Forecasts & Trends newsletter
Why The Economic Recovery Will Continue
by Gary D. Halbert
December 3, 2002
IN THIS ISSUE:
1. Latest from The Bank Credit Analyst (BCA).
2. Why The Economic Recovery Will Continue.
3. Should You Increase Your Equity Holdings?
4. BCA Advises Market-Timing Strategies Now.
Introduction
In 1977, one of the smartest clients I've ever had introduced me to a research publication called The Bank Credit Analyst (BCA) www.bcaresearch.com. BCA is a Canadian research firm which publishes forecasts on the US and global economy, the stock markets, interest rates and bonds, the US dollar and other major currencies, gold and periodically real estate. Over the last 25 years, I have found BCA to be the most accurate of all the sources I follow when it comes to predicting major turns in the economy and the investment markets. That is why I have been a continuous subscriber since 1977, even though their research is quite expensive.
BCA's original monthly research report (apprx. 40-50 pages) costs $995 per year. BCA offers over a dozen other publications, ranging from monthly to weekly to even daily, and the cost to subscribe to all of their regular services is over $10,000 per year. Despite the cost, for the last 25 years I have kept my clients abreast of BCA's latest thinking and forecasts in my monthly Forecasts & Trends newsletter and more recently, in these weekly F&T E-Letters.
BCA caters to large, sophisticated investors and institutions. As such, they assume that their clients and subscribers are always invested in US stocks and bonds, as well as other investments from time to time. As a result, they have only three investment positions in stocks and bonds: "above average" holdings, "average" holdings or "below average" holdings. They assume that most investors have "core" holdings of stocks and bonds that they never sell. This is true of most large investors and institutions.
This week, we look at BCA's latest forecasts provided in their early December publications. While BCA has been the most accurate research source I have followed over the years, when it comes to calling major turns in the economy and the markets, they are not perfect. With that caveat said, here is their latest thinking.
BCA's Prior Forecasts
For the benefit of our many newer subscribers who may not be familiar with BCA, let me quickly summarize their forecasts and investment recommendations over the last couple of years to bring us up to the present. BCA predicted the economic slowdown that has been upon us since mid-2000. Yet unlike the gloom-and-doom crowd, BCA did not expect the economic slowdown to turn into a severe recession. Even after the terrorist attacks of September 11, the BCA editors did not believe the US economy was headed into a severe recession. In fact, quickly after 911, the BCA editors suggested that the US economy might surprise on the upside. It has.
BCA has recommended below average holdings of US equities consistently over the last couple of years. They were among those that warned in 2000 that the Nasdaq was a bubble waiting to be burst. During that same period and up until the middle of this year, BCA recommended above average holdings of bonds. In June of this year, BCA recommended that investors move from above average holdings of bonds to below average holdings. They particularly warned that Treasury bond yields could be near a bottom and recommended that investors switch from Treasuries to high-quality corporate bonds for core holdings. This latest call on bonds was arguably a few months early, but bond investors have certainly taken some hits in the last several months.
Also since the middle of this year, BCA has been warning that US monetary authorities were not taking sufficient actions to head-off growing deflationary pressures. They warned repeatedly that the Fed needed to cut interest rates further, or else global deflation could spread to the US. They actually called on the Fed to cut interest rates by 50 basis-points at the November FOMC meeting. It is believed that several of the Fed governors (and perhaps even Alan Greenspan) read BCA regularly, and it appears they took BCA's advice when the Fed Funds rate was slashed 50 basis-points last month.
With that bit of background out of the way, let's now see what BCA believes is ahead for the US economy and the major investment markets.
BCA's Latest Thinking
I am pleased to report that the BCA editors had a more positive tone in their latest publications. While the editors did not categorically rule out a second recession earlier this year, they never believed it was the most likely outcome. Rather, they believed that the US economy would manage to stay in positive territory with slow growth throughout the year. That has proven to be the case. Now, they expect the moderate recovery to continue over the next year. They say:
"A double-dip recession in the U.S. was never the most likely scenario, and recent data suggest that the odds [of a recession] have dimmed even further. The Federal Reserve's aggressive pump-priming is sustaining buoyant housing activity, the corporate sector continues to gradually heal, the labor market is showing tentative signs of improvement and our estimates point to a rise in the composite leading indicators in November. Meanwhile, the Republican sweep in the mid-term elections clears the way for additional fiscal stimulus next year.
