Forecasts & Trends : Economic Forecast

The Economy & the Commercial Real Estate Bust

Gary D. Halbert — Wed, 30 Sep 2009 00:43:00 GMT

In This Issue:

The Economy Continues to Improve Slowly
Plunge in Commercial Real Estate Values
More Trouble Ahead for the Banks
Glut of Commercial Mortgage-Backed Securities
Personal: Thinking Wrong, But Getting It Right

Introduction

There is broad agreement that we have seen the worst of the recession, and that GDP will show a positive gain for the 3Q when we get the first government estimate in late October. Most pre-report GDP estimates I have seen are in the +2 to +3% range for the 3Q. The actual number remains to be seen, of course.

There is also a growing agreement that we have seen the worst of the housing bust, as sales of new and existing homes rose briskly for the four months ended in July; however sales of existing homes unexpectedly fell slightly in August as reported last week.

Yet while the economy appears to be on the mend, at least for a while, and the housing market seems to be recovering, there is another serious threat to the economy and the credit markets just ahead - the continuing commercial real estate bust which is still getting worse.

This week, we will take a brief look at the latest economic reports, most of which are encouraging, and then I will summarize the very troubling situation in US commercial real estate. This problem has led numerous analysts to predict that the commercial real estate may well be the next shoe to drop in the credit crunch.

The Economy Continues to Improve Slowly

As noted above, most forecasters believe the US economy has expanded at healthy rate in the 3Q which officially ends tomorrow. If so, that will be a welcome relief following GDP declines of -6.4% in the 1Q and -1.0% (annual rates) in the 2Q.

The Index of Leading Economic Indicators (LEI) rose 0.6% in August, marketing the sixth consecutive monthly increase. This is perhaps our best indication that growth in the 3Q and the 4Q will be positive and could surprise on the upside, which is not surprising following the worst recession since the Great Depression.

Most analysts that I follow closely believe, however, that the economic recovery in 2010 will be rather anemic with GDP growth at or below 3% on average. Such estimates could prove too rosy, depending on what happens in the huge commercial real estate sector (details to follow).

Consumer confidence improved significantly in August after falling slightly in June and July. The Consumer Confidence Index rose to its highest level (54.1) since the recession began. The improvement continued into September with the University of Michigan Consumer Sentiment Index climbing to a new recent high of 70.2.

Higher confidence resulted in a nice rise in retail sales in August, up 2.7%. Unfortunately, durable goods orders, which were expected to have risen in August, fell 2.7% last month, following the big increase of 4.8% in July.

On the manufacturing front, the ISM Index rose to 54.1 in August, up from a revised 47.4 in July. Industrial production rose 0.8% in August, following a 1.3% gain in July. Factory orders were up 1.3% in July (latest data available). The factory operating rate rose to 69.6% in August.

As noted above, existing home sales dipped slightly in August following four consecutive monthly increases. New home sales in August were up fractionally (0.7%), well below expectations, following the 9.6% jump in July, the highest in almost a year.

Of course, any analysis of the overall economy would be remiss not to point out that, while things are improving on most fronts, the unemployment rate continues to rise - up to 9.7% in August from 9.4% in July - and will almost certainly continue higher for several more months at least.

Overall, it appears clear that the recession will end this year, and it is quite possible that we will see positive growth in GDP in the 3Q and 4Q. Most of the estimates I read for the 2Q are in the +2-3% range; most of the guesses I read for the 4Q are in the +3-4% range, which remains to be seen, especially in light of the potentially dangerous situation in the commercial real estate markets.

Plunge in Commercial Real Estate Values

US commercial real estate, valued at some $3.5 trillion, has experienced a 39% decline in prices on average from the peak in late 2007, according to the MITCenter for Real Estate.

This current drop is considerably worse than the 27% commercial real estate decline associated with the savings and loan crisis of the late '80s and early '90s. You will recall that the S&L crisis precipitated the government-run Resolution Trust Corporation and the resulting seizures and auctions of hundreds S&Ls around the country.

The same conditions that caused the residential housing bubble, including the Fed's easy credit, lax lending standards and booming mortgage-backed securities underwriting on Wall Street, also drove commercial real estate overvaluation.

Recently, MIT reported that commercial real estate prices plunged 18% in the second quarter, which was the largest quarterly drop in the 25 years since MIT first published its Commercial Real Estate Price Index. MIT also reports that most commercial properties bought or refinanced in the last five years are now upside down on their loans, with current property prices having fallen below the finance or purchase price. Real Capital Analytics reports that owners have lost their entire down payments on about $1.3 trillion worth of property.

According to several sources, nearly half of all the commercial real estate mortgage loans in the US are coming due within the next five years. Deutsche Bank, for example, believes that 65% or more of these loans will fail to qualify for refinancing. Existing high vacancy rates will continue or worsen as long as the unemployment rate continues to rise.

We are hearing more and more talk about the plunge in commercial real estate values these days because commercial real estate value trends tend to lag the overall economy. There are many reasons for this - too many in fact that it is impossible to cover them in this short space.

Susan Smith, who is the director of PricewaterhouseCoopers' real estate advisory practice notes: "The biggest problem is that commercial real estate lags what happens in the economy. Companies are looking for ways to cut costs, many are continuing to reduce workers and are continuing to reduce their space needs." As a result, commercial rental rates have taken a nosedive in most markets.

Ms. Smith and her team at PricewaterhouseCoopers conduct surveys each year of the commercial real estate market, and their latest survey concludes that the rise in vacancy rates and the plunge in rental rate are far from over and may well extend into 2011. Office rents in New York and San Francisco may drop 20% in 2010 alone, the survey found.

The National Association of Realtors projects that retail vacancy rates will increase from 11.7% in the 2Q of 2009 to at least 12.9% in the same period of 2010, the highest vacancy rates since 1991. Likewise, NAR projects that office building vacancy rates will rise from 15.5% to at least 18.8% by this time next year.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

More Trouble Ahead for the Banks

All of the above suggests the following: many of the banks that made commercial real estate have only realized a fraction of their losses. And as those losses continue to mount, we're likely to see more and more bank failures. Commercial real estate loans are not just concentrated among the nations largest banks; these loans are widely made by regional banks and even smaller banks.

Of the largest banks, San Francisco-based Wells Fargo has the largest share of the apprx. $3.5 trillion commercial debt securities, reportedly with 16.5% of its $821 billion loan portfolio invested. JPMorgan Chase is reportedly a distant second with 5.4% of its portfolio invested in commercial loans, followed by Citigroup with 3.4%.

However, smaller banks - 92 of which have already folded this year as of mid-September, according to the FDIC, compared to 25 last year - are even more at risk because they will likely have a harder time accessing the crucial capital to offset rising defaults on commercial real estate loans, according to the TARP-inspired Congressional Oversight Panel's August Oversight Report. The Oversight Panel noted:

"Unlike large banks that can sustain a certain number of defaults, even of large commercial loans, smaller banks may have far more difficulty in absorbing more than a few large loan losses. The FDIC's statement that ‘banks have been able to raise capital without having to sell bad assets through the LLP' may not reflect the reality for these banks."

Indeed, the number of smaller banks expected to be seized by the FDIC is forecast to accelerate later this year and next year. The FDIC's "problem list," of banks that run a higher risk of failure, grew to 416 in the 2Q, up from 305 in the 1Q. That's the highest number since the 2Q of 1994, following the S&L crisis, when there were 434 banks on the list.

As noted above, the S&L crisis resulted in a 27% decline in commercial real estate around the country. This time around the losses are even greater (39% so far) because the apprx. $3.5 trillion is over three times what it was during the early 1990s - meaning the potential for losses is steeper than ever before.

Glut of Commercial Mortgage-Backed Securities

Federal Reserve and Treasury officials are scrambling to prevent the commercial real estate sector from delivering another knockout punch to the US economy just as it struggles to get up off the mat. Yet their efforts could be undermined by a surge in foreclosures of commercial property carrying mortgages that were packaged and sold by Wall Street as bonds. These loans are known as Commercial Mortgage-Backed Securities (CMBS).

As discussed above, many US banks have high exposure to commercial real estate debt that they initiated through their own internal loans. In addition, many banks also bought CMBS and now have additional default risks that I will discuss in more detail as we go along.

Similar mortgage-backed securities (Sub-prime, Alt A, etc.) created out of home loans played a huge role in undoing that sector and triggering the global economic recession and credit crisis. Most sources estimate that there is around $700-$900 billion of CMBS outstanding at this time. These complicated products are being tested for the first time by the massive downturn real estate values discussed above, and so far the outcome so far hasn't been pretty.

A typical CMBS is stuffed with mortgages on a diverse group of properties, often fewer than 100, with loans ranging from a couple of million dollars to more than $100 million. A CMBS servicer, which is usually a large financial institution like Wells Fargo or JPMorgan Chase, collects monthly payments from the borrowers and passes the money on to the institutional investors that buy the securities.

The CMBS sector is suffering from two major problems, which, according to credit rater Realpoint LLC, sent its delinquency rate to 3.14% in July, more than six times the level a year earlier. One is major problem is that many of these mortgages were simply poorly underwritten. In the era of looser credit in recent years, Wall Street's CMBS machine lent owners money on the assumption that occupancy and rents of their office buildings, hotels, stores or other commercial property would keep rising. In fact, the opposite has happened. The result is that a growing number of properties aren't generating enough cash to make principal and interest payments.

The other major problem is the growing inability of property owners to refinance loans bundled into CMBS when these loans mature. By the end of 2012, some $153 billion in loans that make up CMBS are coming due, and close to $100 billion of that will face difficulty getting refinanced, according to Deutsche Bank. Unfortunately, other sources estimate that twice that many CMBS loans will come due between now and 2012; and double the amount that will be difficult or impossible to refinance.

Even though the cash flows of many of these properties are enough to pay interest and principal on the debt, their values have fallen so far that borrowers won't be able to extend existing mortgages or replace them with new debt. That means losses not only to the property owners but also to those who bought CMBS - including hedge funds, pension funds, mutual funds and other financial institutions - thus exacerbating the economic downturn.

Many banks that hold traditional commercial real estate loans have chosen to extend the maturities and/or renegotiate the terms (this is one reason we haven't heard too much about it until recently). Banks have had a strong incentive to refinance because relaxed accounting standards have enabled them to avoid marking the value of the loans down.

Until now, banks have been able to keep a lid on commercial-real-estate losses by extending debt when it has matured as long as the underlying properties are generating enough cash to pay debt service. Unfortunately, CMBS are held by scores of investors, and the servicers of CMBS loans have limited flexibility to extend or restructure troubled loans like banks do.

Mounting foreclosures in the CMBS sector will likely depress values even further as property is dumped on the market. And this, in turn, will likely put pressure on banks to write down the myriad of commercial loans on their books, thereby exacerbating the problem.

The $64 Question: Why Are Bank Stocks Soaring?

At this point, the logical question to ask is, how is it that we have this enormous commercial debt problem, yet bank stocks have been on a tear for the last couple of months? Frankly, I think most bank shares are wildly overbought at this point, but then I'm not a stock picker.

Some of the largest US-based multinational banks saw their share prices plunge to the level of "penny stocks" over the last year. CitiGroup at one point fell to below $1 per share (97¢) on March 5. Yet shares of these mega-banks have rebounded significantly in recent months, albeit from the lowest levels ever recorded for many of the largest banks. In other words, they were due for a significant rebound.

Another reason the large money center banks have seen their shares soar is the widespread belief that President Obama will not allow any of the major financial institutions fail on his watch. The turmoil that erupted after the Lehman failure will not be allowed to happen again, so investors have more confidence in the large bank stocks. The recent spike in bank stocks has also helped the regional bank stocks which, in most cases have seen their share prices rise as well.

None of this, however, makes the commercial real estate debt problem go away, and it will get worse before it gets better. There is virtually no market for CMBS. Potentially hundreds of billions in commercial mortgage loans will not be able to be refinanced over the next couple of years. I fully expect this to weigh heavily on the banks - small and large - in the weeks and months ahead.

If I had very large profits in banks stocks over the last 2-3 months, I would be taking money off the table. But again, I'm not a stock picker.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Thinking Wrong, But Getting It Right

If you have been reading this E-Letter all year, you know that my calls on the economy and the stock market have been off the mark for the most part. Earlier this year, I expected the economy would remain in negative GDP territory all year and not recover until sometime next year. I expected consumer confidence to stay in the dumps pretty much all year.

Despite my forecast, the economy did begin to rebound during the summer, and it now looks reasonable to expect positive growth in the 3Q and 4Q, assuming there are no more big negative surprises. Just how negative the commercial real estate debt problem will be remains to be seen.

In a similar vein, I did not see the recent surge in the stock markets coming. Of course, I don't know anyone else who predicted stocks would spike 50% higher back in March either. Back in early March when the Dow had literally collapsed to 6500, I did feel that the panic was probably over. Yet I never would have imagined that the Dow and other major market indexes would soar over 50% in relatively short order. But they have.

I openly admit to those misgivings to make the following point. I don't manage any of my own money that is in the stock market or in bonds. I haven't made a personal trade in years. I figured out a long time ago that I am too emotional to do it myself.

If I had been managing my own money in stocks or mutual funds, I would probably have bailed out sometime late last year or early this year, as millions of investors did. Given my views of the economy and the stock markets earlier this year, I can all but assure you I would not have jumped back in when the markets turned up in late March and April.

I would still be on the sidelines like millions of other investors, and I would have missed out on the huge gains that followed. By the way, estimates are that there is still $3-$4 trillion in money that bailed out that is still sitting on the sidelines in money market funds, T-bills, etc.

But since almost all of the money I have in the stock markets is managed by professionals, I have been able to participate in this recovery.

If you have read these letters for long, you know that my firm is in the business of finding successful professional money managers to recommend to our clients. As a long-time critic of Wall Street's "buy-and-hold" mantra, I have always preferred "active" or "tactical" money management strategies that have the ability to move to cash (money market) or "hedge" long positions during down periods.

The reality is that my equity managers lost far less than the market during the bear market that began in late 2007, and they have been able to participate in the bull market that began earlier this year. (As always, past performance is no guarantee of future returns.)

My goal has always been to avoid the 40-50% losses that often occur during bear markets. Remember, if you lose 50%, you must make 100% just to get back to breakeven.

If avoiding big losses is a big concern to you, then maybe it's time to checkout some of the active managers I recommend. Hopefully, you read my E-Letter two weeks ago on the Columbus High-Yield Bond Program.

Please feel free to give one of our Investment Consultants a call at 800-348-3601 or click on the following link to complete one of our online request forms. If more convenient, drop us an e-mail at info@halbertwealth.com or visit our website at www.halbertwealth.com to learn more about our actively managed investment strategies.

Very best regards,

Gary D. Halbert

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On the Economy & Obama's Trillions

Gary D. Halbert — Tue, 08 Sep 2009 20:33:00 GMT

IN THIS ISSUE:

The Economy - More Signs of Recovery
Is the Recession & Credit Crisis Over?
Obama Adds $2 Trillion to Debt Forecast
Economic Assumptions Still Too Optimistic
What in the World Are They Thinking?
Do They Want Control Even If It Ruins The Economy?

Introduction

In my June 16 E-Letter, I reprinted the non-partisan Congressional Budget Office's (CBO) projections of annual federal budget deficits over the period from fiscal 2009 to fiscal 2019, which estimated that the national debt will more than double over that 11-year period - not including over $1 trillion for nationalized health care (if it passes) and several trillion more that will be required to rescue Social Security, Medicare and Medicaid over the next decade.

The White House Office of Management & Budget (OMB), which is partisan, runs budget deficit projections similar to those of the CBO. The OMB's deficit projections over the same period, 2009-2019, showed the national debt increasing over $2 trillion less than the CBO's forecast of $11.11 trillion. However, on Friday, August 21, the White House quietly announced that the OMB had revised upward its deficit projections to fall in line with the CBO's. So, it's official.

The only good news on the deficit front is that both the CBO and the OMB recently revised downward the fiscal 2009 budget deficit, which closes out at the end of September, from the earlier reported $1.8+ trillion to around "only" $1.6 trillion. Time to break out the bubbly, right? Wrong! We will look at the latest deficit projections as we go along, but the problem is still the same; Obama seems intent on spending this country into financial ruin.

But first, there is more good news on the economic front. More and more forecasters now believe that GDP has moved into positive territory in the 3Q, and perhaps it has. Unfortunately, we don't get our first 3Q GDP estimate until the end of October. The latest GDP estimate for the 2Q was unchanged at -1.0%, which was better than expected. I will cover the latest encouraging (and not so encouraging) economic news just below.

The Economy - More Signs of Recovery

We have seen considerably more positive signs than negative over the last month. Let's begin with the ISM manufacturing index which rose sharply to 52.9 in August, up from 43.4 in July. It is the highest reading since June 2007. A reading above 50 in the ISM index indicates that the economy is recovering. The ISM "new orders" index jumped 9.6% in August to 64.9, which confirms that inventory rebuilding is intensifying, albeit from very depressed levels.

Durable goods orders jumped 4.9% in July (latest data available) following -1.3% in June. Industrial production increased 0.5% in the same period. The factory operating rate also increased modestly in July. Construction spending, however, was still down slightly in July.

The Index of Leading Economic Indicators rose for the fourth consecutive month in July (latest data available) with a rise of 0.6% following a gain of 0.8% in June. Four consecutive up months in the LEI is quite encouraging, indicating that the worst of the recession is likely behind us, and the economy may move into positive territory before year-end.

The Consumer Confidence Index bounced back in August to 54.1 versus 47.4 in July. After rising sharply in the spring, the Index drifted lower in June and July so the latest recovery was welcomed. The University of Michigan Consumer Sentiment Index also closed out higher at the end of August.

Unfortunately, the rise in consumer confidence that began in the spring has not translated into significantly higher consumer spending. Retail sales in July fell 0.1%. Personal consumption expenditures, another measure of consumer spending, were up only 0.2% in July. Most Americans are still very concerned about the economy, and many are choosing to save rather than spend. The Commerce Department reports that the personal savings rate rose to 5% of disposable income in the 2Q, the highest rate in over a decade.

On the housing front, there was some good news in the last month. Pending home sales rose 3.2% in July following a gain of 3.6% in June. Actual sales of existing homes rose 7.2% in July to an annual rate of 5.24 million units. Sales of new homes rose 9.6% in July, the largest monthly gain since February 2005. Much of the increase in home sales in recent months is attributed to the up to $8,000 in tax incentives for first-time home buyers; yet no one knows what will happen when this stimulus program ends later this year.

The Labor Department announced last Friday that the US unemployment rate jumped to 9.7% in August, up from 9.4% in July, and above pre-report expectations. In August, the official number of unemployed persons increased by 216,000. The Labor Dept. also reported that there are now 14.9 million unemployed Americans, and this number is likely headed even higher in the months ahead.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Is the Recession & Credit Crisis Over?

In the 30 years that I have been writing about the markets and the economy, a "recession" has consistently been defined as two or more consecutive quarters of negative growth in GDP (or GNP back in the old days). Likewise, two consecutive positive quarters meant that the recession was over. Be that as it may, if the initial GDP report for the 3Q is even mildly positive (which we won't get until the end of October), you're going to hear virtually everyone declare that the recession is over - whether or not that proves to be the case.

While I remain a bit skeptical, most of my trusted sources believe at this point that 3Q GDP will be at least mildly positive, and that the 4Q will be as well, in large part due to inventory rebuilding. But most of these same sources are not predicting a strong recovery in the economy. Some believe that there is still a real chance that we will slip back into recession in late 2010 or 2011, especially if consumers continue to save rather than spend.

As for the credit crisis, I think it is fair to say that it is no longer a crisis. But as anyone who is trying to get credit for a business knows, the banks are still not lending remotely as they were before the subprime blowup occurred. New lines of credit are few and far between. Many banks still have too many bad loans on their books, so they're not looking for new ones.

According to the FDIC, 84 US banks have failed so far in 2009, a record pace. So while it may be safe to say that the credit "crisis" is over, we are still far from being out of the woods. There are now 416 banks on the FDIC's "problem list" (up from 305 in March), so there will continue to be multiple bank failures every month for some time to come.

Then there's the 800-pound gorilla in the room - the Fed. At some point, the Fed will have to unload the $2+ trillion in questionable securities and toxic assets on its balance sheet. The Fed can't continue to print money ("quantitative easing") indefinitely; likewise, it will have to shrink the money supply at some point; and finally, short and medium-term interest rates will have to be allowed to rise somewhere down the road, especially if the economy rebounds.

Obviously, no one short of Ben Bernanke knows when this will happen. My best sources believe that because of the deflationary forces created by deleveraging, the Fed has at least a year to maintain its current stimulative policies without risking higher inflation. Similarly, they believe the Fed can wait a year or so before having to begin unloading assets and trim its balance sheet.

Virtually, everyone I read in the financial/investment world agrees that the Fed faces a daunting challenge when the time comes to unload these assets. This problem, above all, will continue to hold the threat of a double-dip recession over the economy and the markets. We all need to keep this in mind even if the economy goes positive for a few quarters.

Obama Adds $2 Trillion to Debt Forecast

2009	$1.845	trillion	2015	$785	billion
2010	$1.379	trillion	2016	$895	billion
2011	$970	billion	2017	$945	billion
2012	$658	billion	2018	$1.023	trillion
2013	$672	billion	2019	$1.189	trillion
2014	$749	billion

TOTAL $11.11 Trillion

As noted in the Introduction, both the CBO and the White House Office of Management & Budget (OMB) recently reduced the budget deficit forecast for fiscal 2009 from the $1.845 trillion noted in the table above to apprx. $1.6 trillion. So, the $11.11 trillion shown above would now be reduced to apprx. $10.87 trillion (if the latest projections prove to be correct).

Note that this astronomical amount does not include over $1 trillion for nationalized health care (if it passes) and several trillion more that will be required to rescue Social Security, Medicare and Medicaid over next decade as the Baby Boomers retire. Nor does it include the existing national debt of $11.7 trillion. The $10.87 trillion is merely the sum of annual budget deficits over the 11 years from 2009 to 2019.

Given that September is the end of fiscal 2009, the talk is now focused on record budget deficits for the 10 years from 2010 to 2019. Never mind that the 2009 deficit will be apprx. $1.6 trillion, almost four times larger than our previous worst deficit in history, which was $438 billion in fiscal 2008 under President Bush.

If you take out the $1.845 trillion 2009 deficit from the table above, the CBO deficit estimate for 2010-2019 is $9.02 trillion. This is $9 trillion that we will add to the national debt over the next 10 years, based on Obama's budget projections. Yet for months now, the Obama administration has taken flack because its own OMB has maintained that the 2010-2019 deficits would only total apprx. $7 trillion. But that has recently changed.

Now if you're the President of the United States, and you have some news that is not flattering to release to the public (especially in a recession), you might decide to quietly release that news at the end of the day on a Friday, and hope that it doesn't get much play on the weekend news shows. That is exactly what happened on Friday, August 21.

At the end of the day on Friday, August 21, a senior White House official announced that the Office of Management & Budget had revised its deficit forecasts for 2010-2019 from $7 trillion to apprx. $9 trillion. At long last, that puts Obama's forecast in line with the CBO's forecast.

Obama Administration officials acknowledged that they relied on overly optimistic assumptions about the economy when they forecast in March that President Barack Obama's budget plans would generate deficits of $7.1 trillion over the next 10 years. After factoring in the severity of the recession and the prospect of a more sluggish recovery, the White House concluded that the budget outlook is significantly worse and revised the 10-year tally of deficits to $9.05 trillion.

Some in the media welcomed the presumably more accurate deficit forecast; some even went so far as to note that such huge spending will be just fine, such as liberal commentator Paul Krugman of the New York Times. Others, however, were quite critical and seriously questioned how the Obama Administration could have been off by $2 trillion in its forecast.

The conservative Weekly Standard published a scathing article on August 31. Here are some excerpts:

"What's $2 Trillion Among Friends?

$2,000,000,000,000. That's the amount by which the Obama administration raised its ten-year estimate of the nation's budget deficit from the one it made only a few months ago. Now, $2 trillion is a lot of money. But even more significant is the fact that this revision represents almost a 30 percent increase -- no tiny percentage of the earlier $7 trillion figure. It seems that expenses are higher -- up 24 percent this year, the largest increase since the height of the Korean War -- than originally estimated, and revenues are lower. The resulting deficit, says Peter Orszag, Obama's budget director, is ‘higher than desirable'. He might have added that the administration's critics had it right when they claimed that the earlier estimate represented a turn around the dance floor with that old seductress, Rosy Scenario.

There's worse: the new estimate assumes that Medicare and Medicaid spending will be cut by $622 billion, even though Congress has made it known that it is reluctant to make any such cut. Then there is the $600 billion in revenue included for the sale of [carbon] emission permits, despite the fact that the House has given away so many permits in order to buy support for the cap-and-trade emission-reduction that the program will produce at most $450 billion. Those two items alone come to almost another trillion dollars in red ink. Throw in another trillion-plus for Obamacare, and it is no surprise that senior economist Bill Gale, at the liberal Brookings Institute, says that the deficit will hit over $10 trillion over the next decade, a figure he finds ‘deeply alarming'.

This year, the deficit will come to 11.2 percent of GDP, and by 2019 the [national] debt will be equal to 76 percent of the [projected] value of the nation's output of goods and services, almost double the 41 percent when Obama took control of the nation's finances. No problem, say White House economists. Unsustainable, says Warren Buffett, among others."

Economic Assumptions Still Too Optimistic

Warren Buffet is absolutely correct. Whether it's $7 trillion or $9 trillion, it's way too much and unsustainable. Over the next five years alone, 2010-2014, the debt swells by $4.5 trillion. In fact, these projections could actually be too low based on the economic forecasts used in the projections. I should point out that this is not just an Obama phenomenon. White House budgets, whoever was president, have been laced with optimism, and no president has forecast a recession in these 10-year projections.

(By the way, all presidential administrations produce these 10-year forecasts on spending, revenues and the budget deficits/surpluses, even though they won't be in office 10 years from now.)

Consider the latest OMB projections for growth in GDP in the next several years in real terms, exclusive of inflation. The White House projects that GDP will grow by 3.8% in 2011 and climb above 4% a year for the next three years, followed by two years above 3%. This is far higher than historical norms; the economy has not seen such a period of growth since the 1960s.

And we can almost be assured of at least one more recession, if not two, over the next 10 years, what with the government running massive deficits every single year. Remember, the Fed will have to unload some $2 trillion in troubled assets at some point in the next few years. And, most forecasters agree that at some point, foreigners are going to curtail US dollar purchases, which will likely drive interest rates higher, at the least, or a currency crisis at the worst.

Excessive Obama optimism is not limited to economic growth. Despite the enormous monetary stimulus pumped out by the Federal Reserve in 2008-2009, bank credit that is widely regarded as potentially inflationary, the Obama administration assumes that inflation will actually decline from 2.1% in 2008 to 1.5% in 2009 and then to 1.3% in 2010 and 2011, and not rise above 1.8% through 2019. While it is true that inflation is declining now, thanks largely to the big drop in energy prices over the last year, we are almost certain to see higher inflation down the road.

What in the World Are They Thinking?

Most Americans that keep up with the economy and rising government spending, even remotely, are very alarmed about the exploding debt that President Obama has proposed for the next decade. Many of us wonder, what in the world could they be thinking? Do they want to purposely wreck the US economy? Frankly, I'm beginning to think so, as I will discuss later on.

Here is a snapshot of how many liberals on the left think about the perpetual rise in government spending and exploding deficits over the next decade. What follows is an August 23 editorial in the New York Times by liberal commentator Paul Krugman. He boldly attempts to explain why Obama's massive spending and deficits won't be a problem. He is wrong, of course, and I have inserted many bracketed words to help his column be more readable. I will elaborate afterward:

"How big is $9 trillion?

There's been some hysteria [no kidding] about the [Obama] administration's new estimate that the cumulative deficit will be $9 trillion over the next decade. Don't get me wrong: this is bad. But it's being treated as an inconceivable sum, far beyond anything that could possibly be handled. And it isn't. [really?]

What you have to bear in mind is that the economy — and hence the federal tax base — is enormous, too. Right now GDP is around $14 trillion [annually]. If economic growth averages 2.5% a year, which has been the norm, and inflation is 2% a year, which is the target (and which the bond market seems to believe), GDP will be around $22 trillion a decade from now. So we're talking about adding debt that's equal to around 40% of GDP [this figure is bogus - see comments below].

Right now, even if we do run these [trillion dollar annual] deficits, federal debt as a share of GDP will be substantially less than it was at the end of World War II. It will also be substantially less than, say, debt in several European countries in the mid to late 1990s. (There are some technical issues in comparing these various numbers — gross debt versus net (mainly about Social Security) and overall government debt versus federal, but they don't change the basic picture.)

Again, the debt outlook is bad. But we're not looking at something inconceivable, impossible to deal with; we're looking at debt levels that a number of advanced countries, the US included, have had in the past, and dealt with."

Wow! So record trillion dollar deficits don't matter, Mr. Krugman? There are so many ways to debunk this article, I almost don't know where to start. Let's first look at Krugman's most egregious misrepresentation. In the second paragraph, he states that the $9 trillion in new debt will be only 40% of GDP by 2019. What he fails to note is that we already have $11.7 trillion in national debt today. If we add another $9 trillion, the debt will be $20.7 trillion - or 94% of GDP - by 2019!! Nice try, Mr. Krugman.

Second, it's a lame attempt to compare the economy today with the period just after World War II. We had the most robust economic growth in history just after WWII when we were rebuilding Europe, veterans were buying homes, durable goods, cars, etc. as never before and our manufactured goods faced very little foreign competition. May I remind you, Mr. Krugman, that we are not in that position today!

Third, why should we all just assume that the US economy will average 2.5% annual growth over the next 10 years, despite doubling the national debt, just because it is some historical average? As discussed earlier, we will almost certainly see another recession in the next decade, as foreign buyers of our massive debt may require higher interest rates or dump the US dollar.

Do you honestly believe the US economy will grow by 2.5% annually for the next 10 years when consumer spending is stagnant and Americans are increasing savings at the highest rate in over a decade? We've just been through the worst financial crisis since the Great Depression, and we are very likely looking at several years of below-trend economic growth. On top of that, if we spend the $9 trillion, taxes will have to go up on almost all Americans at some point, which is also bad for the economy.

Like your liberal cronies, you make these assumptions and leave out certain facts to justify your belief that bigger government and higher taxes are the answer to all of our problems. Mr. Krugman, take a look at Social Security, Medicare and Medicaid - and more recently President Bush's prescription drug program. Give me one example of how these government-run programs have been anything but a fiscal disaster. You can't.

Finally, Mr. Krugman (in case you happen to read this), let me say that I enjoy reading your columns and watching you on the TV talk shows. You give me insight and understanding as to the thinking of those on the far left.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Do They Want Control Even If It Ruins The Economy?

As noted earlier, I have thought about this question for many years. Why do the liberals want the government to control most everything in the economy and our lives? While members of Congress have the best healthcare in the world, they will have dozens of family members and friends and countless colleagues that will be subject to the House healthcare bill, if it is passed. So why are they so hell-bent on passing it?

The answer can only come down to two questions. Question #1: Do they really believe that their proposed national heathcare program is the very best we can offer the American people? And if so, why doesn't Congress adopt it for themselves? Or Question #2: Is this really just a massive power grab that puts the government in control of our healthcare and our lives?

President Obama would like us to believe that nothing will change if healthcare reform is passed - that if you like your current insurance plan, you can keep it. But that is patently false and abundantly clear if you read the onerous House healthcare bill, or even just the highlights that are readily available on the Internet. If they ram this down our throats, I firmly believe that the quality of our healthcare will suffer and the costs will far exceed any estimates being put forth by President Obama and the Democrats.

At the end of the day, I have to conclude that nationalizing healthcare (one-sixth of the US economy) is nothing more than a giant power grab by the liberals. In addition, if our government racks up $10+ trillion in cumulative deficits over the next 10 years, as Obama proposes, we are on our way to financial ruin.

Bill Clinton never scared me; he was too much of a political animal to swerve too far from the center. Unfortunately, the same could be said of George W. Bush, who routinely strayed from his supposedly conservative principles. Not so with President Obama. Sadly, many of those who voted for him did not do their homework or they would have known that he is a left-wing ideologue, as I warned in these pages last year.

Sorry to end on such a negative note, but it is what it is.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Federal deficits to bankrupt America
http://washingtontimes.com/news/2009/sep/04/looking-behind-the-curtain/

ObamaCare's Crippling Deficits
http://online.wsj.com/article/SB10001424052970203585004574393110640864526.html

Massachusetts & the ObamaCare Mistake
http://www.realclearpolitics.com/articles/2009/09/05/obamacare_increases_costs_wait_times_98176.html

Obama Cannot Escape Hard Choices in September
http://www.realclearpolitics.com/articles/2009/09/07/obama_cannot_escape_hard_choices_in_september_98192.html

When Does the Spending Charade End?
http://www.ibdeditorial.com/IBDArticles.aspx?id=336955542241664

Is The Recession Over? Don't Bet On It

Gary D. Halbert — Tue, 18 Aug 2009 22:12:00 GMT

IN THIS ISSUE:

Economic Signs of Improvement
Fed Vows to Keep Rates Low
Market Comments from John P. Hussman, Ph.D.
Conclusions

Introduction

We have seen some encouraging economic news in recent weeks, and President Obama and his cronies in the mainstream media have declared that the worst recession in post-war history is all but over. The advance estimate of 2Q GDP was down considerably less than expected (-1.0%); the unemployment rate actually fell slightly in July to 9.4%; and the ISM manufacturing index posted a nice improvement last month.

While these reports were better than expected, and continue to suggest that the worst of the recession is behind us (as I have suggested often in recent weeks), this economy is far from out of the woods yet. Growth prospects continue to look muted, although a growing number of forecasters are suggesting that GDP will register a positive number in the 3Q due largely to the rebuilding of inventories, as I discussed in my August 4 E-Letter.

This week, we will look at the latest economic reports, as well as the Federal Reserve's latest decision on interest rates and purchases of Treasury securities. Also, the Fed says it will end its record large purchases of government agency debt in October. If indeed this happens, it will be the first step in ending the Fed's massive stimulus spending.

Next, so that we don't all get caught up in the latest hype that the recession is over, I will reprint excerpts from a recent Weekly Market Comment written by John P. Hussman, Ph.D. Dr. Hussman is best known as the president of Hussman Investment Trust, and he manages the Hussman Strategic Growth and Hussman Strategic Total Return Funds, which are actively managed and can go to cash in bear markets.

Dr. Hussman's latest analysis is consistent with the view many of us have that the recession, while improving in some areas, is not over yet, and that the ensuing economic recovery over the next year or longer will be disappointing -- even if there is a bump up in the 3Q. All of this should make for interesting reading, so let's get started.

Economic Signs of Improvement

Over the last several weeks, we've seen some encouraging economic reports. In some cases, "encouraging" simply means that the reports weren't as negative as expected. That was certainly the case with the advance 2Q GDP estimate at the end of June, which showed a decline of only 1% (annual rate) versus pre-report estimates which were considerably worse. Some analysts expect that number to be revised downward somewhat when the second estimate is released later this month.

On the manufacturing front, the ISM Index rose more than expected in July to 48.9, up from 44.8 a month earlier. Industrial production rose 0.5% in July, and construction spending and the factory operating rate both rose modestly last month as well. These are all signs that the recession may be leveling out.

