Forecasts & Trends

Millionaires' Club - Record Plunge In 2008

Gary D. Halbert — Tue, 30 Jun 2009 20:53:58 GMT

IN THIS ISSUE:

Millionaires' Club Shrank at Record Rate in 2008
Global Millionaire Population Still Concentrated, but...
Household Net Worth Continues to Fall
Conclusions

Introduction

With the double-whammy of falling home prices and a major bear market in stocks, and a global credit crisis on top of that, it is not surprising that the number of millionaires in the US and around the world plunged last year.

An interesting new report out last week from Capgemini (a global consulting firm) and Merrill Lynch found that the ranks of the world's millionaires shrank at the fastest rate ever in 2008, with North America suffering the biggest wealth loss worldwide.

The Capgemini/Merrill Lynch annual "World Wealth Report" notes that the global slump in property and equity markets last year cut the number of millionaires by 15% to 8.6 million, wiping out two years of increases. The value of the world's millionaires' assets fell 20% to $32.8 trillion, after a 9.4% increase in 2007, according to the latest report.

Since this weekly E-Letter is primarily sent to high net worth investors, I thought it might be interesting to summarize the 13th annual World Wealth Report for you in the pages that follow. Even if you are not a millionaire, the results of this new study should be both interesting and instructive. The reduction in the number of millionaires may ultimately affect all of us in one way or another as I will discuss later.

Following that summary, we will look at some statistics on household wealth here in the US, which will shed light on consumer spending, the engine of the US economy.

Millionaires' Club Shrank at Record Rate in 2008

The Capgemini/Merrill Lynch World Wealth Report for 2008, which was released last Wednesday, defines a millionaire as someone with a net worth of $1,000,000 excluding the value of their primary residence, collectibles, consumables, and consumer durables (ie – liquid assets). The survey is conducted globally each year. The authors use the acronym "HNWI" to represent High Net Worth Individuals who are millionaires, as defined above.

The Report concludes that at the end of 2008, the world's population of HNWIs was down 14.9% from the year before to 8.6 million, and their wealth had dropped 19.5% to $32.8 trillion. The declines were unprecedented, and wiped out two robust years of growth in 2006 and 2007. As a result, the world's population of millionaires and their wealth ended 2008 below levels seen at the close of 2005.

The global population of millionaires had seen robust annual growth of 7.2% on average from 2005 to 2007, before reversing in 2008. The same trend was evident in HNWI financial wealth, which grew 10.4% per year in 2005-07, before the steep contraction.

The most significant declines in the HNWI population in 2008 occurred in the three largest regions: North America (-19.0%), Europe (-14.4%) and Asia-Pacific (-14.2%). But behind the aggregate numbers lie some interesting developments in the HNWI populations of those regions. The authors summarize as follows:

The number of HNWIs in the U.S. fell 18.5% in 2008, but the U.S. remains the single largest home to HNWIs, with its 2.5 million HNWIs accounting for 28.7% of the global HNWI population.
In Europe, the 14.4% decline in the millionaire population varied widely by country. For example, the number of HNWIs shrank 26.3% in the U.K., but just 12.6% in France and only 2.7% in Germany, which avoided a steep contraction in part because HNWIs there were more heavily invested in conservative asset classes than those in other countries.
Japan, which accounts for more than 50% of the HNWIs in the Asia-Pacific region, suffered a relatively mild HNWI decline of 9.9%, but others in the region suffered greater losses, including Hong Kong (-61.3%) and India (-31.6%).

The apparent resilience of Japan, however, stemmed largely from the fact that the expansion of the HNWI population there had already been capped by the 2007 slowdown in macroeconomic growth and a weakening stock market (market capitalization was down 11.1% in 2007).

The Capgemini/Merrill World Wealth Report also surveys the globe for the super-rich, those with at least $30 million in liquid assets, which they refer to as the "Ultra-HNWIs." The contraction in the overall HNWI population was exacerbated by the steeper-than-average decline (globally and regionally) in the number of Ultra-HNWIs.

A decline in Ultra-HNWI numbers has a disproportionate effect on overall HNWI wealth, because so much world wealth is concentrated in their hands. The Report notes that at the end of 2008, Ultra-HNWIs accounted for 34.7% of global HNWI wealth, but only 0.9% of the total HNWI population.

