memoirs ever since he left office.  As noted in the editorial above, his publisher (Random House which advanced him $10 million) recently announced that the book, entitled “My Life,” will be released in June.  If you’re John Kerry and others in the Dem party, you have be asking, WHY NOW? 

The Clinton book is expected to top the charts as soon as it is released.  Random House has scheduled an initial printing of 1.5 million copies - that’s 500,000 more than the first run for Hillary’s book, “Living History.”   Clinton’s new book will suck all the air out of Kerry’s campaign in June.  Again we ask, why now?  Why not wait until after the election?  It’s not like Clinton needs the money.

This again raises the question of whether the Clintons’ plan is to see Kerry defeated and Bush re-elected in November, thus leaving the door wide open for Hillary in 2008.  This also explains why Kerry is in a rush to name his VP before the Clinton book produces that giant sucking sound in June.

Here’s what Dick Morris, long-time Clinton political advisor, said on May 4 in the New York Post:

“The impact of Clinton's memoirs on the Kerry campaign cannot have escaped so astute a political observer as our 42nd president. He knows full well what he is doing and what its effect on the Kerry campaign will be.

When Clinton's book hits the shelves, Kerry will not be able to get a word in edgewise. All the stories will be about Clinton, just as the Democratic candidate for president is trying to define his themes and get out his message… nothing will deflect from the attention Clinton will get and Kerry will not. There is only so much oxygen in the room and the president will suck it all up.

Clinton is deciding to publish now because he wants to deprive Kerry of momentum. He realizes that if Kerry wins, Hillary will probably never be president. He knows that she won't be able to run in 2008 because a victorious Kerry would undoubtedly seek re-election. Even in 2012, it is Kerry's vice president who would be the likely nominee. And, if he or she wins, he'll run for a second term in 2016. By 2020, Hillary will be 73.

Clinton must know the impact his publication is likely to have. Kerry did not have a very good introduction to the American people. His post-primary period has been, thus far, a disaster, with his own flubs emphasizing Bush’s accusation that he is unready to lead America during wartime.  The Democratic National Convention, in early August, is his chance to re-introduce himself. He needs all of June and July to build momentum. But instead, he will face all Clinton all the time.”

Morris actually thinks Clinton may be using his book release as a way to pressure Kerry to pick  Hillary as his VP.  Let’s hope that doesn’t happen!  While Bush appears to be pulling away from Kerry, the addition of Hillary to the ticket could be a huge boost for Kerry.   Maybe not, since Hillary’s negative ratings are high, but she consistently beats all other Democrats in presidential polls.  As a result, I think she could sway the election.

We’ll just have to wait and see what it is that the Clintons are really after and how it plays out.  Will they help Kerry, or will they sink him?  This could be one of the most interesting presidential election seasons in many years, and certainly will be the most expensive in history.  The Billion Dollar Election.