On Thursday of this week, we get the latest Index of Leading Economic Indicators (LEI) for July, and the pre-report consensus is for a rise of 0.6%, following +0.7% in June. If the LEI is up for July, that will mean the fourth consecutive monthly increase. That would be very encouraging and a sign that we will likely be out of this recession by the end of the year.

The US unemployment rate unexpectedly dropped from 9.5% in June to 9.4% in July, as employers slashed 247,000 jobs, the slowest rate of decline in nearly a year. This news temporarily sent stocks to their highest level of the year since the pre-report consensus was for a rise to 9.6%

However, the July decline in the jobless rate came about not because more people had jobs, but because almost 800,000 "discouraged workers" - people who have essentially given up on looking for a job - were not counted as unemployed, thereby allowing the official unemployment rate to fall modestly in the latest jobs report. The number of long-term unemployed people - those who have been out of a job but looking for more than 26 weeks - rose by another 584,000. Thus, it appears we are still headed for 10% employment before this cycle reverses.

Despite the still troubled employment situation, investors welcomed the reports above, and more and more forecasters have apparently decided that the recession is over. I continue to believe that we are still at least a few months from concluding that the recession has ended. The Consumer Confidence Index fell for the second month in a row in July, and retails sales were down slightly last month. Therefore, it is premature to declare that the recession is over.

Fed Vows to Keep Rates Low

To no one's surprise, the Federal Open Market Committee (FOMC) announced last Wednesday that it will continue its policy of keeping interest rates at their historically low levels. The FOMC also maintained its position that interest rates could remain historically low for an "extended period of time." In other words, the floodgates of liquidity are still wide open.

About the only new revelation was that the Fed announced that it will stop buying long-term Treasuries in October of this year. This could be the ultimate case of good news/bad news, in that it's good that the Fed may no longer be printing money to buy Treasuries, but bad in that these securities will soon have to compete in the open market, and this could lead to higher interest rates. Remember that this is why the Fed committed to start buying Treasuries in the first place.

However, the Fed's printing press will not be idle as it said it will continue to purchase up to $1.25 trillion in agency mortgage-backed securities and other agency debt from Fannie Mae and Freddie Mac. The Fed's hope here is to keep a lid on mortgage rates in an effort to stimulate the housing market.

From an economic standpoint, the latest FOMC statement notes that US economic activity is "leveling out," meaning that the rate of descent has slowed. However, this simply means that the recession may not get deeper. The Fed's prospects for recovery, however, were modest, at best. The Fed expects economic activity to remain weak "for a time" (whatever that means) and a return to sustainable economic growth is likely to be gradual.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Market Comments from John P. Hussman, Ph.D.

Dr. John Hussmanis best known as the president of Hussman Investment Trust (a mutual fund family), and he manages the Hussman Strategic Growth and Hussman Strategic Total Return Funds. Dr. Hussman is also the chairman, president and controlling shareholder of Hussman Econometrics Advisors, Inc. which has published his Weekly Market Comment letters for years, and they always have some interesting points about the economy, the markets, etc.

As a mutual fund manager, Dr. Hussman is somewhat unique in that he not only actively seeks the best opportunities in the stock market, but will also move to neutral positions in his funds during market downturns. In other words, the investment strategies he employs are similar to those used by the active money managers my firm recommends.

The following excerpts are from Dr. Hussman's August 10, 2009 Weekly Market Comment. [Note that we have removed discussions about specific funds where possible.] Pay particular attention to Dr. Hussman's outlook for the economy.

QUOTE:

The U.S. economy lost a quarter of a million jobs in July. Meanwhile, over 400,000 workers abandoned the labor force (and are therefore no longer counted among the unemployed), which prompted a slight decline in the unemployment rate despite the job losses. In the context of an economy still strained by high levels of consumer debt and still record delinquency and foreclosure rates, labor market conditions are still troublesome. Still, the pace of job losses and new unemployment claims has clearly softened from the pace we observed early in the year.

If we knew that this was a standard economic downturn, we might conclude that the recent improvements are durable. However, nothing convinces us that this is a standard economic downturn. As for market action, the major indices have generally been strong, as has breadth (as measured by advances versus declines), but the "investor sponsorship" evident from trading volume has been uncharacteristically dismal compared with initial advances of past bull markets. So here too, we have very strong concerns that the recent advance may not be as durable as investors appear to believe.

All of that said, we aren't inclined to fight even what we view as errant analysis, and the Strategic Growth Fund has about 1% of assets allocated to near-the-money index call options -- about enough to gradually close down about 40% of our hedge in the event that the market advances markedly higher from here, but without putting us at risk of much loss in the event of failure. With investors now anticipating and pricing in a sustained economic recovery, as well as a spectacular earnings rebound, a lot of things will have to go right from here in order to sustain higher prices than we currently observe.

Frankly, our call option allocation here is something of a paean to a notion -- a sustained economic recovery and new bull market -- that I have no belief in whatsoever. But at this point, the broad strength in the major indices, even lacking volume sponsorship or favorable valuation, requires that we allow for the possibility of additional investor speculation. Even if we do observe such an outcome, it's difficult to envision that the S&P 500 will clear the 1000 level for all time, without revisiting it again in the months (not to mention years) ahead. To the extent that we don't clear 1000 permanently, establishing investment exposure here with anything but call options amounts to a game of trying to "ride" the market higher and to get out before it returns to or below current levels. With the market strenuously overbought already, that game strikes me as exquisitely difficult to get right. Hence the use of a modest allocation to call options only, without closing our downside hedges.

Call me skeptical. But if you look carefully at the economic data that shows improvement, and correct for the impact of government outlays, it is difficult to find anything but continued deterioration in private demand and investment. What we do see is a government that has run what is now a trillion dollar deficit year-to-date, representing some 7% of GDP. That sort of tab will undoubtedly buy some amount of Cool-Aid, but it has been something of a disappointment to watch how eagerly investors have guzzled it down. It is not at all clear that short-term, deficit-financed improvement necessarily implies sustained growth in the context of a deleveraging cycle. This is like somebody borrowing money from their Uncle and then celebrating that their income has gone up.

Moreover, it might be enticing to look at a chart of the S&P 500 and envision a quick return to 2007 highs and beyond, but it is important to recognize that those highs were based on profit margins about 50% above historical norms, combined with an elevated P/E multiple of about 19 against those earnings. Even if the economy is poised for a sustained recovery here, the belief that those joint outliers will be quickly re-established goes against historical precedent.

In any event, we've got some call option coverage to gradually allow participation if this run continues.

Post-Crash Dynamics

When markets crashes are coupled with changes in the fundamentals that supported the preceding bubble -- as we observed in the post-1929 market, the gold market of the 1980's, and the post-1990 Japanese market, and currently observe in the deflation of the recent debt bubble -- they typically do not recover quickly. Indeed, the hallmark of these post-crash markets is the very extended sideways adjustment that they experience, generally for many years.

The chart below updates the position of the S&P 500 (red line) in the context of other post-crash bubbles. The horizontal axis is measured in months. Note that very strong and extended interim advances have been part and parcel of similar experiences.

The intent here is not to argue that the U.S. stock market must by necessity follow the same extended adjustment that followed prior burst bubbles. Rather, the intent is to underscore that it is dangerous to infer that structural difficulties have vanished simply because a market enjoys a strong post-crash advance.

My friend James Montier at SocGen draws a similar pattern from a larger historical collection of post-crash bubbles - including the above instances, as well as others such as the South Sea Bubble and the Railroad Bubble of the 1840's. The underlying theme is that the adjustment period following the bursting of a bubble tends to be very extended.

I understand the eagerness of investors to put the entire credit crisis behind them and look ahead to a recovery of the prior highs, but these hopes are based on the assumption that a positive boost to GDP, once achieved, will propagate into a full-fledged recovery. Again, however, no economic improvement is evident in the behavior of consumer demand and capital spending, once you adjust for the impact of government spending (particularly transfer payments).

Yes, we have observed a massive reallocation of global resources from savers (who have bought newly issued Treasury debt) toward mismanaged financial institutions that made bad loans. Yes, there are certainly favorable short-run economic numbers that can be achieved by running a year-to-date federal deficit equal to seven percent of the U.S. economy. The problem is that this money does not come from nowhere. We have effectively sold an identical ownership claim on our future production to those individuals and foreign governments who bought the Treasuries. Government "stimulus" is not free money. The continued attempt to bail out bad loans with good resources (largely foreign savings) will end up costing our nation some of our most productive assets, which will be acquired by foreign countries and investors for years to come.

From my perspective, investors have gotten entirely too far ahead of themselves with the assumption of a sustained recovery. Nevertheless, we again have about 1% of assets in index call options to allow for further market strength if it emerges. I expect that if they move "in the money," we will leave their strike prices unchanged unless market internals deteriorate measurably. Leaving our call option strikes fixed would open us up to losing on any subsequent downturn whatever we make on a further advance, but again, our opening exposure is fairly limited. We'll let the market put us into a more constructive position if investors are inclined to continue their exuberance here. [Emphasis added, GDH.]

Market Climate

As of last week, the Market Climate for stocks was characterized by unfavorable valuation and mixed market action, but enough evidence of speculation (reasonable or not) to own about 1% of assets in index call options. We are otherwise hedged.

During earnings season, there are often days where most of the performance of the Fund is driven by significant movement in a small handful of Fund holdings. These movements can be positive or negative, and may cause the Fund to move differently than one would expect that the Fund "should" move based on our investment position, and on what the market did on a particular day. As I've frequently noted, short-term movements, particularly day-to-day, are not effective indicators of the Fund's investment position, or predictors of Fund performance. Performance is always best measured from the peak of one market cycle to the peak of the next, or over an extended period of years representing neither a peak-to-trough nor trough-to-peak movement in the market.

Based on our standard methodology, which considers normalized earnings (not the far more depressed level of current earnings) the S&P 500 is now priced to deliver 10-year total returns in the area of 6.9% annually. This is a figure that has historically been associated with bull market peaks, including 1969 and 1987. In most instances, such valuations turned out badly in reasonably short order. It is, however, true that prospective returns were even worse prior to the 1929 crash, and during the bulk of the period since 1996, so there have been some historical periods where speculators have driven valuations to higher levels, and during these times, it has not been particularly effective to stand in front of speculators saying ‘no, stop, don't.' [Emphasis added, GDH.]

Ultimately, all of those periods where valuations were driven to higher levels were followed by poor long-term returns, with stocks generally trading at lower levels at some point one or more years later. So we can say with a reasonable degree of confidence that even if the present advance continues, investors will most likely observe current levels again either within the current market cycle or (worse) several years out. Overvalued markets simply do not "run away" for good. Still, it can be painful or at least unenjoyable to remain defensive during a speculative advance.

In bonds, the Market Climate last week was characterized by relatively neutral yield levels and moderately unfavorable yield pressures. As usual, we will tend to increase our bond durations on spikes in yield (weakness in bond prices), and these are becoming more interesting -- though not strongly attractive. Our most recent extension of durations was in the 3.9%-4% area for 10-year Treasuries, and a push materially above that level would represent enough of a yield pickup to move a modest amount of short-maturity Treasury allocations into mid-maturities. As I've noted in recent weeks, we don't anticipate much in the way of extended directional movement in the bond market, so most of our portfolio activity will probably tend to be modest reallocations in response to yield fluctuations. At the point where we observe either fresh inflation pressure or general declines in Treasury yields (i.e. general downward pressure on real interest rates), I expect that we'll observe fresh pressure on the U.S. dollar and upward pressure on precious metals shares. For now, those markets are likely to be somewhat range-bound as well.

We've got an extended economic adjustment ahead. Most probably far longer than most investors presently expect. As always, we'll take our opportunities as the evidence emerges, with the objective of outperforming our respective benchmarks over the complete market cycle, and an additional emphasis on defending capital over the course of that cycle. [Emphasis added, GDH.]

END QUOTE

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

While we have seen some encouraging economic reports over the last few weeks, it is premature to declare that the recession has ended. As discussed above, the unemployment rate is very likely to rise even higher before this cycle is over. Remember that consumer spending is still the main driver of this economy, and retail sales fell slightly in July well below the pre-report consensus. The Consumer Confidence Index fell a second month in a row in July.

On the positive side, the Fed remains committed to keeping interest rates very low for an extended period, and liquidity is plentiful for now. If this Thursday's Leading Economic Indicators report is positive, that will market the fourth consecutive monthly increase, which will be a very good sign that the recession will end by the end of the year.

I agree with Dr. Hussman that stocks are overbought at this point, as many investors who bailed out in February and March are now jumping back in. The stock market has felt like a mini-bubble since the March lows and especially in July. Thus, I would not be surprised to see the downward correction that began last week to continue in the weeks ahead.

Finally, I recently told you about our online webinar featuring the Potomac Guardian Program on August 6th. We had hundreds of investors register for the webinar and it was well-received. If you were unable to attend this webinar but would still like to learn more about the Potomac Guardian Program and its investment strategy, you can now find a recorded version on our Internet website at www.halbertwealth.com.

Wishing you profits in a difficult market,

Gary D. Halbert

SPECIAL ARTICLES

Stocks: Five Key Signals for Investors
http://www.businessweek.com/investor/content/aug2009/pi20090817_099111_page_2.htm

Why Obama's Ratings Are Sinking
http://online.wsj.com/article/SB10001424052970204683204574354383543314054.html

Public Spending's Day Of Reckoning
http://www.forbes.com/2009/08/12/public-spending-finances-economy-debt-opinions-contributors-desmond-lachman.html

Recession May End But Growth Prospects Low

Gary D. Halbert — Tue, 04 Aug 2009 21:25:00 GMT

IN THIS ISSUE:

Finally, Some Good News For The US Economy
More Insights From The Latest GDP Report
Media & Obama Declare The Recession Is Ending
Consumer Spending Is Still The Key
100+ Hedge Fund Managers Offer Their Predictions

Introduction

The Commerce Department announced last Friday that the US economy contracted less than expected in the 2Q. According to the "advance" estimate, Gross Domestic Product declined at an annual rate of only 1% in the April-June quarter. This is considered to be good news since the rate of decline was below the pre-report consensus. Never mind that the better than expected number was almost entirely due to greatly increased federal spending in the 2Q. Also, never mind that the government announced that 1Q GDP was worse than previously reported.

The latest GDP report has caused many economists and analysts to declare that the recession is ending. Yet the report noted that most sectors of the economy and consumer spending are still contracting. While I would say that it is still too early to declare that the recession is ending, the latest data strongly suggests that we've seen the worst of this recession/credit crisis. We will look at the latest economic numbers and draw some conclusions as we go along.

While it is possible that the recession will end in the 3Q and GDP could go into mildly positive territory, the unemployment outlook is likely to get worse for at least the rest of this year and possibly through the first half of 2010. Even President Obama conceded recently that the unemployment rate will almost certainly rise above 10% by the end of this year. Thus, we're looking at another "jobless recovery" if we indeed pull out of this recession later this year.

Next, as we all peer into the likely economic outlook for the balance of this year and next year, and try to formulate our investment strategies accordingly, I will summarize the latest survey of the nation's largest hedge fund managers. What are they thinking about the economy and the investment markets; where are they positioning their assets now; and what do they think are the greatest risks down the road? I think you'll find their predictions very interesting.

Finally, Some Good News For The US Economy

Last Friday, the Commerce Department announced that the US economy contracted less than expected in the 2Q. According to the "advance" estimate, Gross Domestic Product declined at an annual rate of only 1% in the April-June quarter. The GDP report came as a surprise to many, since the pre-report consensus suggested a decline of at least 1.5%, and many (including your editor) expected a decline of 2-3% for the 2Q. Of course, this is the first of three estimates on 2Q GDP, so it could well be revised lower over the next two months. Even so, this is good news for the economy.

According to the latest report, GDP fell less than expected in the 2Q primarily due to the large increases in government spending. The Commerce Department report cited that the decrease in real GDP in the 2Q primarily reflected negative contributions from business investment, personal consumption expenditures, inventory contraction and exports. According to the report, these negative influences to GDP in the 2Q were mostly offset by positive contributions from the increase in federal government spending and to a lesser extent by state and local government spending, and a decrease in imports.

The fact that the economy declined by less than expected in the 2Q primarily due to increased federal spending and falling imports is certainly not the desired scenario. But after four consecutive quarters of negative GDP growth, investors were happy to see a drop of only 1% in the 2Q. Consumer spending, which makes up apprx. 70% of GDP, continued to fall in the 2Q, but again not as much as had been feared. Personal consumption expenditures fell 1.2% in the 2Q, which means that consumer spending is still on the decline, but somewhat less than pre-report estimates.

The latest GDP report was indeed better than expected, even if most of the improvement was due to increased federal spending. Unless you've been hiding under a rock over the past few days, you have no doubt heard the mainstream press cheering that the recession is ending and that happy days lie ahead. While we probably have seen the worst of the recession, we need to look at the latest numbers to get a better insight as to the bigger economic picture.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

More Insights From The Latest GDP Report

As noted above, last Friday's 2Q GDP report was better than expected, even though it showed that the economy contracted at a -1% annual rate in April-June. All the news in the report, however, was not so encouraging. The Commerce Department revised down its GDP report for the 1Q of this year from -5.5% to -6.4%. This means that the January-March quarter was considerably worse than earlier reported.

I should also note that the Commerce Department upwardly revised GDP for the 4Q of last year from –6.3% to –5.4%, which largely offsets the downward revision for the 1Q of this year as noted in the previous paragraph. Most notably, however, the Commerce Department also substantially revised the GDP number for the 3Q of 2008 downward to a negative 2.7% annual rate. This was a huge revision that was not expected. Thus, we have seen four consecutive negative quarters in GDP in the last year alone: 3Q 2008 – down 2.7%; 4Q 2008 – down 5.4%; 1Q 2009 – down 6.4%; and 2Q 2009 – down 1.0%.

This makes the current recession the worst since WWII, eclipsing even the previously worst recession in 1981-82.

In addition to the headline GDP numbers noted above, last Friday's report also revealed that consumer spending declined in the 2Q. Personal consumption expenditures (PCE) fell by 1.2% in the 2Q following the very modest increase of 0.6% in the 1Q. This was well below the pre-report consensus that was looking for an increase of 2.4% in consumer spending in the 2Q. So much for the widely heralded rebound in consumer spending, but we should not be surprised given that consumer confidence turned lower once again in June.

Other indicators in the latest GDP report also suggest that the recession is not over yet. Durable goods orders decreased 7.1% in the 2Q, while non-durable goods orders decreased 2.5 percent, in contrast to an increase of 1.9% in the 1Q. Non-residential fixed investment decreased 8.9% in the 2Q, while non-residential structures decreased 8.9%. Equipment and software purchases decreased 9.0%. Exports of goods and services decreased 7.0%, while imports of goods and services decreased 15.1% in the 2Q. And the list of negatives goes on.

How is it then that GDP fell only 1% in the 2Q? Answer: increased federal spending. According to the GDP report, federal government consumption expenditures and gross investment increased 10.9% in the 2Q, compared to an increase of 4.3% in the 1Q. While we can all be happy that GDP fell less than expected in the 2Q, there is little comfort in knowing that the main reason for the better number was increased government spending.

Media & Obama Declare The Recession Is Ending

Many in the mainstream media wasted no time last Friday in predicting that the recession is ending, if it hasn't ended already. Since the 2Q GDP number was only down 1%, many now predict that 3Q GDP will almost certainly be a positive number. Predictably, President Obama took to the microphone on Friday afternoon to announce that we are now seeing the light at the end of the economic tunnel, and he attributed the better than expected GDP report to his $787 billion stimulus plan, even though only around 10% of the money has been spent.

[Editor's Note: FYI, more and more analysts are coming around to the idea I suggested in my July 21 E-Letter, that the government should scrap the apprx. 90% of the $787 billion that has not yet been spent. As an example, see the Investor's Business Daily editorial in SPECIAL ARTICLES below. Of course, this will never happen because Obama and the leaders in Congress can't wait to spend that money on their pork barrel projects.]

The latest argument for the recession ending now goes as follows. Since the Commerce Department revised 3Q 2008 GDP down sharply to -2.7%, this means that the worst of the recession started sooner than we thought. For some reason that I cannot discern, this is supposed to mean that the recovery from the recession will end sooner than we think – as in now.

Adherents to this suggestion point to the fact that the Index of Leading Economic Indicators has risen for the last three months in a row. Likewise, home sales and housing starts have risen modestly over the last three months in many parts of the country. No doubt, these are signs that the worst of the recession may be behind us, but they are no guarantee that the recession has ended. Nevertheless, there are now widespread forecasts that GDP will go positive for the 3Q.

There is, actually, a credible reason that GDP could manage a positive uptick in the 3Q. Given the severity of the recession and the credit crisis, businesses across America have slashed inventories dramatically. According to the latest GDP report, US businesses have cut back inventories by almost $300 billion in the four months ended in June. Most analysts had expected that inventory rebuilding would have begun in the 2Q, but in fact inventories continued to contract in the 2Q.

At some point, businesses will have to rebuild inventories, and some of my best sources believe that a modest rebuilding has begun in the 3Q. Companies that have weathered the worst of the recession and remain afloat will likely have to rebuild their inventories at some point just to stay in business. Plus, federal spending will remain high going forward, so it would not be a surprise to see a positive number in 3Q GDP. But we will not see the first advance report on 3Q GDP until late October. Unfortunately, a modestly higher GDP number for the 3Q will not necessarily mean that the recession is over.

Consumer Spending Is Still The Key

Personal consumption expenditures fell sharply in 2008 as a result of the housing slump, the credit crisis and the bear market in stocks. While there was a modest bump (+0.6%) in consumer spending in the 1Q of 2009, as noted above the latest GDP report showed that personal consumption expenditures declined 1.2% in the 2Q, well below expectations.

As I have noted in recent letters, not only are consumers holding back on unnecessary expenditures, they are also boosting their savings. It is now estimated that the national saving rate has climbed to 7% and may be headed even higher. Consumers remain fearful about the rising unemployment rate and the continued record rise in home foreclosures.

Unemployment typically continues to rise even after GDP starts to increase, so pain for workers is far from over. As noted above, even President Obama concedes that the US unemployment rate is headed to 10%, and it may well go even higher next year. The Labor Department noted that already 144 of America's 372 largest metropolitan areas reported unemployment rates of at least 10% in June. Rising unemployment will mean less shopping and a slower recovery.

While we have seen some mildly encouraging reports on home sales over the past few months, the home foreclosure rate continues to set new record highs. Just two years ago, the prediction was that only about two million Americans would lose their homes to foreclosure, a prediction based on the number of subprime mortgage loans with pending interest rate resets.

As we know now, however, more than five million homes have been foreclosed on since 2007, and there were more than 336,000 foreclosure filings in June alone according to RealtyTrac. Thus, it is now predicted by some that ten million homes will be foreclosed on before this cycle is over. If that is remotely correct, we are only about half way through the cycle.

With the unemployment rate and the foreclosure rate continuing higher, I don't think we will see consumers boosting spending significantly anytime soon. The latest consumer confidence numbers show that Americans are still jittery, with the Confidence Index falling from 49.3 in June to 46.6 in July.

Bottom line: The recession may well end later this year, but the recovery is likely to be disappointing. Those who are suddenly predicting 2-3% GDP growth in the 3Q and 4-5% in the 4Q are way too optimistic in my opinion.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

100+ Hedge Fund Managers Offer Their Predictions

The accounting firm RSM McGladrey recently published the results of their inaugural Hedge Fund Industry Survey. The survey, representing the thoughts and opinions of 102 hedge fund managers, offers some interesting findings about the state of the industry and their predictions for the economy, the investment markets and real estate.

You may be wondering why you should care what hedge fund managers think. After all, the mainstream press continually demonizes them with terms like "secretive," "risky," "unregistered" and a whole host of other dubious adjectives. In the latest stock market crash, hedge funds were singled out for their shorting of bank stocks (a strategy that can actually make money on a falling stock), which some said helped to accelerate the stock market's fall in the last quarter of 2008.

And let's not forget notorious hedge fund managers such as George Soros, who is known for being the man who "almost broke the Bank of England" in 1992, or Long Term Capital Management, a hedge fund managed by Nobel Prize-winning economists that almost caused a global financial crisis in 1998. These and other widely publicized implosions, coupled with the complexity and restricted availability of such investments, have generally cast hedge fund managers in a bad light, at least in the mainstream media.

Yet the 102 hedge fund managers surveyed by McGladrey represent some of the brightest and most successful minds in the investment world. Some of these managers are very adept at reading the economic tea leaves, especially as they relate to the markets. This not only helps them to make money for their clients, but to make money themselves since they typically base their fees on a share of client profits. No profits, no pay. Thus, you can bet that the future prospects for the global economy continue to be where hedge fund managers are concentrating their research, and why we want to peek over their shoulders through this survey.

A good portion of the survey deals with the new regulatory oversight of hedge funds that Obama has proposed and the managers' reactions to it, since heretofore hedge funds have been largely unregulated. It was surprising to see that 42% of the respondents felt that the SEC needs additional regulatory authority to do its job effectively, while 50% said the agency should simply be better funded to enforce existing rules, not make a lot of new ones.

While we might think all hedge fund managers would resist additional regulation of the funds they manage, another surprising result was that 37% of respondents believe there should be more regulation of hedge funds versus only 18% who said less regulation is needed. 43% of respondents believe that the current regulatory environment is the right amount.

However, hedge funds are now in the crosshairs and Congress will no-doubt put them on a shorter leash. Knowing this, 75% of those surveyed worried about the regulatory pendulum swinging too far and becoming so restrictive that it stifles the markets. Note that this includes some of those managers who believe that additional regulatory oversight is needed.

All in all, these results actually seem to indicate that a much larger segment of hedge fund managers are open to greater regulation than we might have thought. However, I think the real meat of the survey is in their outlook for the future of the economy and markets. 60% of respondents think that the current economic environment presents more investment opportunities than challenges. Knowing that some hedge funds "short" stocks in declining markets, a bear market expectation could be viewed as an investment opportunity for some funds. Thus, we need to look deeper into the survey's findings.

To begin with, 57% of hedge fund managers surveyed believe that the economy is now headed in the right direction (recession ending fairly soon), even though 83% of hedge fund managers believe that the unemployment rate will continue to rise, and 65% believe that consumer spending will decrease in the next 12 months. Over 80% of hedge fund managers believe that government spending, the Fed's balance sheet and tax rates (income and capital gains) will all continue to increase over the coming year. This explains why 42% believe the economy is still headed in the wrong direction.

Elsewhere, 59% believe that the stock markets have bottomed and are on the right track. However, respondents also acknowledge that there are still dangers lurking in the bushes that could derail the recovery. For example, 82% of respondents see both interest rates and inflation rising over the next year. While less than 20% expect either to increase "a lot," they acknowledge that the Fed faces a very difficult challenge on both fronts.

Since prospects for the stock markets generally depend upon the health of the economy, the survey asked hedge fund managers when they thought the US economy would return to positive growth. 33% of respondents felt that the economy would have positive growth by the end of 2009. 58%, however, believe that the US economy won't return to positive growth until sometime in 2010.

Of course, what we really want to know is what hedge fund managers expect the stock markets to do. After all, that's where most of us feel they have the greatest area of expertise. To get a better perspective of their predictions, it's important to note where the market stood when the survey report was written in mid-June 2009. Keep the following figures in mind as I discuss the stock market outlook of these hedge fund managers:

Dow Jones Industrial Average:	8,612.13
Russell 2000 Average:	511.83
S&P 500 Average:	923.72

To make a long story short, most hedge fund managers surveyed expect little or only moderate growth to occur in the major market indexes over the next year. For the Dow, the opinions are pretty evenly split among four general ranges of future values. 22% of hedge fund managers believe that the Dow will be under 8,000 a year from now. Another 22% believe it will be between 8,001 to 8,500 and yet another 22% believe it will be between 8,501 and 9,000. The next largest group of 21% believes that the Dow will end up between 9,001 and 9,500 in 12 months.

Clear as mud, right? About all we can glean from these predictions is that 87% of hedge fund managers think that the Dow will be between 8,000 and 9,500 in a year or so. Being so evenly split, I believe that these predictions fall in line with my best sources who think that the market will be in a trading range over the next year and possibly much longer than that.

Predictions of the future value of the S&P 500 were somewhat less concentrated, but still followed the same general pattern. 64% of respondents expected the S&P 500 Index to be between 851 and 1,100 a year from now, again pointing to a trading range market.

The Russell 2000, generally representing the small-cap stock universe, had the widest range of expectations with respondents fairly evenly spread among expectations ranging from under 400 to over 850. This result seems to say that anything can happen in small-cap stocks over the next year. What else is new?

As this is written, I find it interesting that the major market indexes are near the upper estimates reflected in the survey. With the Dow currently near 9,300 and the S&P 500 Index breaking above 1,000 yesterday, the markets have benefited from a significant rally since the McGladrey survey was taken. Perhaps this means that these hedge fund managers were too pessimistic in their views. However, if you believe that we're in for a trading range market, these levels could mean that we may experience some downward pressure on stock prices in the near future.

While we typically think of hedge funds as being only involved with financial instruments such as stocks, bonds, derivatives, etc., hedge fund managers also weighed in on the future of real estate values. 70% of respondents expect residential real estate values to continue to fall over the coming year, while a whopping 83% believe commercial real estate values will continue to fall. If they are correct, this will continue to have a chilling effect on the credit markets.

We all know that everyone from political candidates to the media leveled criticisms at the hedge fund industry for its part in the subprime meltdown and resulting credit crunch. The survey turned the tables and allowed hedge fund managers to rate the government on the job it's done during the recent economic malaise. So, how do the managers of these funds feel about the government's performance so far?

Interestingly, the Fed and its Chairman, Ben Bernanke, both fared well in the eyes of hedge fund managers as did the FDIC. President Obama and Treasury Secretary Tim Geithner got mixed reviews, but sentiments were overall positive. At the bottom of the barrel we find the SEC, which has been under a lot of criticism for its delayed response to the economic crisis.

One final question I'll highlight from the survey dealt with who hedge fund managers thought would ultimately clean up the "toxic assets" at the core of the financial crisis. 41% of respondents felt that the public sector (i.e. – the government and taxpayers) would end up holding the bag. I think that many of us are in this same camp.

However, 56% of managers felt that the private sector would provide the solution to cleaning up these hard-to-value securities. If that's the case, then hedge funds are likely to be at the epicenter of these private efforts to rid the financial system of these toxic assets.

Earlier on, I asked why we should care about the opinions of hedge fund managers. Perhaps the possibility that hedge funds may relieve taxpayers from some of the burden of having to clean up these toxic assets is the best reason of all to care about the opinions of those who manage these specialized investments.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

While investors welcomed last Friday's GDP report showing growth contracting only 1% in the 2Q (with two more revisions to come), we must keep in mind that this marked improvement from the 1Q was largely due to the large increase in federal spending. Consumer spending continued to fall in the 2Q and is unlikely to rise substantially anytime soon, as consumer confidence fell in June. Unemployment is likely headed over 10% well into 2010.

There is now a broad consensus that GDP in the 3Q will actually be at least mildly positive. That may indeed occur as businesses are forced to rebuild inventories at some point, and federal spending will certainly remain high in the 3Q and beyond. However, one quarter of positive GDP does not necessarily mean that the recession is over. Even if the recession is ending, economic growth is going to be weak due to decreased consumer spending.

Finally, there is the question of the stock markets. The meteoric rise of stocks since the lows in early March has obviously been a prediction that the credit crisis would ease somewhat and that the worst of the recession was behind us. Yet having risen apprx. 50% in just five months, even though the economy is likely to remain sluggish, this suggests that stocks may be testing their upper limits.

While it looks doubtful that stocks will retest their March lows, given how much money is still on the sidelines, I would be hesitant to recommend that investors jump back in the market now – unless you do so with a professional money manager(s) that has the ability to move to cash or hedge long positions.

Wishing you profits in a difficult market,

Gary D. Halbert

SPECIAL ARTICLES

Pull Back Unspent Part Of The Stimulus
http://ibdeditorials.com/IBDArticles.aspx?id=333152018981557

The Stimulus Lesson (why it isn't working)
http://www.weeklystandard.com/Content/Public/Articles/000/000/016/791ucyiq.asp

Has the Market Gotten Ahead of the Recovery?
http://www.smartmoney.com/investing/short-term-investing/has-the-market-gotten-ahead-of-the-recovery/

Is America On The Road To Financial Ruin?

Gary D. Halbert — Tue, 23 Jun 2009 19:53:11 GMT

IN THIS ISSUE:

Obama's Government Takeover Continues
Editorial: "Too Big to Fail, Or Succeed"
Americans More Concerned About Deficits
Economy May Have Seen the Worst of It
Conclusions

Introduction

The more I think about it, I believe that last week's E-Letter which revealed President Obama's plans to double the national debt over the next decade was one of the most important e-letters/newsletters I have ever written. If by chance you did not read last week's E-Letter, you need to click on the link above and do so now, since Obama's planned explosion in US debt will be a continuing theme in these weekly E-Letters for some time to come.

I sincerely believe that if our current $11.4 trillion national debt doubles over the next 10 years (and possibly even sooner), it will bankrupt America and send us into an even worse financial and economic crisis. President Obama's plans to run trillion dollar annual budget deficits for at least the next few years are almost certain to wreck the US dollar, which in turn will be very bad news for the stock and bond markets, not to mention the long-term inflation implications.

I have warned for over 25 years that politics are intimately intertwined with the course of the economy, the markets and thus our investments. This argument has never been clearer than today, and more and more Americans are coming to realize this. A Wall Street Journal/NBC News poll late last week found that 58% of respondents now believe that Obama's trillion dollar deficits are a greater concern than the recession in the economy. Maybe I'm making some progress!

President Obama has made public statements in recent weeks that he would prefer a smaller government had he not "inherited" this recession and financial crisis from George W. Bush. He has also said that he does not want to run (own) companies like AIG, GM and Chrysler. Yet his administration continues to promulgate new regulations that will make it even more likely that the government will eventually own much larger stakes in the private sector.

Obviously, Obama's plan to have the government take over national health care is a prime example of his intentions to greatly expand an already bloated, inefficient government and run unprecedented trillion dollar budget deficits. I have not chosen to weigh-in on the healthcare debate so far, partly because polls show that a majority of Americans want major healthcare reforms. All I will say at this point is, be careful what you wish for.

Last week President Obama announced sweeping regulatory changes that will dramatically affect the financial and investment markets for years to come. These so-called "reforms" could result in the government and/or the Fed owning some of our big banks and financial institutions that are deemed to be "too-big-to-fail." While the recent financial crisis suggests that some reforms are needed, having the government own or control many of our largest financial institutions is not the answer.

I will discuss these sweeping new financial regulations as we go along. I will also discuss the latest economic indicators which remain mixed, along with my thoughts on the investment markets. It's a lot to cover, so let's get started.

Obama's Government Takeover Continues

Last Wednesday, President Obama announced the most sweeping financial industry reforms since the Securities and Exchange Commission was created in 1934. Obama unveiled new proposals that would refashion the federal rules governing almost every corner of finance, and will push the government and the Federal Reserve much more deeply into banks and the private markets. The administration's 85-page "white paper" on financial reform sounded the opening salvo in a likely overreaching regulatory process that could expand for several years.

Most importantly, government supervision of all financial firms that are deemed to be big enough to threaten overall economic stability ("systemic risk") will be consolidated under, and be regulated by, the Federal Reserve. We're not just talking about banks here – the new regulations will allow the Fed to oversee any private or public companies that are deemed to pose systemic risks (ie- "too-big-to-fail").