Recall as noted above that the entire world population of HNWIs was down 14.9% in 2008, and their wealth had dropped 19.5% to $32.8 trillion. Yet the world population of Ultra-HNWIs shrank and lost even more. The number of Ultra-HNWIs plunged 24.6% in 2008, and their wealth was down 23.9%. This is very interesting!

The Ultra-HNWIs (those with at least $30 million in liquid assets) should have access to the very best in money management, and they should be highly diversified. Yet they lost more numbers and more wealth than the mere millionaires.

The authors suggest that the sharp decline in the number of Ultra-HNWIs globally largely resulted from that group's "partiality for more aggressive products, which tend to deliver greater-than-average returns in good times, but delivered hefty losses in 2008." While this may have been true in some cases, I strongly suspect that the losses occurred primarily because many millionaires (along with average investors) bought into Wall Street's buy-and-hold mantra, and when the stock markets plunged, so did their assets.

It is also true that some of the most highly sought after, high profile professional money managers lost 40% or more last year. And who knows, they may have had money with Bernie Madoff! I would also suggest that the plunge in oil prices last year played a role in the losses among Ultra-HNWIs, many of whom are Middle East oil sheiks.

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.

Global Millionaire Population is Still
Concentrated, but the Ranks are Shifting

The Report noted that the U.S., Japan and Germany together accounted for 54.0% of the world's HNWI population in 2008, up very slightly from 53.3% in 2007, despite the substantial loss of wealth by HNWIs in those countries, particularly the United States. The authors noted:

China's HNWI population surpassed that of the U.K. to become the fourth largest in the world in 2008 (364k HNWIs), after having exceeded France in 2007. In 2008, despite steep market capitalization losses, the closed nature of China's markets combined with robust macroeconomic growth to help China avoid some of the steep losses felt elsewhere.
Brazil surpassed Australia and Spain to reach 10th place among HNWI populations globally (131k HNWIs). It is also striking to note how the financial crisis impacted HNWIs differently in different types of economies. For example:
Hong Kong's HNWI population took by far the largest hit in percentage terms, with a 61.3% drop to 37k. Hong Kong is unique in that it is a developing economy with an extremely high market-capitalization-to-nominal-GDP ratio (5.76). That ratio indicates Hong Kong is particularly vulnerable to large market capitalization declines like the one experienced in 2008 (-49.9%). By contrast, the ratio is 1.49 in Singapore, and just 0.83 in the U.S. Furthermore, Hong Kong has a very large proportion of its HNWIs in the $1m-$5m wealth band, and many of these HNWIs dropped below the $1m threshold in 2008 due to market losses.
India's HNWI population shrank 31.6% to 84k, the second largest decline in the world, after posting the fastest rate of growth (up 22.7%) in 2007. India, still an emerging economy, suffered declining global demand for its goods and services and a hefty drop in market capitalization (64.1%) in 2008.
Russia's HNWI population declined 28.5% to 97k, the seventh largest per-country drop in 2008, after growing at the tenth fastest rate (14.4%) in 2007. Russia's economy decelerated rapidly, in line with the steep decline in global demand for oil and gas. Compounding the problem was the sharp fall in equity markets—down 71.7%, and the largest drop globally.
The U.K. experienced a 26.3% drop in its HNWI population in 2008, to 362k. A mature economy, heavily reliant on financial services, the U.K. was particularly hard-hit by falling equity and real estate values.

HNWI Wealth is Forecast to Resume
Growth as Global Economy Recovers

The authors of the Capgemini/Merrill World Wealth Report are considerably more optimistic than I am about global economic growth over the next several years. (But then what do you expect from Merrill Lynch?) They expect that the US will lead the recovery, along with Asia. I have my doubts, of course, but here are their forecasts:

"We forecast HNWI financial wealth will grow to $48.5 trillion by 2013 [up from $32.8 trillion at the end of 2008], advancing at an annualized rate of 8.1%. This growth will be driven by the recovery in asset prices as the global economy and financial system right themselves.

Also, the 2008 flight-to-safety imperative is expected to ease, encouraging HNWIs to return to higher-risk/higher-return assets, and away from capital-preservation instruments, as conditions improve.

We expect North America and Asia-Pacific to lead the growth in HNWI financial wealth, and predict Asia-Pacific will actually surpass North America by 2013. Growth in these regions will be driven by increased U.S. consumer expenditure as well as newfound autonomy for the Chinese economy, which is already experiencing increased consumer demand.

