The Commerce Department revised 1Q GDP downward from 4.4% to 3.9% in its latest report.  The ISI manufacturing index rose again in June.  Unemployment continues to improve with over one million new jobs created in the last four months.  The Consumer Confidence Index jumped sharply in June to the highest level in two years.  The Index of Leading Economic Indicators rose strongly in May and is expected to have been up again in June.  Most economists now expect GDP will grow at an annual rate above 4% in the second half of the year.

The Fed raised short-term rates by a quarter point at the end of June, which surprised no one.  The Consumer Price Index rose 0.6% in the latest report for May and was 3.1% higher than a year ago.  This virtually assures that the Fed will continue to edge short-term rates higher at subsequent FOMC meetings.

The stock markets have continued in a broad trading range.  As I will discuss inside, there are good reasons to expect the equity markets to finish the last half of the year on a strong note - even in the face of incremental hikes in short-term interest rates.  As discussed last month, in presidential election years since 1900, the Dow has gained an average of almost 11%.  I continue to argue that you should be fully invested in stocks now, especially with the professional Advisors we recommend.  The boom in the economy should also boost high yield bonds this year, while Treasuries are likely to continue to underperform.

The national polls on the presidential race show Bush and Kerry neck-and-neck.  Yet the individual state-by-state polls show that Bush has a very comfortable lead in the electoral count.  I analyze this data for you this month.  Actually, Kerry should be 10-15 points or more ahead of Bush in the national polls, given all the bad news Bush has had to endure this year. But so far, Kerry has only been even to just a few points ahead at times.  Look for Kerry and Edwards to get the “convention bump” in the polls this month, but don’t be surprised if it is less than they hope for.  Bush/Cheney should also get their bump in August, and it will be interesting to see if they can carry that lead on into the election.  Let’s hope so.

Would You Buy Stock In America?

One year ago, I wrote an article which compared the United States to a giant corporation – USA, Inc.  In that article, I predicted that USA, Inc.’s economy would surprise on the upside over the next year, and it certainly has.  I had already recommended - in March of last year, before the Iraq war began - that investors move back to a fully invested position in stocks at that time, if they had not already done so based on my advice earlier in the year.

When I wrote that article on USA, Inc. last year, most in the media were pessimistic on the outlook for the economy.  Unemployment was considered to be chronic, even though it was only slightly above 6%.  In this issue of F&T, we revisit USA, Inc. a year later to see what has happened, if my advice paid off and finally, what the prospects are for the next year or longer.

USA, Inc. – The Biggest
Corporation In The World

In many ways, the US economy is like a giant corporation.  In this analogy, President Bush is the current Chief Executive Officer (CEO).  Congress is the Board of Directors.  Alan Greenspan is the Chief Financial Officer (CFO).  The population represents the shareholders.  The different sectors of the economy could represent separate operating divisions. 

Even though USA, Inc. is the strongest and most powerful corporation in the world, it has experienced some severe shocks in recent years, and its share price plummeted from record heights just a few years ago.  The first telltale shock came in March 2000 when the bubble in USA, Inc.’s high-flying Technology Division (Nasdaq) finally burst.  Not long after, the entire Corporate Division (Dow, S&P 500, etc.) rolled over into a major bear market that would see most share prices tumble by 40-60%.  Simultaneously, another shock occurred: a mild economic recession unfolded in the first three quarters of 2001.

Then came the terrorist attacks of September 11, 2001 that left thousands of innocent shareholders dead and the rest in a state of shock.  CEO George W. Bush announced that the corporation would launch a global War On Terror (WOT), which continues to this day.  The initial act in the WOT was the war in Afghanistan which ousted the Taliban and Osama bin Laden. 

The second act was a hostile takeover of a foreign country (Iraq) that was believed to possess WMDs and assisted terrorists.  As discussed below, the war in Iraq did not go as expected and problems remain, but a ruthless dictator was removed from power and ultimately captured alive.

This string of major events over the last several years has affected the company’s performance (GDP) and bottom line (federal deficits), and shareholders have been understandably very nervous and skeptical (consumer confidence) about the outlook, at least until very recently.

In 2002, many high-profile analysts (Wall Street) who had traditionally always been very bullish on USA, Inc. turned surprisingly bearish on the company’s outlook.  For the most part, they recommended that investors sell their equity shares of USA, Inc. and move into the supposedly safer USA notes payable (Treasury bonds).  Investors did so in droves and this, along with unprecedented monetary stimulus from CFO Greenspan, drove yields (interest rates) to the lowest level in more than 40 years.