These entities will be required to hold more capital and liquidity than other firms, and will face other regulatory requirements as deemed appropriate by the Fed and/or the Treasury Department. Firms that cannot meet the Fed's requirements can be taken over, partly or wholly, by the government – as was the case with insurance giant AIG, or simply shut down – as was the case with Lehman Brothers. This is scary!

Obama's regulatory net is also being cast over the credit markets whose growth contributed to the financial crisis. Those who package loans together for sale in securitizations (including mortgages) will have to disclose more and will be required to keep 5% of any deal to encourage sounder underwriting. Likewise, the new plan calls for payment of their fees to be spread over time and reduced if the loans go bad. Frankly, these specific regulations may actually make sense, while others are simply unnecessary government intrusions in the private sector.

The president's new reforms also include the creation of a Consumer Financial Protection Agency (CFPA). In theory, this new government agency will safeguard against mortgage, credit card and other abuses that may have contributed to the current crisis. In reality, this new agency may ultimately be the arbiter of who can – and cannot – get a home mortgage, what interest rates lenders and credit card companies can charge, etc., etc. Concern is already mounting that the new agency will take an overly restrictive view of permissible financial products, limiting access to credit and curbing good as well as bad innovation.

What follows are excerpts from an Investors Business Daily editorial published last Friday that fairly, I think, points out the assessment of those who will oppose Obama's sweeping regulatory reforms:

"Many on Wall Street have been stunned by a plan that subjects America's free-market capitalism to the controlling whims of bureaucrats, newly appointed czars and congressional committees headed by anti-business liberals such as Rep. Barney Frank.

‘We intend to take our case to Congress to explain why we believe adding new layers to a broken regulatory system is not the answer,' David Hirschmann, who heads the U.S. Chamber of Commerce's Center for Capital Markets, told the Los Angeles Times. Indeed, there are lots of objectionable things in the plan.

…We hope Wall Street — banks, investment houses, hedge funds, private investors — continues to speak up. The Democrats' plan slips the government's fingers around the economy's neck, choking off the risk-taking that is the very essence of America's capitalist success. Bold risk-takers will be replaced with risk-averse bureaucrats, and the dynamic growth engine that feeds our ever-expanding standard of living will be shut down.

This in turn will create a permanent bailout culture — one that will deem certain companies ‘too big to fail' and subsidize their failure with taxpayer money, while burdening small, entrepreneurial companies with unnecessary and costly regulatory oversight."

The IBD editors hit on only a few of the potential problems with President Obama's sweeping new regulatory reforms included in his 85-page report released last week. Analysts are still sorting out the details and considering the long-term implications. Certainly, some of the reforms will be welcomed by many Americans, especially those who believe that the government should control the private markets. But with any such government intervention, freedoms are sacrificed and free markets are restricted. A June 18 Wall Street Journal editorial makes the best argument I have seen regarding Obama's sweeping regulatory reform proposals.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

QUOTE: TOO BIG TO FAIL, OR SUCCEED
Everyone will want to become big enough to enjoy 'systemic risk' protection.
by Peter Wallison (senior fellow at the American Enterprise Institute)

In a speech at the White House yesterday, President Barack Obama outlined what he envisions for future regulation of the financial system. He called his plan "a new foundation for sustained economic growth . . . a transformation on a scale not seen since the reforms that followed the Great Depression." Indeed it is.

His plan, if adopted, will fundamentally change the nature of our financial system and economy. The underlying concerns and assumptions are clear, and they are made clearer by considering other ways that his administration has dealt with the consequences of competition -- particularly the faux bankruptcies of General Motors and Chrysler and the impending change in antitrust policy. Although the president said in his speech that he supports free markets, these initiatives confirm that the administration fears the "creative destruction" that free markets produce, preferring stability over innovation, competition and change.

According to the administration white paper circulated prior to the president's speech, the Federal Reserve would be authorized to create a special regulatory regime -- including requirements for capital, leverage and liquidity -- for any firm "whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed." In addition, if a large financial firm is failing, the Treasury is to be given the power -- in lieu of bankruptcy -- to appoint a conservator or receiver to "stabilize" it.

Designating particular financial firms for this kind of special regulatory treatment clearly signals to the markets that these institutions are too big to fail. It will reduce the perceived risk of lending to them, enabling them to raise funds at lower cost than their smaller competitors.

In other words, the administration's plan would create what are essentially government-sponsored enterprises like Fannie Mae and Freddie Mac in every sector of the financial economy -- insurers, securities firms, finance companies, bank holding companies, and hedge funds -- where these specially regulated firms are to be designated. The result will be devastating for competition. Larger firms will squeeze out smaller ones and aggressive small companies will have less opportunity to overcome the government-backed winners.

Moreover, the administration's proposal to provide a special bailout mechanism for large firms confirms the likelihood that these firms will never be closed down or liquidated. Citing the market turmoil that followed Lehman's collapse, the administration will argue that failures like this are "disorderly." But failure comes from risk-taking -- the very source of our economy's strength -- and it is ultimately risk-taking and its consequences that the administration's plan is intended to prevent.

The turmoil following Lehman's failure occurred because market participants expected, after the rescue of Bear Stearns, that any larger firm would also be rescued. When Lehman wasn't, all market participants were required to recalibrate the risks of dealing with all others, causing a freeze-up in lending and hoarding of cash. Lehman's failure itself did not cause any substantial losses, and within two weeks of its bankruptcy filing, Lehman's trustee sold its brokerage, investment banking, and investment management businesses to four different buyers.

Contrast this with AIG, the administration's paradigm, which was saved by the government because it was allegedly too big to fail. That firm is gradually wasting away under government control, with the taxpayers footing the bill.

The administration's fear of competitive outcomes is not reflected solely in financial-sector policies. Consider General Motors and Chrysler. They were defeated in the marketplace. Simply put, they failed to build automobiles [that] enough Americans wanted to buy.

Their disappearance would not have threatened the stability of the financial system, although it would undoubtedly have been disruptive for suppliers, dealers and employees. Yet the administration wouldn't allow them to fail, either. Despite all the talk about credit priorities, the fundamental point is that the administration used taxpayer money to overturn the market's verdict. If we want a preview of what the administration will do with the resolution authority it wants for large financial companies, we need look no further.

The same pattern with regard to competitive markets can be seen in the Justice Department's new antitrust policy. Christine Varney, the new assistant attorney general in charge of antitrust policy, has said that U.S. policy should be more like Europe's. Until now, U.S. antitrust policy has tried to protect competition. Europe attempts to protect competitors. Protecting competitors means blunting the skills of superior players, allowing inferior managers and business models to remain in business and thus preventing better managements and business models from emerging. Again, stability wins out over change and progress.

The president has said on several occasions, including in yesterday's speech, that "I've always been a strong believer in the power of the free market." But his administration's prescriptions tell a different story. In AIG, GM, Chrysler, Fannie Mae and Freddie Mac we can see the future that the administration envisions for our economy -- a sclerotic and unchanging structure of big companies working with, protected by, and relying on big government.
END QUOTE

I could not agree more with Mr. Wallison's analysis above. Yet most Americans have no idea what President Obama's sweeping regulatory changes really mean, much less how they may negatively affect competition and the free markets. Most Americans only hear the media sound-bites which leave the impression that the Obama administration reforms will "fix" the financial markets once and for all.

Were some changes in regulation of the financial markets in order? Certainly. Subprime loans, "no-doc" loans and "liar" loans allowed millions of Americans to purchase homes they could never afford. Likewise, credit rating agencies allowed investment bankers to create AAA-rated bonds secured by these questionable mortgages, which greatly broadened the impact of the subprime debacle.

These and other abuses ultimately led to the housing crisis, the credit crisis and the most severe recession since the Depression. So, changes to the financial regulatory system were needed.

As I noted above, some of Obama's new regulations on mortgage lenders make a lot of sense and will help to curb abuses. But many others are nothing less than purposeful government intrusion in the private markets in ways that will stifle competition. In many ways, these new rules look more like nationalization than regulation.

Americans More Concerned About Deficits

While President Obama continues to enjoy high (but falling) approval ratings overall, the public is growing much more concerned about Obama's record-large budget deficits and government intrusion in our lives, as noted in this week's SPECIAL ARTICLES below. In particular, a new Wall Street Journal/NBC News poll published last Thursday had some surprising findings.

For example, a solid majority – 58% – were more concerned about the budget deficit than they are about the economy. Specifically, they said that the president and Congress "should focus on keeping the budget down, even if it takes longer for the economy to recover."

When asked about the expanding role of government (e.g. ownership stake in GM, executive compensation, health care, etc.) a whopping 69% said they were very concerned (49% answered "a great deal" and 20% answered "quite a bit").

On the issue of Obama's health care plans, the WSJ poll results suggest that the president still has a lot of convincing to do. 33% think it's a good idea, 32% think it's a bad idea, and 35% have no opinion. Put differently, 67% either think government run health care is a bad idea, or they're not sure.

The New York Times also released its latest poll last Thursday. It also revealed that the public is growing more wary of the expanding role of government. When asked if the government is doing too much or too little, the result was: 56% too much versus 34% too little.

These surprising poll results suggest that more and more Americans are realizing just how dangerous it will be for America to double the national debt in a decade or less, as I discussed in detail last week.

Economy May Have Seen the Worst of It

Barring a major negative surprise, I think we have likely seen the worst of this recession. The Commerce Department will release its final estimate of 1Q GDP on Thursday, and most forecasters expect it to be in the -5.5% to -5.7% range (annual rate), which is at least mildly less negative than the -6.3% plunge in the 4Q of last year. Together, these two quarters should prove to be the worst of the most severe US recession since the Great Depression.

There is a broad consensus that the US economy has continued to contract during the 2Q, with most suggesting a decline of 2-3% in GDP over the last three months. From there, though, forecasts vary widely as to what will happen in the economy during the second half of the year. While I continue to believe that GDP will remain in negative territory all year, a growing number of analysts believe that GDP could actually go positive in the 4Q.

We have had more good economic news in the last couple of weeks. Most importantly, the Index of Leading Economic Indicators (LEI) rose a better than expected 1.2% in May, following a 1.1% gain in April. These were the first back-to-back monthly increases in almost three years.

The Commerce Department reported on June 11 that retail sales rose 0.5% in May, the first increase in three months. However, the report indicated that much of the rise in sales was due to the significant increase in gasoline prices.

On the manufacturing front, the latest reports were mixed. The ISM Index rose modestly to 42.8 in May versus 42.3 in April. Remember that any reading in the ISM below 50 indicates an economy that is still contracting. Industrial production fell another 1.1% in May, while the factory operating rate slipped to 68.3% in May, down from 69% in April.

On the housing front, there was a bit of encouraging news. Housing starts rose sharply in May, thanks in large part to the federal home tax credit that expires in November. Building permits were also up modestly in May. However, the inventory of unsold homes remains at a record level with over 11 months' supply on the market. Home prices nationally plunged 19.1% in the 1Q and are down 32% from the peak in 2006. So the housing slump is far from over.

The US unemployment rate continues to spike higher, rising to 9.4% in May, up from 8.9% in April. A recent Wall Street Journal survey of economists found a consensus opinion that the unemployment rate will hit at least 9.9% by the end of this year. The continued rise in the unemployment rate is almost certain to keep consumers on the defensive.

While we are seeing signs that the worst of this recession is behind us, that does not mean the economy will move into positive territory by the end of this year. Consumer spending is still lagging and is likely to stay below trend for some time to come. The personal savings rate jumped to 5.7% in April (latest data available), the highest level in more than 14 years, and this trend is likely to continue.

The combination of declining housing and stock-market values with the heavy debt loads Americans took on during the housing boom has inflicted significant damage on household finances. The Federal Reserve's latest "flow of funds report" earlier this month showed that household net worth fell $1.1 trillion in the 1Q from the 4Q of last year to $50.4 trillion, putting it $13.9 trillion below its 2007 peak. Collectively, homeowners held 41.4% of the equity in their homes, the lowest level since records have been kept and down from 53.9% two years earlier.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

As noted above, we have seen some encouraging signs in the economy. If you watch any of the financial channels, you will find that there is a great deal of optimism that the recession will be over before the end of this year. Sorry, but I just don't buy it. I continue to believe that the economy will still be in negative territory at the end of the year, as measured by GDP. I hope I am wrong.

As for President Obama's sweeping financial regulatory reforms he announced last week, we would hope to be implementing new regulations that should prevent anything similar to the sub-prime meltdown and the credit crisis from ever happening again. However, I believe that most of Obama's proposed regulatory changes are over-reaching and onerous. But Congress is likely to pass most or all of them, despite the long-term market implications.

On a positive note, I am very encouraged that more Americans are becoming increasingly concerned about the mammoth level of spending and deficits planned by the Obama administration over the next decade. Doubling the national debt in the next decade (or less) will have extremely negative consequences for the economy and stocks and bonds.

I feel that more of the public is coming to realize just how much exploding federal deficits will affect the future of their children and grandchildren. Perhaps we have come to realize just how large a sum one trillion dollars is, how long it could take to pay it back and who will be required to make those payments. More people want the government to do what every family must do - make tough decisions on which expenditures are most important and which can be deferred.

Finally, I believe that the public is picking up on the fact that capitalism's very structure is changing. Specifically, the government has switched from a role of economic supporter and regulator to owner and controller. This is a fundamental shift in the very nature of capitalism and could have ramifications far into the future. To me, this is the most disturbing of all of the recent events that have come to pass.

Let's hope that our representatives in Washington get the message that the recent polls are sending – that Obama's incredible spending and bigger government plans will wreck our economy over time. If not, it could be a very bleak future that we leave to our heirs. Sorry to end on a negative note, but it is what it is.

Wishing you a great summer,

Gary D. Halbert

SPECIAL ARTICLES

Independent voters worried about Obama's spending
http://online.wsj.com/article/SB124570175501838333.html

More polls show growing concern over Obama's deficits
http://www.nydailynews.com/opinions/columnists/goodwin/index.html

Public confidence in Obama stimulus plan is falling
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/22/AR2009062202000.html?hpid=moreheadlines

Signs of the End of the Recession - Maybe

Gary D. Halbert — Tue, 21 Apr 2009 19:29:18 GMT

IN THIS ISSUE:

The Latest Economic Reports -- Mostly Negative
Latest Wall Street Journal Survey of Economists
Fed's Latest "Beige Book" Outlook is Bleak
Conclusions -- What To Believe?

Introduction

We have clients calling us every day to ask if we believe the economy and the stock markets have seen the bottom. We don't know for sure, of course, but it may be reasonable to assume that the 4Q of last year and the 1Q of this year will mark the worst two quarters of this severe recession. We won't see the government's first estimate of 1Q GDP until next Wednesday, April 29, and it is expected to be about as bad as the 4Q decline of 6.3% (annual rate).

Economic reports over the last few weeks have been mixed to negative. I will highlight those reports as we go along. To get a better idea where we stand in the recession, we will also review the latest Federal Reserve "Beige Book" released on April 15, which analyzes the national economy in greater detail. Overall, it was quite negative and reinforced my view that we will be in negative economic growth territory for all of this year.

The stock markets bottomed in early March, and we have seen an impressive rally since then. The Dow Jones rebounded almost 25% from the lows in early March. There is historical evidence that the stock markets are often an early indicator of a change in the economic indicators, and tend to lead the economy by an average of six months. More and more analysts are calling the March lows the bottom, but this assumes there will be no more major negative surprises.

The stock market recovery and signs that the credit markets are unfreezing just a bit prompted some rather optimistic predictions (overall) in a recent Wall Street Journal survey of 53 economists and market analysts. On average, the 53 forecasters predicted an end to the recession by September of this year. I am not so optimistic, and the combined WSJ survey results are not nearly as positive as the September end-of-recession conclusion suggests. More on this later.

As I wrote in my April 7 E-Letter, many of the largest insurance companies are in financial trouble, so I believe it is still too early to assume that there will not be more major negative surprises. Although, as I noted in last week's letter, it appears that the Treasury Department will allow most major insurers access to TARP bailout monies, assuming the companies are willing to submit themselves to government controls.

As we go along, I will direct you to a weekly economic publication I follow that is produced by the Wachovia Economics Group (Wachovia bank was purchased by Wells Fargo bank in December of 2008). While the analysts at Wachovia are considerably more optimistic than I am about the recession ending later this year, they do a decent job of forecasting and analyzing the various economic reports that are released each week, and it's free of charge. I'll tell you how to access it later on in this letter. Let's get started.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

The Latest Economic Reports -- Mostly Negative

At the end of March, the Commerce Department released its final estimate of 4Q GDP, showing that the economy fell at an annual rate of 6.3%, the worst quarterly drop in 25 years. Personal consumption spending plunged 4.3% year-over-year in the 4Q. As noted above, the first estimate of 1Q GDP will not be released until next Wednesday, April 29. Pre-report estimates vary from down 4-5% to down 7-8%. My guess is that 1Q GDP will be down slightly more than the -6.3% in the 4Q of last year.

We have recently seen a few encouraging signs that the worst of the recession and the credit crisis may be behind us, such as improving profit numbers from several of the big banks that took TARP money. At the same time, there are persistent rumors that several of the major banks have failed their so-called "stress tests" being conducted by the Treasury Department. For a host of reasons, I believe that the recession will drag on for the rest of the year.

Most importantly, every week we continue to hear of mounting job losses. The unemployment rate jumped to 8.5% in March, up from 8.1% a month earlier. The Labor Department announced last Thursday that the number of Americans receiving unemployment benefits topped six million for the first time in US history. Initial unemployment claims have been above 600,000 for the last four weeks running. Most of my trusted sources believe that the unemployment rate will hit at least 10% by the end of the year, another suggestion that the recession will drag on for at least another 2-3 quarters.

Consumer confidence remains in the tank. The latest report for March had the Consumer Confidence Index at 26.0, down from 60 just last September. Lynn Franco, Director of The Conference Board Consumer Research Center noted:

"Consumer Confidence was relatively unchanged in March, after reaching an all-time low in February (Index began in 1967). The Present Situation Index suggests that the overall state of the economy remains weak and that more job losses are on the horizon. Apprehension about the outlook for the economy, the labor market and earnings continues to weigh heavily on consumers' attitudes. Looking ahead, consumers remain extremely pessimistic about the short-term future and do not foresee a turnaround in economic conditions over the coming six months."

With consumer confidence so depressed, it should not have surprised anyone that retail sales for March were worse than expected, falling 1.1%. It was the biggest decline in three months and a much weaker showing than the 0.3% decline that analysts expected. A big drop in auto sales led the overall slump in demand. Sales also plunged at clothing stores, appliance outlets and furniture stores, just to mention a few.

Along with the slowdown in consumer spending, we are seeing credit card delinquencies continue to soar. It was recently reported that banks and credit card companies wrote off a record $21 billion in unpaid credit card debt in 2008. Such credit card write-offs are estimated to balloon to a whopping $41 billion this year. This will mean more bad news for the major banks.

The Conference Board reported yesterday that the Index of Leading Economic Indicators (LEI) fell 0.3% in March, following a decline of 0.4% in February. The chart below illustrates the severity of the economic downturn and does not suggest that the recession has bottomed out yet.

The ISM manufacturing index was essentially unchanged in March at 36.3, up fractionally from February's 35.8. Any reading in the ISM index below 50 indicates that the economy is contracting. The March decline was the 14th consecutive month that the index was below 50. A spokesperson for the ISM noted, however, that the March reading of 36.3 marked the third consecutive month that the index was in the mid-30s, suggesting that the decline may be stabilizing. We will see.

Industrial production contracted by 1.5% in March after a similar decline in February. Analysts estimate that industrial production fell at an annualized rate of 20% in the 1Q. If correct, that would mean the 1Q would be the largest drop since the 1Q of 1975. With the exception of utilities, all major industrial sectors registered declines. Capacity utilization (the factory operating rate) fell to 69.3% in March, which is the lowest on record, down from near 80% a year ago.

On the housing front, March brought more bad news following the brief respite the month before. Housing starts plunged 10.8% in March to a seasonally adjusted annual rate of 510,000 units. That was the second lowest home construction pace in records that go back 50 years. The decline was worse than economists had expected, and February activity also was revised lower. Applications for building permits fell 9% in March to a record low of 513,000 units. Some would argue that the declines noted above are a good thing since there are still far too many unsold homes on the market.

Unfortunately, the home foreclosure rate jumped by 24% in the first three months of this year and is poised to rise further as major lenders restart foreclosures after a temporary break, according to data released last Thursday. Nationwide, nearly 804,000 homes received at least one foreclosure-related notice from January through March, up from about 650,000 in the same time period a year earlier, according to RealtyTrac Inc., a foreclosure listing firm.

The big unknown for the coming months, however, is President Obama's supposed plan to help up to nine million borrowers avoid foreclosure through refinanced mortgages or modified loans. The Obama administration expects its plans to make a big dent in the foreclosure crisis. But it hasn't happened yet, and it remains to be seen whether the lending industry will fully embrace it, despite $75 billion in potential incentive payments.

Predictions of a Recovery in the Economy

As noted in the Introduction, the analysts at Wachovia Economics Group are considerably more optimistic than I am about the second half of this year. As you can see in the chart below, the Wachovia Group expects 1Q GDP to come in around -6%, and they could be correct. In any event, the 1Q GDP number will almost certainly be one of the worst in decades.

The Wachovia Group believes that economic growth will recover in the 2Q and 3Q with GDP registering only a negative 1-2%. And they currently forecast that GDP will improve into mildly positive territory in the 4Q. I believe Wachovia's prediction of an end to the recession by the 4Q is too optimistic, as do several of my most trusted sources for economic forecasts.

If you would like to read Wachovia's latest weekly economic analysis released on Friday, click on the following link:
http://www.realclearmarkets.com/articles/WeeklyEconomicFinancialCommentaryApril172009.pdf

If you would like to subscribe to Wachovia's weekly economic commentaries, click on the following link -- the service is free of charge:
http://www.wachovia.com/economicsemail

Latest Wall Street Journal Survey of Economists

As noted in the Introduction, the latest Wall Street Journal (WSJ) survey of 53 economists and market analysts yielded some (emphasize some) surprisingly positive suggestions, despite the continued drumbeat of negative economic news. The WSJ survey was taken in early April. On average, the 53 economists and analysts surveyed predicted that the recession would end by September of this year.

While the average forecast among the 53 economists suggests that the recession will end late in the 3Q, there were a number of the economists surveyed that were not so optimistic. I agree. Here are some highlights from the latest WSJ economic survey. Pay special attention to the unemployment forecasts. Those, to me, tell us more than anything about when the recession will end.

"Economists in the latest Wall Street Journal forecasting survey expect the recession to end in September, though most say it won't be until the second half of 2010 that the economy recovers enough to bring down unemployment.

Gross domestic product was predicted to contract in the first and second quarters of this year by 5.0% and 1.8%, respectively, on a seasonally adjusted annualized rate. A return to growth -- a modest 0.4% -- isn't expected until the third quarter.

Indeed, economists' prospects for the labor market remain bleak. Just 12% of the economists expect the unemployment rate to fall some time this year. More than a third of respondents expect the jobless rate to peak in the first half of 2010, while about half don't see unemployment declining until the second half of 2010. By December of this year, the economists on average expect the unemployment rate to reach 9.5%, up from the 8.5% reported for March...

Meanwhile, asked to name the biggest risk to their forecasts, economists singled out problems in the credit markets. ‘Once the virtuous cycle starts, the chief headwind will be credit availability,' said Kurt Karl of Swiss Re. The possibilities of a failure of a major financial institution and persistent reluctance of consumers to spend, both related to the credit markets, were tied for second place in the list of concerns."

Many market analysts around the world follow the WSJ economist surveys, and they are always insightful. But this one published earlier this month raises more questions than answers. How likely is it that the recession will end in September when the consensus among the economists is that the unemployment rate will continue to ratchet up until at least mid-2010? I don't get it.

My conclusion is that the recession may well hit bottom by September of this year, but we won't be back to positive economic growth until sometime in 2010. And that assumes we are not looking at major insurance company bankruptcies (and/or major bailouts) if we see a bad hurricane season this summer or fall (as discussed in my April 7 E-Letter).

ENDORSED ADVERTISEMENT

Fed's Latest "Beige Book" Outlook is Bleak

The Federal Reserve issues a very insightful economic publication entitled the "Beige Book" eight times per year, essentially every month and a half. Each of the 12 Federal Reserve Banks gathers information on current economic and financial conditions in their district, and this information goes into the Beige Book report every 45 days or so. The latest Beige Book economic summary released this month is perhaps the most negative I have ever read. Here is the summary and highlighted remarks:

"Reports from the Federal Reserve Banks indicate that overall economic activity contracted further or remained weak. However, five of the twelve Districts noted a moderation in the pace of decline, and several saw signs that activity in some sectors was stabilizing at a low level.

Manufacturing activity weakened across a broad range of industries in most Districts, with only a few exceptions. Nonfinancial service activity continued to contract across Districts. Retail spending remained sluggish, although some Districts noted a slight improvement in sales compared with the previous reporting period. Residential real estate markets continued to be weak.

Home prices and construction were still falling in most areas, but better-than-expected buyer traffic led to a scattered pickup in sales in a number of Districts. Nonresidential real estate conditions continued to deteriorate. Difficulty obtaining commercial real estate financing was constraining construction and investment activity. Spending on business travel declined as corporations cut back. Reports on tourism were mixed. Bankers reported tight credit conditions, rising delinquencies, and some deterioration of loan quality.

Agricultural conditions were generally favorable across Districts, although drought conditions persisted in the Dallas and San Francisco Districts. The Districts reporting on energy said reduced demand, high inventories, and lower prices led to steep cutbacks in oil and natural gas drilling and production activity. The Minneapolis, Kansas City, and Dallas Districts noted declines in employment in the oil and gas extraction industry.

Downward pressure on prices was reported across Districts. Wage and salary pressures eased as labor markets weakened in all Districts, and many contacts continued to report job cuts and wage and hiring freezes. Employment continued to decline across a range of industries, with only scattered reports of hiring."

This summary of the latest Beige Book report sounds rather benign. But keep in mind that the Fed hates to come across sounding too negative. The report continues as follows:

"Manufacturing activity continued to decline in most Districts and across a wide range of industries… Orders and shipments of capital goods, autos, paper, and construction-related equipment and products such as metals, wood products, lumber and electrical machinery remained mostly sluggish and below year-ago levels…

Districts that report on nonfinancial business services said demand continued to fall across most industries. Providers of health-care services noted further declines in activity, and contacts in several Districts noted demand for professional services, such as architecture, business consulting and legal services, remained weak. Auto dealers continued to struggle, and overall vehicle sales were sluggish in all reporting Districts as weak demand and tight credit continued to limit sales…

Travel and tourism activity contracted further in several reporting Districts, as households and businesses continued to scale back on discretionary and travel spending. Tourist spending in the New York, Minneapolis, and San Francisco Districts saw double-digit declines compared with the prior year. Airlines in the Dallas District and hotel contacts in the Kansas City District reported weakening demand for business travel, while the Atlanta District noted convention cancellations. Restaurants continued to see sluggish activity in the Kansas City and San Francisco Districts, which prompted further layoffs and closures in the latter region.

Housing markets remained depressed overall, but there were some signs that conditions may be stabilizing… New home construction activity fell further, however, as inventories remained elevated. Home prices continued to decline in most Districts, although a few reports noted that prices were unchanged or that the pace of decline had eased… Nonresidential real estate conditions continued to deteriorate over the past six weeks. Demand for office, industrial and retail space continued to fall, and there were reports of increases in sublease space.

[Commercial] property values moved lower as reality ‘set in…' Commercial real estate investment activity weakened further. Contacts said a decline in credit availability and markdowns on commercial property were keeping buyers and sellers on the sidelines.

… Demand for commercial and industrial loans was weak, and there were several reports that business borrowers were postponing capital expenditures. Commercial real estate lending continued to decline. Credit availability generally remained very tight across regions. A number of Districts reported deteriorating loan quality and rising delinquencies for all types of loan categories. In particular, several reports noted more stringent requirements for commercial real estate loans due to worries of worsening loan quality in the sector.

Labor market conditions were weak and reports of layoffs, reductions in work hours, temporary factory shutdowns, branch closures and hiring freezes remained widespread across Districts. Staffing firms in the New York, Cleveland, Richmond, Chicago, and Dallas Districts reported that demand for workers remained sluggish.

… Continuing layoffs, furloughs and hiring freezes kept wage pressures minimal. Contacts from a broad range of industries reported pay freezes, with some noting salary reductions. The Minneapolis District reported that unionized faculty at Minnesota's technical and community colleges had tentatively accepted a two-year pay freeze. Contacts in the Boston, Philadelphia, Richmond, Chicago, and San Francisco Districts reported cuts in certain non-wage employment benefits, including cuts in bonuses, elimination or suspension of employer contributions to employee retirement programs, and increases in copayments on employer sponsored healthcare plans.

… Consumer spending remained generally weak. Travel and tourism activity contracted further in several reporting Districts, as households and businesses continued to scale back on discretionary and travel spending… Retailers kept inventories lean, in line with the slow pace of sales, and most expect demand to stay at current low levels over the next few months… Auto dealers continued to struggle, and overall vehicle sales were sluggish in all reporting Districts as weak demand and tight credit continued to limit sales."

I could go on and on with quotes from the April Federal Reserve Beige Book, but you get the picture. This is the most negative Beige Book assessment of the economy that I can ever remember reading over many years.

Notice how many references the Fed makes to the weakness in the commercial real estate markets. Some analysts believe that commercial real estate markets may be the next shoe to drop in the recession (along with insurance companies, as I warned two weeks ago). This does not suggest an economy that is about to rebound from a recession anytime soon.

Have the Stock Markets Bottomed?

The major market indexes rebounded 20-25% since the recent lows in early March, and investors around the world are wondering if we've finally seen the bottom. The latest recovery has indeed been impressive, but we need to keep it in perspective. As you can see in the S&P 500 monthly chart below, the market was extremely oversold by the end of February.

Given that the S&P 500 had plunged almost 45% from the peak in late 2007, the market was overdue for a significant rebound. Over the last couple of weeks, there have been plenty of analysts and financial writers who have proclaimed that we've seen the bottom. But many of these same analysts are always bullish. Others, of course, maintain that this is just a bear market rally.

No one knows which camp will ultimately be proven correct. Here are a few observations as to how things may play out. First, if Wachovia and the majority of economists surveyed by the WSJ are correct that the recession will end and the economy will improve significantly in the second half of this year, then I would bet that the bottom is in.

It is also very helpful that several of the major banks have been reporting good news for the 1Q, and the credit markets are starting to unfreeze a bit. Several of the big banks that had TARP money shoved down their throats are now begging to give it back, which is also good, and is encouraging to the equity markets and investors in general. But keep in mind that we have yet to see the results of the stress tests, and some fear this news will not be good. We'll see.

Also, keep in mind my ongoing concerns about the insurance industry where the 1Q financial reports are expected to be very ugly. Also, as discussed above, the commercial real estate markets are turning down as we speak. So, I will not be surprised if we see at least a retest of the March lows in the major indexes. Whether we've seen the bottom or not may depend on how much concern develops for the insurance industry and commercial real estate just ahead.

Several of the professional money managers I recommend have moved back on the long side of the market, but most are not fully invested (i.e., they still have some money on the sidelines). And if their systems indicate that this rally is fizzling, they won't hesitate to move back to cash and/or hedge their long positions.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions -- What To Believe?

At the end of the day, the question is whether or not this recession will end before this year is over, or will it drag on into 2010? This, of course, depends on one's definition of recession. If we are to believe that the recession is over when negative economic growth bottoms out, but has not yet improved to positive territory, then I would tend to agree that the recession will end later this year.

But if we agree that the recession has ended only when the economy returns to positive growth, then I believe the recession will not end until sometime in 2010. I hope I am wrong. The economists at Wachovia Group believe the recession will end in the second half of this year, as does a consensus of Wall Street Journal economists based on an April survey.

I sincerely hope they are correct, but I fear they are not, especially if it is confirmed over the coming weeks that the big insurance companies are in financial trouble. It's a lot to think about, especially as it pertains to your investment accounts, your retirement portfolios and meeting your financial goals.

Time will tell which camp is correct. In the meantime, I continue to recommend that you use this market rally to move to more defensive (alternative) portfolio strategies that have the potential to protect you from major market downturns.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

A Backdoor Nationalization of the Banks (read this)
http://online.wsj.com/article/SB124027165661037073.html

Big-Spending Conservative
http://www.nytimes.com/2009/04/21/opinion/21brooks.html?_r=2&ref=opinion

Tea Party Economics
http://www.forbes.com/2009/04/20/tea-party-taxes-opinions-columnists-ear-marks.html

When Will The Bull Market Return?

Gary D. Halbert — Tue, 17 Mar 2009 20:48:30 GMT

IN THIS ISSUE:

David Henry On A New Bull Market
Why Wall Street Needs A New Bull
Make Half A Decision

Introduction

This week, I am off spending some time with my son, who is home from college for Spring Break. Since we live on the lake, I’m putting in a lot of time driving the boat while he and his friends ski and wakeboard on Lake Travis. It’s a tough job but somebody’s got to do it.

Since I’m out most of the week, I have chosen to reprint below a very informative analysis on the history of bear markets in stocks, and what it might take to turn the one we’re in around. This article originally appeared in Yahoo! News and I thought the author, David Henry, had some good insights into how stock market cycles work.

Last week, many market analysts were pleased to see a consecutive string of positive days in the stock market. Of course, this immediately sent some in the financial media into a frenzy about how we have now seen the bottom of the bear market and we can only go up from here. It seems that there is no shortage of cheerleaders for a renewed bull market. If wishing could make it so, we’d definitely have an up market from here on out. But for now, I remain unconvinced.

That being the case, I follow David Henry’s reprint with a discussion about why we often see so much attention being given to a return of the bull market. Obviously, everyone from investors to the government wants the market to go up since it’s supposedly a sign of a healthy economy. But as we all know, our economy and financial system are far from healthy at this point, so it remains to be seen if the bear market is over.

The last two bear markets in US stocks have underscored the weaknesses of the widespread “buy-and-hold” investment strategies that have been Wall Street’s mantra for decades. The bottom line, in my opinion, is that when you offer buy-and-hold investment products that only work in up markets, you root for a bull whenever you can.

I’ll end up the E-Letter by discussing a way for you to include active management investment strategies that may be more comfortable for you. Sometimes, making “half a decision” can help you to test the waters of active management, while still having a foothold in other investment strategies that may be more familiar to you. Let’s get started.

Stock Markets: When Will the Bull Return?
By David Henry, Yahoo! News, Fri Mar 6, 2009

QUOTE:

The stock market is crashing -- slowly, and in plain view of the people who count on it most. The 53% plunge in the Dow Jones industrials since October 2007 [measured as of March 6th – GDH] has wrecked the college- and retirement-savings plans of millions of investors. It has permanently lowered the long-term investment projections of private endowments and pension funds. It has sent corporate compensation experts scrambling to figure out how to reward top employees. All told, more than $10 trillion of stock market wealth has vanished, and with it the confidence that springs from financial security.

While 17 months may feel like an eternity, it could turn out merely to be a prequel. The questions on the minds of investors, money managers, and corporate executives are threefold: How much longer will the bear market last? How low will the averages go? And when might investors get their money back?

As Warren E. Buffett has said: "Beware of geeks bearing formulas." It's especially difficult to predict the direction of the markets these days because the most popular gauges, from price-earnings ratios to measures of investor "capitulation," have stopped working. The peculiar nature of this bear market limits the kit of useful tools to just a handful of bond market and business confidence indicators.