The big issue for the U.S. economy in recent months has been whether or not the consumer would run out of steam before the corporate sector was ready to start spending. Recent data support a moderately positive view."
Specifically, BCA believes that unemployment may have peaked and will begin to decline slowly. They also believe that the housing market will remain stable to buoyant and is not a bubble about to burst. They believe that the worst of the corporate retrenchment has been seen, and that companies will slowly begin to increase investment spending. Their proprietary advance indicators suggest a significant rise in the Index of Leading Economic Indicators for November. That report will be released on December 19.
While the BCA editors were more positive in their latest reports, they are not expecting a robust economic recovery over the next year. In fact, they believe it will be a slow, "sub-par" recovery, meaning that GDP growth will likely be in the 2-3% annual range in the next year.
Deflation Is Still A Concern
As noted above, the BCA editors have repeatedly warned US monetary authorities to pay close attention to the deflationary threat over the past several months. They cautioned that if deflationary forces were to set in, they would be very hard to reverse, as has been the case in Japan for a decade.
In their latest issue, the BCA editors say they believe Alan Greenspan and a majority of the Fed governors have gotten the message on deflation, and that they will not hesitate to slash rates further - even to zero if necessary - to prevent a deflationary trend. While most market analysts predict that interest rates will be higher a year from now, BCA predicts that the Fed Funds rate a year from now will be either the same as today, or lower.
Alan Greenspan actually said recently that the Fed would even resort to buying up longer-dated Treasury securities if needed to get the economy growing and stave-off deflation. For now at least, the BCA editors seem to believe that the deflationary threat in the US has subsided somewhat. Of course, this assumes there are no more major terrorist attacks in the US; if that were to occur, then all bets are off.
Time To Increase Equity Positions
Probably a surprise to most of their subscribers, the BCA editors recommended moving from below average to average holdings of stocks and equity mutual funds in their early December issue. However, rather than jumping in the market immediately, or all at once, the editors suggest buying on weakness during the days and weeks ahead.
The S&P 500 has gained apprx. 20% from its October low, while the Nasdaq is up apprx. 33% in the same period. There have been three previous rally attempts since the markets peaked in 2000. Each time, the rallies failed when the S&P gained apprx. 20%. While they do believe there will be some corrections (downward price movements) just ahead, the BCA editors believe that stocks have bottomed, and that the current uptrend will be sustained this time around. They say:
"All of the above trends suggest that the current equity market is on sounder foundations than it was back in July/August. Another encouraging development is that the NASDAQ has closed above the key resistance level of around 1420.
The combination of improving economic data and more positive market signals suggest that downside risks in equities have diminished. They have not disappeared altogether, but a neutral [average] rather than underweight [below average] stance can now be justified."
Let me be perfectly clear here. The BCA editors are NOT predicting a huge new bull market in stocks and equity mutual funds just ahead. Rather, they are simply saying that they believe the equity markets bottomed in October, and this warrants increasing positions from below average to average. Specifically, they say:
"A new secular bull market in stocks is not about to begin. More likely, the market will churn about within a broad trading range as valuations gradually compress. The market is no longer expensive and there is plenty of cash sitting on the sidelines.
As we have discussed in the past, the buy-and-hold era in the stock market has ended. Average returns from stocks will likely be mediocre in the years ahead, and the only way to generate excess returns will be to play the cycles. The current cycle should be one worth playing, and we recommend using periods of weakness to build positions back to neutral [average] levels."
Let me clarify what that last paragraph means. As stated earlier, BCA assumes that investors have "core" holdings in both stocks and bonds that they never, or rarely, sell. That is a buy-and-hold approach. (In a future issue, I will discuss professional asset allocation strategies specifically for such core holdings.)
What BCA is saying above is that the days of putting most of your money into an "index fund," like the hugely popular Vanguard S&P 500 Index Fund, and hoping to make 15-20% or more a year, are OVER.
Specifically what BCA is saying is that to generate attractive returns in stocks over the next few years, it will be necessary to have a portion of your equity portfolio that moves into and out of the market from time to time.
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