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To: Joan Osland Graffius who wrote (164189)	5/6/2002 10:13:15 PM
From: ild	Respond to of 436258

Sunday May 5, 2002 : Hotline Update The Market Climate remains on a Warning condition, freshly deteriorated and notably hostile. I've noted frequently that a plunge in the U.S. dollar would likely be the first indicator of oncoming economic weakness. Over the past two weeks, the dollar has declined forcefully. Meanwhile, corporate bonds have encountered sudden pressure. This is very dangerous. I've also written about the persistent distribution evidenced by surging downside volume even on days where advances widely outpace declines. We saw this again on Thursday and Friday. Vickers notes that sales by corporate insiders have surged to a 5-to-1 lead over insider purchasers. Again, these signs are very dangerous. Here is a very unpopular, almost unheard-of position. I believe that the recession in the U.S. economy is not over, that capital spending will fail to rebound measurably, and that corporate bankruptcies are about to surge. I would prefer to be wrong about this. In the past few weeks, there has been a pronounced shift toward credit tightening, and an eagerness by banks to step away from providing backup lending facilities to companies encountering difficulty in the commercial paper market. The recent announcement to this effect by J.P. Morgan is part of a broader trend. The cheerleading position on the economy is that with the labor market showing weakness, the Fed will certainly put off raising rates. At the same time, the cheerleaders note that unemployment is a lagging indicator, and that recent weakness is due to extended unemployment benefits that raise the level of claims. So the general view, as I understand it, is that the weakness in the labor market is important and unimportant at the same time. It must be convenient to hold views so unencumbered by consistency. As I've noted in recent months, there are really two indications which would have to improve in order to confirm expectations of sustainable economic strength. One is the level of Capacity Utilization, and the other is the Help Wanted Index. Both are languishing, with the Help Wanted Index actually declining in the latest report. This weakness in labor demand underscores the high rate of new claims for unemployment. The argument regarding extended unemployment benefits strikes me as a kernel of truth being used to explain away the whole field of corn. It certainly doesn't address the weakness in job creation, the failure in the Help Wanted Index, and the persistently downward revisions in prior job creation figures. In short, while the unemployment rate is certainly a lagging indicator, the broader trends in employment indicators cannot be so casually dismissed. There are many individual stocks that remain attractive as long as their market risk can be hedged away. At present, we remain fully invested in such stocks, and fully hedged against their market risk. We expect to be compensated by the difference in performance between those favored stocks and the market indices which we use to hedge (primarily the Russell 2000 and the S&P 100). We view smaller stocks as attractively valued only relative to large ones. All classes of stocks are broadly overvalued in our estimation, and small stocks tend to fall harder in bear market declines, so any preference for small versus large stocks is largely moot at this point. We build our portfolio strictly stock by stock, with no inherent preference here for large versus small. As long as we can find favorable value, market action, and sufficient liquidity, we couldn't care less about market capitalization. In an overvalued market such as this, I would expect that we could expand our approach to the $3 billion range without any significant change to our management technique. In a more attractively valued market with a larger number of favorably situated large-cap stocks, the carrying capacity of our approach would rise to many times that amount. Needless to say, I have no concern regarding our ongoing ability to execute our strategy, even in a market that remains peculiarly overvalued. On the subject of gold stocks, I should note that we completed some liquidations on Friday. I certainly believe that the U.S. dollar has a long distance to decline, and that this will tend to support gold over a more extended period. But gold stocks are remarkably volatile, and the best time to hold such stocks is when both valuations and macro trends are firmly aligned. Gold stocks have run up to the point where I believe that they are vulnerable even to a slight upward correction in the U.S. dollar (even if the overall trend in the dollar remains down as I expect). Sharp and sustained rallies in gold stocks generally prefer a rising rate of inflation, falling trends in Treasury bond yields, and a Purchasing Managers Index below 50, none of which are present here. I'm not one to invest on scenarios - adhering instead to observable criteria. But if I was to put together a scenario, my guess would be that gold stocks may pull back until the economy more clearly begins to weaken again. I do expect the Purchasing Manager's Index to decline back under 50, and my suspicion is that that would be a good signal to renew positions in gold stocks. Again though, this is not a forecast. We simply don't have the evidence to continue holding gold stocks based on our own discipline. And we're willing to be wrong about taking profits if we would have to violate that discipline in hopes of getting more. Long-term Treasury bonds continue to appear attractive, though the level of yield does not allow for a very sustained advance in prices. As a result, the attractiveness of long-term Treasuries would become less compelling if the 30-year yield was to fall below about 5%, which is still some distance away. As for corporate bonds - run. Run like the wind. www.hussman.com