Those signals, along with interviews with financial historians, market strategists, and economists, point mostly to painful scenarios. Stocks don't seem likely to fall much more from here -- but market turmoil could continue for months or even years. Worse, by the time the market revisits its highs, so many years are likely to have passed that many older people will have gotten out of stocks, missing out on the rebound. The flip side is that new money put into the stock market now will likely do comparatively well over the long term. That's welcome news for twentysomethings and executive compensation consultants, but perhaps not for soon-to-be retirees.

Searching For Precedents

History can't provide as many clues to the market's direction as usual. That's because while most bear markets more or less track the business cycle, this one began with a broken financial system. That makes the current bear more like the one that snarled from 1929-32 than others of the past 100 years. But that analogy doesn't fit perfectly, either. "We have no good precedents to help us," says Peter L. Bernstein, a 90-year-old market essayist and financial historian who was a teenager during the Great Depression. "What's breathtaking is the rapidity of the decline and its breadth."

The market anxiety is especially high now because of the raging fire in the economy. "The next six to nine months are going to be awful," says Desmond Lachman of the American Enterprise Institute. Waves of corporate defaults, home foreclosures, bank failures, and job losses are still to come.

Of course, the stock market already knows that for the rest of 2009 the economy will be a "shambles," to use Buffett's recent description. Today's low share prices may well reflect that. The Dow Jones industrial average has already fallen through the 7,000 level predicted earlier this year by Nouriel Roubini, the New York University economist nicknamed “Dr. Doom” for daring in 2006 to foretell the credit calamity. That's right, even Dr. Doom was too optimistic.

If recent history were a reliable guide, it would be just about time for the bear to retreat to his den, which nowadays might include a flat-panel TV and leather chair bought at a foreclosure sale. The market's average decline during bear markets since the 1929 market crash is just 30%. What's more, those past bears lasted an average of 13 months, making this one look not just mean but old.

But this is no ordinary slump. Even the most basic market gauge, the price-earnings ratio, which measures a company's share price relative to the earnings it generates, is unreliable. Historically, the overall market has traded at prices that average 15 times earnings, ranging from roughly 8 during the worst bear markets to 25 or greater during bull runs. At the start of the year, the market's p-e ratio was about 11, suggesting that stocks were already cheap and wouldn't drop much more. Instead, the Standard & Poor's 500-stock index fell 19% in January and February, the worst opening months on record.

Why did the p-e ratio get it so wrong? The "e" is plunging -- by 18% in January and February alone, according to Thomson Reuters. As a result, even though the stock market has dropped, it hasn't gotten any cheaper relative to earnings. Sure, a lot of earnings vanished amid a fog of one-time charges that may say nothing about companies' future profit power. But analysts still aren't seeing through that fog; their earnings projections are more scattered than they've been in two decades. "You don't know what the 'e' is because the economy is in free fall," says Charles Biderman, CEO of TrimTabs Investment Research.

The credit bust has rendered other trusted market indicators useless -- most notably monetary policy, or the Federal Reserve's raising or lowering of its benchmark interest rate. Before the current slump, the federal funds rate was a reliable indicator in all but one bear market since World War II, says James B. Stack, president of InvesTech Research and Stack Financial Management. When the economy slowed, the Fed began cutting rates to turn the business cycle back up. After the second cut came, investors stepped in to buy, anticipating higher corporate earnings. But the Fed has cut rates 10 times since August 2007, to essentially zero, and yet the economy and stock market keep sliding. "The Depression is the only parallel for the lack of effectiveness in monetary policy," says Stack. It is failing because too many borrowers don't want to borrow and too many lenders don't have the capital or courage to lend.

Measures of capitulation, Wall Street's term for the final moment of a sell-off when the last weak investors give up on stocks, aren't working, either. The idea is that once the wobbly players are out, the ones left are strong enough to bid up stocks. Bull runs begin during those moments. Market mavens try to track capitulation by parsing statistics from days of heavy selling and comparing the intensity of past routs. Many thought they saw capitulation last September, says Eric C. Bjorgen, senior analyst with the Leuthold Group in Minneapolis. "But then the market kept going down," says Bjorgen. "Extreme fear was not a good indicator." The gauges became even more bullish with the selling in November, after which the market rallied 24%. Then it fell again. Biderman of TrimTabs says that's because much of the selling was by hedge funds that had been using borrowed money, not a major factor in previous bear markets.

Another signal that's turned out to be misleading is "cash on the sidelines," or the funds in money market and bank savings accounts. In normal times, strategists could look with some confidence to money in these accounts as buying power that investors were holding back from the stock market. The greater the cash compared with the value of the overall market, the more impact it could make on stocks. In January the reading reached its highest levels since 1984, says Bjorgen. Even so, he's dubious. As long as investors are worried about their own incomes, he says, the money seems most likely to stay right where it is. TrimTabs' Biderman, who tracks how investors move their money among asset classes, says he doesn't see much chance of this cash flowing into stocks with the job and housing markets so weak. He figures investors have been taking more money out of stocks than they've been putting into their cash accounts. "Some people are being forced to sell stocks to eat," Biderman says. "They are certainly not going to buy Google here."

With the ordinary historical measures failing, experts are looking further back for clues. During the Great Depression, the Dow plunged 89% from the 1929 crash to July 1932. Then it went through some big swings before losing 49% in 1937-38 as the economy tanked again. World War II, which grew in part out of financial stress around the globe, followed. The Dow didn't get back to its 1929 high until 1954.

Much, of course, has changed in the U.S. since the Great Crash. Back then Washington made major policy mistakes, such as erecting trade barriers and letting too many banks fail without protecting depositors. This time, with a couple of exceptions, the government hasn't blundered so, even though it hasn't yet solved the economy's many problems.

So this bear market likely won't rival that of the Great Depression. But the bear markets during other banking crises have been brutal in their own right. In a recent study of 21 such episodes from around the world, including ones from Spain in 1977, Sweden in 1991, and Thailand in 1997, professors Carmen M. Reinhart of the University of Maryland and Kenneth S. Rogoff of Harvard University found that stocks fell an average of 56% -- the same loss the S&P 500 had suffered through Mar. 3. Those bear markets also tended to be agonizingly slow, taking an average of 3.4 years to reach bottom. "Everything is protracted," says Reinhart. "In the best-case scenario, you are looking at six years or longer" to return to past highs. Bad as that sounds, it would compare favorably with Japan, whose Nikkei index reached 38,900 in 1989 and now trades at around 7,200.

Of course, just because investors have lost money in stocks doesn't mean equities are a bad choice from this point onward. "Stocks can't make up for the past 10 years, but they can do extremely well from our current position," says Jeremy J. Siegel, author of Stocks for the Long Run and professor at the Wharton School of the University of Pennsylvania. Siegel says that while stock returns have fallen behind government bond returns over the past 20 years, history says that's almost certain to reverse. He's found only one 30-year period when stocks returned less than bonds, and that one ended in 1861. "That tells us that once you are down 50%, those who are in stock markets for 10 to 15 years will get much better returns," he says. Lately, government bond prices have run up, boosting the odds that stocks will be the better play in the future.

So where to look for signs of an incipient upturn? One logical place is the corporate debt market, which understands the economy's core problem firsthand. Eventually, the pace of new defaults on corporate bonds will slow, and bad debts will be reduced or erased in financial reorganizations and bankruptcies. When those things happen, the economy and stock market should breathe easier…

Another critical factor is the health of the banking system. One measure to watch is banks' so-called net worth, or the difference between how much they owe and the value of their assets. Rebuilding the banking system's net worth will be monumentally difficult. "On average, this process takes about six years," says Joseph Mason, a banking professor at Louisiana State University who has studied past banking crises. So far, little has been accomplished -- a big reason the stock market hasn't gotten up from its knees.

Keep An Eye On CEOs

Government policy decisions could speed or slow the pace of rehabilitation for the banks and, in turn, the stock market. David A. Hendler, a New York-based bank analyst at CreditSights, says his job has shifted from financial analysis toward Washington analysis. Essentially, his task is to figure out how quickly the government will permit weak banks to consolidate. When investors believe they know which banks will survive, they'll buy their stocks. The process is so critical to the stock market that Richard Bernstein, chief investment strategist at Merrill Lynch, is tracking six signposts for financial industry consolidation. Among them: the extent to which the government carves up and sells bad banks rather than buying into them to prop them up.

Other strategists are keeping a close eye on the people who really know what's happening in the economy: business leaders. Biderman says he'll know corporations are getting confident once they start buying back their own shares and acquiring other companies. Right now they show no such bravado. Announcements of share buybacks are down 90% from a year ago, leaving that market thermometer so cold the mercury is off the scale.

In the end, the timing of the bear's retreat will likely hinge on that great market imponderable: psychology. How investors feel has a lot to do with whether they start seeing mixed signals as proof of a glass half-full. "The (market) stress causes the analytical part of our brains to shut down, and that makes us hyperreactive to bad news," says Michael A. Ervolini, CEO of Cabot Research, a consultancy catering to institutional investors. People become convinced conditions are worse than rock-bottom bad, he says. Only after they see that they've overreacted can things improve: "We look for the market to start (saying) tomorrow will be brighter."

For now, pessimism is winning the day. In the worst-case scenario, bad debts will continue to weigh on borrowers and lenders, causing the economy to slow even more, which will erode incomes and push more borrowers over the edge. Economies and corporations around the globe will weaken and rattle investors and business executives even more. Such fears have prompted Ben McCoy, a 30-year-old software engineer, to swear off new stock investments. Instead, he's putting money into his own business ventures, such as writing software for real estate appraisers and a blog about personal finance called moneysmartlife.com. "With these investments, I feel like I have more control," he says.

More Ben McCoys could signal the stirrings of an upturn. A market bottom, says Merrill's Bernstein, "generally occurs when everyone thinks it will never happen. You want to hear people giving up on the stocks-for-the-long-run theme."

But something positive must draw investors back. George A. Akerlof, a Nobel prize-winning economist at the University of California at Berkeley and co-author of a new book, with Yale professor Robert J. Shiller, on the importance of sentiment in moving markets, says investors will have to be offered a new story they can believe to get them to buy again.

That new story likely involves corporate and consumer debts being reduced to what borrowers can pay, freeing them of past mistakes so that new money can be put to productive use. Banks resume lending, and the stock market bottoms, signaling that the recession will be over soon. Budding optimism reverses the vicious cycle of losses. A bull is born.

A more probable outcome is the one drawn from the narrow history of bear markets that grew out of financial crises. In it, the bear scenario continues to play out until the bull takes over, with more debt busts and government trial and error until things get set right again. That could mean two more years of bouncing around and then another six or so before the Dow is back above 14,000. Not long ago, such an outcome would have seemed unimaginably bleak. Given the other possibilities, it doesn't seem so bad now.

END QUOTE

Why Wall Street Desperately Needs A New Bull Market

As this is written, the stock market has just staged a comeback of sorts. Yesterday (March 16th) marked an end to four consecutive days of positive returns, something not seen since November of last year. The Dow closed up just over 9% for the week, even after falling to its lowest level in 12 years on March 9th. Is the bear market over? Have we seen the bottom of the market? Can you again trust your buy-and-hold advisors who counsel you to “stay the course?” Maybe, but don’t count on it.

As the above article indicates, a new bull market may not be just around the corner, and David Henry isn’t the only one saying so. Peter Schiff, an analyst and fund manager also nicknamed “Dr. Doom” for his early warnings about the subprime crisis, says the worst is not yet over. A January 23rd Fortune magazine article highlights Schiff’s evaluation of the current situation:

“I'm as negative as I've ever been because everything the government is doing now is going to make the situation much, much worse. They're trying to reflate this bubble. All along I knew that what would potentially be fatal wasn't the recession itself but the government’s response. But what they've already done exceeds even my worst-case imagination.”

More recently, Schiff has provided a counter-argument to the idea that the market’s recent rally marks the end of the current bear market. In a March 11 entry on his Internet blog (http://peterschiffblog.blogspot.com), he again states his opinion that the bear market is not yet over. Though he concedes that we could see a bear market rally (read: sucker rally) that lasts for a period of weeks or months, he notes that such rallies were common in the 1930s and do not necessarily point to an end of the current bear market.

I think one of the reasons the analysts that are calling the market bottom get so much attention is because Wall Street and the financial media so desperately need a new bull market to appear. Quite frankly, it’s the only kind of market environment where their buy-and-hold investments are likely to work, so it’s really sort of a matter of survival. If our experience is any indication, investors are leaving buy-and-hold investments in droves, no longer heeding the tired old “stay the course” message.

Yet, these purveyors of the failed buy-and-hold strategy continue to advise clients to stay invested. If you exit the market, they say, you’ll miss out on the big market moves that usually occur early in a new bull market cycle. Of course, what they don’t say is that if you get out, they’ll miss out on their fees and possibly commissions too, but they don’t like to dwell on that.

In reality, many financial firms simply have too much invested in software, marketing materials, broker training, etc., etc. to toss their buy-and-hold strategies in the garbage can where they belong. Almost every day, we get calls from investors who are tired of listening to advice that puts a financial firm’s best interest above their own. Good for them!

The stories we hear from new investors calling us now are all different, but really they are largely the same. They had a comfortable retirement nest egg going in the late 1990s. The multi-decade bull market, and their buy-and-hold strategies, had served them very, very well for two decades. But then came the tech bubble bursting in 2000 and the bear market of 2000-2002. Unfortunately, I don’t think that bear market really got the attention of investors, especially with the market rally in 2003.

Next, we experienced the subprime crisis, and next the freeze in the credit markets, and an unprecedented bear market in stocks in such a short time. Stocks have plunged well over 50%, and buy-and-hold strategies have collapsed commensurately over the last year. Now, investors who have believed in buy-and-hold for years are abandoning such strategies in droves.

Two gut-wrenching bear markets since 2000 have shown investors and brokers alike that the “stocks are best for the long haul” mantra may not be the best alternative. After all, what is the “long haul?” Unfortunately, buy-and-hold strategies may require a time period far beyond the realistic time horizons of many investors.

These bear markets have also illustrated that the asset values can vanish into thin air at the very time they are needed the most, even though “proven” diversification and asset allocation (buy-and-hold) techniques have been employed. The most recent bear market is a good case-in-point, where once non-correlated asset classes all plunged in value at the same time.

I have argued for years that the buy-and-hold strategies advanced by Wall Street and “Modern Portfolio Theory” were fatally flawed, and it would be nice to conclude that I told you so. But that misses the point. The only question now is how to go forward without incurring 50+% losses in the future. If my argument for avoiding huge buy-and-hold losses has not gotten your attention by now, I guess it never will.

But if it has, I offer the following advice as to how to get started. I have offered this line of reasoning for over two decades, and it has worked consistently for many investors.

Make Half A Decision

“You don’t want to abandon the investment strategy (buy-and-hold) that worked so well for you during the bull markets of the 1980s and 1990s,” or so you have been told by your broker or financial advisor. But now your portfolio is down over 50% and your retirement plans are in shambles. Now, finally, you are open to other ideas. Good. What follows is an easy way to get started comfortably.

Frankly, we realize that the type of investment strategies we recommend are very different from what most investors, and even many investment professionals, have been educated to believe. Since the onset of the bear market back in October of 2007, my staff has told me of many calls from investors who are interested in the actively managed programs we recommend, but who are reluctant to make the change.

In those cases, we suggest that investors consider making “half a decision.” In other words, place only half as much as you might otherwise commit to active management strategies, as long as applicable minimum investments are met. We have many investors who will test the waters with smaller accounts before making a full commitment to active management strategies.

I am so confident that active management strategies will prove their merit versus buy-and-hold strategies that I welcome you to make half a decision in regard to your investment portfolio. If you prefer, open a minimum account in one of the actively managed programs we offer in our AdvisorLink® Program. Once you see the difference between the performance of your actively managed investments and your buy-and-hold strategy, I believe you’ll begin to see the light. Of course, there are no guarantees in regard to the future performance of any investment.

This is a very good way to get started, in my opinion. Based on how the buy-and-hold mantra has served you over the last several years, maybe now is the time to try something different with at least part of your portfolio. Think about it.

For more information on the programs I recommend, and have most of my own money invested in, feel free to give one of my Investment Consultants a call at 800-348-3601 or, if you prefer, send us an e-mail at info@halbertwealth.com. You can also obtain more information on our website at www.halbertwealth.com. Whatever you do, don’t let buy-and-hold’s empty promises continue to decimate your portfolio.

Hoping we can help you in these tough times,

Gary D. Halbert

SPECIAL ARTICLES:

The Market’s Rally is Misguided Optimism
http://articles.moneycentral.msn.com/Investing/SuperModels/market-rally-just-misguided-optimism.aspx

Obama’s Incompetent Socialism
http://www.newsmax.com/morris/obama_bailout/2009/03/16/192401.html

Will China Dump the Dollar?
http://www.fundmasteryblog.com/2009/03/16/will-china-dump-the-dollar/

Why The Stock Markets Are Collapsing

Gary D. Halbert — Tue, 10 Mar 2009 20:46:56 GMT

IN THIS ISSUE:

The Economy Continues To Slump Badly

US Stock Markets Continue To Plunge

Obama's Multi-Trillion Dollar Spending Spree

Obama's Budget – The First $2 TRILLION Deficit?

Obama's Plan To Nationalize Health Care This Year

Obama's “Cap-and-Trade” Environmental Proposal

Conclusions – Why The Stock Markets Are Collapsing

Introduction

Economic news continues to worsen week after week. As I will discuss below, Gross Domestic Product contracted at almost twice the previously reported pace in the 4Q of last year, and most analysts now expect a similar or worse slowdown in the 1Q. Many forecasters now believe the recession will last all year, with a modest rebound beginning in 2010. We will look at the latest economic data as we go along.

The stock markets continue to plunge, even as trillions of dollars in bailouts and government spending have been announced. The Dow and the S&P 500 fell 33.8% and 38.5% respectively in 2008. So far this year, the Dow and the S&P 500 are down another 25+%. Both indexes are down more than 50% from their peaks in October 2007. While the equity markets are grossly oversold, there is still no evidence of a bottom, although I fully expect that we are close.

Investors around the world are stunned, not only as a result of the collapse in the US and global equity markets, but also due to the continuing severe credit crisis. More and more analysts and politicos are calling for the US to nationalize the major money center banks that are teetering on the brink of insolvency. Clearly, people around the world are preoccupied with the economic and financial crises.

In the following pages, we will recap the unprecedented spending that President Obama has proposed over the last six weeks, including his first federal budget proposal totaling a record $3.55 trillion for fiscal 2010. Obama's 2010 budget projects a record deficit of $1.75 trillion, and I believe it will be even higher as I will discuss below. No wonder the markets are not happy!

It is also clear now that President Obama has decided to use these crises as an opportunity to cram down all of his big liberal plans for the country this year. In addition to spending trillions of dollars, he is also moving forward with other major plans including “Cap & Trade” (carbon emissions), “Card Check” (expanding unions) and nationalized health care – just to name a few, all of which will eventually mean higher costs for American consumers.

When Mr. Obama was elected, most political analysts believed that he would attempt to enact these major liberal plans over the course of his four-year presidency. Yet it is obvious now that he wants them all this year, while Americans are preoccupied with the economic and financial crises. If he gets his way, it will dramatically change the face of America. More on this as we go along

The Economy Continues To Slump Badly

It will come as no surprise to readers of this E-Letter that the US economic numbers continue to falter. But by far the most shocking number released over the last several weeks was the latest 4Q GDP report released in late February. In late January, the Commerce Department's advance estimate for 4Q GDP was -3.8% (annual rate), which was the worst in well over a decade.

Then on February 27, the government revised this number to -6.2%, the deepest quarterly decline since early 1982. I have been watching US economic data for over 30 years, and I have never seen the Commerce Department miss the GDP number this badly over just a one-month period of time. Clearly, this economy is contracting severely.

The US unemployment rate continues to ratchet up rapidly. On Friday, the Labor Department reported that unemployment rose to 8.1% in February, up from 7.6% in January. Many forecasters predict this number to rise to near 9% by year-end, and some even project the jobless rate to reach 10% by the end of this year.

The Consumer Confidence Index plunged again to a new record low in February of 25.0, down from the previous record low of 37.4 in January. Consumers' appraisal of overall current economic conditions, which was already bleak, worsened much further in February. Those claiming business conditions are “bad” rose to 51.1% in February from 47.9% the prior month.

On the manufacturing front, reports are equally grim according to the reports for January (latest data available). Durable goods orders plunged 5.2% in January following a drop of 4.6% in December. Factory orders fell 1.9% in January following a plunge of 4.9% in December. Industrial production fell 1.8% in January following a drop of 2.4% in December.

The nation's factory operating rate fell to 72.0% in January, down from 73.3% in December. Elsewhere, the construction spending rate fell another 3.3% in January, down from 2.4% in December. This is the worst manufacturing downturn in decades.

On the housing front, the numbers continue to worsen. Existing home sales fell to 4.49 million in January from 4.74 million in December (again, latest data available). New home sales fell to 309,000 in January, down from 344,000 in December. Housing starts in January fell to 466,000, down from 560,000 in December. Meanwhile the median home sale price continues to fall, sliding to $170,300 in January, down 15% from a year earlier.

In summary, we find ourselves in the worst economic slump since 1981-82, and many would argue something worse. A growing number of forecasters are coming to the conclusion that we may be headed into a depression. But as I will discuss as we go along, Obama has authorized over $3 trillion in new spending, the Fed will spend up to $2 trillion and Congress has just passed more new spending projects. So, that much money should start to show up in the economy before long.

US Stock Markets Continue To Plunge

As noted in the Introduction, The Dow and the S&P 500 fell 33.8% and 38.5% respectively in 2008. So far this year, the Dow and the S&P 500 are both down over 25%. Both indexes are down more than 50% from their peaks in October 2007. The Nasdaq Composite Index fell 40.5% in 2008 and is down another 17.6% so far in 2009, down over 55% since the peak in late 2007.

Stocks have been battered with a steady stream of bad news so far this year, as noted in the latest economic reports above. In addition, there has been report after report of faltering banks. The government now owns 36-40% of Citigroup, which saw its share price fall below $1.00 last week. The 30 companies that make up the Dow Jones Industrial Average are commonly referred to as “Blue Chips” or the strongest of the strong. Over the last year, however, the number of Dow stocks trading under $10 per share has increased dramatically.

In addition to Citigroup, other beleaguered Dow stocks include General Motors at $1.50 per share, Bank of America at $3.00, General Electric at $6.00 (down 60% this year alone), and Alcoa at $5.00.

The government has also increased its equity stake in AIG, now reportedly owning over 80% of the insurance giant. Speaking of insurance, I am hearing from sources inside the industry that we could be hearing announcements soon that some major insurers are in serious financial trouble.

Investors around the world want to know what is driving the equity markets down so dramatically. Certainly, the credit crisis and the economic recession are weighing heavily on stock prices. But I believe there is much more to it than that. As I will discuss later on, I believe that the markets are voting NO on the massive spending Obama has authorized in his first 40 days in office.

Obama's Multi-Trillion Dollar Spending Spree

In sheer size, the economic measures announced by President Barack Obama to address “a crisis unlike we've ever known” are remarkable, rivaling and in many cases dwarfing the New Deal programs that Franklin D. Roosevelt famously created to battle the Great Depression. Here is a list of the massive spending that Obama has gotten passed or is proposing:

1. In February, Congress passed and Obama signed into law a record $787 billion stimulus bill, which is mostly new federal spending along with aid to struggling states and tax incentives.

2. Treasury Secretary Geithner announced last month that the government would make available up to $2 trillion on top of what has already been spent or promised in a rescue effort for banks and other financial institutions, including credit card companies and those who make student loans. We have yet to see the details on this massive rescue plan. Clearly, the lack of a detailed financial rescue plan for the banks is spooking the stock markets.

3. The president pledged up to $275 billion in federal aid to help stem the tidal wave of home foreclosures. Here, too, the details are unclear as to how it will work.

Add it all up and the total for these three spending proposals alone is over $3 trillion in new government debt over the next 2-3 years. In all, the plans noted above would raise the federal portion of the US economy to some 31%, more than twice the level after eight years of FDR's historic New Deal spending.

This does not include the remaining $350 billion in TARP money that Obama will get to spend this year. Plus, there is also talk of a second stimulus package later this year, one supposedly aimed at consumers directly.

And let's not forget that the Federal Reserve has purchased over $1 trillion in troubled assets and related securities over the last year alone. Fed chairman Bernanke told Congress recently that the Fed is prepared to double that amount this year.

President Obama and Bernanke tell us that all this massive spending is necessary to avoid a “catastrophe.” Yet no one knows if these huge spending programs will work. No wonder the stock markets are tanking.

Obama's Budget – The First $2 TRILLION Deficit?

President Obama unveiled the largest federal budget in history in late February – a whopping $3.55 trillion. With the economy in recession, the Obama administration projected that the budget deficit for fiscal 2010 would be a record $1.75 trillion. However, there are reasons to believe it will be even higher.

For example, Obama's budget plan assumes that Gross Domestic Product, the sum of all goods and services produced by the nation, will shrink by only -1.2% this year and rebound to about 3.2% by next year. Given that GDP plunged by 6.2% (annual rate) in the 4Q, and the likelihood that the 1Q will be just as bad or worse, we would have to see a huge rebound in the second half of this year for GDP to average only -1.2% for the year overall.

Furthermore, none of my trusted sources expect GDP to rebound to 3.2% in 2010. The point is, federal tax revenues in 2010 will almost certainly be lower than the assumptions in Obama's $3.55 trillion budget, so the deficit is almost certain to be larger than projected.

Obama's budget plan also assumes that the US unemployment rate will average 8.1% this year and get slightly better in 2010. The US unemployment rate stood at 7.2% for December 2008. It has since risen to 7.6% in January and to 8.1% in February. Most economists now expect the unemployment rate to reach 9% by year-end. That does not average out to 8.1% for the year.

Here again, the unemployment realities will mean that federal tax revenues in 2010 will almost certainly be lower than the assumptions in Obama's $3.55 trillion budget. As noted above, the Obama administration projects a budget deficit of $1.75 trillion for fiscal 2010. But it will not surprise me if the deficit is $2 trillion or more in 2010. No wonder the markets are tanking!

$410 Billion Omnibus Spending/Pork Bill

The Senate is expected to pass the huge $410 billion omnibus spending bill that will finance the government through the end of September any day now. This is possibly the most pork-laden spending bill in history. It is widely reported that the bill contains over 8,500 “earmarks” (pet spending projects for lawmakers' states and districts).

The omnibus spending package ran into trouble last week when several Democratic senators opposed not only the pork-barrel spending in the bill, but also the shear size of the bill - $410 billion. That is an 8% increase over the prior omnibus bill. Among the Democrats in opposition was Senator Evan Bayh of Indiana who told the Wall Street Journal:

“The omnibus increases discretionary spending by 8 percent of last fiscal year's levels, dwarfing the rate of inflation. Such increases might be appropriate for a nation flush with cash or unconcerned with fiscal prudence, but America is neither.”

During the presidential campaign, candidate Obama promised that he would wholly change the budget process in Washington by going line by line through spending bills, picking out the wasteful earmarks, vetoing the bills, and telling Congress to send them back stripped of the pork. President Obama has echoed that promise since he took office - but just not for this bill. Since this omnibus bill was largely negotiated last year when Bush was still in office, Obama labeled it “unfinished business,” which he says he will sign and “start fresh next year.”

So, it is politics as usual in Washington, only the numbers are much bigger! These historically huge spending programs and bailouts that Obama and the Democrats in Congress have authorized have really spooked the stock markets. And the Democratic spending machine isn't finished yet. Using the “never let a crisis go to waste” doctrine, Obama has made it clear that he plans to pursue massive spending for other pet liberal programs over the next couple of years.

Obama's Plan To Nationalize Health Care This Year

President Obama recently convened a health care summit at the White House, which was attended by “experts” across the health care and insurance industries. The Washington summit is to be followed by regional meetings across the country in the weeks and months ahead.

The summit concluded without specific details as to what an Obama health care system would look like. We do know that Obama's 2010 federal budget calls for the creation of a $634 billion health care reserve fund to cover reforms over the next 10 years. The President's remarks at the summit included the following:

“To the liberal bleeding hearts hoping for universal health coverage, I don't think we can solve this problem without talking about costs. And to those obsessed with costs…[we will] not slash the social safety net. I just want to figure out what works. We don't have a monopoly on good ideas. We've got to balance heart and head.”

For those fearing a total socialization of health care, this is at least some good news. By all accounts, President Obama is resisting the liberal calls for a “single-payer” socialized health system of the type that exists in Canada and Europe. So what can we expect? No one knows for certain just yet, but two of the ideas being floated are: 1) an expansion and retool of Medicare; and 2) some variation of the health plan that members of the federal government enjoy.

It is abundantly clear that Obama intends to enact his massive health care reforms this year, and unlike the Clinton administration, Obama appears to have the votes in Congress to get it done. So, now the question is, how to pay for it? As noted above, his 2010 budget includes $634 billion over 10 years to help fund his health care “reforms.” But where does this money come from?

The Obama administration says that $318 billion of it will come from tax increases on the “wealthy.” Another large portion will supposedly come from “internal reforms” to the Medicare system. Specifically, Medicare Advantage would be placed into a new competitive biding system that will supposedly do away with federal subsidies paid to these private medical plans, which is projected to save $175 billion over 10 years.

They say another $37 billion could be saved as home health care payments to Medicare are reduced, and a further $20 billion could come from higher rebates from drug companies for drugs sold to the Medicaid program. All of this only adds up to $550 billion. Where will the other $84 billion come from? I have no idea, and at the moment, neither does the Obama administration.

The Obama plan does not seem to be in danger of going the way of the ill-fated Hillary-Care proposal in 1993. House Representative Joe Barton (R-TX) was on hand for Obama's health care summit last week. Barton was pivotal in derailing Hillary-Care, but he told those assembled at Obama's summit that he largely supports the health care reforms that President Obama has outlined thus far.

Barring some big surprises, President Obama is going to get his massive reform of the health care system, whether we like it or not, possibly before the end of this year. While it may stop short of socialized medicine, the government will be in charge of our health care system, and we all know how well the government controls spending, costs and quality. Again, no wonder the stock markets are tanking!

Obama's “Cap-and-Trade” Environmental Proposal

The “cap-and-trade” concept is not a new idea. The type of cap-and-trade program that President Obama wants is very similar to that of the European Union. Yet, the EU's cap-and-trade program is in near-collapse, which demonstrates the weakness of this strategy.

Under a cap-and-trade system, polluters (think power generation plants, steel mills, etc.) are given a cap on greenhouse gasses they can emit into the atmosphere. If they exceed their limits, they can either make their process more environmentally friendly by upgrading technology and equipment, or they can buy credits from other entities that produce fewer emissions than their caps. The goal is that, as the overall emissions caps are reduced over time, industries will find that reducing emissions is more cost efficient than buying credits.

The cap-and-trade idea is often confused with a “carbon tax,” but the two are different. In a carbon tax, the government charges a fee for the production, distribution or use of fossil fuels, rather than creating a system of emission credits that can be traded among companies. Whatever the structure, virtually all agree that any program to curb greenhouse gasses will increase prices as higher costs are passed on to consumers. Even President Obama admits this.

President Obama's recent $3.55 trillion budget proposal calls for a cap-and-trade system to be implemented by the year 2012. The government would auction credits to power plants, industrial plants, etc., with some of the proceeds over the cost of administering the program to go back to taxpayers (I wouldn't count on it).

The Congressional Budget Office (CBO) estimates that a cap-and-trade system will cost middle-income families as much as $880 to $1,500 per year in added costs. Thus, Obama's plan to offset these increased costs through a payroll tax rebate ($400 for individuals, $800 for families) won't cover all of these costs. Plus, the liberals in Congress have not yet had their say. The final bill may concentrate the rebates on lower income families, possibly leaving many middle income and high income families out entirely. Of course, the rationale is that higher-income families will reduce their costs by lowering their energy bills through conservation. …Right.

Also, it is important to recognize that certain areas of the country will be hit much harder by cap-and-trade, especially those that rely heavily on coal for electricity. I have included a link to a very good article on which areas will be hurt the most in Special Articles below.

Here again, Obama's cap-and-trade plan serves as yet another tax on higher income folks who create most of the new jobs in this country. Critics also say that a cap-and-trade program could lead to the loss of as many as four million jobs and reduce the US GDP, but still may not effectively reduce emissions. Again, no wonder the stock markets are tanking!

Obama's “Card Check” Proposal To Strengthen Unions

It is no secret that Obama has long been an advocate for the organized labor unions. As a senator, he co-sponsored the “Employee Free Choice Act of 2007,” which was very favorable to unions but was fortunately never enacted. As a presidential candidate, he had a very pro-union agenda, including repeated promises of making “Card Check” the law of the land.

Card Check, considered one of the most sweeping revisions of labor law since the 1930s, would allow unions to do away with secret ballot voting by workers who are deciding whether or not to unionize. Instead, workers would be required to vote in public by signing a card signifying their desire for, or against, union representation.

Secret ballot elections have been the law of the land for a very long time, and even many union members do not want this to change. Critics of the Card Check system say that a secret ballot election is the only way to insure that employees are not faced with undue coercion when making their decision. Card Check changes all that, since union organizers can place a card in front of a worker and know exactly which box they check. Liberal union leaders have wanted Card Check for a long time, since it makes unionization much easier.

Union membership has been steadily declining since the 1950s when an estimated 35% of the American workforce belonged to a union. Today, the Bureau of Labor Statistics reports that only 12.4% of wage and salary workers belong to a union. By far, government employees are the most likely to be unionized, with a membership rate five times that of private employees.

Unions hope that the new Card Check rules, which are almost assured to pass and be signed into law, will help to put them back on a growth path. The economic consequences will be higher labor costs for producers, lower productivity and higher prices for goods and services to consumers over time. Just look at the big three carmakers and see how beneficial increased unionization is likely to be for the US economy.

Conclusions – Why The Stock Markets Are Collapsing

I now firmly believe that President Obama and his top advisers have made a calculated decision to try to ram through the largest parts of his liberal agenda this year, while the American people are preoccupied with the economic and financial crisis.

I recently wrote that Rahm Emanuel, Mr. Obama's new Chief of Staff, told a Wall Street Journal conference of top corporate executives late last year (comments he almost certainly probably wishes he could take back):

“You never want a serious crisis to go to waste. Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with. This crisis provides the opportunity for us to do things that you could not do before.”

So Obama's liberal policy agenda that would have been considered aggressive over the full four years of his presidency is apparently going to be crammed down the American peoples' throats this year if possible.

Obama's massive emergency spending/bailout plans announced in just the first 40 days of his presidency total over $3 trillion, something never before remotely seen. Obama's 2010 federal budget of $3.55 trillion will likely result in a budget deficit of $2 trillion next year, and over $1 trillion in each of the next 2-3 years.

Meanwhile, the Fed is in the process of printing and spending another $2 trillion in debt to fund banks and buy toxic assets. Where this Fed printing and spending will stop is anyone's guess, unfortunately. The implications for inflation down the road are ominous.

And let's not forget the Congress which is about to pass a $410 billion omnibus spending package to keep the government running through September that was 8% higher than last year at this time, and included over 8,500 pork-barrel earmarks. Obama obnoxiously broke his campaign promise to veto earmarks by saying this enormous omnibus spending bill was “unfinished business” left over from the Bush administration, and promises to sign it into law.

On top of all this, Obama's liberal policy initiatives such as nationalized health care, cap-and- trade and Card Check (just to name a few) will add hundreds of billions in cost to American consumers over the years ahead. And despite what Mr. Obama says, taxes at all levels will have to eventually be increased to pay for this massive spending. It will change the face of America as we know it, but that is a story for another time.