So, in just a few years, USA, Inc.’s outlook went from one of great optimism to a growing pessimism that the company was headed down the same path as Japan, Inc. for the last decade – economic abyss, with a deflationary depression to follow.  The gloom-and-doom crowd was having a field day in 2002.

Yet USA, Inc. Surprised
On The Upside Once Again

Yours truly cautioned often in 2002 and 2003 in this newsletter and in my weekly E-Letters that USA, Inc. was not in as much trouble as the pessimists warned, and I suggested that the company would once again surprise on the upside.  In addition, I frequently quoted my very best forecaster of economic trends – The Bank Credit Analyst – who predicted that the economy would rebound strongly.

In late January, February and early March of last year, I wrote a series of three articles in these pages entitled, “The Mutual Fund Merry Go-Round,” all of which were designed to help investors know how to get back into the market.  You can go to my website, www.profutures.com, and read those timely reports.

Also in March of last year, I specifically recommended that investors get back in the equity markets prior to the start of the war with Iraq.  In the March 4, 2003 issue of this E-Letter, I wrote:

“The equity markets are very oversold; consensus opinion is quite bearish now; and thus the markets are ripe for a turnaround.  As I have stated for weeks, I believe this will be the best buying opportunity of the year…”

USA’s share price bottomed in mid-March (March 12, specifically) last year.    The market bottom on March 12 came at roughly the same level (7,500 in the Dow) as the two previous lows in August and October of 2002.  In my March 18, 2003 weekly E-Letter, I emphasized the significance of the “triple bottom” in the equity markets:

“The stock markets bottomed last week at almost the exact same spot as they bottomed last October and last August.  Assuming this rally continues, we have made what is known as a ‘triple-bottom.’  This is a strong technical signal… 

If the war goes well, consumer confidence should improve and if so, the economy should expand at least modestly in the remainder of the year.  How far stocks could rally is anyone’s guess, but don’t under-estimate the markets and the economy should the war be won quickly and decisively.”

As we know now, the war in Iraq was won decisively, at least initially.  The Bush administration failed to anticipate the guerrilla war that unfolded in the weeks and months after the initial invasion and occupation, as I will discuss below.  Yet even that did not slow down USA’s economy and the rise of its share price.

The Economy & Equities Boomed

USA, Inc.’s economy soared in the second half of 2003.  After rising at an annual rate of 2.0% in the 1Q and 3.1% in the 2Q, GDP swelled by 8.2% in the 3Q and 4.1% in the 4Q.  In late May, the Commerce Department reported that GDP rose by 4.4% in the 1Q of this year.  Most economists now expect that growth will be above 4% for all of 2004.

The long-awaited improvement in employment is also now well underway.  Over one million new jobs have been created this year.  Equally encouraging has been the significant increase in capital spending which has occurred in 2004.  Consumers are no longer the only significant engine driving USA, Inc.’s economy.

Short of another major terrorist attack on our soil, USA, Inc.’s economy should continue to grow at a healthy pace for another year or longer.

Equity prices surprised just about everyone following the bottom in March of last year.  From the low in March near 7,500, the Dow Jones rallied above the 10,000 mark, ending the year up over 28%.  Ditto for the S&P 500 Index.  The Nasdaq Index gained over 50% for 2003.  The equity markets continued to rise this year with the Dow managing to rise above 10,600 at the high point.

Uncertainties Stall The Bull Market

The recovery in the equity markets has stalled in recent months as several serious uncertainties have arisen.  Although much progress has occurred in Iraq, we continue to incur military casualties.  Even though the official handover of control has now occurred, USA, Inc. will have to maintain a significant military force in Iraq for some time to come – perhaps even permanently.  This reality is bothersome to USA, Inc.’s shareholders.

Another uncertainty that has hindered the advance in equity prices is in the area of interest rates.  USA, Inc.’s CFO, Alan Greenspan, began the process of raising short-term interest rates at the end of June.  While this has been a worry in the equity markets, it did not come as a surprise.  In fact, the equity markets are already priced to reflect several small interest rate increases over the next year.

Another concern is rising inflation.  Just a couple of years ago, investors were worried about deflation, not inflation.  However, as I have written in the past, the Fed responded swiftly and decisively in slashing interest rates, both to stimulate the economy and to head off the deflationary threat.  Yet in cutting rates to 40-year lows and keeping them there for a sustained period, the Fed also planted the seeds for the next inflationary cycle.

The Consumer Price Index rose 0.6% in May, largely due to big increases in energy and food, and was 3.1% above May 2003.  The latest increase in inflation has been more bad news for the bond markets, but if you have followed my advice over the last year, you should be under-invested in (or out of) long-term bonds and Treasuries, which may go even lower in the months ahead.