Latin America is poised to grow again when the U.S. and Asian economies start to pick up, as it has the commodities and manufacturing capability that will be needed during the return to growth. Europe's economic recovery is likely to lag, as several major countries there continue to face difficulties.

In the Middle East, oil is expected to be a less dependable driver of wealth in the future, so growth there is likely to be slower than it has been in the past.

Our global forecasts assume continued difficulties for the global economy in 2009. We expect some initial signs of growth in selected countries, which could pick up steam from 2010, but protracted weakness in the global economic and/or financial systems could force a downward revision in our forecast numbers. [Emphasis added, GDH.]

Notably, HNWI wealth grew at a strong annualized rate of close to 9% in 2002-07—the recovery years following the bursting of the technology bubble. While the tech downturn and the most recent financial crisis are not identical forms of disruption, we nevertheless expect the recovery in HNWI wealth to be similarly robust this time around, as the business cycle starts to trend back up."

While I am not nearly as optimistic as the folks at Capgemini and Merrill Lynch, I certainly hope they are correct. In any event, their annual World Wealth Report is very interesting and appreciated, at least by me.

Finally, I am sure there will be readers who will respond and ask, Why should I care if a lot of millionaires and super-millionaire fat cats took a beating over the last 18 months; after all, I lost a lot of money in the market as well. To that question, I would simply remind everyone that the wealthy create lots of jobs and pay a lot of taxes (top 5% of taxpayers pay over 60% of all income taxes). To that end, their large loss of wealth will have a negative effect on economic growth and the federal budget deficits.

But at the end of the day, what this demonstrates for all investors is that Wall Street's buy-and-hold mantra was a recipe for huge losses over the last 18 months, just as it was during the last bear market in 2000-2002. Perhaps that is why we are seeing a wave of investors seeking actively managed alternative investment strategies such as those I recommend.

Household Net Worth Continues To Fall

The Capgemini/Merrill Lynch report on the plunge in millionaires globally wasn't the only recent source of bad news about last year's drop in personal net worth. According to a Federal Reserve report earlier this month, 2008 was the worst year on record for US household net worth (assets minus liabilities).

Household net worth in the United States declined by $11.2 trillion (-18%) last year and Americans curbed their spending as they watched the value of their assets fall. It was the worst yearly decline in household net worth on record.

In the 4Q of last year alone, household net worth plunged by $5.1 trillion (-9%), the largest quarterly drop in dollar terms on record, going back to 1951, when the government began keeping quarterly records.

On June 11, the Federal Reserve reported that US household net worth plunged $1.7 trillion (-2.6%) in the first three months of this year. That followed the record large drop in 2008 when household net worth plunged (18%). The 1Q of this year marked the seventh consecutive quarterly drop in household net worth.

The continued swift decline in household net worth was caused, once again, primarily by the continued decline in home values and the stock markets in the 1Q, plus the significant rise in the unemployment rate.

The Fed reported that the value of household real-estate holdings, mostly home residences, fell 2.4% in the 1Q to $50.4 trillion overall, down from $51.7 trillion at the end of 2008. Collectively across the US, homeowners had 41.4% equity in their homes in the 1Q, another record low. That was down from 42.9% in the 4Q of last year.

Making matters even worse, the damage to US household wealth in the 1Q also came from the sinking stock market. The Fed reported that the value of Americans' stock holdings dropped 5.8% from the final quarter of last year.

While the equity markets have rebounded nicely since the early March lows, home values have continued to fall, so household net worth on average is almost certainly lower today than it was at the end of March (latest data available). And, of course, we know that many Americans, and foreigners as well, bailed out of the stock markets late last year and early this year and have yet to get back in, so they have not benefitted from the recent rebound in equities and related mutual funds.

This Does Not Bode Well For Stocks

Consumer spending accounts for 66%-72% of GDP (depending on whose stats you use). Almost every forecaster that is predicting an end to the recession in the second half of this year is counting on a revival in consumer spending. I find that wishful thinking in light of the continued fall in household net worth.

It is true that there have been some bright spots over the past few weeks. Consumer confidence has picked up over the last few months from very low levels, although it declined slightly in June as reported this morning. Personal income saw a healthy 1.4% jump in June, thanks in part to the government's stimulus checks. Personal spending and retails sales ticked up slightly in May (latest data available), also from very low levels.