The long-term implications of these unprecedented multi-trillion dollar spending plans are unknown. No one knows for sure if all of these huge spending efforts will work to revive the economy and unfreeze the credit markets. If they do, then there is the prospect for spiraling inflation in the years to come.

Investors around the world are watching their stock portfolios being decimated – down over 50% in just over one year – and are asking WHY is this happening? Sure, the subprime mortgage debacle was the catalyst. But in my view, the radical changes that President Obama is pursuing – sooner rather than later – are in large part why the stock markets are in a freefall collapse instead of a normal bear market.

Fortunately, the professional money managers I have recommended to you in this E-Letter over the last several years have done their jobs admirably. Their active management strategies that have the ability to move to cash or hedge long positions have limited losses to less than half what the stock markets have lost. Some have even made money in this historic bear market. As always, I must add that past performance is no guarantee of future results.

As always, I invite you to call us at 800-348-3601 so we can help you make sense of this frustrating investment environment. That is all for this week, depressing as it may be once again.

Wishing you the best in tough times,

Gary D. Halbert

SPECIAL ARTICLES:

Deception at Core of Obama Plans
http://www.realclearpolitics.com/articles/2009/03/a_dishonest_gimmicky_budget.html

The Anti-Stimulus Plans
http://weeklystandard.com/Content/Public/Articles/000/000/016/249nhfrg.asp

Winners & Losers in Huge Congress Spending Bill (who got what in pork)
http://www.foxnews.com/politics/2009/03/09/winners-losers-proposed-massive-spending/

Who Pays for Cap and Trade?
http://online.wsj.com/article/SB123655590609066021.html

Obama Seeks Multi-Trillion Dollar Bailouts

Gary D. Halbert — Tue, 03 Feb 2009 22:25:16 GMT

IN THIS ISSUE:

The Recession Continues To Deepen
So, How Deep & How Long?
Multi-Trillion Dollar Bailouts In The Works
Obama's $825 Billion "Stimulus" Package
Obama's Next "Big Bang" Bank Bailout
Fed Gearing Up To Buy Treasury Bonds

Introduction

We are witnessing the most aggressive government intervention into the US private sector in history, and I am not simply referring to President Obama's massive $825 billion so-called "stimulus" package passed last week by the House of Representatives. As we will discuss as we go along, there are also plans in the works to borrow and spend trillions more, which will result in the government owning even more of the private sector, starting with the banking system.

We should all recognize that President Obama and most of the Democrats in Congress have no problem whatsoever with the government owning (and eventually controlling) much of the private sector. What we are, and will be, witnessing is unprecedented and is being planned under the guise of the economic and financial crisis, when in fact there is a much larger political agenda ongoing now that the Democrats have control of the White House and the Congress.

Speaking of the economic and financial crisis, the US recession continues to deepen as does the global economy. The Commerce Department reported on Friday that US GDP slumped at an annual rate of 3.8% in the 4Q. Most of the other economic reports of late have also been on the negative side. Most forecasters now predict that 1Q GDP will also be down at least 3-4%. This week, we look at the latest data and some forecasts of what lies ahead for 2009.

Following that, we will examine the latest $825 billion stimulus package that was passed last week by the House. While initially touted as a way to jump-start the banks and unfreeze the credit markets, the final bill is loaded with pork-barrel spending and has nothing for the banks. Following that, we will discuss new government plans totaling $1-2 trillion to bail out the banking system. There is so much to talk about, I don't know where to start, but let's begin with the economy.

The Recession Continues To Deepen

As one analyst put it, there is still no light at the end of the tunnel for the US economy, which officially entered this recession in December 2007 (with the benefit of hindsight). As noted above, US Gross Domestic Product fell at an annual rate of 3.8% in the 4Q, the largest quarterly decline since 1982. The latest GDP number was not as bad as pre-report expectations, but it does reflect the reality that holiday retail sales plunged over 8% in December according to MasterCard.

The Consumer Confidence Index dropped to another all-time low in January, falling to a reading of 37.7, down from 87.3 one year ago. Consumers remain very pessimistic about the state of the economy and about their earnings. Those saying business conditions are "bad" increased to 47.9% from 45.8% in December, while those saying business conditions are "good" declined to 6.4% from 7.7% in December. These are the lowest readings since the Consumer Confidence Index has been in existence.

In what was initially thought to be a bright spot, the Conference Board announced last week that the Index of Leading Economic Indicators (LEI) rose 0.3% in December. However, the Conference Board was quick to point out that the increase in the LEI was almost entirely due to the large surge in the money supply in December. The economic component of the LEI was actually down -0.5% in December. The LEI has declined for the last seven months in a row.

The unemployment rate rose more than expected in December, to 7.2%, when every state in America saw its unemployment rate rise. The nation lost apprx. two million jobs in the last four months of 2008 alone. Employment data for January will be released this Friday, and analysts expect the unemployment rate to rise to 7.5%. At the rate major layoffs are being announced, the unemployment rate could approach 9% by the end of the year.

On the manufacturing side, most reports were worse than expected. The ISM Index fell to 32.4 in December, down from 36.2 in November, and worse than pre-report estimates of a decline to 35.4. This morning, the ISM Index for January showed a modest increase to 35.6, which was higher than expected. But keep in mind that any figure below 50 indicates an economy that is contracting.

Industrial production fell 2.0% in December, twice the pre-report consensus. Durable goods orders fell 2.6% in December following a decline of 3.7% in November. Factory orders plunged 4.6% in November (latest data available).

On the housing front, there finally were some encouraging reports. Sales of existing homes rose 6.5% in December to an annual sales pace of 4.74 million units according to the National Association of Realtors, although the NAR noted that many of the sales were "distressed sales" in an effort to avoid foreclosure.

Thanks to the unexpected home sales increase, the inventory of homes for sale decreased 11.7% in December to 3.68 million units. That represents a 9.3-month inventory of unsold homes at the current pace of sales, down from a 11.2-month supply in November. The median home sales price fell to $175,400 in December, which was down 15.3% from the same period in 2007.

New home sales, on the other hand, fell more than expected in December to apprx. 331,000 units. Housing starts fell more than expected in December to apprx. 550,000 units – this is actually a good thing. Building permits also fell more than expected in December to apprx. 549,000 units, also a good thing from an economic standpoint, though not so good if you are or work for a builder.

So, How Deep & How Long?

The truth is, no one knows for sure how long this recession will last or how bad it will get. As noted earlier, most forecasters are predicting that GDP will fall by 3-4% in the 1Q. Among the analysts and forecasting groups I read and respect, there are basically two camps. One camp believes that the recession will get worse, perhaps considerably worse, the credit markets will remain very tight all year, and that a mild recovery will not begin until sometime in 2010.

The other camp is less pessimistic and believes that the economy will begin a slow recovery and the credit markets will unfreeze in the second half of this year. Most in this camp believe that the vast sums (trillions as we will discuss below) the government and the Fed are throwing into the economy will fill the void left by contracting consumer spending. Some in this camp are optimistic that the unexpected upturn in existing home sales in December will have marked the bottom of the housing slump.

Personally, I have been leaning more toward the first camp. However, as we will discuss in the pages that follow, if the Treasury and the Fed are prepared to throw an additional $1-$3 trillion of liquidity into the economy, perhaps the outcome is somewhere between the two camps noted above. In either case, we will not be out of this recession any time soon.

Multi-Trillion Dollar Bailouts In The Works

As I noted earlier, I do not wish for this week's E-Letter to be considered a political piece, but there are some political realities that sophisticated investors must consider. The question for me is where to start. I choose to start this discussion with a quote from President Obama's Chief of Staff, Rahm Emanuel, shortly before Obama took office.

Rahm Emanuel, who was a senior political advisor to former president Bill Clinton, and most recently a member of the House of Representatives from the state of Illinois, is one of the most powerful (and foul-mouthed) members of the liberal Washington elite. Interestingly, Emanuel supported Hillary Clinton in the campaign, but Obama picked him as Chief of Staff anyway.

As President Obama's Chief of Staff, Emanuel is essentially the second most powerful politician in Washington. Mr. Emanuel stated the following to the Wall Street Journal after Barack Obama named him as Chief of Staff prior to his inauguration (read carefully):

"You never want a serious crisis to go to waste. What I mean by that is that you have an opportunity to do things you could never do before. Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with."

Let me interpret this political message that Emanuel unintentionally stated: We are in an unprecedented financial crisis that will pave the way for the implementation of the liberal policies that we believe in, including things that the American people would not otherwise tolerate. And some of those things are now in the pipeline as I will elaborate below.

You have no doubt heard about President Obama's estimated $825 billion "stimulus" package that was passed by the House last week (with not a single Republican voting yes). As you probably also know, that "stimulus" package was loaded with pork-barrel spending that, during the campaign, Obama said he would not tolerate.

What you probably do not know is that Obama has an additional stimulus plan to recapitalize the banks and financial institutions that could total $2 trillion or more, and will mean that the government gains substantially more equity ownership of the major banks and financial institutions, as well as others.

Should President Obama run into problems financing these huge bailout initiatives, the Federal Reserve has let it be known that it stands ready to purchase a trillion or more in long-term bonds in order to keep interest rates low and keep the credit markets from seizing up, according to recent statements from his new Treasury Secretary, Timothy Geithner.

We will look in more detail at Obama's breathtaking plans in the pages that follow, beginning with the latest $825 billion "stimulus" package passed by the House last week. Then we will look into the potentially $2 trillion rescue package for the banks and the possibility that the Fed will be buying hundreds of billions of Treasury bonds, if needed.

Obama's $825 Billion "Stimulus" Package

Unless you are politically tone-deaf, you know that President Obama has proposed another so-called ‘economic stimulus package' of apprx. $825 billion, on top of President Bush's $700 billion "Troubled Asset Relief Program" (TARP) last year, of which only apprx. half has been spent so far. Obama will now get to decide how the other half is spent.

Oh, and let's not forget the additional $800 billion that the Fed intends to spend in an attempt to further unfreeze credit markets for homebuyers, consumers and small businesses. Never mind that the Fed's plan aims to do the very things that Secretary Paulson initially planned for TARP – buy up troubled mortgage securities – but then said there were better uses for the money.

Many analysts have argued for several months now that Bush's TARP program was not enough to keep our nation's largest banks afloat, and that much more in the way of rescue funds would need to be made available by the Treasury. Plus, most analysts also agreed that any such new stimulus package should include tax breaks and incentives to get consumers spending again to revive the plunging economy.

As a result, many of these same analysts welcomed the idea of the additional $825 billion Obama requested. That is, until they saw how Obama planned to spend the money. Most analysts figured that the $825 billion would go to banks in the form of loans or other capital injections, and to consumers in the form of tax cuts, rebates or other tax incentives to put money in their pockets.

But when the Obama administration finally released the substance of the $825 billion stimulus package, most analysts (your editor included) were shocked. The latest enormous stimulus package is loaded with pork. Around two-thirds of the $825 billion is liberal pork-barrel spending, with little for infrastructure rebuilding; only around one-third is tax cuts and credits for consumers; and there is nothing in the bill for helping the banks.

Remember, this was Obama's proposal. The House tweaked it a little, but not much in the end. The plan passed by the House last week totaled $819 billion, with only $275 billion for tax cuts and a whopping $544 billion in new spending programs as outlined below. The Senate, which has yet to vote on the bill, reportedly has plans to increase it to apprx. $900 billion. For discussion purposes below, I will simply refer to it as the $825 billion stimulus package.

As reported last week, the liberal spending components in Obama's plan include an estimated: 1) $92.3 billion for education, labor, etc.; 2) $88.9 billion for Medicaid to help out state budgets that are in the red; 3) another $79 billion for states that are running budget deficits; 4) $59.5 billion for transportation and urban development; 5) $48.9 billion for the Energy Department; 6) $27 billion for the Agriculture Department; and 7) $15 billion for the environment – just to name a few.

If your blood is not already boiling, get this. Obama's $825 billion bailout also includes over $5 billion that is targeted for low-income housing assistance organizations that prominently includes Chicago-based ACORN, which is really a left-wing political group that Obama worked for in his early days after law school. ACORN could be a big recipient of this money, even though it is under federal investigation for voter fraud. Hmmm.

As you can see, the bulk of Obama's $825 billion stimulus package is targeted toward government agencies – not consumers or banks – and is estimated to result in at least 600,000 new federal employees. So Obama's first major legislative initiative – supposedly a stimulus package to jump-start the economy – is a bloated spending package to increase the size of government, with only about one-third going directly to help consumers.

The Democrats in the House were surprised initially at the makeup of the bill, but quickly passed it last week with few changes. As you have likely heard, Obama's giant "stimulus" package was voted against by every Republican in the House of Representatives and even a number of Democrats. Assuming the Senate passes it (or something even larger) in the next week or two, it will soon become the law of the land.

Making matters worse, precious little of the spending and tax breaks will occur in 2009. According to the Congressional Budget Office, only apprx. $93 billion of the $825 billion will be spent in fiscal 2009, the time we need it most, and only apprx. $225 billion would be spent in fiscal 2010. The balance reportedly doesn't get spent until after that time, when we should be out of the recession.

Instead of giving the economy a "targeted, timely and temporary" injection as Obama had promised, the plan has been larded with spending on existing social programs or hastily designed new ones, with much of it permanent - and not enough of it likely to create new jobs. The Obama administration says that it wants 75% of the money to "spend out" within 18 months. But the Congressional Budget Office estimates that, under the House bill, only 64% of the spending and tax cuts will hit the economy by 2011.

Also troublesome is the likelihood that the bill will become a vehicle for new protectionism policies. The House added "Buy American" protectionism provisions for iron, steel and textiles, and the Senate seems bent on expanding the list of products. The Obama administration seems unconcerned about the danger these measures pose. The protectionism provisions insisted on by the Democrats could undo whatever measured job creation the stimulus plan achieves by provoking US trading partners to reduce purchases of American-made goods.

And finally, there is the question of whether or not these large new amounts of spending will be counted toward the "baseline budget" for all of the government departments receiving funds under Obama's $825 billion spending plan. For example, will the $92.3 billion going to education, labor, etc. mean that their baseline budget going forward is permanently $92.3 billion higher?

The $825 billion stimulus plan is supposed to be a "one-time" expenditure. But we will have to wait and see if this is true, or if all the departments getting this new money will try to say that their budgets should be increased by that amount permanently in future fiscal years. In Washington, it is easy to give money away, but it is next to impossible to scale it back.

Obama's Next "Big Bang" Bank Bailout

In addition to the $825 billion stimulus package discussed above, Congress also approved the release of the remaining $350 billion from the TARP program to the Obama administration last week. Late last week and over the weekend, Obama and his spokespersons promised that new Treasury Secretary Geithner will soon be announcing their plans for how to spend the remaining $350 billion of TARP monies – plus a whole lot more. What could this mean?

The Wall Street Journal reported on Thursday of last week that the Obama administration is planning another $1-$2 trillion bailout aimed at restoring the financial health of US banks. What, you haven't heard about this yet? Surprise, surprise. This may explain why none of Obama's $825 billion stimulus plan, and apparently none of the remaining $350 billion of TARP funds, will be targeted to banks and financial institutions that are teetering on the brink.

The Wall Street Journal noted the following last Thursday, January 29:

"Government officials seeking the revamp the U.S. financial bailout have discussed spending another $1 trillion to $2 trillion to help restore banks to health… The potential size of the rescue efforts being discussed suggests the administration may need to ask Congress for more funds [a trillion or two]… The administration is expected to take a series of steps, including relieving banks of bad loans and securities.

The so-called ‘bad bank' that would buy these assets could be seeded with…as much as $1 trillion to $2 trillion raised by selling government-backed debt or borrowing from the Federal Reserve."

Wow – another $1-$2 trillion bailout of the banks! The question that arises, of course, is how will the government make these enormous funds available to the banks? Will they be in the form of loans or direct giveaways? New Treasury Secretary Geithner said last week that such new money would be loaned to the banks. Thus far, government loans to the big banks have been made in return for non-voting "preferred shares" in these banks.

Yet given the magnitude of the loans they are talking about – $1-$2 trillion – it is entirely possible that the government will have to take collateral in the voting "common stock" of the banks, potentially giving the government some element of control over the banks and their operations. This sounds like the first step toward "nationalizing" the banks.

On Wednesday of last week, Treasury Secretary Geithner said that he wants to avoid nationalizing banks if possible. He stated: "We'd like to do our best to preserve that [banking] system." Read that quote very carefully. I read it as follows: We'll try to avoid nationalizing the large banks, but if we feel we have to, we will. This is very scary!

As I have stated twice over the last two months, President Obama comes from a political persuasion that has no problem with the government owning – and eventually controlling – large parts of the private sector. Many Americans who voted for Obama had no idea, or ignored the fact that he embraces this ideology.

So we should not be surprised if the government ends up owning big equity stakes in our nation's largest banks over the next year or so. And there is even the chance that the government will actually nationalize the banking system before it's over. Hello Europe!

Fed Gearing Up To Buy Treasury Bonds

The massive bailouts we have already seen, plus those outlined above to follow soon, lead to one pivotal question: How is the US Government going to pay for all of this? Since we're already running a trillion-dollar deficit, the new spending would have to be funded by selling even more Treasury debt. Thus, this leads to additional questions such as: 1) Who is going to buy these trillions in new government debt? Will foreigners continue to buy US Treasury securities as they have in the past; 2) Or will these trillion-dollar deficits spook them away; and 3) Will the US dollar plunge as a result and lose its status as the world's reserve currency?

It is impossible to know the answers to these questions, and the Obama administration knows this. Therefore, the Federal Reserve is gearing up to be the "lender of last resort" as Obama's massive bailout programs move forward. The Wall Street Journal reported last Thursday that the Fed is gearing up to purchase long-term US Treasury securities on a massive scale.

This has never happened in the post-Great Depression era. Yet the Fed is reportedly now gearing up to directly buy US Treasury bonds in case Obama's bailout plans for the banks don't work. Supposedly, the Fed has the legal authority to directly buy long-term US Treasury bonds, but it has never done so on a massive scale before.

Government officials are trying to put lipstick on this pig by claiming that the Fed's action to buy Treasuries will help to reduce long-term interest rates and thus facilitate more business and mortgage borrowing. However, the real reason is that there's likely not going to be anyone left to buy our Treasuries, especially if the Dems pursue idiotic protectionist measures that would harm the very trading partners we rely on to buy our debt.

And if the government usually sells Treasuries to finance its operations, where will the money come from to buy its own Treasury securities? That's right, folks. They'll just keep the printing press running until they have enough. As I have noted before, Obama and our monetary authorities are scared to death about deflation, and they will do anything within their power to avoid a debt deflation (a la: Japan) from unfolding in the US, regardless of the inflation implications down the road.

Fed chairman Ben Bernanke has recently stated in public that the possibility of the Fed buying Treasuries is real. The latest policy statement from the FOMC made it clear that the Fed "is prepared" to take such a step as a result of the "evolving circumstances" in the credit crisis. I interpret these developments to mean that the Fed will fire up the printing presses immediately if Obama has problems raising the trillions of dollars he plans to spend.

Conclusions?

I have always tried to tackle the complicated issues of the day and explain them in ways that most anyone could understand. Yet the current economic and financial crisis defies a simple explanation. Yes, we know what lead us into this crisis – home mortgages were made available to millions who had little or no chance of being able to make the payments.

Pundits can argue as to who is to blame for this. Conservatives can make a strong argument that the incentives for giving home loans to people who could never make the payments go back to the Clinton presidency, which is true. But liberals can argue, rightly so, that these sub-prime lending practices continued, and even increased, during the Bush administration.

Yet where to place the blame largely misses the point, in my opinion. We are now in what looks to be the worst economy since the Great Depression. Not even the best thinkers of our time suggested that we would be in such a broad-based financial crisis a year ago. But here we are.

It is clear that President Obama prefers a Keynesian approach to solving this crisis – that is by spending trillions of dollars and substantially increasing the size and scope (control) of government. This should not have come as a surprise to anyone who has read this E-Letter for long – I warned you about this on numerous occasions well before the election in November.

Interestingly, we learned yesterday that the Republicans in Congress are busy crafting their own economic stimulus package to counter President Obama's. There are few specific details known about this GOP rescue package as I prepare to hit the "send" button, but it appears that the Republicans' stimulus package will focus on numerous tax cuts and spending that might help the economy in the near-term. Depending on what the Republicans come up with, I might write about that next week – we'll see.

Getting back to the economic discussion at the beginning of this letter, this recession is clearly worse than even the naysayers predicted. As discussed above, it could last a few more months, or it could last well into 2010. Whatever proves to be the case, it will not be good news for the stock markets, which are flirting with new lows as this is written.

In recent weeks, I have emphasized that the mantra of "buy-and-hold" investing is going the way of the buggy whip. Investors around the world have seen their portfolios crushed by the bear market. And it may not be over.

Over the last couple of months, we have seen a significant increase in interest for our actively managed investment programs that have the ability to move to cash (money market) or hedge long positions, and especially our more aggressive programs that will "short" the market. It seems that more and more investors are coming around to my views on risk management.

If your investment portfolio has been hit hard over the last year or so, maybe now is the time to reallocate some or all of your portfolio to professional money managers and strategies that have the potential to get out of the way of bear markets. Call one of my Investment Consultants at 800-348-3601 if you are interested in learning more about these strategies.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Obama Should Fix the Flawed Stimulus Package
http://www.washingtonpost.com/wp-dyn/content/article/2009/01/31/AR2009013101535.html

Lessons from the Stimulus Fight
http://www.weeklystandard.com/Content/Public/Articles/000/000/016/100dyjdy.asp

Public mixed on stimulus package.
http://www.usatoday.com/news/washington/2009-02-02-poll-stimulus_N.htm

Economic & Investment Outlook For 2009

Gary D. Halbert — Tue, 06 Jan 2009 22:10:01 GMT

IN THIS ISSUE:

Editor's Notes On BCA & The Other Gary Halbert
Obama & The New Age Of Big Government
The Economy -- Have We Seen The Worst Of It?
Are The Bailouts Necessary & Will They Work?
The Latest Disappointing Economic Reports
Stock Markets -- Might We Have Seen The Bottom?

Introduction

2008 proved to be a catastrophic year in the financial and credit markets as well as for most investors as judged by the global equity markets. The credit markets and bank lending activity ground to a virtual halt, something not seen in most of our adult lifetimes. Consumer confidence and spending, which now accounts for over 70% of US GDP, fell off a cliff in the span of just 3-4 months late last year. We are now in an unprecedented "credit crisis," the outcome of which remains to be seen.

The US government and the Federal Reserve have responded to the credit crisis in ways that most of us could never have imagined, and they are not nearly done yet. Much more is to come. We can agree or disagree with these giant bailout measures, but like them or not, even more enormous government rescue programs are sure to come in the Barack Obama administration, on top of his already aggressive plans such as nationalized health care, etc.

One thing to keep in mind is that our new President is a man who embraces government ownership and control of the private sector, so we can expect more massive bailouts in the next year or longer as needed. Already, Mr. Obama is suggesting another fiscal stimulus package approaching $1 trillion this year, and that is just the beginning -- I promise. But the point of what follows is not a political piece. The question is whether or not the plans will work.

What we do know is that we are officially in a recession that reporting agencies now believe began in December 2007. Most forecasters now expect that GDP plunged 4-5% (annual rate) in the 4Q of last year, and will continue to fall for at least a couple more quarters. Meanwhile, deflation is becoming a greater threat. In the pages that follow, we will take an in-depth look at the latest economic and inflation numbers. I'll give you the latest thinking from my best sources on what may lie ahead.

But first, I have a couple of important Editor's Notes that have resulted from many reader inquiries, before we get into the meat of this week's letter. Let's get going.

Editor's Notes

The Bank Credit Analyst: I frequently get questions from long-time readers asking why I do not mention the Bank Credit Analyst (BCA) or quote from their monthly reports as I have for many years. Considering the amount of interest, an explanation is in order.

You may recall that BCA maintained throughout 2007 that the subprime mortgage dilemma would be contained to the housing market, and that a recession was not the most likely scenario for the US or the rest of the world. Then in early 2008, BCA did an abrupt about-face on the subprime crisis, complete with a forecast of a credit crisis and a potentially deep global recession.

I have to admit I was surprised that BCA was late in identifying perhaps the most significant trend change in our lifetimes and an oncoming credit crisis. However, no economic forecasting service is perfect, and I have a number of other sources of economic and financial forecasts that were also late to recognize the full effect of the subprime debacle. So that is not the reason I no longer quote BCA.

Quite the contrary. In early 2008, BCA contacted me in regard to my summarizing and quoting their materials. According to BCA, some of their subscribers had complained about having to pay a large amount of money for what I periodically offered to my clients and E-Letter readers for free. When I first began sharing BCA's outlook over 20 years ago, my comments were limited to a monthly newsletter that went only to my clients and prospective clients. Now, however, my Forecasts & Trends E-Letter goes out to over a million e-mail addresses each week.

While BCA has long been a valuable source of information for me, I fully understand their concerns. After all, they make their money through subscriptions, so anything that might diminish their subscription base would obviously need to be addressed. As a result, I agreed to no longer quote or summarize BCA's views of the economy or markets in light of their concerns.

Finally, it is important to note that BCA has never been my sole source of economic information and forecasts. My staff and I review numerous other sources for forecasts and analysis that help me in forming my own view of the economy, the markets, etc.

The "Other" Gary Halbert: As a reminder, to this day I am often confused with Gary C. Halbert, which is most interesting since Gary C. Halbert passed away in early 2007. For the record, I am Gary D. Halbert and am no relation to Gary C. Halbert; in fact, I never met the man. Apparently, Gary C. Halbert was a successful copywriter and marketer at some point in his life, and he had a newsletter called "The Gary Halbert Letter" and a website by the same name.

The confusion typically occurs when someone does an Internet search for "Gary Halbert." If you type Gary Halbert into Google, for example, the entire first page of results are for Gary C. Halbert -- even though the man has been dead for nearly two years. The first Google result for me -- Gary D. Halbert - is not until the lower part of page two.

We have often wondered how much business we have lost over the years from investors who searched the Internet looking for me but found the other Gary Halbert instead and were not favorably impressed! I have no idea why Gary C. Halbert's website is still on the Internet.

If, however, you type in "Gary D. Halbert," you'll find me at the top of the non-sponsor results. Bottom line: if you should refer someone to me, please advise them to include my middle initial "D." if they wish to find me on the Web. Better yet, advise them to go to my website at www.halbertwealth.com.

On that note, let me extend a huge THANK YOU to all of our clients who have referred friends, relatives, etc. to us over the years. Client referrals are one of our best sources of new business!

With the above noted housekeeping items out of the way, let's turn our attention to the economy, the ongoing credit crisis and the investment markets. But first, let's consider the bigger picture of what to expect from President Obama. The following is not meant to be a political slam on our soon-to-be new president; rather it is simply a perspective on the times to come.

Obama & The New Age Of Big Government

There is no arguing that Barack Obama is one of the most liberal politicians of our time, as is Joe Biden. President-elect Obama believes that more government is the solution, not the problem. He has stacked his new Cabinet with Clinton retreads who believe as he does, including Hillary Clinton as his Secretary of State designee.

President-elect Obama vows that as soon as he is in office, he will pass a gargantuan financial rescue bill (bailout) that is estimated to be as large as $800 billion to $1 trillion in an attempt to unfreeze the credit markets and create at least one million new jobs. No doubt the Democrat controlled Congress will go along. It appears that a number of Republicans will go along as well.

Mr. Obama says his huge rescue plan will be targeted at tax cuts and infrastructure projects that will create new jobs. I, however, predict that much of the bailout money will continue to go to recapitalize banks, financial institutions, automakers and other large companies that get into serious trouble. Obama may have no choice if he and the Fed are to stave off a debt deflation and a depression.

In fairness to President-elect Obama, he comes into office at one of the worst possible times in the last century. He is inheriting the worst economy in decades, the worst financial crisis since the Great Depression and a record large federal budget deficit -- just to name a few. He has an enormous job ahead of him with major problems that have no immediate solutions, and which may get worse before they get better.

But keep one thing in mind dear readers. President-elect Obama comes from a political persuasion that believes it is perfectly acceptable for the government to own equity stakes in the private sector. And he comes into power at exactly the time in which much of the public is more than willing to see this happen, and when even some conservative analysts admit that such steps are probably a "necessary evil."

Based on the many comments I receive from readers, it is obvious that many of you are totally against the government bailouts. Be warned, however, that the bailouts are far from over in my opinion. So it is in this context that I move on to more specific issues.

The Economy -- Have We Seen The Worst Of It?

As noted above, we see and read lots of economic, financial and investment forecasts at my company. Here is the general consensus on the economy of late (obviously, there are forecasts that are better and worse than the consensus I see out there). The general consensus is that the US economy (GDP) fell by an annual rate of 4-5% in the 4Q. We won't get the first official GDP estimate until the end of this month.

The general consensus is that the first half of 2009 will also see negative GDP, but perhaps not as bad as the 4Q we just endured. The unemployment rate is expected to rise to at least 8%, and some believe 10%, well before the end of this year. However, most forecasters currently believe that the US economy will bottom out and begin a slow recovery some time in the second half of this year -- assuming, of course, that there are no more big negative shocks, and that the banks slowly resume lending.

Some of my respected sources believe that, if necessary, the Obama administration and/or the Fed will institute some government mechanism that will guarantee bank loans if that's what it takes to unfreeze the credit markets. (I'm not making this up, folks.)

Assuming the economy bottoms out sometime in the second half of this year, the general consensus is that GDP will grow at a below-trend rate of only 1½-2½% for the next several years following 2009 as the world continues to deleverage (i.e. -- reduce debt).

Of course, there are some respected forecasters that believe the above noted scenario is too optimistic. Some believe that the bailouts will not be successful, the credit markets will not unfreeze this year, and that we are headed for a modern day depression. Others believe that even if the bailouts work, we will be facing runaway inflation in 2010 and beyond. Clearly, there are few, if any, rosy scenarios floating around today.

Are The Bailouts Necessary & Will They Work?

Most conservatives (and even some liberals) I talk to are opposed to the various government bailout measures to-date and the trillion dollar rescue package that President-elect Obama has planned. Many say, "Let ‘em all fail." Several media polls have shown that a majority of Americans are opposed to the bailouts. Personally, I would much prefer an economic stimulus plan that eliminated the capital gains tax and reduced other taxes, but that is not going to happen with the Democrats in control of Congress and the White House.

Given that reality, most of the sources that I respect agree that the bailouts and the various actions by the Fed were necessary in an effort to avoid a debt deflation and a possible depression. Their argument is that with consumer spending accounting for over 70% of GDP, and with consumer spending having fallen off a cliff, the government had to step in to keep us from going from a serious global recession to something worse.

In fact, some forecasters are calling on other countries to follow the lead of US policymakers and slash their interest rates and recapitalize their money center banks. Some actually criticize Europe for resisting such rescue efforts, while praising the UK for its financial rescue efforts.

Further, I would also say that there is a consensus in the forecasting world that it was a huge mistake for the government to let Lehman Brothers go bankrupt. Many analysts believe that it was the failure of Lehman that caused the major banks to put a lockdown on lending, even to each other.

I certainly don't expect to make any bailout converts with this discussion. However, I think it is pertinent to point out that there are respected analysts and forecasters that believe the government and the Fed had no choice but to do what has been done, and that the government may have to do even more if we are to avoid a depression.

Now to the question of whether the bailouts will work. At this point, the answer is we don't know. The first "economic stimulus package" of $168 billion last spring was considered pretty much a non-starter. Various sources have estimated that most Americans who received the tax rebate checks in late April and May saved most of the money or used it to pay off credit card debt or other bills, rather than spend the money as was hoped by the Bush administration.

One thing is clear, however: the Bush administration did not have a well-designed plan for how it intended to use the first $350 billion of the $700 billion Troubled Asset Relief Program (TARP). That was obvious when President Bush and Treasury Secretary Paulson changed the objective of the TARP from buying up troubled mortgage-related securities to recapitalizing the major banks and most recently the automakers.

Some (but certainly not all) of the criticism of Bush and Paulson may have been unfair. I don't believe anyone knew how difficult it would be to reinstate trust in the credit markets and to get the major banks lending once again. As discussed above, President-elect Obama will face the same challenge when he takes office, and talk of some kind of government loan guarantee program for the banks continues to gain momentum, for better or worse.

While it remains unclear if the bailouts will work, there is now little doubt that Mr. Obama's request for a massive new rescue program of up to $1 trillion will be passed by the Congress within the next month or two. Over the weekend, several leading Republicans stated that they would support such a huge stimulus program, provided it was not loaded with earmarks. So I believe it is safe to assume we will see Obama get his wish.

The Latest Disappointing Economic Reports

I have been poring over economic data for over 25 years, and I do not remember another time when the various reports have been as overwhelmingly negative as over the last month or so. Let's take a look at the latest numbers. As noted earlier, most forecasters expect that 4Q GDP fell by 4-5%; however, that report won't be out until January 30.

The final report on 3Q GDP was an annual rate of --0.5%, about as expected, following +2.8% in the 2Q. The decline in 3Q GDP was largely the result of a 3.8% drop in personal consumption expenditures.

The Index of Leading Economic Indicators (LEI) fell 0.4% in November (latest data available). The LEI has been falling for over a year. More troubling, the six-month change in the LEI was negative 2.8%, and the 12-month change was --5.6%. The Conference Board reported that the Consumer Confidence Index fell to a new all-time low of 38.0 in December.

Consumers' appraisal of current conditions grew substantially worse in December. Those claiming business conditions are "bad" increased to 46.0% from 40.6% in November, while those claiming business conditions are "good" declined to 7.7% percent from 10.1%. Consumers' assessment of the labor market was also considerably more negative than in November. Those saying jobs are "hard to get" rose to 42.0% from 37.1% in November, while those claiming jobs are "plentiful" decreased to 6.2% from 8.7% a month earlier.

The plunge in consumer confidence resulted in even worse than expected retail sales during the holiday season. Spending Pulse, an organization that collects consumer spending data from MasterCard, says consumers spent about 20% less on electronics, women's clothes and jewelry in November and December in comparison with the same period last year. Spending Pulse says total retail sales declined up to 8% during this holiday season.

The numbers are not all in yet, but it also appears that online sales declined for the first time ever. Reuters reported that online sales for the holiday period up to December 23 fell 3% from the same period last year, marking the first decline in Internet spending since comScore, Inc. started tracking online sales in 2001.

On the manufacturing front, the news is equally dismal, if not worse. The Institute for Supply Management (ISM), a purchasing management group based in Tempe, Ariz., said its manufacturing index was 32.4 for December, the lowest reading since June 1980, when it stood at 30.3.

Manufacturing activity failed to grow for the fifth consecutive month, according to the ISM, and ISM noted that the December decline was representative of all sectors of manufacturing. An ISM index reading above 50 indicates growth, while a reading below 50 indicates a slowdown. A reading below 41 is typically associated with recession in the broader economy.

Industrial production fell 0.4% in November and was 5.5% below yearago levels. Capacity utilization (the factory operating rate) fell to 75.4 in November, down from 81.1 a year ago. Durable goods orders declined 1.0% in November, following the huge drop of 8.4% in October. It was the fourth consecutive monthly decline in durable goods orders.

The unemployment rate jumped to 6.7% in November, the highest level in more than 14 years. Forecasters expect the December unemployment rate to jump to 7% when the latest report comes out on Friday. Nonfarm payroll employment fell sharply by 533,000 in November. As noted earlier, most analysts expect the unemployment rate to rise to 8% or higher in the first half of 2009. At 500,000 jobs lost per month, it could hit 10% by the end of this year if the economy doesn't begin to rebound.