Will Shareholders Reappoint CEO George Bush?

Perhaps the greatest uncertainty facing the investment markets now is whether or not USA, Inc.’s shareholders will re-elect CEO George Bush in November.  Or will they vote to oust the Bush team and bring in his challenger, John Kerry, the liberal senator from Massachusetts?  Bush promises he will fight to make his tax cuts permanent, while Kerry promises to raise taxes on those making $200,000 a year or more.

The race has been neck-and-neck so far based on the national polls, although in the individual state polls Bush has a comfortable lead in the electoral count, as Iwill discuss below.  Traditionally, the equity markets have performed better when the incumbent is in the lead and is re-elected.  Since it is far from clear if that will happen, the equity markets have been understandably jittery in recent weeks.  The equity markets do not like the prospects for higher taxes.

One of the key factors that will decide the outcome of this race is the Bush team’s ability to get the word out on the strong economy and jobs growth.    The Media Division of USA, Inc. has largely chosen to ignore the good economic news by not reporting it.  For example, we had great news in April and May when 346,000 and 248,000 new jobs were created.  As noted earlier, over one million new jobs have been added so far this year.

Yet the Media Division elected to focus on the prison scandal and other problems in Iraq.  The result: an Associated Press survey in early June revealed that 57% of Americans still believed the economy was losing jobs!  Americans are simply not hearing the good news.

The June 21st issue of Investor’s Business Daily had a telling chart on its front page.  The graph illustrated how many times per month the economy was mentioned on ABC’s evening news program.  In January, Peter Jennings mentioned the economy 120 times (mostly negative), but in May he mentioned it only 20 times.  This is how the Media Division ignores the good news on the economy.

The Bush administration must do a better job of getting the good news on the economy and the good news on Iraq out into the public view.

What To Do Now

The economic boom is now no longer a subject of much debate.  USA, Inc. is on a roll, perhaps the biggest roll since 1984.  This boom is likely to continue for another year at least, barring some major negative surprises.

Yet despite the great economic news, many investors remain under-invested (or not invested at all) in equities.  Money market funds are still bulging with cash from folks who bailed out of the equity markets in 2002 near the bottom and have never gotten back in.  They missed the great year in 2003.

There are several reasons why so many investors are on the sidelines, despite the great economy.  As discussed above, many people are simply unaware that the economy is so strong.  Others believe they missed the boat in stocks last year, and the markets are too high to get in now.  That is a classic reason why so many people miss the big moves.

Some investors are worried that there will be another terrorist attack in the US prior to the election.  No one knows if there will be another major attack or not, certainly not me.  However, the intelligence sources I read seem to agree that a terrorist attack prior to the election would help President Bush, rather than hurt him.  In any event, I would not let the threat of terrorism keep you on the sidelines.

Let The Professionals Do It For You

As I regularly remind you, my advice for investing in today’s markets is to let successful professionals manage all or a good part of your portfolio.  There are plenty of professional money managers who are always fully invested, and they make or lose money just as the markets go up or down. 

Yet as you know, there are also professional money managers who use successful strategies that alert them to downtrends in the markets, and they can reduce their positions or move 100% to cash if their systems indicate that risks are too high.

Over the last couple of years, many of these tactical money managers have implemented “hedging” strategies to their systems.  There are several mutual funds that actually go UP in value when the stock market goes down.  The Rydex Ursa and Tempest funds and the Profunds Bear and UltraBear funds are just some examples of these so-called “short funds.”

Rather then sell their positions when they get a signal to reduce positions or get out of the market, more and more tactical managers are using these short funds to “hedge” their long positions.  In some cases, this can reduce transaction costs while protecting the long positions from a decline in the market.

All of the professional money managers I have recommended for mutual funds use “hedging” techniques such as those discussed just above.   They can use the short funds in case of a serious downturn in the markets.

Niemann, Potomac & Capital Management

Niemann Capital Management has a time-tested system for identifying hot sectors of the markets and then invests in those equity mutual funds where they expect the most growth.  They may invest in any of the hundreds of mutual funds on Fidelity’s fund platform, and they use short funds occasionally for hedging purposes.  The minimum investment is $100,000.

Potomac Fund Management utilizes a somewhat more conservative strategy for selecting mutual funds that deliver growth but also those that have not tended to fall as much as the overall market during down periods.  They also use short funds occasionally for hedging purposes.  The minimum investment is $25,000 for the time being.