Yet most Americans are increasing their savings significantly, which is more money that will not find its way into cash registers. The Commerce Department reported last Friday that the personal savings rate spiked to 6.9% of disposable income in May, up from 5.6% in April and 4.3% in March. The May savings rate of 6.9% was the highest since December 1993. Most analysts believe the personal savings rate is on its way to 10% by year-end.

So, in addition to the continued decline in household net worth, which is likely to continue all year as home prices fall further, the rapidly rising savings rate does not bode well for a lasting surge in consumer spending just ahead. This is a key reason why I believe we will not emerge from this recession until 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.

Conclusions

The bear market in stocks, which saw the S&P 500 Index fall by more than 50% from the peak in late 2007, has certainly inflicted a lot of casualties on the world's millionaires and super-millionaires.

The White House National Economic Council estimates that on a global basis, $50 trillion dollars in wealth has been erased over the last 18 months. This includes $7 trillion dollars in US stock market wealth which has vanished, and $6 trillion dollars in US housing wealth that has been destroyed over that period. These declines were unprecedented, and wiped out two robust years of growth in 2006 and 2007.

In 2008, the world's population of millionaires was down 14.9% from the year before to 8.6 million, and their wealth had dropped 19.5% to $32.8 trillion. The super-millionaires ($30 million or more) fared even worse. The number of super-millionaires plunged 24.6% in 2008, and their wealth was down 23.9%.

I found this surprising since you would think that those with fortunes of $30 million or more would avail their portfolios (or at least part of them) to professional money managers and programs that employ defensive strategies that can go to cash or hedge long positions in a bear market.

As most readers know by now, Halbert Wealth Management specializes in finding such professional money managers, doing due diligence on their programs, verifying their past performance records and then recommending them to our many clients across the US.

All of the equity managers we recommend in our AdvisorLink® program performed much better than the stock market in 2008. Some of the equity managers that I have featured in these pages in recent years actually made money in 2008 and thus far in 2009. Of course, past performance is no guarantee of future results.

If you would like to see detailed information on these professional money managers, including their actual performance records (net of all fees), simply CLICK HERE. Remember that all of these programs have the ability to move to cash and/or hedge long positions in case of a bear market. Obviously, that has been a very good option to have in the last year and a half!

As always, if you would like to learn more about the benefits of active money managers, feel free to give one of my professional Investment Consultants a call at 800-348-3601 or visit our website at www.halbertwealth.com. If you prefer, you can also contact us via e-mail at info@halbertwealth.com.

Wishing you a great summer,

Gary D. Halbert

SPECIAL ARTICLES

P.S. Now that the House of Representatives has narrowly passed President Obama's "cap and trade" bill, otherwise known as "cap and tax," you might want to look at the following articles on the subject. Most Americans have no idea what this bill really holds for the future.

The Cap and Tax Fiction
http://online.wsj.com/article/SB124588837560750781.html

Cap and trade being cancelled in other countries
http://online.wsj.com/article/SB124597505076157449.html

Cap and trade bill flunks the math
http://blogs.forbes.com/digitalrules/2009/06/waxmanmarkey-flunks-math.html

No Recovery in Sight
http://www.nytimes.com/2009/06/27/opinion/27herbert.html?ref=opinion

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

Obama On Course To Double National Debt

Gary D. Halbert — Tue, 16 Jun 2009 22:27:44 GMT

IN THIS ISSUE:

Obama's Unprecedented Spending Spree
Obama's Deficits To Double The National Debt
Will The Markets Halt The Explosion In Debt?
How Will Obama Fund His Massive Spending?
Inflation Implications of Obama's Spending
Conclusions - Why Is He Doing This?

Introduction

It took the United States of America 233 years (1776-2009) to amass a national debt of $11 trillion. Yet President Barack Obama's record large 2009 budget deficit estimated at $1.85 trillion and his own spending plans for the next 10 years (2010-2019) show that our national debt will likely double over the next 10 years.

Using the Obama administration's own projections, the non-partisan Congressional Budget Office (CBO) estimates that, including the record 2009 budget deficit of $1.85 trillion, and huge annual deficits over 2009-2019 will result in an additional $11.1 trillion in national debt, on top of the current $11.4 trillion. As I will discuss below, the national debt will very likely more than double in the next decade because some of the CBO's economic assumptions may be too optimistic.