News on the housing front was equally disappointing. Sales of existing homes plunged 8.6% nationally in November. New homes sales also declined again in November. The national median sales price for existing homes fell by the largest monthly amount on record in November. The median price was $181,000 as compared to $208,000 a year ago, a decline of 13.2% nationally. Of course, in many areas prices are down far more than 13% over the last year.

The National Association of Realtors reported that there were 4.2 million unsold homes on the market at the end of November. At the current sales pace, it would take 11.2 months to sell all the homes on the market. NAR also notes that many homeowners have taken their properties off of the market. Understandably, housing starts continue to plunge, with November starts at 625,000 versus 771,000 a month earlier.

Deflation -- Consumer Price Index Goes Negative

As I have discussed above and in previous E-letters, the government and the Fed desperately want to hold off deflation in the economy. This fear is the overriding reason behind the bailouts, including the potentially $1 trillion stimulus package Mr. Obama and Congress are planning. Lawmakers are particularly frightened now that the Consumer Price Index has gone negative for the last several months, and especially as it plunged lower in October and November.

In October, the CPI fell by a full 1.0% - the largest monthly dive since records began to be kept in 1947. Yet the record October decline was significantly eclipsed in November when the CPI plunged 1.7%. The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) decreased a full 2.0% in November. Of course, the significant fall in energy prices is helping this trend along, but there is much more at work here than just falling gasoline prices.

For the 12 months ended November, the CPI actually rose 1.1%. That compares starkly to July of last year when the CPI was up 5.6% on a year-over-year basis. The trend in price inflation is clearly falling rapidly. Even the "Core" CPI -- less food and energy -- is falling. The Core CPI was down 0.1% in October and was unchanged in November.

Wholesale prices are falling even faster. The Producer Price Index fell 2.8% in October and another 2.2% in November. The 2.8% dive in October was the largest monthly decline on record. The Labor Department also reported that the price of imported goods dropped 4.7% in November and more than 10% in the past quarter. Prices are coming down in a hurry! This is Bernanke's worst nightmare!

Price data such as the above, and similar numbers from around the world, are leading to increased discussion about deflation. A recent cover story in The Economist made it pretty much official: Deflation, not inflation, is now the greatest concern for the world economy.

Over the past year, producer prices have fallen throughout the developed world. Consumer prices have been falling for the last six months in France and Germany. In Japan, wages have actually fallen 4% over the past year. Prices are also falling in China and Hong Kong.

So far, none of these price declines looks anything like the massive deflation that accompanied the Great Depression. But the appearance of deflation as a widespread problem is disturbing, not only because of its immediate economic implications, but because until recently most economists regarded sustained deflation as a fundamentally implausible prospect, something that should not be a concern.

Such assumptions are now under fire as the Fed has slashed short rates to zero. I assume we'll be discussing deflation a lot more this year.

Stock Markets -- Might We Have Seen The Bottom?

The US and global equity markets will be buffeted in 2009, on the negative side, by slowing economic growth, continued deleveraging, a shortage of credit and possible deflation. On the positive side, the markets should be aided by extremely low interest rates, the government's massive efforts to reflate the economy and unfreeze the credit markets and the possibility that a lot of money now on the sidelines could come back into the market at some point.

Unlike the general consensus about where the economy is headed this year (worse in the first half, but a recovery by year-end), there is no such consensus regarding where the stock markets are going over the next year or longer. Opinions and forecasts are all over the board.

Some analysts I respect believe that the US stock market is in a secular bear market, and that we probably have not seen the worst of it. If the economy is going to get worse in the near-term, and then grow at below-trend rates of 1½-2½% over the next 2-3 years after 2009, this is a rather dire forecast for corporate earnings, which supports the case for lower stock prices over time.

Other analysts I also respect believe that the waterfall collapse in equity prices in 2008 significantly overshot on the downside, and that the November lows could represent the bottom, although they would not be surprised to see a retest of the late November lows at some point.

Forecasters in the latter camp point to the fact that there is an ocean of money around the world that is sitting in Treasuries and other no-risk/low-risk vehicles earning next to nothing. They suggest that with an even modest uptick in consumer confidence, a flood of domestic and international money could come rushing back into US equities -- especially with the rebound in the US dollar last year.

Most analysts in both camps seem to agree that the equity markets are overdue for a potentially strong corrective rally which could play out over the next several months. Specifically, most forecasters I read believe that there will be some kind of "Obama rally" after the inauguration. The problem is that the broad equity indexes have already rallied 20-25% from the five-year lows in November.

Conclusions

One thing appears clear: 2009 is likely to be another wild year in the markets. So, what is an investor to do? Remain in cash and earn little or no return, or jump back into equities and risk losing even more money if the market retests the November lows as some analysts expect? I can't tell you what the market is going to do in 2009, but I can restate what I have said since beginning this E-Letter in 2002 -- it's wise to have at least part of your portfolio in an investment program that can switch to a defensive posture (cash or hedged) in uncertain markets, in my opinion.

While I don't have space in this week's E-Letter, in upcoming issues I'm going to discuss how active management -- investment programs that have the ability to go to cash or hedge long positions - benefited investors in 2008. I'm also going to highlight the huge inflows into some of these programs during 2008, even though most mutual funds were hemorrhaging assets badly. And you may be interested to learn where these inflows were coming from. What do they know that you don't know? The answer may surprise you.

I'll also bring you up to date on the performance of the latest additions to our AdvisorLink team, the Scotia Partners Growth S&P Plus and S&P Moderate Growth programs. While past performance cannot guarantee future results, suffice it to say that Scotia's programs continue to meet our expectations.

If you'd rather not wait on these future issues and want to learn more about Scotia and the other actively managed investment programs that have the potential to become defensive when market conditions warrant, feel free to give one of our Investment Consultants a call at 800-348-3601 or send us an e-mail at info@halbertwealth.com. You can also find out more about these programs on our website at www.halbertwealth.com, or request a complete Scotia Investors Kit by completing our online Scotia request form.

Wishing you a profitable New Year,

Gary D. Halbert

SPECIAL ARTICLES

Tyranny of the Tax-Exempt (Must Read!!!)
http://www.newsmax.com/insidecover/obama_stimulus_package/2009/01/06/168219.html

Obama's Trillion Dollar Political Stimulus Package
http://www.realclearpolitics.com/articles/2009/01/fiscal_follies.html

Obama Eyes $300 Billion Tax Cut - What A Surprise!
http://online.wsj.com/article/SB123111279694652423.html

Obama Lies About Government Bailout Plan
http://www.aim.org/aim-column/obamas-lies-about-government-bailout-plan

"Buy-And-Hold" Bites The Dust - Now What?

Gary D. Halbert — Tue, 11 Nov 2008 20:54:52 GMT

IN THIS ISSUE:

Economic Overview
The Conventional Wisdom Was Wrong
The Shortcomings Of Index Investing
Are Low Fees The Key To Investment Success?
Risk Management Is Crucial

Introduction

In the newsletter business, it's rewarding to see market action reinforce the advice you have been giving in your publication. Ever since I started writing this E-Letter, I have warned of the perils of passive "buy-and-hold" investing in general, and "index investing" in particular. While adherents to these strategies like to trot out long-term charts and graphs supporting their case, I have always warned that passive investing can result in major losses at just the wrong time from the investor's perspective.

However, I have to admit that being right rings hollow in the aftermath of the carnage we have seen in the US stock market since its peak in October of 2007, and especially over the last month or so. It is estimated that over $8 trillion of investor value has been lost in the US equity markets since then, and no one knows how long the bear market may continue. Many Baby Boomers are now realizing that their passive investments have incurred huge losses at a time when capital preservation is far more important to them.

How did we ever get to the point where buy-and-hold became investment gospel? It's as if investors were convinced that it's OK to stay on the track and get hit by an oncoming bear-market train, since a bull-market train going the other direction would soon bring them back to where they were before, and eventually higher over the long term. Yet it has always made sense to me to step off the tracks (go to cash or hedge) to avoid oncoming trains altogether.

Many investors are now feeling as if their portfolios have been hit by a train and it's uncertain if and when one going the other direction (bull market) may come along. Since many of the highest investment balances were held by Baby Boomers nearing retirement, it's an even worse train wreck because they lack the lengthy time horizon that may be necessary for the market to regain recent large losses.

This week, I'm going to revisit the issue of passive investing, and especially index investing. I'll discuss why I think they became so popular, and why I continue to recommend actively managed programs that have the potential to reduce risk during market meltdowns. First, however, I'm going to give you an overview of the latest economic forecasts I am seeing. Let me warn you, the news is not good.

Economic Picture Getting Darker

Every economic forecasting group that I read has downgraded its predictions over the last few weeks in light of the plunge in the global equity markets in October. As noted last week, 3Q GDP was estimated at -0.3% (annual rate), and that estimate is likely to be downgraded later this month. Most forecasters are now predicting that 4Q GDP will be down at least 1-2%.

While forecasts earlier in the year suggested that the economy would rebound to positive growth in the second half of next year, such forecasts have all but disappeared. Now, there is a general consensus that the US economy will be negative for at least several more quarters to come. Specifically, that this will be the worst recession since the Great Depression. All of the sources I trust believe that it will take several years to work out of this financial crisis.

It remains to be seen if the stock markets have seen the bottom. In any event, most forecasters I respect believe that once the stock markets have bottomed, they will move into a broad, multi-year trading range. No one I respect is predicting a "V" bottom or a quick return to a bull market.

This is precisely why we need to revisit the problems associated with passive, buy-and-hold investment strategies. These strategies got killed over the last year, especially the last month or so, and are not designed to do well in a broad trading range, which could persist for the next several years. Fortunately, there are alternatives.

The Conventional Wisdom Was Wrong

The basics of passive investing are relatively simple. You put your money into a diversified portfolio, usually based on "asset allocation" strategies, and leave it there during good and bad market cycles. Armed with reams of historical data, the conventional wisdom was that including multiple asset classes in a portfolio would protect investors during all types of market conditions. While changes are made periodically to rebalance allocations or adjust for advancing age, the portfolio is largely a "set it and forget it" instrument, so the theory goes.

The historical data also suggested that most hands-on mutual fund managers were not adding value above and beyond what the broad market indexes could provide, so mutual funds tied to various market indexes were developed to offer a low-cost alternative to actively managed mutual funds. However, back in December 2005, I wrote an E-Letter about the potential drawbacks of passive index investing:

"'Index investing' is growing like wildfire among investors today…And it's no wonder why. The allure of a simple, low-cost investment strategy tied to market indices that have been shown to grow over long periods of time sounds irresistible…The main problem is that Wall Street's ad machine is only telling half of the story. They often use historical time periods that are far longer than what most people have to invest, and they also fail to disclose how much an investor might lose in a bear market or major correction."

To illustrate, during the 2000 - 2002 bear market, the S&P 500 Index lost over 44% of its value, and the Nasdaq Composite fared even worse, losing over 75%! Unfortunately, however, neither investors nor Wall Street learned a lesson about how fickle the market can be, and at the worst possible times.

Thus, even with those huge 2000 - 2002 market losses fresh on their minds, investors still flocked to index investing as if there would never be another bear market or correction. I think there were several reasons for this, including:

Having just been through a major bear market caused some of them to think that the worst was over, and that the market would now over-perform in order to get back to historical long-term averages. Unfortunately, they failed to study history, which shows that, since 1952, bear markets have occurred an average of once every five or so years, so we were actually due for a bear market.

The market's action during 2003 through 2006 seemed to confirm index investors' convictions that happy days were, indeed, here again. The S&P 500 Index gained 28.68%, 10.88%, 4.91% and 15.79% in 2003 through 2006, respectively. This annualized return of 14.74% over those four years compared favorably to the 10% to 12% touted as the long-term average stock market return, so "reversion to the mean" became the watchword of the day.
Though 2007 saw the first warnings of the subprime crisis, the Dow and S&P 500 market indexes still managed to hit all-time record highs in October of 2007. Investors were convinced that this, too, shall pass and stayed invested.
The bear market of 2000 - 2002 also claimed another victim, and that was the average mutual fund manager. Unfortunately, all active management strategies seemed to be lumped into the same category by the financial media and Wall Street firms. No difference was made between an active mutual fund manager and specialized strategies such as market timing, sector rotation, long/short or a variety of other active management techniques. Wall Street even promoted flawed statistics to support their point, as I noted in my June 21, 2005 E-Letter.
Investors were subjected to so many different investment opinions and theories that many of them just didn't know which way to turn. They were paralyzed by all of the conflicting information out there. I call it "information overload." Thus, they chose the option that seemed to be the simplest, plus it was supported by Nobel Prize Winning theories. How could they possibly go wrong?
Since most index investing used asset allocation strategies based on the work of Nobel Laureate Dr. Harry Markowitz, many investors felt that using multiple asset classes including bonds and international investments would protect them in a bear market. Another big plus was that the financial services industry found Markowitz's theories relatively easy to incorporate into computerized portfolio modeling programs, resulting in highly effective proposal presentations.

Unfortunately, we have learned that the subprime crisis spared no asset class as it ravaged global stock and bond markets. The traditional correlation among asset classes broke down, which is often the case in severe bear markets.
Finally, fees became one of the major selling points of passive index investing, especially among the financial media (more about this later on). I now find it interesting that some members of this same financial media are now declaring that "buy-and-hold is dead." How convenient to be able to change your story to fit the times.

Over the course of my 30-plus-year career in the investment business, I have found that most investors' goals are very simple. They want to put their money into investments that are: 1) reasonably safe; 2) have the potential to earn a reasonable rate of return; and 3) will not suffer large losses along the way. While these goals are relatively simple, how you invest to achieve them is not a simple process.

However, the investment industry is always willing to create products to fill investor demands, some of which are based on the conventional wisdom of the day. For those wanting a simple solution, the financial services industry created a number of different "one-size-fits-all" investment products, with index investing being one of the most popular.

They even created "target-retirement" and "lifestyle" funds that incorporated asset allocation so that investors need only know the year they wanted to retire in order to select the "right" investment. I guess you could call this the ultimate in conventional wisdom portfolios.

Chinks In The Index Investing Armor

Before I discuss some of the arguments against index investing, let me say that I am a big fan of both index mutual funds and ETFs. I feel that the ability to "buy the index" has changed the investing landscape in a number of positive ways, though I don't always agree with proponents of buying and holding index funds. Several of the Advisors whose programs I recommend use index mutual funds to facilitate their active management strategies, so I am a big fan.

That being said, I have often advised against combining index funds and asset allocation programs as the sole investment strategy in an investor's portfolio. The reason for this is within the passively managed nature of the index fund. Index funds, by their very nature, will not exit positions and move to cash during bear markets or downward corrections. An index fund will follow its underlying index, even if it dives right into the dirt (or gets hit by a train).

Index fund proponents say that this is no problem - just diversify among a variety of index funds covering various stock and bond asset classes, and everything will be OK in the long run. I can best illustrate this strategy using an investment offer I once received from a financial Advisor back in 2005. While the information is somewhat dated, the shortcomings are the same today as they were then.

The Advisor recommended only "index" funds allocated among a variety of selected funds based on traditional asset allocation principles. The Advisor went on to illustrate the performance of a set of index funds over a 25-year period of time from 1979 through 2004. The performance was excellent, especially as compared to fixed rate investments like CDs and fixed annuities.

The Advisor's implication was clear: the market indexes will do well over long periods of time, so all you need to do is invest in his special blend of index funds and you'll be just fine. Since the time period included returns during the bear market of 2000 - 2002, it would seem that his argument would have been fair, right?

Sorry, but I'm still not convinced. Here are just a few of the fallacies of this Advisor's argument, in my opinion:

It assumed the next 25 years will be the same as the last 25 years. Let's see, did 78 million Baby Boomers retire in the last 25 years? Were we afraid of terrorist attacks on our major financial centers prior to 2001? Will Medicare and Social Security costs be the same percentage of government spending in the next 25 years as they were in the last 25 years? And, of course, had we experienced a housing and subprime mortgage crisis resulting in a global credit crunch, massive Wall Street bailouts and a stock market meltdown? (Hint: "NO" is the appropriate answer to all of these questions.)
The 25-year time period cited as an example doesn't necessarily correspond to any individual investor's actual time frame. What if an investor's time frame had them needing their money for retirement in September of 2002 at the bottom of the bear market? I doubt index investing would have met with much praise at that point in time. Fast forwarding to the present, what if a retiree needs money NOW?
It doesn't hurt your argument when you choose a 25-year period that just happens to include the longest bull market in history, along with a stock market bubble in the go-go 90s. Let's roll the clock on back a bit. What if we chose a period of time from 1966 through 1982? Over this 16-year span of time, the stock market went nowhere.

Even Vanguard's John Bogle, the father of index investing, has pointed out that "each and every comparison we see is period-dependent." This means that the time period you choose can greatly affect the outcome of your analysis. I have written about this before, but it is especially important in regard to index investing.
Finally, historical analysis of stock market returns does show that stocks increase in value over long periods of time. Yet, there are many shorter periods in which stocks do poorly, or even lose money. Investors are often confronted with glossy charts and graphs illustrating stock market performance data over 25 years, 50 years and even 75 years. Yet, few people trying to make investment decisions today have a 50 or 75-year time horizon!

Let's look at the timelines. The youngest of the Baby Boomers are now nearing age 45, at which time they will have 20 years until retirement at 65. A 50-year-old has only 15 years, and at 55, you're looking at only a decade to accumulate wealth. Are there lots of 10-year periods during which the major market indexes did poorly? You bet there are, and we're in one of them right now!

So, you have to ask yourself, what historical 10-year period will the next 10 years be like? Don't know? Neither do I, and neither do economists, financial planners, mutual fund managers, or anyone else.

Because of these shortcomings, I continue to believe active management strategies with a historical track record of having provided reasonable returns with reduced risks are more appropriate for many investors than buy-and-hold index investing. Some of the financial media are now agreeing with me, but where were they in 1995 when I first began to recommend these active management strategies to my clients?

Do Low Fees = Good Investments?

One facet of investing where the index proponents have been successful is that of fees. Many investors will automatically reject any investment with expenses greater than those of an index fund. They have bought into the idea that active management doesn't pay, so they are not willing to pay higher fees for the expertise of an active manager. They use fees as a simple way to eliminate alternatives from their investment radar screen.

Unfortunately, this simple criterion can eliminate many qualified alternatives. After all, do you drive the least expensive car? Why not? Don't all cars offer you a mode of transportation? Do you shop for the least expensive doctor, lawyer or dentist? Those who do many times find out exactly why they charge fees below the going rates.

The important thing is not always what fees are being charged, but how the investment program has performed net of all fees and expenses. Many people will pay more for a product or service if they can see, hear, or feel added value, and investments should be no different.

Now, however, the focus on low fees is coming back to haunt many investors. For example, the Vanguard S&P 500 mutual fund has one of the lowest fees around, at only 0.15%, but according to the Vanguard website, this fund had a year-to-date loss of 32.87% as of the end of October.

At the same time, the Niemann Equity Plus Program that I have featured in this E-Letter had a year-to-date loss of only 10.85%, net of Niemann's 2.3% annual fee. Would you pay an additional 2.15% fee to shave over 22 percentage points off of your losses right now? I'll bet you would! (Past performance is not necessarily indicative of future results. Niemann's October 2008 performance is an estimate and may vary. Be sure to see Important Notes at the end of this E-Letter.)

It gets even better - since the inception of the Niemann Equity Plus program in November of 1996, it has produced an annualized return of 12.25%, again net of all fees. Over the same period of time, the Vanguard S&P 500 Index mutual fund has produced an annualized gain of only 4.32%, also net of fees. Again, the lower fee alternative produced an inferior return to the higher-fee actively managed program. Of course, there are no guarantees it will always do so.

Obviously, we have other programs that have higher and lower returns than the Equity Plus Program, but this comparison does show that relying on fees alone can be detrimental to your investment returns, even in comparisons spanning over a decade. Of course, there are no guarantees.

Finally, there are some financial services companies that extol the virtues of low fees to "retail" investors, while at the same time offering hedge funds to their wealthy clients. As you probably already know, hedge funds carry some of the highest fees of any investment vehicle.

So, if high fees are such a bane on the investment industry, then why have wealthy individuals flocked to hedge funds as never before? The answer is that there are some (albeit few) money managers who are able to provide value over and above their fees in the form of consistent risk-managed returns. This is the type of money manager we look for to recommend in our AdvisorLink® Program.

What About Risk Management?

As I noted above, many investors seek investments that are: 1) reasonably safe; 2) have the potential to earn a reasonable rate of growth; and 3) will not suffer large losses along the way. My biggest problem with index investing is that it can fail all three of these tests, and the recent market meltdown is a good case in point.

On the first issue of safety, you could say that index investing passes this test in one sense because there is little likelihood of losing money through embezzlement or fraud. However, safety can mean more than protection from fraud. One example is in regard to a type of mutual fund that has been getting a lot of attention lately. There are some new index funds that allow investors to "short" the market, or participate in a fund that generates double the movement of the underlying market through 2-to-1 leverage.

As the stock market has been hit by loss after loss, these funds are looking very attractive. Investors who have moved to these funds brag of outsized performance, and will continue to do so as the markets continue to go down. However, when the markets do turn around, the leverage and short position will begin to work against the investor. And since much of the gain is concentrated in the early days of a new bull market, losses could be big and quick.

Thus, while the ability to short the market and use leverage offer a lot of flexibility, they can also offer a lot of additional risk. Unless managed by a competent professional using a disciplined strategy, I consider participation in leveraged and short funds little more than gambling. You might win big, but you can lose just as big, and may never be able to recover your losses.

As for the second test of the potential to earn a reasonable rate of growth, index investing proponents would say that index funds pass this test with flying colors, considering the historical long-term return of the stock market. However, as I have shown in this article, stock market returns are very period-dependent. The shorter your investment time horizon, the better the chance that index funds will provide results below their long-term average. In fact, there have been examples in the past where the stock market has gone virtually nowhere for 10, 15 or even 20 years.

On the final qualification that the investment program not suffer large losses along the way, index investing fails miserably. Since there is no active management of the underlying portfolio, the investor is destined to rise and fall with the markets. During the past bear market of 2000 - 2002, the major market indices had some tremendous drawdowns in value, with the S&P 500 losing over 44% of its value, and the Nasdaq Composite Index losing over 75%!

In the current bear market, drawdowns have not yet accumulated to the low points experienced during 2000 - 2002, but they are very close. As this is written, the S&P 500 Index is approximately 40% below its October 2007 peak. The last bear market drawdown bottomed out in September of 2002, so that's two 40% drawdowns in six years. No wonder many retirees are saying they're "done" with the stock market.

My staff and I have personally talked to a number of investors who needed their money for retirement during this time, only to find that a large part of their investments' values had vanished into thin air. Even if I were sold on the value of index investing over the long haul, I would still not recommend it to my clients simply because of this last shortcoming.

Conclusions

I would like to believe that the latest market mayhem will spell the end of one-size-fits-all index investing, but I know better. Wall Street has sunk far too much money into literature and software to let the concept die a peaceful death. Just as we saw index investing take off after the 2000 - 2002 bear market, I expect to see it marketed heavily once the market starts to come back from the current low point.

Oh yes, some of the marketing material will be changed to reflect the subprime debacle, but I will bet that the industry will attempt to explain the current market malaise away by saying it's a "market aberration" that won't happen again because of improved regulatory scrutiny that is almost certain to come. Thus, Wall Street will attempt to skip over this bump in the road and do what they do best - marketing.

One of the primary reasons I agreed to write this weekly E-Letter in the first place was the hope that I might be able to make a difference by countering some of the expensive marketing efforts launched by the major Wall Street firms and large mutual fund families. In this way, I can share some of the insights I have been able to gain from my 30+ years in the investment industry. To that end, I hope that I have provided some information this week that will help you resist the siren song of index investing in the future.

Through the years, many of my readers have sought out some of the investment programs my company offers, but many have not. While I'm the first to admit that some of our programs did a better job of limiting risk than others, almost all have been successful in holding risks to less than those of the S&P 500 Index, which is what they are designed to do. Plus, we have a couple of programs that have actually made money during the down market. Past performance, however, cannot guarantee future results.

If you are among those who have put off checking out our risk-managed investment programs, perhaps the current market meltdown will convince you it's time to take a look. Just give one of our Investment Consultants a call at 800-348-3601 or complete our online information request form. You can also find out more about these programs and the strategies they employ on our website at www.halbertwealth.com.

Wishing you a market bottom,

Gary D. Halbert

SPECIAL ARTICLES:

The Death of Buy and Hold
http://www.cnbc.com/id/27651174

The Specter of Deflation
http://www.realclearpolitics.com/articles/2008/11/the_specter_of_deflation.html

What lower oil prices mean for the world
http://www.ft.com/cms/s/0/5c238848-af5d-11dd-a4bf-000077b07658.html?nclick_check=1

IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM) and Niemann Capital Management, (NCM) are Investment Advisors registered with the SEC and/or their respective states. Some Advisors are not available in all states, and this report does not constitute a solicitation to residents of such states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. There is no foolproof way of selecting an Investment Advisor. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from NCM in exchange for introducing client accounts to the Advisors. For more information on HWM or NCM, please consult HWM Form ADV Part II, NCM Form ADV Part II and Niemann's Annual Disclosure Presentation, 2007, available at no charge upon request. Any offer or solicitation can only be made by way of the Form ADV Part II. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.

As benchmarks for comparison, the Standard & Poor's 500 Stock Index, the Vanguard S&P 500 Index and the NASDAQ Composite Index (which include dividends) represent an unmanaged, passive buy-and-hold approach. The volatility and investment characteristics of the S&P 500, the Vanguard S&P 500 Index and the NASDAQ Composite Index may differ materially (more or less) from that of the Advisor. The performance of the S & P 500 Stock Index, the Vanguard S&P 500 Index and the NASDAQ Composite is not meant to imply that investors should consider an investment in the Niemann trading program as comparable to an investment in the "blue chip" stocks that comprise the S & P 500 Stock Index and the Vanguard S&P 500 Index, or the stocks that comprise the NASDAQ Composite. Historical performance data is provided by the Advisor in compliance with the Global Investment Performance Standards (GIPS), except for the month of October 2008, which is an estimate which has not been verified for GIPS compliance. The actual final performance number for October 2008 could change significantly from the estimate. See the Annual Disclosure Presentation, 2007 for more details on GIPS performance. Statistics for "Worst Drawdown" are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Any investment in a mutual fund carries the risk of loss. Mutual funds carry their own expenses which are outlined in the fund's prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Niemann Equity Plus trading program.

In addition, you should be aware that (i) the Niemann Equity Plus trading program is speculative and involves risk; (ii) the Niemann Equity Plus trading program's performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Niemann will have trading authority over an investor's account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Niemann Equity Plus trading program's fees and expenses (if any) will reduce an investor's trading profits, or increase any trading losses.

Returns illustrated are net of actual management fees, custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. All dividends and capital gains have been reinvested. Performance is based on actual fee-paying, fully discretionary accounts in a composite. Individual account performance may differ from the composite. No adjustment has been made for income tax liability. Some Funds also charge short-term redemption fees and excess transaction fees (Special Fees), which are billed to shareholders at the time of the event causing the fee. All of these fees are in addition to Niemann's advisory fees. In selecting Funds in which to invest, Niemann considers the nature and size of the fees charged by the Funds. Niemann will select a Fund only if Niemann believes the Fund's performance, after all fees, will meet Niemann's performance standards. Consequently, Niemann may select Funds, which have higher or lower fees than other similar Funds, and which charge Special Fees. When deciding whether to liquidate a Fund position, Niemann will take into consideration any Special fees which may be charged. Niemann may decide to sell a Fund position even though it will result in the client being required to pay Special Fees. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.

On The Economy And Active Management

Gary D. Halbert — Tue, 21 Oct 2008 22:07:39 GMT

IN THIS ISSUE:

A Look At The Latest Economic Numbers
Economic Forecasts Roundly Downgraded
Fallacies Of A "Buy-And-Hold" Only Approach
The Goal Of Active Management Strategies
The HWM Difference
Is It Time To Try Active Management?
Conclusions -- Don't Miss The Next Bull Market

Introduction

This week, we will take a look at the latest economic numbers which look quite bleak overall. There is little doubt that the US and the rest of the world are headed into a global recession sparked by the international credit crisis. The only question now is: How deep and how long?

Following that discussion, I will review the advantages of including active investment strategies in your portfolio. Long-time readers know that I have been a strong advocate of "active management" strategies, especially those that have the flexibility to move to cash (traditional market timing), "hedge" long positions during market downturns or even go "short" and provide the potential to profit even when the markets decline. Not surprisingly, such active management strategies are back in demand in the wake of the recent stock market collapse.

Now that active management strategies are coming back into vogue, I will tell you why I have always been a fan of money management techniques that seek to avoid big losses, especially of the magnitude that we've all seen over the last 4-5 weeks. I think you'll find that discussion very interesting in light of the recent stock market chaos.

Though I have mentioned the advantages of active management strategies many times in the past, the current market environment has resulted in many more calls to my staff from investors who now seek to include these strategies in their portfolios. Thus, this may turn out to be one of my most popular E-Letters ever, though it's unfortunate that investors have had to endure severe losses in their portfolios to make it so.

A Look At The Latest Economic Numbers

We have long known that consumer spending accounts for apprx. 70% of US Gross Domestic Product, and consumer spending is predicated on consumer confidence. At this point, consumer confidence is in the tank and consumer spending is falling off a cliff.

The mid-October University of Michigan Consumer Sentiment Index plunged to 57.5, down from 70.3 in the last half of September. This is one of the deepest monthly declines in the Sentiment Index since it has been recorded. The latest report noted that there have only been four surveys that posted monthly declines of 10 index points or more. The government's Consumer Confidence Index to be released next Tuesday is expected to show a similar sharp decline.

So a recession is upon us despite the fact that US GDP rose by a healthy 2.8% in the 2Q. We may even find that the economy remained technically in positive territory in the July-September quarter when the government releases its first report on 3Q GDP on October 30. Regardless of what next week's GDP says about the 3Q, there is little doubt that economic growth will fall into negative territory in the current 4Q. And it will likely be down a lot.

Not that much else matters when consumer confidence and spending are in freefall, but here are some of the other recent economic reports.

The Index of Leading Economic Indicators (LEI) actually rose 0.3% in September, reversing the recent downward trend. However, analysts are careful to point out that the rise was primarily due to a large increase in the money supply, essentially masking sharp declines in stock prices and residential building permits and increased layoff activity. The September increase was also offset by a larger downward revision to August's LEI. The leading indicators are almost certain to fall again for October, probably significantly due to the continued washout in the stock markets.

Retail sales fell more than expected in September, down 1.2% following a decline of 0.4% in August. Chain store sales, including Wal-Mart, declined sharply in September and will almost certainly be down even more this month. I don't shop very often, but I was in Macy's over the weekend and it looked like two-thirds of the store was marked down 40-50% or more.

US auto sales plunged 26.6% in September, making it the first month since 1993 when buyers drove less than one million new cars and trucks off the dealerships' lots. Analysts predict that October will be even worse. GMAC announced on October 13 that it will only make car loans to buyers with a credit score of at least 700. This is bad!

On the manufacturing side, the ISM Index fell from 49.9 in August to 43.5 in September. Any reading below 50 in the ISM Index indicates that manufacturing is in a recession. Factory orders fell a whopping 4.0% in August (latest data available). I'm sure it has happened before but I don't remember seeing a 4% drop in one month in the past.

The unemployment rate held steady at 6.1% in September, but this number will definitely go higher for October and the rest of the year as well.

Economic Forecasts Roundly Downgraded

I read and hear a lot of economic forecasts, and every one is being downgraded in light of the events of the last 4-5 weeks. Other than the gloom-and-doom crowd that always predicts a recession or worse, I don't know any outfit that predicted what we have seen in the last month or so. Thus, everyone is having to downgrade their economic forecasts.

The consensus outlook, prior to the last 4-5 weeks, was that the US economic growth would go mildly negative in the 4Q and somewhat more negative in the 1Q and 2Q of next year. Most forecasters felt the US economy would rebound back into positive territory in the second half of next year. But frankly, I don't know anyone that has a clear forecast for what happens next year.

The problem is, no one knows for sure if the massive government bailout is going to work. The Treasury Department is working feverishly to put together the apparatus to begin buying up distressed debts. It's a complicated process that is rife with conflicts of interest. The thinking originally was that the Treasury would be buying assets after the first of the year. Now they are hoping to be in business before the holidays. They need to be.

Fallacies Of A "Buy-And-Hold" Only Approach

The stock market collapse over the last several weeks has devastated millions of investors' portfolios and shattered retirement plans for untold numbers of Americans. Many investors' portfolios are down 35-40% or more in just the last 5-6 weeks. The market plunge has brought into serious question Wall Street's mantra of "buy-and-hold" for the long-term.

Whether it's called "asset allocation" or "index investing" or any of a number of other names, the basic premise of buy-and-hold investing is to indefinitely hold a group of investments in hopes they will produce gains in an amount to meet investment goals. If you have read me for long, you know that I have never been a big fan of having your entire investment portfolio in a buy-and-hold strategy, especially if there is no "risk management" component involved to deal with periodic bear markets.

Instead, I have recommended "active management" strategies which incorporate risk management techniques. While active management can include programs that stay fully invested and rotate among market sectors, most of those that we recommend have the flexibility to move to the safety of cash (money market) or "hedge" long positions during bear markets. Some can even "short" the market and can profit when the market drops.

At Halbert Wealth Management (HWM), we specialize in finding successful money managers that use active management strategies which seek to minimize the effects of bear markets in stocks and bonds. This is not to say that the strategies we offer cannot lose money in down markets. Any equity investment has the potential to lose money. Instead, the Advisors we recommend in our AdvisorLink® Program use sophisticated investment strategies to limit the downside risk of a bear market or major downward correction -- something you won't find in most buy-and-hold portfolios.

We continually search the universe of professional money managers in an effort to find those Advisors who have delivered solid "risk-adjusted" returns and have managed to avoid the huge losses so common in bear markets and major downward price corrections. As it has turned out over the years, we have found the best risk-adjusted returns among active managers that move out of the market or hedge long positions from time to time to avoid bear markets.

The traditional Wall Street wisdom over the years has been that it is impossible to "time" the market. They argue that if you are out of the market from time to time, you are likely to miss the best days. So you should stay fully invested at all times.

Does that argument sound familiar? I'll bet it does, especially over the last year or so when you may have wanted to sell out, but your broker talked you into holding on. Now, with the stock markets down 35-40% or more (and it may not be over yet), it's probably the worst time to sell out, so you're stuck.

But there were active managers who limited losses in the latest bear market by moving to the safety of cash, hedging their long positions and/or shorting the market. This includes many of the equity money managers I have recommended to you in these pages. Later on, I'll tell you how to find detailed performance statistics on these money managers, but first let's look at the underlying premise of one active management strategy known as "market timing."

The Goals Of Active Management Strategies

Simply put, successful active management/market timing strategies have two basic goals:

1. Participate in stock market gains in the good times; and

2. Limit market losses to half or less of equity losses in the bad times.

These goals are simple in concept, I trust you would agree, but more than a little challenging to deliver. In fact, most active managers we run across don't succeed in meeting these goals over the long haul. Yet there are those that have, if you just know where to find them.

To be honest, many money managers and even individual investors can decide to move to cash in bad times. We are encountering investors who have been on the sidelines for months due to subprime fears. The real challenge is to know when to get back into the market once the market rebounds.