Capital Management Group is unusual in that they invest in large, highly diversified high yield bond funds.  High yield bonds were the big winners last year when Treasuries and other high-grade bonds were hammered.  CMG will occasionally use short bond funds for hedging purposes.  The minimum investment is $25,000 for the time being.

All three of these money managers have outstanding performance records.  You can go to my website, www.profutures.com, to see their actual results in real accounts, net of all fees and expenses.   Or you can call us at 800-348-3601 and we will be happy to send you detailed information and application forms.  Past results are not necessarily indicative of future results.

These three money managers (along with others we recommend) share a portion of their management fee with my company for referring clients to them.  You can find these money managers on the Internet and go to them directly, but their management fee is the same either way. 

It might interest you to know that this fee sharing arrangement is quite common in the investment industry.  However, you should also know that we only recommend money managers who have met our strict “due diligence” requirements.  We not only scrutinize their performance records, but we also conduct on-site visits to check out their operation, their systems, their personnel, etc., etc. 

You might also be interested to know that we reject over nine out of every ten managers we review.  Only a select few make the cut in our due diligence process.

Perhaps most importantly, as one of my clients, you will always know if we change our mind about a manager.  There have been times in the past when we have withdrawn our recommendation of a manager, and we have moved our clients elsewhere.  When is the last time a money manager told you to close your account?  Probably never!

The most common reason for withdrawing our recommendation of a manager is deterioration in performance.  As the common securities disclaimer goes, past performance is not necessarily indicative of future results.  There are times when a previously great manager goes cold, usually because their system or strategy has not adapted to changing market environments, or because they have changed their system in some material way.

The most important point is that we are on your  side of the table.    We only recommend those money managers we consider suitable for you, in light of your financial situation.  We visit with you periodically to make sure that the manager(s) you have selected are still suitable for you.  Also, we will advise you immediately if we revoke our recommendation of a manager. 

Based on the calls and e-mails I receive, I know that many of our clients are still under-invested in equities and/or looking for an alternative to Treasury bonds.  If you are in that position, I strongly recommend that you consider these very successful money managers.  I think they will serve you well.

The economy is in great shape and should continue to grow at a healthy pace for at least another year, short of some major negative surprise.  While equity prices remain in a trading range, Ilook for the markets to begin a new upward trend soon.  So, for that reason, now may be a good time to open accounts with Niemann and/or Potomac.

As discussed earlier, interest rates are on the rise, and this trend should continue for the next year or two.  While this is generally bad news for Treasury and other long-term bonds, high yield bonds have the potential to continue doing well going forward.  High yield bonds tend to do well when the economy is recovering.  This argues for Capital Management Group which invests in high yield bond funds.

Even if you have accounts with one or more of these Advisors, now may be an excellent time to ADD to your accounts.  If you would like to discuss any of the Advisors and their programs, feel free to call us at 800-348-3601.

2004 Has Been A Political Disaster For Bush

Until the last few weeks, 2004 has been a near disaster for George W. Bush's presidency.  Deaths of American soldiers in Iraq were rising. The Abu Ghraib prison scandal shocked and embarrassed the country, leading to more doubts about the Bush administration's handling of the war and foreign policy in general.  At the same time, there was a general lack of belief that the economy was recovering, thanks in large part to the liberal media. You remember the cliche, “The Jobless Recovery” that we heard almost daily until very recently.

Add to that several new books and now a movie that depict the president as either a fool, a liar or both. Meanwhile, the Kerry-friendly “527” groups, brimming with George Soros’ millions, were blasting Bush at every turn. 527s are a special class of non-profit, tax-exempt organizations that are raising LOTS of money for political purposes - mostly for the Democrats.

The president has clearly been damaged by the convergence of these events, some unpredictable and some clearly orchestrated. As recently as March, Bush’s approval ratings were still in the mid 50s. Yet the early July CBS/New York Times poll had Bush  down to 42%, the lowest point of his presidency.  Surely Bush is toast, right? Not so fast!

Bush Should Be 10-20 Points Behind Kerry

With Bush having come through nothing short of a political apocalypse, and with the Democrats and the media exploiting the events to their advantage, John Kerry should be 10-20 points ahead of Bush in the polls. Bush should be down for the count.  Kerry should be ahead just as Bill Clinton was against Bob Dole at this point in 1996.

Yet the race has been a statistical dead-heat in the national polls for the last several months. Over the last 2-3 weeks, Bush has actually pulled slightly ahead of Kerry in five of the last six major national polls, in some cases by more than the margin of error. Folks, this is devastatingly bad news for John Kerry and the Democrats!