As noted above, the CBO also recently revised its estimate for the budget deficit for fiscal year 2009 to at least $1.85 trillion. But unless the economy rebounds soon, that number will very likely top $2 trillion by the end of September when FY2009 comes to an end. According to the CBO, Obama plans to run a FY2010 deficit of apprx $1.4 trillion and almost $1 trillion in FY2011.

Keep in mind that these deficits do not include even half of the massive costs for Obama's health insurance plan, which some experts now project will cost between $1.5 and $2 trillion over the next 10 years. Likewise, these projections do not include any money for the trillions that will have to be spent saving Social Security and Medicare over the next decade.

Whether you are a liberal or a conservative, these numbers should alarm you! If the national debt doubles over the next 10 years, it will almost certainly be a disaster for the US dollar and the bond markets, and it will almost certainly wreck the stock markets as well. The largest foreign holders of US Treasury debt are already expressing concern about Obama's record spending, and they could abandon the dollar and US Treasury securities if the national debt rises 50% over the next five years, and doubles over the next 10 years, as is projected by the CBO.

This week, I will discuss the market implications of the national debt doubling in the next decade. Let's get started. [Note: this week's E-Letter will print longer than normal because I have included several charts and graphs.]

Obama's Unprecedented Spending Spree

In just four months of his presidency, President Obama has shown he isn't afraid to spend hundreds of billions of dollars on corporate bailouts or run up trillions of dollars in US debt in an effort to end the economic and financial crisis. But in doing so, he has initiated the largest expansion of federal government since World War II and set up a massive challenge for his administration.

During the first 100 days of his presidency, Obama has signed the $787 billion stimulus bill into law, proposed an eye-popping $3.6 trillion federal budget for the 2010 fiscal year, taken over a massive $700 billion Wall Street bailout program (TARP) and created other multi-billion-dollar government programs supposedly to help grease the economic wheels.

In the wake of the economic and financial crisis, numerous respected economists and financial forecasters, including The Bank Credit Analyst and billionaire Warren Buffet just to name a couple, agreed late last year that the government should intervene with a large fiscal stimulus package to help rescue the US economy. Many of these same sources wasted no time jumping onboard when Obama floated his idea of a near $1 trillion “stimulus package” earlier this year.

After some congressional tinkering, the final stimulus package came in at $787 billion. While many argued that most of the huge stimulus should be spent in 2009 and 2010, President Obama strung it out over the next 3-4 years to fund his liberal programs, with relatively little of the money being spent in 2009 to jump-start the economy out of recession.

To-date as of late May, according to the Congressional Budget Office, Obama has only spent $37 billion of the $787 billion stimulus package this year. Are you surprised? Coming under increased scrutiny for not spending more sooner, Obama said last week that he is trying to accelerate the rate of spending of the stimulus money. Whatever happens, this misses the point we should be focused on.

The point is, while many respected analysts agreed that a large stimulus package was needed in the short-term, they didn't expect that President Obama would string-out the stimulus over four years with very little spent in 2009, plus continue to run trillion dollar annual budget deficits for several more years.

Now that the economy is showing signs of a modest turnaround - with only $37 billion in stimulus spending - some are suggesting that Obama should rescind the remainder of the $787 billion stimulus package and save the money. To that I say, fat chance!

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.

Obama's Deficits To Double The National Debt

Along with the President's request for a record $3.6 trillion budget for FY2010, he also submitted to Congress and the CBO his spending plans for the next decade. These numbers shocked even many of those who initially supported the $787 billion stimulus package. What follows are Obama's projected annual deficits for FY2009 and the next 10 fiscal years according to the non-partisan CBO:

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

http://www.cbo.gov/ftpdocs/100xx/doc10014/selected_tables.xls

You can confirm these huge budget deficits by the CBO at the link above.

[Editor's Note: Obama promises to cut the deficit in half in four years, and the $658 billion projected deficit in 2012 certainly accomplishes that, but it is still $200 billion more than Bush's record-large budget deficit of $458 billion in fiscal 2008.]