It is also important to note that some active money managers go one step further and seek to make money in down markets by entering into "short" sales of major market indexes using specialized mutual funds. While this is a more aggressive strategy than one that will only go to cash or hedge long positions, it provides investors with the potential to make money even when the markets are going down.

Here is the basic challenge for active managers if they are to beat the buy-and-hold strategy: How do you devise a system that keeps you in the market on most of the good days, but also takes you out (or "short") when bear markets come along? Let me say, this is not easy! And most active managers and market timers are not successful over time.

Those that have been successful over time, generally speaking, have developed sophisticated systems that gauge stock market trends and generate signals for when to enter and exit the market. This is not seat-of-the-pants, emotional trading, though some Advisors do have some measure of discretion built into their systems.

There is much, much more to it than this, of course. It is one thing to be generally correct about the trend -- up or down; it is quite another to know which sectors of the market to invest in. Space doesn't permit me to elaborate on how successful active managers determine which sectors to invest in, when they get their trend signals, but trust that this is another important variable when it comes to selecting a successful active money manager.

The bottom line is, there are active managers and market timers out there that have been successful in delivering their clients good returns over time, but more importantly have avoided the sometimes huge losses that come with buy-and-hold strategies.

The key is, how do you find them? Most investors don't know how to find these successful active managers. Most of these successful managers don't advertise, so they are not household names. The big brokerage firms are not likely to tell you about them, since they don't buy into the Wall Street buy-and-hold mantra.

Truth is, you will probably only find them if you stumble into a boutique investment firm like mine that has the money and the commitment to search high and low for the handful of successful active managers that are out there.

The Halbert Wealth Management Difference

My firm recognizes that we're not the only company that offers active management strategies to our clients. We do, however, believe that we have structured our AdvisorLink® Program in such a way as to offer investors the most flexible way to participate in such programs.

In many cases, actively managed investment programs are "packaged" and sold to investors as a single solution. The selection and retention of each money manager, the types of strategies employed, and the allocation to each participating manager is set by the sponsoring firm. Think of it as being something like a fund of funds. There's nothing wrong with this approach, and we are even considering some of these programs to offer our clients. However, the drawback of such programs is that they limit the investor to pre-selected options.

At HWM, we have "unbundled" the mix of active money managers so that each is available with or without any of our other managers, and in an allocation that can be tailored for each investor. Since most of our clients tend to be do-it-yourself investors, we feel it offers them the following advantages:

Due Diligence -- I have written a number of times about the extensive due diligence each money manager must endure in order to be added to our list of recommended programs. We not only subject the numbers to intense analysis, but also the Advisor's administrative capabilities and business stability.

We also have face-to-face meetings with each Advisor in order to not only get a feel for his or her grasp of the strategy being employed, but also to get a personal feel for the individual with whom our clients' money will be placed. Most of the time, these meetings take place as part of an on-site visit to the Advisor's office by my due diligence staff.

We then summarize the results of our findings in an Advisor Profile document that is made available to each prospective investor. For the investor, this means that the money manager has been subjected to a great deal of scrutiny as to performance, strategy and administrative capabilities. Thus, a lot of the legwork has already been done for our clients.

Another part of due diligence is in regard to ongoing monitoring of an active money manager's performance and operations. We monitor trading and performance on a daily basis, and communicate with money managers immediately if we notice anything out of the ordinary or not within our expectations for the particular program being monitored.
Transparency -- Even before the recent subprime mortgage debacle, "transparency" was a big issue in the managed funds world. Now, it's likely to become the law of the land, even for secretive hedge funds. Fortunately, investors have always enjoyed a high level of transparency in regard to the programs we offer.

As I noted above, some sponsors of actively managed investments will keep the details of who is managing parts of the portfolio a secret. That way, they can make a change in the lineup with a minimum of disruption. However, HWM offers each money manager as a stand-alone unit, providing full visibility of each manager and his or her approach to managing money. This transparency also allows each prospective client to review a detailed summary of the money manager's actual performance since the program's inception.

Beyond the ability to know and evaluate each individual money manager, investors also are able to see exactly how their money is being invested. All of the various money managers we recommend offer our clients the ability to follow the trading of their accounts online.
Flexibility -- Since we do not offer any set portfolios containing a mixture of money managers available in our AdvisorLink® Program, investors have complete flexibility to combine programs in a way they feel is most suitable for their unique situation. We have some clients who invest in only one of the programs we offer, while many others choose to allocate their investments among several programs.

We feel that combining the various AdvisorLink® investments can offer investors additional diversification beyond just having a variety of different asset classes in a buy-and-hold portfolio. This additional diversification comes about in a number of ways, including the following:

● Diversification for different market environments. We all know that a declining market will generally result in losses in a buy-and-hold investment. However, such a market environment could also result in some active management strategies becoming "neutral" by going to cash or hedging long positions. In that event, an extended bear market could result in only money market returns. A combination of investment strategies can provide the potential for making money even in a down market. For example, it may be suitable to have both a "long or cash" strategy and a program that can go both long or short in the market. This would provide a potential for portfolio gains even in a declining market.

● Diversification to reduce correlation. I have discussed correlation of investment programs in past E-Letters, but the basic idea is that two investments are "correlated" if they tend to go up and down at the same times. It is generally best to include some non-correlated investments in a diversified portfolio. I have noted before that most of the investment alternatives in our AdvisorLink® Program have a low correlation to the major market indexes. However, it is also true that many of these programs have little or no correlation to each other

● Diversification among investment strategies. The recent market meltdown has shown that when times get tough, virtually all equity asset classes suffer. Even for investors who choose to maintain an asset allocation or other buy-and-hold investment strategy, adding actively managed programs that go to cash or even "short" the market can result in a higher level of strategic diversification.
Control -- A final advantage of our unbundled approach to active management strategies is that you have complete control over what managers are included in your portfolio. While HWM provides due diligence services and can assist you with making an allocation decision, the final say is up to you. This keeps you in complete control of your investment destiny.

Nowhere is this more important than when it comes time to move from one money manager to another. I often tell prospective clients that few, if any, money managers will ever tell you to fire them. I am personally aware of Advisors with substandard investment programs who keep promising investors that "things will get better" in an effort to retain their business.

At HWM, our due diligence and ongoing monitoring will help to identify Advisors whose programs may no longer be suitable for meeting your needs, and we will offer other alternatives. However, the final decision as to whether to retain a money manager is yours, as it should be. There are also no "lockups," early termination charges or any other impediments to accessing your money should the need arise.

In short, the HWM AdvisorLink®Program offers investors a "cafeteria-type" approach to money management. Do-it-yourself investors can evaluate each money manager on its own merits rather than accepting it as part of a "canned" approach. For investors who are not do-it-yourselfers, the HWM staff can help evaluate the most suitable mix of money management programs based on the investor's assets, risk tolerance and investment goals.

Our experienced staff is also available for ongoing questions about the performance of each of our recommended programs, as well as inquiries about specific issues regarding your account.

As you consider the investments that make up our AdvisorLink®Program, it's also important to remember that none of our Advisors invest in subprime mortgages or anything of the like. The equity managers I recommend invest in well-known, US-based mutual funds that you probably have heard of and can look up in the newspaper or on the Internet daily.

Plus, no one on my staff is paid a commission, so there is never any pressure to invest or incentive to sell you something that may be unsuitable for your needs. On that, you have my promise. Likewise, we have an ironclad "privacy policy" and your private financial information is never, ever shared with anyone else, other than as may be required by law.

Is It Time To Consider Active Management?

As I noted above, many of my readers have recently contacted us for information on the money managers I recommend in light of the market's recent meltdown. They have seen their buy-and-hold portfolios devastated by losses of 35-40% or more. Retirement prospects have been shattered for millions of investors. People across the US are now looking for risk-averse ways to invest their money that can deliver market returns with less downside risk.

Earlier, I said that I'd provide a way for you to see how our various programs have fared so far this year. If you are ready to explore the world of actively managed investments, I recommend that you visit our AdvisorLink® performance summary web page at the following address:

http://www.halbertwealth.com/advisorlink/programs.php

While you will no-doubt notice that some of the programs we offer had year-to-date losses as of the end of September, you will also note that these are far less than those suffered by the major market indexes. Our goal is to offer programs that limit losses to half or less than those of the market, which means that when the markets turn up again, there's less ground to make up.

One noticeable exception to this goal is the Niemann Dynamic Program, which has a year-to-date loss close to that of the overall market. The reason that losses have not been limited is that this particular program is a high-octane long-only program that is always fully invested. Niemann does not have the option to go to cash or hedge any of Dynamic's positions, so it suffers in down markets. However, I also urge you to look at the long-term performance of this program as compared to the S&P 500 Index. Of course, past performance is not necessarily indicative of future results.

Conclusions -- Don't Miss The Next Bull Market

The stock markets have imploded in the last 4-5 weeks on a scale that virtually no one anticipated. Buy-and-hold strategies are down nearly 35-40% or more in less than five weeks. Americans' retirement plans are now turned upside down.

I certainly don't have all the answers. But I do have some suggestions for avoiding the huge losses that have occurred in just the last few weeks.

I have argued these points about minimizing losses for over five years in these E-Letters. I have argued my thoughts about active management strategies that seek to minimize losses in market downturns.

Maybe now is the time to do something about it.

I don't know when the stock markets will bottom. Much depends on how quickly the credit markets free up. Whenever the market bottoms, I fully expect we will see a powerful bull market emerge. When that happens, you want a professional manager that will get you back in the market for the next run.

A very successful money manager once told me the following: Investors think they pay us our management fees to get them out of the market during the down periods. But what they really pay us for is to get them back in when the market heads higher again.

This is so true, I believe. Millions of investors have bailed out of the market in the last few weeks. Sadly, most will not know when to go back in. The only way to recover the massive losses that have been experienced over the last couple of months is to participate in the recovery.

The professional Advisors I recommend have histories of catching major trends in the market -- both up and down. And you don't want to miss the next bull market. Maybe it's time to get the professionals I recommend on your team.

If you are ready to join the ranks of investors who are putting active management strategies to work for them to reduce the risks of being in the market, I urge you to contact us about the various opportunities available in our AdvisorLink® Program. Feel free to call one of our Investment Consultants at (800) 348-3601, or send us an e-mail at info@halbertwealth.com. You can also request additional information about our risk-managed investments by completing one of our online request forms.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

How to Read the Constitution (By Justice Clarence Thomas -- A Must-Read!)
http://online.wsj.com/article/SB122445985683948619.html

Get Ready for the New New Deal
http://online.wsj.com/article/SB122455099434052597.html

The Coming Pink Slip Epidemic
http://www.businessweek.com/bwdaily/dnflash/content/oct2008/db20081020_022663.htm?chan=top+news_top+news+index+-+temp_top+story

Mortgage Bailout Passes, Finally - Now What?

Gary D. Halbert — Tue, 07 Oct 2008 21:04:06 GMT

IN THIS ISSUE:

An Inside Look At The Mortgage Bailout Bill

Equity Ownership & Limits On Executive Pay

Mortgage Assistance & The Bankruptcy Code

Expanded FDIC Limits On Bank Accounts

Was The Bailout The Right Thing To Do?

The Senate's $150 Billion In Extra Bailout Pork

John McCain Blew An Election Saving Opportunity

Electoral Map Now Leaning Heavily To Obama

Scotia Partners - Making Money In The Bear Market

Introduction

The massive $700+ billion bailout package finally passed Congress and was signed into law by President Bush late last Friday, to the dismay of millions of Americans. The House rejected the huge bailout bill on Monday, and the Dow Jones promptly plunged a record 777 points on that same day. Fearing the worst, the Senate amended the bailout with another $150 billion in pork and passed it overwhelmingly on Wednesday, with both Senators Obama and McCain voting in favor. On Friday, the House passed the bill by a comfortable margin.

This emergency bailout plan supposedly had only one goal: to allow the government to hoover up hundreds of billions in distressed mortgage-related securities from banks and financial firms to shore up our faltering banking and credit markets. No one knows if this rescue plan will work, or if the government will need even more money later. We'll discuss all of this as we go along.

The Senate passage of the $700 billion bailout bill on Wednesday included, drum roll please, yet another $150 billion in mostly pork barrel spending, bringing the final cost to $850+ billion. Why was this extra spending necessary? I would argue that the extra $150 billion in pork was added to buy more "yes" votes for the bailout plan in the Senate and sweeten the odds for passage in the second vote in the House. Wait until you read what they added below (hint: they think we are all idiots!).

I did not think that Secretary Paulson's initial $700 billion bailout plan was the best approach, with no accountability, no transparency and no oversight. That was never going to work or be passed. Actually, I would have preferred one of the alternative rescue plans that would have involved government loans and insurance for ailing banks, rather than the Treasury buying up distressed assets directly. But John McCain never got behind such alternative plans, so they fizzled, and now his presidential campaign is in real trouble.

There is so much to talk about this week I'm not sure where to start, but I think the best place to begin is with a summary of the latest bailout bill, now that it has become the law of the land. We will also take a look at the extra $150 billion in pork that the Senate added to the bill. Next, we'll revisit John McCain's latest moves and the Electoral Map, which shows him falling fast in the polls.

Finally, we will revisit Scotia Partners, a very successful money manager that I have written about several times this year - and for good reason. As you can read at the end, Scotia is one of the few money managers that has done well in this bear market in stocks. As always, past performance is no guarantee of future results.

An Inside Look At The Mortgage Bailout Bill

Since my company is intimately involved in the securities business, and since government regulation of the securities business gets more complex every year, we engage top-notch law firms to help us sort through the regulatory maze. One of our main legal firms is Sidley Austin LLP, one of the leading law firms in the industry.

Sidley Austin released a detailed summary of the latest government bailout bill, and its possible ramifications, on Friday of last week. We appreciate these periodic reviews from our attorneys, and the ability to share them with our clients and readers. What follows is my abbreviated summary of Sidley's latest analysis of the final bailout bill.

On October 3, the House of Representatives passed the "Emergency Economic Stabilization Act of 2008,"(the "Act") which authorized up to $700 billion in new government spending (actually more than that) to bail out banks and financial institutions that hold troubled mortgage and related debt. The Act will create a "Troubled Asset Relief Program" ("TARP") which will be overseen by the Treasury and will be the vehicle in which distressed assets are purchased from banks and other sellers of mortgage-related securities.

The Act authorizes up to $700 billion to the Treasury Secretary to enable TARP to purchase and fund commitments to purchase "troubled assets" from "financial institutions." Financial institutions, in this case, are defined as those which are established and regulated under federal or state law, or have significant operations in the US (in the case of foreign entities). The Act suggests that financial institutions would include, but would not be limited to: banks, savings and loans, credit unions, broker-dealers and insurance companies. The 'but not limited to' language gives the Treasury significant flexibility in determining which entities may participate in the TARP.

"Troubled assets" initially include residential or commercial mortgages and any securities, obligations or other instruments that are based on or related to such mortgages originating on or before March 14, 2008. Yet the language also authorizes the Treasury Secretary, in consultation with the Fed Chairman, to purchase any other financial instruments they deem necessary to promote financial market stability, but such non-mortgage related asset purchases must be reported to the Congress. Again, the scope of potential asset purchases is very large.

The Act provides up to $700 billion to the Treasury, but unlike the original proposal, the Act will make only $250 billion available in the first tranche, with the next $100 billion coming upon the President's request, and the final $350 billion subject to a joint resolution of Congress.

The Act states that the Treasury can establish programs, vehicles or entities that are authorized to purchase troubled assets, manage the assets and dispose of them over time. I predict this will result in dozens of newly-created government agencies and sub-agencies and many new federal employees (presumably dominated by out-of-work ex-bankers) under the Treasury.

The Treasury Secretary is directed to minimize taxpayer expense by encouraging the private sector to participate in purchases of troubled assets, and to invest in financial institutions, thereby providing opportunities for private funds looking to leverage the TARP as a partner rather than a competitor. Here, too, the Secretary has broad flexibility in such partnership arrangements. However, the Secretary is required under the Act to take steps to avoid the "unjust enrichment" of any financial institutions that participate in the TARP. This will be tricky to enforce.

Interestingly, the Act stipulates that the Treasury "must make available to the public in electronic form the description, amount and pricing of assets it acquires pursuant to the Act within 48 hours of purchase, trade or other disposition." This language was included to require "transparency," meaning that the public will know what the Treasury is paying for the assets it purchases. This requirement is intended to make clear that there is a market for these distressed mortgage-related assets and what the government is paying for them.

I would point out that while some Americans may appreciate knowing what the Treasury is paying for these distressed assets, and while this knowledge may help in freeing up liquidity in these markets, there is little doubt that potential buyers of these same securities down the road will take what the government paid for then into account when submitting offers to buy these same securities in the future.

Equity Ownership & Limits On Executive Pay

Then there is the matter of the Treasury taking equity positions in those financial institutions that sell assets to the TARP. The Act requires that the Treasury receive either warrants with the right to receive non-voting common or preferred shares from participating public companies, or a senior debt instrument in cases where the selling company is not listed on a national securities exchange.

As I read it, this process will be very complicated since the Act envisions that the Treasury will get a large enough position in potential ownership (warrants) or debt to cover any losses it might incur when it eventually sells the assets down the road. If so, this suggests that the Treasury could require a large stake in the institutions wishing to unload toxic securities, which could discourage participation.

This, of course, also brings up the question we have had all along: How does the Treasury value many of these very complex and esoteric mortgage-related instruments? Many of these credit swaps, CDOs and derivatives are extremely hard to value, which is a big reason why we are now in a credit crisis.

Next is the matter of limiting executive compensation for those companies that wish to participate in the program. In addition to requiring an equity position in the companies wishing to sell assets to the TARP, the Act also requires the Treasury to limit the compensation paid to top executives of the participating companies, especially in terms of undue bonuses and so-called "golden parachutes." Specifically, the Act changes the tax code (Section 162m) such that the corporate salary tax deduction is reduced from the current $1 million to only $500,000.

These compensation changes include the top five executives in each participating company. This effectively will put a ceiling of $500,000 on the salaries of the top five execs of the participating companies, plus whatever bonuses, if any, that are allowed by the Treasury Secretary. Again, it remains to be seen just how many companies will take the equity hit and the executive compensation hit required to participate in the bailout program.

Next, we turn to the insurance provisions in the Act. In a concession to Republican opponents of the original Treasury plan, the Secretary is required to create a program for the guarantee of troubled assets, as an alternative to straight asset purchases. Under this plan, the Treasury could agree to insure troubled assets on the books of participating companies. Upon request from a financial institution, the Secretary may guarantee, on terms established by the Secretary, the timely payment of principal and interest on a troubled asset. Frankly, I don't understand how this insurance mechanism will work, but it is not clear that the Treasury will even make use of it.

Mortgage Assistance & The Bankruptcy Code

One of the most troubling aspects to the proposed bailout (at least for conservatives) was the suggestion that the Bankruptcy Code should be changed so as to allow bankruptcy judges to unilaterally modify terms of mortgage loans. The Act does not contain any such amendments to the Bankruptcy Code that would permit so-called "cram downs" by bankruptcy judges. However, the Act does contain provisions designed to insure that the government uses its vast powers as the owner of mortgages and mortgage-backed securities to facilitate loan modifications (such as reduced interest rates, principal amounts, monthly payments and/or extended time of repayment) in order to prevent avoidable foreclosures.

In fact, the Act requires the Treasury to implement a plan that seeks to maximize assistance to homeowners and to encourage servicers of underlying mortgages to take advantage of programs to minimize foreclosures, including the HOPE for Homeowners Program under Section 257 of the National Housing Act. Also, the Treasury is authorized to use loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures.

Expanded FDIC Limits On Bank Accounts

In an effort to shore up confidence among depositors, Congress added a provision to the bailout bill to increase FDIC insurance from $100,000 per account to $250,000 per account beginning on October 3 and until December 31, 2009. While the Act provides this increased limit temporarily, the FDIC Chairman, Sheila Bair, said that she expects Congress to make the increase permanent later this year. If the credit crisis continues, I would expect Congress to insist that the government guarantee all amounts in bank accounts and credit unions, as it has already done for money market mutual funds.

Previously, to ensure that more than $100,000 was covered by FDIC insurance, many consumers had spread cash among multiple banks, especially in recent weeks. People had also been setting up separate accounts in each spouse's name at the same bank, which provided $100,000 for each of the two separate accounts, plus a joint account (husband and wife) which doubled the coverage to $200,000 - or $400,000 total for all three accounts. Under the financial rescue plan which raises the coverage to $250,000, this combination of a joint account and a separate account in each spouse's name will result in $1 million total coverage.

Was The Bailout The Right Thing To Do?

As noted earlier, I would have preferred one of the alternative rescue plans that would have involved government loans and insurance for ailing banks, rather than the Treasury buying up distressed assets directly. But what was abundantly clear was the fact that something had to be done. The financial markets around the world were seizing up, and we were facing an international credit crisis, which may yet be far from over.

So while the $700+ billion bailout, with the government directly buying up hundreds of billions in distressed mortgage-related securities, was not my first choice, the government had to take action in my opinion. Millions of Americans were outraged over the bailout plan and many still are. Yet the market plunge of 777 points in the Dow on Monday of last week, after the House failed to pass the bailout, certainly sent a signal to many Americans that the situation was growing dire.

While the summary of the bailout bill above should be helpful, there is still much that we don't know. We still don't know, for example, how the Treasury will price the assets it will be buying, especially in light of the new wrinkles such as the equity stake they will demand from the participating companies. Will the government pay too much, to the expense of taxpayers? Will they pay too little, thus causing more waves of failures? We don't know.

Likewise, we don't know if the $700 billion will be nearly enough. Estimates vary widely, but it is generally agreed that there is at least $2 trillion in troubled mortgage-related paper out there, just in the US. Fortunately, it is also generally agreed that not all of that $2 trillion in subprime and other mortgage-related paper is worthless. That remains to be seen, of course.

The next question is, when will we know if the bailout is working? A lot may depend on when it begins. Some suggest that it will be several months before the Treasury gets the bailout plan up and running. There is a feeling that it may have to wait until after the new administration gets into power on January 20. Personally, I don't think we can wait that long.

Clearly, the markets will let us know, loud and clear, whether the new bailout plan is an acceptable option, and just how soon it needs to get up and running. I for one do not believe the bailout plan passed last Friday is a panacea, and I certainly expect the markets to continue to be a wild roller coaster just ahead. Yesterday (Monday) was a good example when the Dow Jones plunged 800 points by mid-day before reversing to close down 363, or 3.5%, on the day.

The Senate's $150 Billion In Extra Bailout Pork

Politicians on both sides of the aisle in Washington have one universal solution for solving serious issues: When in doubt, just throw more taxpayer money at the problem. This line of thinking certainly came into play when the House failed to pass the massive bailout plan on Monday of last week. The Senate wasted no time in adding on another $150 billion to the already massive $700 billion bailout plan.

There was enormous pressure to pass some kind of massive bailout plan, especially with Bush, Bernanke and Paulson warning of financial Armageddon. So what was the Senate's first thought as to what it should do? Let's add even more money to the tab so as to make it easier for House members to change their votes. This is sick! Here is a summary of the last minute add-ons:

The Senate extended provisions to exempt many Americans from the Alternative Minimum Tax, which was never intended to affect millions of middle class Americans. Never mind that Congress does not have the guts to address this egregious tax measure directly and eliminate it.
Another provision added in the Senate would require most employers and health insurers to put mental-health problems on par with physical illnesses, including coverage for hospital stays and doctor visits as well as co-payments and deductibles.
The Senate bill also added in several more key elements designed to attract House Republican votes - particularly popular tax measures that have garnered bipartisan support. It would extend a number of renewable energy tax breaks for individuals and businesses, including a deduction for the purchase of solar panels. It would also continue a host of other expiring tax breaks, among them the research and development credit for businesses and the credit that allows individuals to deduct state and local sales taxes on their federal returns. And there's more.
$397 million for the "domestic production activities deduction" for the motion picture industry, and another $81 million to extend and modify treatment of "certain film and television productions."
$179 million for tax incentives for "investment in the District of Columbia." $100 million in tax breaks for "certain motorsports racing track facilities." $61 million in added credits for "steel industry fuel."
$49 million in tax breaks for people (mostly in Alaska) receiving compensation from the litigation over the Exxon Valdez oil spill. $49 million for a charitable deduction for corporations that donate books to libraries. $33 million for an economic development credit in American Samoa. $2 million in excise tax exemption on "certain wooden arrows designed for use by children."

These are just some examples of the many spending measures that were added to the $700 billion bailout plan in the Senate. We can argue about the importance of these expensive add-ons, but they never should have been a part of a financial system rescue plan in my opinion. In total, these so-called "sweeteners" (formerly known as 'earmarks') were included in the Senate version at a cost to taxpayers of at least $150 billion, bringing the total tab for the emergency bailout bill to over $850 billion.

What is clear is that these huge add-ons in the Senate were designed to give more House members "cover" so that they could switch their votes in favor of the bailout package. Never mind the cost to taxpayers. And it worked. The bailout bill passed in the House rather easily last Friday. Such is the twisted political world we live in.

John McCain Blew An Election Saving Opportunity

I really hesitate to throw in this last point, but I shall. In my view, Senator McCain blew the last opportunity he had to save his presidential campaign with his vote in favor of the massive government bailout plan. Senator McCain has accurately portrayed himself as a political 'maverick' that has frequently gone against the Republican Party on numerous contentious issues over the years. That is why he is not so popular among the GOP faithful.

With public sentiment so overwhelmingly negative over this massive bailout bill, it would have been easy for either McCain or Obama to come out against it. But Obama quickly got behind the bailout. If McCain had come out against it, and in favor of one of the alternative plans (or better yet, offered a plan of his own), he could have generated a potentially large shift in public opinion in his favor. But he didn't for reasons unknown.

As the maverick on curtailing wasteful spending, McCain could have easily justified his vote against the bill, especially with the extra $150 billion in largely pork-barrel spending put in by the Senate, in which he is a member, but he didn't. Like Obama, McCain quickly fell into line.

For the first time during this presidential campaign, Senator McCain pulled ahead of Obama shortly after the successful Republican National Convention. But then the mortgage-related financial crisis began to unfold. The media, not surprisingly, laid the blame on the Bush Administration (what else is new), and McCain's lead in the presidential polls evaporated.

Over the last 2-3 weeks as the financial crisis rose to the front pages, McCain's showing in the polls has worsened by the day. The presidential election is far from over, but as this is written, Senator McCain is behind by 5-6-7 points or more in the national polls. He will need a major gaffe by Obama, or some other serious surprise, to have a chance of winning on November 4.

Maybe Senator McCain felt he had no choice but to vote for the massive government bailout plan. I don't know. But I do believe his failure to get behind one of the alternative plans, or suggest a new one of his own, has sunk his presidential chances.

Along that line, let's take a look at the latest Electoral Map where Barack Obama has taken a commanding lead.

Electoral Map Now Leaning Heavily To Obama

The general election is less than a month away and Barack Obama is dominating John McCain in both national and state polls. Not a single national poll has McCain in the lead; in fact, Obama leads by an average of nearly six points which is beyond the margin of error.

The states solidly in the McCain column now total only 163 electoral votes. The states solidly in the Obama column total 277 electoral votes. He only needs 270 to win. If the election were held today, Obama would win even if McCain carried all the toss-up states.

I hate to be the bearer of bad news but the situation is what it is. So is McCain totally sunk? Well, never say never, but his path to 270 looks very bleak. McCain would have to pull the mother of all hat tricks and carry all seven toss-up states. (They are: IN, OH, NC, FL, CO, NV and MO.) And, he would also have to recapture VA which is now clearly in the Obama column.

It should be noted that North Carolina, Indiana and Virginia have not voted for a Democrat for president in decades. NC last voted for a Democrat - Jimmy Cater - in 1976. And IN and VA have not voted for a Democrat president since Lyndon Johnson in 1964. This is a dire situation for John McCain.

The most obvious problem McCain faces is the financial melt-down. (No it isn't Sarah Palin, though she has not helped his cause with many voters.) The financial crisis could not have come at a worse time for him, or a better time for Obama. No other issue will have much traction between now and the election; it will be all financial crisis/economy all the time. This takes McCain's biggest strength - security/foreign policy - off the table. The party in power gets the blame and takes the credit for the economy, and now there is nothing but blame to be had.

The presidential lines have been clearly re-drawn - it's no longer close. This election is now Obama's to lose. If the Electoral trends continue as they have in the last few weeks, Obama could win in a landslide. If McCain manages to win, I am sad to say, he will be the political comeback artist of the century!

Scotia Partners - Making Money In The Bear Market

Since early June, I have written about the Scotia Partners investment programs several times in this E-Letter. Many of you have responded and requested information on Scotia's Growth S&P Plus and S&P Moderate Growth investment programs, and I'm pleased to say that a number of my readers have become clients.

Many others, however, have been calling periodically to see how the Scotia mutual fund programs fared during the market's wild (mostly down) gyrations in September. I am all too happy to update everyone!

During the month of September, the Scotia S&P Plus program was up a whopping 22.67% net of fees, and the less aggressive S&P Moderate Growth program delivered a net gain of 26.37%. As you can see, both of these programs compared very favorably to the S&P 500 Index's loss of over 9% during September. These are real numbers in real accounts in real-time trading.

From June 1st through September 30th, Scotia's Growth S&P Plus program has produced a gain of 60.37%, with the Moderate program close behind at +41.25%, both net of fees. Thus, the E-Letter readers who got on board early on have had quite a good ride, depending upon when their money was actually invested. The monthly details for both programs for June through September are as follows:

Program Name	June Return	July Return	August Return	September Return	YTD Return (as of 9/30)
S&P Plus	+ 16.21%	+ 8.66%	+ 3.53%	+ 22.67%	+ 112.59%
S&P Moderate	+ 6.94%	+ 5.92%	- 1.32%	+ 26.37%	+ 62.85%

Past performance is not necessarily indicative of future results.

Remember, the underlying investment strategy employed by Scotia's founder, Cliff Montgomery, has have thrived during the market's greatly increased volatility since the middle of 2007. Thus, it was no surprise to us that September's spike in volatility was actually good for Scotia's performance.

Hopefully, the financial markets will calm down soon, but the stock markets have continued their wild ride so far in October. Frankly, it is impossible to know how long this high level of volatility will continue. If you agree, then the S&P Plus and/or S&P Moderate program may be a good place for a partial allocation within your overall portfolio.

Many of you read about Scotia early on but wanted to wait and see how they would perform. Yet if you had invested on July 1, you would have enjoyed profits of 38.0% in the S&P Plus program, and over 32% in the S&P Moderate program in July, August and September alone. Again, past performance is not a guarantee of future results.

If you would like to see if one of the Scotia programs might be suitable for your portfolio, please call one of our Investment Consultants at 800-348-3601. Or, you can request additional information by sending an e-mail to info@halbertwealth.com, or clicking on our Scotia online request form link.

Also, be sure to read all of the Important Notes and disclosures following my signature below.

Wishing you profits,

Gary D. Halbert

IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM), Scotia Partners, Ltd. (SPL) and Purcell Advisory Services (PAS) are Investment Advisors registered with the SEC and/or their respective states. Information in this letter is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. There is no foolproof way of selecting an Investment Advisor. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from PAS in exchange for introducing client accounts. For more information on HWM, PAS or SPL please consult Form ADV Part II, available at no charge upon request. Any offer or solicitation can only be made by way of the Form ADV Part II. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.

The Standard & Poor's 500 Stock Index and the Dow Jones Industrial Average represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of these Indexes may differ materially (more or less) from that of the Advisor. The performance of these Indexes is not meant to imply that investors should consider an investment in the Scotia Partners Growth S & P Plus or the Scotia Partners S&P Moderate Growth trading programs as comparable to the stocks that comprise these Indexes. Historical performance data represents actual accounts in programs named Scotia Partners Growth S&P Plus and Scotia Partners S&P Moderate Growth, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Since all accounts in the program are managed similarly, the results shown are representative of the majority of participants in these programs. The signals are generated by the use of a proprietary model developed by Scotia Partners. Statistics for "Worst Drawdown" are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Mutual funds carry their own expenses which are outlined in the fund's prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

In addition, you should be aware that (i) these programs are speculative and involve a high degree of risk; (ii) the Scotia Partners trading programs' performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the programs; (iv) Purcell Advisory Services will have trading authority over an investor's account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Purcell Advisory Services trading program's fees and expenses (if any) will reduce an investor's trading profits, or increase any trading losses.

Returns illustrated are net of the maximum management fees (which are deducted in full quarterly, and not accrued month-by-month), custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. No adjustment has been made for income tax liability. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.

Might Uncle Sam Make Money On The Bailout?

Gary D. Halbert — Tue, 30 Sep 2008 19:36:00 GMT

IN THIS ISSUE:

The Latest $700 Billion Bailout Package
What Could Go Wrong? Potentially A Lot
What Could Go Right, If We're Lucky?
What Would Happen To The Profits, If Any?
A "Main Street" Backlash To Come?

Introduction

Like it or not, members of the House and Senate, with the approval of President Bush and both Senators McCain and Obama, reached a final agreement on the massive $700 billion mortgage bailout package over the weekend, with the much-awaited announcement on Sunday afternoon. Yet on Monday, the bailout bill failed to pass in the House of Representatives. As this is written, is not certain what will happen next. The next action probably doesn't happen until Thursday.

Assuming the latest rescue package (or some version of it) passes both houses of Congress, which is a real stretch at this point, it will give President Bush, Treasury Secretary Paulson and Fed Chairman Bernanke most of what they asked for. I'll discuss the details below.

Most Americans do NOT like the latest huge government bailout of Wall Street banks, brokers, etc. Some polls late last week and over the weekend suggested that 65-75% of Americans opposed the bailout. I can understand why, especially with millions of American families struggling to make their monthly mortgage payments.

One reason for this anger over the bailout is the widespread perception that the $700 billion (or whatever the number turns out to be) is money down a rat hole that the government and taxpayers will never see again. While there are numerous risks in the bailout, the odds seem low that the government will lose all or even most of the bailout money. I will discuss some of the main risks to the bailout as we go along.

Interestingly, there is a growing number of intelligent folks in the financial world that believe the government could actually make a lot of money on this huge bailout effort, especially if they play their cards correctly. As I will discuss below, some respected analysts believe the government could net $1 trillion or more off of its investment of $700 billion.

Don't count me among this group, however. While I would concede that there may be some potential upside in this massive bailout program, we have to keep in mind that it's the government, after all, that will be running the enormous and complicated operation. The government is not known for making money, especially in complex financial dealings.

In any event, I do believe that if more Americans understood there is the potential to get most or maybe even all of the bailout money back, they might not be quite so angry about the deal. We'll talk about all of this as we go along this week.

The Latest $700 Billion Bailout Package

As discussed at length in last week's E-Letter, the massive rescue package floated by President Bush, Treasury Secretary Paulson and Fed Chairman Bernanke on September 19 was fraught with problems. That plan would have us turn over $700 billion to the Treasury Secretary with no oversight, no transparency, no accountability and no legal challenge in the courts.

There was no chance that package was going to pass, as I pointed out last week. Yet over the ensuing week, all parties rolled up their sleeves, put in very long hours, made compromises on both sides of the aisle and came up with a much better rescue plan by last Sunday. Whether we like it or not, here is an overview of the latest massive bailout plan as we now understand it.

Doling the money out: The $700 billion would be disbursed in stages, with $250 billion made available immediately for the Treasury's use. More would be made available as needed. Authority to use the money would expire on Dec. 31, 2009, unless Congress certifies a one-year extension.