The Red States, Blue States & Undecideds

The general election is not a coast-to-coast popularity contest, as is the case with the national polls. Instead, the presidential election is a series of 50 individual state elections where, with the exception of Maine and Nebraska, the winner takes all the electoral votes. It is the Electoral College vote that decides the president, as it has throughout our nation's history. This is why the real story lies in the state-by-state polls, more so than the national polls.

The so-called “Red States” are those believed to be solidly locked up by Bush.  They include AK, AL, CO, GA, ID, IN, KS, KY, LA, MS, MT, NC, ND, NE, OK, SC, SD, TN, TX, UT, VI and WY. These 22 Bush states total 190 electoral votes.

The “Blue States” are those believed to be solidly locked up by Kerry. They include CA, CT, DC, DE, HI, IL, MA, MD, NJ, NY, RI and VT. These 11 Kerry states and DC total 168 electoral votes.

Then there are the so-called “battleground states,” where, for purposes of this discussion, the presidential vote could go either way. Broadly speaking, there are 17 possible battleground states including AR, AZ, FL, IA, ME, MI, MN, MO, NV, NH, NM, OH, OR, PA, WA, WI and WV. As noted above, the remaining states are believed to be solidly locked up by Bush and Kerry.  Let’s look at the polls from these battleground states to see who is ahead, where and why.

Here are Bush’s current standings in the eight battleground states he won in 2000. AK, less than 2% down but within the margin of error (typically + or - 3 to 4 points). AZ,12 points ahead, well beyond the margin of error. FL ranges from +10 points ahead for Bush to dead even. MO, two points ahead but within the margin of error. NV, three points ahead but within the margin of error. NH, four points behind but within the margin of error. OH, four points ahead but within the margin of error. WV, six points ahead, beyond the margin of error.  Given the recent rocky times for the Bush administration, these standings are not too shabby. Those states total 88 electoral votes, with Bush currently winning 78 of them.

Now lets look at how Kerry is doing in the “blue” states that Gore won in 2000. Starting with IA, Kerry is up by two points (Gore won by 1 point in 2000), which is well within the margin of error. In ME, Kerry is up by two and a half points, again within the margin of error. MN has Kerry well ahead, outstripping the slim Gore victory there in 2000. Not bad so far, until we come to MI, where Kerry trails Bush by a narrow margin. Bad news here since MI is a must win for Kerry, he cannot be elected without it.

Grim news from PA as well, where Bush leads beyond the margin of error. These two states represent 38 electoral votes that Kerry absolutely must have in order to win. Fortunately for Kerry, he is well ahead in the remainder of the blue battleground states.  In all, this gives Kerry a battleground state electoral vote total of 54. Even if you give him the 10 leaning votes from the Bush states, Kerry is still 14 electoral votes behind in the battleground states: Bush 78, Kerry 64.

So why is Bush running ahead in Democratic strongholds like MI, PA, and OH, all states heavily hit with unemployment? I can only speculate, but I think it goes back to the issues of leadership, trust, the fight against terrorism, and Kerry's inability to inspire big labor. Kerry has also failed to articulate a coherent and passionate national message. As one political commentator recently put it, hating George Bush will only get you so far and it certainly won't get you elected president.

All in all, an unpleasant picture is emerging for the Democrats and Kerry. You can see that while the national polls are close, they are not the best indicator of how well a candidate will do in the Electoral College.  Despite what you have heard in the mainstream media, if the election were held today, Bush would win. Here are the latest (as this is written) projected electoral vote totals based on the most recent states polling data: BUSH 322 /  KERRY 216.

This outcome includes giving Kerry the 10 electoral votes noted above from the blue states which are currently leaning toward Kerry. By the way, political commentators Fred Barnes and Mort Kondracke did a similar state-by-state analysis last week.  Their projection: BUSH 318 / KERRY 220.

Conclusions

The national polls show the presidential race very close, with Bush pulling slightly ahead in the last 2-3 weeks. Yet with all of Bush’s troubles this year, Kerry should be ahead by 10-15 points or more. However, the state-by-state polls show Bush has a very comfortable lead in the electoral vote. Kerry has failed to capitalize on Bush’s troubles.

The Kerry/Edwards camp may get a nice boost in the polls from their convention this month, but this is not unusual.  At the end of the day, Kerry must win all the “blue”states and flip one or two “red” (Bush) states to his side if he is to win. Unfortunately, his VP John Edwards can’t even deliver up his own home state (NC) or any other, but he looks good and he makes Kerry look better.

A lot can change, but right now, it is still Bush’s race to lose.  I hope Bush wins because Iwant to see the War On Terror continue.