Where to begin?? First, these numbers should be staggering to anyone reading this, regardless of whether you are a liberal, a conservative or anywhere in between. Second, if these numbers prove to be reasonably accurate, the United States will go from a national debt of $11.4 trillion today to $22.5 trillion by the end of FY2019. As I will discuss below, it could be even higher. This is unheard of!

If you add up only the first five years, 2009-2013, you find that the national debt explodes by almost 50%. This unprecedented spike in the national debt will greatly exacerbate concerns on the part of our largest foreign buyers of Treasury debt, not to mention the downward pressure it will create on the US dollar and further upward pressure on interest rates.

If we look at the FY2009 deficit alone, estimated to be $1.85 trillion, we find that it equals 13.1% of GDP, according to the Congressional Budget Office. That's over twice the post-World War II record of 6% in 1983 under Ronald Reagan.

Fed Chairman Ben Bernanke testified last week that: “The ratio of federal debt held by the public to nominal GDP is likely to move up from about 40% before the onset of the financial crisis to about 70% in 2011.” That puts the debt-to-GDP ratio at its highest level since the early 1950s, as a result of the huge debt buildup during World War II and just afterward. The CBO projects that the debt-to-GDP ratio will soar to 82% by 2019.

In his House testimony last week, Bernanke added: “Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.” Of course, that comes from the head of the Fed which is in the process of buying up to $2 trillion in toxic securities and printing the money to pay for them.

Finally, to be fair, I must acknowledge that the current cycle of exploding debt began with George W. Bush. In the latter years of the Bush administration, spending rose rapidly, while revenues remained reasonably flat. Bush created an expensive new entitlement, the Medicare drug benefit ($63 billion cost this year), and let spending on many domestic programs run wild. Over seven years, the wars in Afghanistan and Iraq added a total of some $900 billion to the budget.

All told, Bush raised federal spending from 18.5% of GDP to 21%, setting in motion a chronic budget gap by piling on new spending without paying for it. Long-time clients and readers will recall that I roundly criticized President Bush numerous times in these pages as he proved he could spend with the best of the Democrats.

Yet Obama has elected to take spending and budget deficits to a whole new level. Take note that Bush added apprx. $4 trillion to our national debt during his two terms, whereas President Obama is planning to add more than $11 trillion over the next decade. Americans should not buy into the idea that President Obama is only spending this much because he inherited a recession and credit crisis from Bush.

As Fortune magazine's financial writer Shawn Tully wrote last week, “Under Obama the Bush trend keeps going, but this time on steroids.” Doubling the national debt in a decade should be unconscionable!

As noted earlier, it is quite conceivable that the federal budget deficits could more than double, especially if Obama wins a second term as president. Why? First, the CBO projects that real GDP will grow by 2.9% in 2010. I certainly hope they are right, but I doubt growth will be anywhere near that robust next year. Second, the CBO projects that real GDP will grow by 4% in 2011 and 3.6% annually during the years 2012-2015. You can view these assumptions at: http://www.cbo.gov/budget/data/econproj.xls

The latest CBO estimates also assume there will not be another recession between now and the end of fiscal 2019. Granted, it is next to impossible to predict when the next recession will occur, but it is also a stretch to believe we won't have one again for over a decade.

The bottom line is, these economic growth projections are very optimistic in my view and that of several other analysts I read. Bond market maven Bill Gross of PIMCO fame agrees:

“The obvious solution to both dollar weakness and higher yields is to move quickly towards a more balanced budget once a sustained recovery is assured, but don't count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have.” [Emphasis added, GDH.]

If real GDP does not grow by the CBO projections of 2.9%-4.0% in 2010-2015, then tax revenues will be lower than projected, and this will increase the annual deficits, unless spending is reduced accordingly or income taxes are raised significantly.

Likewise, the CBO does not factor in any federal expenditures that would be required to overhaul Social Security and Medicare in the next 10 years. Estimates on what it will take to make these agencies solvent in the years ahead vary widely, but most economists agree it will take at least $20-$40 trillion.

Thus, the national debt could easily increase by more than $11.1 trillion in the years 2009-2019, especially if President Obama wins a second term.

Will The Markets Halt The Explosion In Debt?

It is my strong opinion that the markets will NOT sit by and watch the national debt soar by 50% in five years and double in 10 years. In 2009-2011 alone, the projected deficits total $4.2 trillion. That amount alone will, in my opinion, be more than enough to send the US dollar sharply lower. And the dollar is already quite low as you can see in the chart below. From its highs in 2001, the dollar lost apprx. 40% of its value before rebounding modestly beginning in 2008.