Overseeing the program:The bill would establish two oversight boards. A new Financial Stability Oversight Board would be charged with ensuring that the policies implemented protect taxpayers and are in the economic interests of the United States. The oversight board would include the Federal Reserve Chairman, the Securities and Exchange Commission Chairman, the Federal Home Finance Agency Director, the Housing and Urban Development Secretary and the Treasury Secretary.

Second, a congressional oversight panel would be charged with reviewing the state of financial markets, the regulatory system and the Treasury's use of its authority under the rescue plan. Sitting on the panel would be five outside experts appointed by House and Senate leaders.

Insuring against losses:The Treasury would establish an insurance program - with risk-based premiums paid by the industry - to guarantee certain of the companies' troubled assets, including mortgage-backed securities purchased before March 14, 2008. The amount the Treasury would spend to cover losses minus company-paid premiums would come out of the $700 billion the Treasury is allowed to use for the rescue plan.

Protecting taxpayers: One provision requires the President to propose legislation to recoup losses from the financial industry if the rescue plan results in net losses to taxpayers five years after the plan is enacted. In addition, Treasury would be allowed to take ownership stakes in participating companies.

Limiting executive pay: Curbs would be placed on the compensation of executives at companies that sell mortgage assets to the Treasury. Among them, companies that participate will not be able to deduct the salary they pay to executives above $500,000. They also will not be allowed to write new contracts that allow for "golden parachutes" for their top five executives if they are fired or the company goes under. However, the executives' current contracts, which may include golden parachutes, would still stand.

Like it or not, these are the highlights of the latest proposed massive government bailout of troubled financial institutions which may yet be signed into law this week. While leaders of Congress praised themselves for acting quickly, it is indeed a very sad time for America.

What Could Go Wrong - Potentially A Lot

Let's be clear from the outset: this is the largest and most complex financial rescue plan in history. Given that fact, some argue that Treasury Secretary Hank Paulson is the right man for the job. Paulson was Chairman and CEO of investment banking giant Goldman Sachs from 1999 to June 2006 when be became Treasury Secretary. While Paulson may be very qualified to head-up this massive financial operation, we must keep in mind that the rescue plan will hardly be off the ground by January 20 when the new administration takes over.

Perhaps the new president will keep him on, but there's no guarantee. So, leadership of this massive, complex operation is a big, big question mark as we begin our summary of the possible risks and problems.

The next fundamental risk is this: the banks, brokerages and others will be trying to unload the worst of the worst of their mortgage-backed securities on the government for the best possible price. The question is, will the government pay too much?

The mortgage-backed securities (MBSs) that the Treasury will buy from the various financial institutions that hold them are in many cases very complicated instruments. Space does not permit a discussion of all the intricacies and the various combinations and mutations of these complex packages of MBSs (not to mention that I don't fully understand them all myself).

Suffice it to say that even the supposedly brilliant minds of Wall Street cannot determine how to value many of these securities today, so why should we think that government bureaucrats will know how to value them correctly? Why would we not assume that the Wall Street banks and brokers will convince Treasury to pay more than the securities are really worth?

And as I discussed briefly last week, the government has some incentive to pay more than these assets are really worth. After all, the supposed purpose of this massive bailout is to allow the banks and other financial institutions to recapitalize and resume lending and unfreeze the credit markets. If the government buys these MBSs at even further discounted prices, the banks would have to book even more losses, and more banks would fail.

The thinking is that since Uncle Sam has the deep pockets and the ability to hold these securities for a long time, it can pay the banks somewhat more than today's crisis values, thus allowing them to recapitalize. Presumably, the government can hold the mortgage securities long enough for them to recover and make at least a decent profit on some of them. That remains to be seen, of course.

I think we can all agree that the government has the deep pockets, at least as long as the world is willing to buy our Treasury bills, notes and bonds. But my question is whether the Treasury, the Congress (and the public for that matter) will have the patience to hold these distressed securities, potentially for years for them to recover. Or will there be pressure on the Treasury to dump these securities prematurely?

Patience is not a commodity that is in heavy supply in today's debt-laden, entitlement-oriented society in America. Baby Boomers need a renewed bull market in stocks to fund their retirement, which may be postponed due to this massive pool of MBSs hanging over the market.

Bottom line: if the Treasury is pressured into unloading these mortgage-backed securities before the economy and the debt markets have recovered, then we should expect to incur potentially huge losses and possibly yet another credit crisis.

Next, there is the question of how will the Treasury determine which banks and other financial firms get to participate in the bailout, especially in the first $250 billion tranche (assuming that is the final deal). One possible mechanism that has been discussed by Paulson and others is a "reverse auction." However, a traditional reverse auction may not be effective in this situation where the government is not necessarily looking to purchase the MBSs at the lowest possible price. The objective of the enormous bailout is not to drive more financial firms out of business, but to help them recapitalize, stay in business and resume normal lending.

Another tricky part of determining which banks and financial firms get to unload their bad debt is as follows. As noted earlier, everyone will likely try to unload the worst of the worst MBSs on the government. Some firms that are in better shape and have limited MBSs may be in a position to take less for them just to get them off their books, whereas firms that have much higher exposure to MBSs could yet go out of business were they to unload their toxic positions at further discounted prices.

The bottom line is, the process for determining which firms get to unload these securities, and at what prices, will be extremely complicated and risky. A lot could go very wrong.

The discussion just above is by no means a comprehensive summary of the possible risks to this massive mortgage bailout. In fact, it is overly general, but I think you get the idea that we are far from out of the financial crisis, even if the massive bailout becomes law later this week.

What Could Go Right, If We Are Lucky

As noted in the Introduction, there are some very smart people that believe the government could actually make a profit on the bailout, perhaps a lot of money if managed effectively. Bill Gross is one of the most highly respected money managers and financial writers around. He is the portfolio manager for the largest bond mutual fund in the world, PIMCO's Total Return Fund. He is also the author of two very popular books on investing.

Last Wednesday, Bill penned an editorial in the Washington Post in which he made it known that he was in favor of some form of the government rescue plan that was being debated in Congress last week. Furthermore, he made it clear that he believes the government could make a lot of money on the mortgage-related assets the Treasury intends to buy. He said of the bailout plan:

"The extreme measures [needed] are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from ‘troubled financial institutions' to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent.

Calls for appropriate oversight of this auction process are more than justified. There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested. My estimate of double-digit returns assumes lengthy ownership of the assets and is in turn dependent on the level of home foreclosures, but this program is, in fact, directed to prevent just that…

Today, the purchase of junk mortgages, securitized credit card receivables and even student loans will be bought at prices significantly below ‘par' or cost, and prospectively at levels allowing for capital gains. This is a Wall Street-friendly package only to the extent that it frees up funds for future loans and economic growth… The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic."

So, Bill believes the government should be able to make 10-15% on average on the distressed mortgage and related securities it purchases – IF the massive operation is managed well. Interestingly, it was reported in the media late last week that Bill offered to manage the government-owned mortgage/securities portfolio himself for free. Who knows if this offer is for real, but PIMCO manages over $825 billion in assets now, an amount similar to the size of the proposed bailout, so…. Hank, are you listening?

The next example of a savvy market maven who thinks the government could make some serious dough on the bailout package is Andy Kessler. Andy is a former hedge fund manager who made his claim to fame by reportedly taking $100 million in his fund's assets in 1996 to $1 billion by 2001. He has since written several popular books on investing and business.

Andy believes the government could make far more money on this mortgage rescue package than Bill Gross envisions. Here are excerpts of what Andy offered up last Thursday in his latest Wall Street Journal editorial (emphasis added):

"There is a saying on Wall Street that goes, ‘The market can stay irrational longer than you can stay solvent.' Long Term Capital Management learned this lesson 10 years ago when it got its portfolio picked off by Wall Street as its short-term financing dried up. I had thought the opposite -- hedge funds picking off Wall Street -- would happen today. But in a weird twist, it's the government that is set up to win the prize.

Here's how: As short-term financing dried up, Fannie Mae and Freddie Mac's deteriorating financials threatened to trigger some $1.4 trillion in credit default swap payments that no one, including giant insurer AIG, had the capital to make good on. So Treasury Secretary Henry Paulson put Fannie and Freddie into conservatorship. This removed any short-term financing hassle. He also put up $85 billion in loan guarantees to AIG in exchange for 80% of the company.

Taxpayers will get their money back on AIG. My models suggest that Fannie and Freddie, on the other hand, are a gold mine. For $2 billion in cash up front and some $200 billion in loan guarantees so far, the U.S. government now controls $5.4 trillion in mortgages and mortgage guarantees.

Fannie and Freddie each own around $800 million in mortgage loans, some of them already at discounted values. They also guarantee the credit-worthiness of another $2.2 trillion and $1.6 trillion in mortgage-backed securities. Held to maturity, they may be worth a lot more than Mr. Paulson paid for them. They're called distressed securities for a reason.

Now Mr. Paulson is pitching Congress for $700 billion or more to buy distressed loans and CDOs [Collateralized Debt Obligations] from the rest of Wall Street, injecting needed cash onto balance sheets so that normal loans for economic activity can be restored. The trick is what price he will pay. Better mortgages and CDOs are selling for 70 cents on the dollar. But many are seriously distressed (15-25 cents on the dollar) because they are the last to be paid in foreclosures. These are what Wall Street wants to unload the quickest.

Firms will haggle, but eventually cave -- they need the cash. I am figuring Mr. Paulson could wind up buying more than$2 trillion in notional value loans and home equity and CDOs for his $700 billion...

It's not without risk, but the Feds, with lots of levers, can and will pump capital into the U.S. economy to get it moving again. Future heads of Treasury and the Federal Reserve will be growth advocates… This is a huge change. Plus, a stronger U.S. economy, with its financial players having clean balance sheets,[the U.S.] will become a safe haven for capital...

You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion -- the greatest trade ever. Every hedge-fund manager will be jealous. Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.

Over 10 years this could change the budget scenario in D.C., which can also strengthen the dollar. The next president gets a heck of a windfall. In the spirit of Secretary of State William Seward's purchase of Alaska for $7 million in 1867, this week may be remembered as Paulson's Folly."

What exactly does this mean? Kessler believes that the Treasury will recover at least $1 trillion off of the investment of $700 billion – even with some of the mortgage securities fetching zero – and quite possibly as much as $2.2 trillion. Only if the operation is bungled should the government lose a dime, so Kessler believes.

Finally, I'm seeing more and more analysts come to increasingly positive conclusions about how the government ought to be able to make money – and not lose money – on this massive mortgage rescue package.

As for me, I'm not drinking the kool-aid just yet, but then again, I'm willing to admit that there's potential if a lot of things happen right. But a lot could go wrong as well. We are talking about the government after all, and one that may well be controlled by a liberal Congress and a liberal president for the next four-to-eight years. So I would not bet a dime that this massive bailout will end up being profitable. On the other hand, I do hope that it will.

What Would Happen To The Profits, If Any?

No doubt we will all rejoice if the $700 billion bailout reaps some big profits in the next 5-10 years (not that I am convinced, of course). As thoughts of some sizeable profits have become the talk of the town in recent days, questions have arisen as to what the government would do with the windfall should it happen.

Would Uncle Sam issue checks directly to the taxpayers? Not hardly! That would be seen as a tax cut, when in fact the taxpayers never had to loan the government any money directly to fund this massive $700 billion bailout.

Some intelligent observers have suggested that the government could use the potential profits from the giant bailout to pay down the national debt. This is precisely what Andy Kessler refers to above when he writes: "Over 10 years this could change the budget scenario in D.C." He is suggesting that the government could use the profit he projects (up to $1.5 trillion) to pay down the national debt.

Others have suggested that the potential bailout windfall could be used to help shore-up Social Security and/or Medicare. A trillion dollars, they suggest, could go a long way toward keeping these giant entitlement programs solvent in the years ahead.

That's a nice idea, assuming such a windfall profit actually occurs. But even if you assume that there will be some large profits some years down the road on this huge bailout, which I don't, what do you think Congress and the Administration in power at the time will do with the money? Three guesses, and the first two don't count.

They will spend it and delight in doing so. They will not send us a check or even cut taxes. They will not pay down the national debt. They will see it as a green light to increase the budget and thus the size of government. Just keep this in mind in a few years – if there are any profits to be dealt with.

Thus, I would insist that there should be clear language in the bailout bill, assuming one passes, that specifies exactly what would be done with any profits that might result from it. Yet that is not likely to happen.

A "Main Street" Backlash To Come?

As noted earlier, some polls over the last two weeks suggested that two-thirds to three-fourths of Americans were opposed to the Wall Street bailout. Clearly, millions of Americans are downright angry about it. A few polls indicated that the numbers were not as negative as 65-75% opposed, but clearly there are far more Americans who oppose the bailout than are remotely in favor.

This indeed raises the question of whether there will be a Main Street backlash if the $700 billion bailout is voted into law. Clearly, millions of Americans see this massive bailout as nothing more than the government's willingness to spend historic amounts of taxpayer money to bail out the Fat Cats on Wall Street.

Along this line, let me remind you of something I wrote last week: "the current financial crisis and the enormous $700+ billion government bailout virtually assure that, if elected: 1) Obama will not be able to push through his aggressive spending plans; and 2) McCain will not be able to push through any tax cuts. Realistically, the money for either of these proposals is no longer there."

Let there be no mistake, millions of Americans have been counting on the promises made by these two candidates. Most of Obama's supporters have bought into his promises of wide sweeping social reform, including nationalized health care, lower taxes on the middle class, and higher taxes on those making $250,000 or more a year. Likewise, many McCain supporters are banking on him extending the Bush tax cuts and other tax cuts he has promised.

If sound fiscal minds prevail, in light of the latest $700 billion spending bailout, neither candidate will be able to pursue these campaign promises. If people are angry today, they are likely to get even angrier in the months and years ahead. Why?

Despite the dire warnings of financial calamity from the White House, the Treasury Secretary, the Fed Chairman and some high-profile business leaders, much of Middle America wasn't buying the story that their own livelihoods were linked to the fate of the rescue package. Instead, average workers read the plan as the big guys in Congress bailing out their friends on Wall Street.

A majority of Americans didn't want Congress to use taxpayer dollars to bail out financial institutions, even if their collapse meant a rocky ride for investors in the stock market. A few congressmen and women admitted publicly that their calls from constituents were running as high as 100-to-one against the bailout plan.

Never mind that the collapse of Wall Street will almost certainly result in a recession, or worse, that will affect virtually all Americans. Never mind that the credit markets have seized up, and that lending for such things as home mortgages had ground to a virtual halt. Never mind that credit card spending may actually be at risk next.

I am reminded of the 1970s the movie "Network" which featured a news anchor who lost control and exclaimed, "I'm mad as hell and I'm not going to take it any more." I think that many in our country today have similar feelings, and no one knows at this point exactly what the eventual consequences will be.

Will there be a major backlash against the big Wall Street banks, brokers and others? Will Americans opt to move their money and their business to local banks that never participated in subprime mortgages, CDOs and other complicated mortgage backed securities? Will they move their investments from the Merrill Lynches of the world to local investment firms?

In my opinion, this suggests that big banks, big brokerage firms and multi-million dollar executive big bonuses may be in big trouble. We may well see a return to local community banks, many of which are in fine shape and have no subprime/MBS exposure at all. Local investment firms, financial planners and the like may benefit from a migration from "big box" brokerage/investment firms that were big players in toxic mortgage securities and still paid their CEOs and top execs multi-million dollar bonuses.

Unfortunately, we'll also likely see a move toward populist political candidates, who are far less friendly to big business – that being the Democrats. For example, Senator Obama has seen a big bounce in the polls over the last two weeks as the credit crisis worsened and the massive bailout was concocted.

If there is a further trend toward populist politicians, that will mean more spending and higher taxes, which will be bad for our economy over the long-term. But then, that's a subject for another E-Letter.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

The Bailout Defeat: A Political Credibility Crisis
http://www.time.com/time/nation/article/0,8599,1845655,00.html

ACORN, Obama and the Mortgage Mess (what, you didn't hear about this?)
http://www.realclearpolitics.com/articles/2008/09/acorn_obama_and_the_mortgage_m.html

Congress lives up to its abysmal approval rating.
http://online.wsj.com/article/SB122273257698488295.html

What Goes Before a Fall? On Wall Street, Reassurance
http://www.nytimes.com/2008/09/30/business/30sorkin.html?_r=3&ref=business&oref=slogin&oref=slogin&oref=slogin

Uncle Sam's $700+ Billion Toxic Securities Fund

Gary D. Halbert — Tue, 23 Sep 2008 20:03:55 GMT

IN THIS ISSUE:

Details Of The Massive $700 Billion Bailout
Government Guarantees Money Market Funds
Will Congress Pass The Bailout Plan?
Should The Government Bail Out Homeowners?
Will Uncle Sam Overpay For The Assets?
Credit Crisis May Tip The Election To Obama
Time To Prepare For A Recession Just Ahead

Introduction

By now, everyone reading this is well aware that the Bush Administration, the Treasury Department and the Federal Reserve Bank are pushing Congress to quickly approve a gargantuan $700+ billion bailout plan, with the hope of saving large banks, investment firms and other financial institutions that are overloaded with troubled mortgage-related securities.

This is by far the largest financial rescue plan ever envisioned on the part of the government, and I would argue, by far the most risky – both in terms of the potential losses for American taxpayers, and in terms of the sweeping, unchallengeable powers it would grant to the government. I will have more to say about the latter in the pages that follow.

Three questions emerge: 1) Is this massive bailout necessary?; 2) Is it the best way to solve the credit crisis?; and 3) Will it work? Unfortunately, the answer to all three is, we just don't know.

I believe that Treasury Secretary Paulson and Fed Chairman Bernanke were correct last week to fear that we were headed for a potentially serious run on banks and money market funds, starting possibly as early as this week, had the carnage in the markets continued. Whether you agree or disagree with the bailout, I think Paulson and Bernanke believed they had no other choice.

Of course, it remains to be seen if Congress will pass the colossal $700+ billion bailout this week as Bush, Paulson and Bernanke are urging. The stock markets that plunged lower early last week reversed their losses late in the week as rumors of the huge bailout package surfaced, culminating with the official announcement on Friday.

Yet on Monday of this week, the stock markets plunged again amid fears that Congress may not go along with the government's massive bailout plan. As this is written, it is impossible to know what will happen. But what is clear is that the US financial markets have frozen up, and if something significant isn't done soon, I believe we will be headed for a stock market crash and a serious recession or worse.

Finally, there will be millions of Americans who do not understand the dire implications of this financial meltdown, and will assume that this is just another massive bailout of the Wall Street rich by the Bush Administration and the Republicans (McCain included). Therefore, I expect this latest crisis and enormous bailout will likely hand the election to Barack Obama.

There are so many ramifications of this massive bailout that I don't even know where to start. But start we must, so here we go.

Details Of The Massive $700 Billion Bailout

We are told that the government's proposed $700 billion bailout may be structured along the lines of the Resolution Trust Corporation ("RTC") established in 1989 to liquidate the assets of failed Savings & Loans. But there is one distinct difference this time around. In 1989, the RTC was formed to take over assets of S&Ls that had already gone into bankruptcy.

This time, should the massive Treasury bailout (or something like it) be passed, the government will be taking over toxic assets of financial institutions that still survive, but are at risk of failure due to the mortgage related securities they hold. Here are the details of the massive government bailout plan, at least as we know at this point.

Under the proposal (the "Act") submitted to Congress on Saturday, the Treasury Secretary would be authorized to purchase mortgage-related assets from any financial institution having its headquarters in the United States, totaling up to $700 billion at any given time. On Monday, the government expanded the bailout to include foreign corporations with "significant operations" in the US that bought mortgage related securities.

The term "mortgage-related assets" is defined in the Act as: "residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008."

If the bailout passes in its proposed form, the Treasury Secretary would be authorized to take wide-sweeping actions at his sole discretion.

Such actions include: 1) designating financial institutions as "financial agents" of the government, and requiring them to perform duties related to the Act as the government may require of them; 2) creating agencies to carry out the bailout and appointing such employees as may be required to carry out the authorities in the Act and defining their duties; and 3) issuing such regulations and other guidance that may be necessary to carry out the authorities of the Act.

Such actions also include: The Secretary shall have authority to manage mortgage-related assets purchased under the Act, including revenues and portfolio risks. The Secretary may, at any time at his discretion, sell or enter into securities loans, repurchase transactions or other financial transactions in regard to any mortgage-related asset purchased under the Act.

In short, the Treasury Secretary would have complete control of how the massive bailout effort is undertaken. The Act states: "The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act."

The only requirement under the proposal sent to lawmakers on Saturday is that the Treasury Secretary must report to Congress within three months of the first exercise of the authority granted in the Act and only semi-annually thereafter. Wow! $700 billion, and you only have to report to Congress twice a year!! But that is not likely to stand.

Over the weekend, Democratic leaders discussed enhancing oversight by carving out a special monitoring role for the Government Accountability Office (GAO), the investigative arm of Congress. The Republican leadership echoed similar wishes for tougher scrutiny, suggesting the creation of a congressional oversight panel, headed by top leaders in both parties.

Oversight, or lack thereof not withstanding, there was another bombshell in the rescue package. The bailout proposal sent to Congress on Saturday states the following: "Decisions by the [Treasury] Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

This provision, if it stands, would mean that the Treasury bailout would be beyond the rule of law, both as it relates to the current Treasury Secretary and the next one appointed by McCain or Obama. Obviously, this provision was included to protect against potentially unlimited challenges in the courts which could stall or prohibit the rescue efforts. This is very troubling.

While the brief summary above is not comprehensive, it should give you an idea of the enormity of the latest massive plan to rescue financial institutions to the tune of at least $700 billion – actually much more as I will discuss later on.

We will continue our discussion of the bailout plan below, but first here's the latest on the money market fund developments.

Government Guarantees Money Market Funds

I trust that virtually everyone reading this E-Letter has some assets in money market funds. As you probably know, the turmoil in the financial markets spilled over into the supposedly safe money market mutual funds last week. Last Tuesday, one of the oldest and largest institutional money market funds, the Reserve Primary Fund, announced that its share price had fallen below the $1.00 level to 97 cents. In financial terms, it "broke the buck."

The Reserve Primary Fund dipped below $1.00 as a result of the bankruptcy of Lehman Brothers. The Reserve Primary Fund, with over $62 billion in assets, announced last week that it owned $785 million in Lehman bonds, and that it was writing those bonds down to zero, which effectively caused its share price to break the buck. Redemptions were halted.

Also, last week Putnam Investments closed an institutional money market fund and said it will return money to clients, after investors pulled out cash despite the fund's lack of exposure to troubled financial firms such as Lehman.

To shore up investor confidence, the Treasury Department announced plans Friday to insure and guarantee US money market funds.

President Bush authorized the Treasury to tap up to $50 billion from a Depression-era fund to insure the holdings of eligible money market mutual funds. And the Federal Reserve announced it will expand its emergency lending program to help support the apprx. $3.5 trillion in assets in US money market funds.

The government guarantee will be in place for at least one year. Money market funds will pay a fee to be in the insurance program. So for now, at least, your money in money market funds is as safe as if it were in a FDIC insured bank. Note, however, that the Treasury pronouncement on the money market funds guarantee stated that the insurance only applies to money that was on deposit with such funds on or before September 19. Money deposited after September 19 is apparently not covered by the guarantee.

Now back to the $700 billion mortgage bailout.

Will Congress Pass The Bailout Plan?

As noted in the Introduction, the stock markets surged higher late last week as news of the massive bailout plan surfaced, reversing all or most of the huge losses incurred early last week. But then the nation had the weekend to think about the enormous bailout plan, and whether or not the Congress would go along with the gigantic intervention.

The House of Representatives and the Senate are both controlled by the Democrats. While I believe there is a sufficient sense of urgency regarding the passage of some kind of large bailout plan, I will not be surprised if the Democrats, along with some Republicans as well, will not approve the rescue package. I believe that is precisely why the stock markets tanked again on Monday.

As this is written, several prominent Democrats are insisting that such a bailout must be accompanied by increased regulation and oversight. Certainly everyone would agree that the regulation of our financial markets is sorely overdue for an overhaul. But as Treasury Secretary Paulson made clear over the weekend, he believes the funding of the huge bailout package needs to happen NOW, whereas the regulatory changes will take time to implement.

Over the weekend, Democrats and some Republicans also complained that the proposed $700 billion bailout does little to help homeowners that are struggling to make their mortgage payments. It is very possible that lawmakers will tack on additional hundreds of billions of dollars to the already enormous rescue package that would go directly to homeowners who may be facing foreclosure.

Some Democrats, including Barack Obama, are arguing that the rescue package must include restrictions on the compensation of corporate executives of companies that make use of the rescue program to unload toxic mortgage securities on the government. On Monday, even John McCain suggested that the top executives of companies seeking to participate in the bailout should not make more than $400,000 a year (no more than President Bush's salary).

Some Democrats, including Senators Chris Dodd (D-CN) and Chuck Schumer (D-NY), are pushing for more egregious changes in US bankruptcy laws regarding home foreclosures. The proposal that Dodd has sent to Treasury Secretary Paulson would let bankruptcy judges modify the mortgages of homeowners facing foreclosure to allow them to keep their homes. Judges rewriting existing mortgages so people can stay in their homes? This is scary!

Some Democrats, including Barack Obama, are arguing that the rescue package must include a second economic stimulus package of up to $100 billion, following the $160 billion sent out earlier this year.

Then there is always the risk that Congress will load the already huge bailout legislation with billions more in "earmarks." It would not surprise me if the final bill easily surpasses $1 trillion if it is actually passed, which is looking increasingly uncertain. In that case, one can only wonder if President Bush will sign it.

So, it remains to be seen if the massive bailout Act, or something like it, is passed or not. Based on the stock market plunge on Monday, and the rhetoric coming out of the Senate banking hearings this morning, I would say the odds are no better than 50/50 for passage. If that is the case, look for the stock markets to continue to tank. Something serious needs to happen soon.

Should The Government Bail Out Homeowners?

As discussed above, many Democrats and some Republicans are arguing that, as a part of the government bailout, something should be done to help homeowners who are struggling to make their mortgage payments. In particular, many in Congress want to minimize the effect on homeowners who financed their homes with subprime and other non-traditional mortgages.

Never mind that many of these families should never have been given a mortgage due to their credit history or employment (or unemployment) situation in the first place. Most of us have heard the term NINJA loans: No Income, No Job or Assets. We also heard about the so-called LIAR loans where mortgage applicants purposely lied about their financial condition to buy a house.

Of course, in the spirit of political correctness, the government has now identified families who lied on their applications to get a mortgage as "victims." Thus, while many moan and groan about the lack of moral hazard in relation to the Wall Street bigwigs who wanted to make money, no one seems to want to hold individuals responsible for lying on their applications.

Instead, as John McCain ridiculously claimed last week, they were "forced" to take these mortgages. Give me a break! While many mortgage lenders were clearly too aggressive in offering home loans, no one forced borrowers to take out these loans. Let's get real.

It is clear now that the Democrats who run Congress are going to insist that additional billions be added to the bailout plan that will help out homeowners who are having a hard time making their mortgage payments, with little regard to whether they lied about their financial condition when they applied. If so, the bailout plan could be substantially higher than the $700 billion the Treasury asked for – if it is passed at all.

In fact, if we consider what has already been spent on the mortgage crisis, the total may be well above $1 trillion already, assuming that Congress passes the $700 billion rescue package this week, plus whatever amounts they add to it.

Will Uncle Sam Overpay For The Assets?

Treasury Secretary Paulson made the rounds on the Sunday talk shows, pushing the $700 billion bailout plan, and urging lawmakers to pass it this week before they adjourn. One thing Secretary Paulson did not make clear was how the government would value the mortgage-related assets that it would purchase from those wishing to participate in the program.

A Treasury pronouncement released on Saturday made the following statements about pricing: "Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets… The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions."

The problem is, there's no liquid market for subprime mortgages and other mortgage-backed securities that have dragged down banks and investment firms. With no trading in the assets, no one knows what they are worth now or might be worth in the future. They are being carried on institutions' books with values based on various indexes that are in some cases little more than guesses. And as those indexes have gone down, the institutions have recorded huge losses.

Furthermore, some of the instruments are complex, opaque derivatives tied to slices of other derivatives and financed by the sale of credit-default swaps to hedge funds and a variety of buyers. How do you price something like that? 80 cents on the dollar, 20 cents on the dollar, or somewhere in between? Who knows?

The government is, in some respects, constrained in driving a hard bargain because the whole point of the rescue program is to help banks get back on solid footing - not to force them into much deeper write-downs, potentially exacerbating their problems staying afloat. At the same time, the market turmoil has complicated efforts to determine the "real" value of the assets.

Obviously, it is too early for the Treasury to have all these details worked out. Suffice it to say that it will be a complicated process that will have serious implications, not only for the government and the holders of toxic debt, but also for the financial markets themselves.

Credit Crisis May Tip The Election To Obama

Americans have grown increasingly nervous as the mortgage/credit crisis has unfolded this year. The failure of Wall Street financial giants like Bear Stearns, Lehman Brothers, Merrill Lynch, AIG and others has only heightened concerns among the public.

Add to that the significant stock market downturn over the last year, which has affected tens of millions of Americans' investment and retirement accounts. Until now, most people thought this credit problem was at least reasonably under control.

Yet, last Friday's announcement of a $700+ billion government bailout of the banks and financial institutions sent a shockwave not only to Americans but investors around the world. Few, if any, had an inkling that the number would be remotely that large, and now we know that the ultimate number could be much higher, well over $1 trillion. It was a startling revelation!

But here's the reason I now believe the massive bailout may gift the election to Obama. Millions of American voters will see the bailout as nothing more than another George Bush giveaway to his rich friends and cronies on Wall Street – at the taxpayers' expense. Many may believe that John McCain would do the same thing if he were president.

Many Americans will not understand the gravity of the current financial crisis which has the potential to trigger a global recession or worse. Many will not understand Secretary Paulson's plea to enact the bailout now and reform the system and pursue and prosecute the bad guys later.

John McCain and Barack Obama have been in a statistical dead-heat for the last several months, although Obama has been marginally ahead most of the time. McCain got a bump up following his selection of Sarah Palin and the GOP convention, but over the last week or so, Obama pulled back into the lead, marginally, in the national polls.

Because of the latest escalation in the credit crisis, and the gigantic $700+ billion bailout request, I expect that potentially millions of undecided voters will now opt to go for Barack Obama. Even some who had never before considered voting for Obama may be rethinking that decision in light of the latest developments.

A lot can change in the next 43 days to the election. Who knows what other financial surprises may await us between now and November 4? But if I were to have to bet today, I would sadly put my money on Obama to win by a comfortable margin.

I have made no secret that John McCain was not my first choice for the GOP presidential nominee. But I have also made it known that I would certainly prefer Senator McCain over Senator Obama by a long-shot. So, it is not easy for me to predict now that Obama will likely be our next president.

One last political point: the current financial crisis and the enormous $700+ billion government bailout virtually assure that, if elected: 1) Obama will not be able to push through his aggressive spending plans; and 2) McCain will not be able to push through any tax cuts. Realistically, the money for either of these proposals is no longer there.

In light of the credit crisis and the massive bailout plan, McCain is now hedging on his promise of tax cuts, realistically so. Obama on the other hand says his social spending programs, including nationalized health care, are "already paid for." How is that? By allowing the Bush tax cuts to expire (a tax increase) and raising taxes on those making over $250,000 a year. Yet Obama claims shamelessly that he will cut taxes for 95% of Americans. Never mind it's a lie.

Time To Prepare For A Recession Just Ahead

On Friday, the Commerce Department will release its final report on 2Q Gross Domestic Product. In its previous estimate, 2Q GDP was 3.3%, well above most expectations. The pre-report estimate is that the government will raise that number to 3.4-3.5% on Friday. But in light of the deepening financial crisis, this week's final 2Q GDP report will be ignored.

While I have tended to be on the more optimistic side for the last several years as it pertains to the US economy, I am now turning bearish. I believe the events we have seen over the last two weeks will crush consumer confidence in the weeks and months ahead.

It seems clear that most consumers are angered and alarmed by the proposed massive $700+ billion bailout of financial institutions. They certainly are not comforted by it. Many are scared by the magnitude of the crisis. Virtually everyone knows who Merrill Lynch is - or was. Now it is gone as an independent American financial icon. People are realizing that we are in dangerous territory.

I predict we will see a significant slowdown in consumer spending for the balance of this year unless the financial markets stabilize quickly. Consumer spending accounts for over 70% of GDP. If I am correct, then we are headed for a recession.

The Index of Leading Economic Indicators fell 0.7% in July and 0.5% in August (latest data available). The Index has been down in three of the last four months. This suggests that economic growth slowed significantly in the 3Q. I will be surprised if economic growth doesn't fall into negative territory in the 4Q.

Much will depend on whether or not the mortgage bailout works.

Conclusions

Given the scope and magnitude of the recent mortgage-backed securities bailout proposed by the government, I think there are a number of conclusions that we can draw:

1. The massive mortgage bailout is unprecedented and extremely risky, but some kind of government intervention is most likely necessary in order to avert a global financial meltdown;

2. While the government is asking for $700 billion, we already know that the Fannie Mae, Freddie Mac and AIG bailouts transactions will push the combined cost to well over $1 trillion, plus whatever the Congress adds on, and you can bet there will be a major addition that will directed, rightly or wrongly, to struggling homeowners;

3. We are now past the issue of "moral hazard," in my opinion. We are now truly in a financial crisis that could easily spiral out of control very quickly. Something major needs to be done quickly, and there is no time for political games. People are on the verge of panic, and the stock markets may continue to plunge. Expect volatility to remain sky-high for a while longer.

4. I now believe this financial crisis will send us into a recession just ahead. While I have correctly been more optimistic than most of my peers in newsletter-land for the last several years, I am now turning bearish on the US economy. It now appears just a question of how deep it will be and how long it will last;

5. It remains to be seen just how deeply this financial crisis will affect the campaign rhetoric coming out of the two presidential contenders. Any thinking person can see that a $700 billion to $1 trillion bailout will severely restrict any politician's ability to cut taxes or increase social spending, but let's see if we hear any scaling back of such campaign promises; and

6. Finally, I now believe that the housing/financial crisis and the massive government bailout may hand the presidential election to Barack Obama in November. The general public does not fully understand the seriousness of the credit crisis, and will deem the massive bailout as just one more example of President Bush bailing out his rich cronies on Wall Street

The race between McCain and Obama has been neck-and-neck for several months, but Obama has pulled back into the lead following McCain's convention bounce. Barring something unusual, I expect the credit crisis and the bailout to send Obama increasingly ahead in the polls, with a win likely in November.

In fact, the latest polling data out this morning show Obama pulling decisively ahead in Colorado, ahead in Virginia and up to even in Ohio and North Carolina. McCain has to carry every one of these battleground states to win, yet they are now trending to Obama.

If this trend continues, it will be Obama, a Senator for less than three years, who will be in charge of solving the worst financial crisis in most of our lifetimes.

Sorry for a depressing E-Letter, but things are what they are.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

How Fannie & Freddie Failed (prepare to be angry)
http://www.ibdeditorials.com/IBDArticles.aspx?id=306978378974502

Treasury agrees to some changes in mortgage bailout proposal.
http://online.wsj.com/article/SB122209290438362805.html

Obama's spending & McCain's tax cuts are out the window now.
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/19/AR2008091903185.html

‘Wall Street' No Longer Exists
http://online.wsj.com/article/SB122212959612065505.html