Note that since late February, the US dollar Index has once again rolled over to the downside and is trading around 80 as this is written. If the dollar falls below the 2008 lows, I would expect another potentially powerful leg to the downside, fueled largely by the explosion in US debt and credible fears of rising inflation in our not-too-distant future.

With our major foreign lenders already complaining about buying US Treasury debt, a weaker dollar will only cause them additional concerns about rising inflation. Ditto for rising US Treasury yields. After falling significantly for the last several years, especially as the credit crisis unfolded, yields on Treasury securities have reversed sharply higher since the first of the year, much to the Fed's dismay.

[Note: Treasury futures decline when yields go higher.]

The 10-year Treasury note yield, for example, almost doubled in recent months, rising from around 2% at the beginning of the year to near 4% as this is written. Like the dollar, US Treasury yields are extremely sensitive to inflation expectations.

Adding to the problem is the fact that the largest foreign buyers of US debt are notably concerned about the trillions Obama plans to spend and the likelihood that it will lead to higher inflation in the US. China has recently called for the yuan to replace the US dollar as the world's reserve currency. That won't happen anytime soon, of course, but it certainly indicates the level of discomfort among the major foreign buyers of our debt, which include:

China	$768 billion	OPEC	$192 billion
Japan	$687 billion	Russia	$138 billion
Caribbean	$213 billion	Un. Kingdom	$128 billion

Source: U.S. Treasury Dept. as of March 2009.

Obviously, if the dollar resumes its bear market, and Treasury yields continue to rise, this will raise even more concerns among foreign lenders regarding higher US inflation down the road. In addition, this will not only hamper the modest recovery from this severe recession, but could also throw us back into a new recession over the next few years as Obama increases the national debt by $4.2 trillion in 2009-2011 alone.

How Will Obama Fund His Spending
If The Markets Force His Hand?

If the markets respond to Obama's enormous increases in spending and budget deficits as I fully expect they will, he will have to resort to other measures to fund his record large spending plans. Here are some examples of how he may attempt to do so.

During the campaign and since taking office, Obama has promised to raise taxes only on those Americans making $250,000 a year or more. For those making $249,999 or less per year, he has promised to leave in place former President Bush's tax cuts. But the math doesn't remotely add up.

Numerous recent studies have shown that if Obama wants to cover his spending plans by raising taxes only on those making $250,000 a year or more, he would have to raise their tax rate to at least 60%. That is not likely to happen (or so I would presume).

Facing the projected annual budget deficits from the CBO discussed above, Obama will have little choice but to renege on his promise not to raise income taxes on the middle class in the next year or two if the economy does not rebound robustly. I will go on the record and predict that Obama will repeal the Bush tax cuts on the middle class by 2011 if not sooner.

Yet even that will not come close to covering Obama's massive spending plans in the next few years. On this point, conservatives and even many liberals agree, including liberal maven Paul Krugman, a leading columnist for the New York Times. Krugman is urging Obama to raise income taxes on both the wealthy and the middle class.

The Obama administration clearly understands that its spending plans will lead to huge deficits in the future. Yet President Obama refuses to admit publicly that his spending plans will double the national debt in 10 years, as the CBO has projected, and he is reluctant to break his promise and raise taxes on the middle class (although I believe he will by 2011 at the latest).

Another option President Obama and Congress are now considering is a European-style “Value-Added Tax”(VAT) that will increase costs to ALL Americans for the goods and services we buy. Space does not permit me to go into all of the details of a VAT tax, but suffice it to say that additional federal taxes are levied on goods and services at various levels in the production process before these products and services are offered to the public.

In my opinion, the VAT tax is the most egregious way for politicians to raise taxes in an effort to deceive the public. Yes, the informed public will know exactly what is happening with a VAT tax, but many taxpayers will simply see it as the continual rise in the prices of goods and services due to inflation, and not as the result of an increase in taxes.

For over two decades, the VAT tax has been discussed only in the context of an alternative to our current progressive income tax system. The discussion has been, if we implement the VAT tax (or a national sales tax), we could eliminate the current income tax. Never before now has a VAT tax been discussed in addition to the current income tax. But it is on the table now!

Obama's press secretary said last week that a VAT tax is not on the table now, but others in his administration have admitted that it has been discussed. Congress is already considering a VAT tax openly. I will not be surprised if Obama and Congress try to implement a VAT in 2010 or 2011, especially if the markets react as I suggested above.

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.

Inflation Implications of Obama's Spending

Over the years, many clients and readers have asked me how and why we have had spiraling inflation at various times over our history. The textbook answer is that inflation rises when too much money is chasing too few goods and services. Too much money chasing too few goods is far too simple an explanation in today's incredibly complex financial world. Yet the basic premise is still true.

The Federal Reserve controls the money supply, and the money supply has skyrocketed over the last 18-24 months as the credit crisis has played out. Yet because of the severe recession, because consumers are spending less and saving more, and because home prices continue to implode, the dramatic rise in the money supply has not sparked higher inflation. In fact, deflation has been the greater threat over the last 18-24 months.

For the reasons noted above and others, the Fed has had the ability to pump up the money supply by a record amount over the last 18-24 months without generating sharply higher inflation. But most economists and financial analysts agree that at some point the Fed must remove some of this liquidity and increase interest rates or else inflation will begin to rise, perhaps significantly. This is part of the reason why Treasury yields have jumped recently.

As you can see in the chart below, commodity prices are already on the rise. The CRB Index represents a basket of traditional commodities (grains, meats, metals, sugar, cotton, rubber, etc.), and this index has jumped apprx. 20% just since mid-March.

Interestingly, the CRB Index does not include crude oil, heating oil or gasoline. As we all know, crude oil prices have surged from $35 a barrel in mid-February to above $72 a barrel last week. The national average price for a gallon of gasoline was over $2.60 last week according to the Dept. of Energy, and has risen over $1 per gallon since the first of the year.

So, it is clear that the seeds of higher inflation have been planted. But because the recession is likely to continue at least another quarter or two, I don't expect inflation to spike higher anytime soon. However, the Fed faces some very difficult choices in the second half of this year as the economy shows more signs of recovering.

Conclusions - Why Is He Doing This?

Based on the Obama administration's own spending projections, the non-partisan Congressional Budget Office projects that the US national debt will almost double by 2019. It will increase by 50% in the next five years alone, as Obama runs trillion dollar deficits for several years. The CBO now estimates that the fiscal 2009 deficit will be a whopping $1.845 trillion, and it could be even higher.

Fed Chairman Ben Bernanke warned that the US debt-to-GDP ratio will soar from 40% to 70% between now and 2011 as Obama records trillion dollar deficits. The CBO projects that the debt-to-GDP ratio will soar to 82% by 2019. Sadly, all of these numbers could come in even higher if the CBO's economic assumptions prove to be too optimistic, as I believe they will.

It is my belief that the US dollar will plunge, and bond yields will rise sharply if Obama insists on running trillion dollar deficits for the next several years. If so, the president will have to resort to raising taxes on not just the “rich” but the middle class as well. It may come in the form of a “Value-Added Tax” which will raise taxes for everyone. We'll see.

The commodity markets are signaling that higher inflation lies ahead. Maybe not in 2009 but it will almost certainly happen if Obama runs trillion dollar deficits for the next several years. We will see if the Fed can keep inflation under control. I doubt it unless the Fed is willing to risk another recession in late 2010 and 2011.

At the end of the day, the question is, why is President Obama willing to risk so much in order to spend record amounts of taxpayer money? I will leave that question for others to ponder.

Likewise, I have not opined in this letter as to Obama's push to get his health care “reform” program passed as soon as possible. However, there is a very good article on the subject in SPECIAL ARTICLES below.

Finally, I rest assured that I will get blasted by readers who are Obama supporters as a result of this E-Letter - I always do when I write anything negative about him. But as noted earlier, doubling the national debt in 10 years (or possibly less) ought to concern ALL Americans regardless of their political persuasion. If you agree, feel free to let me know.

That's all for now.

Wishing you a great summer,

Gary D. Halbert

SPECIAL ARTICLES

The Beginning of the End of Private Health Insurance
http://www.reason.com/news/show/134016.html

A Red (Ink) Letter Day For Gov't: $1,000,000,000,000 In 8 Months
http://www.ibdeditorials.com/IBDArticles.aspx?id=329442095812782

Bonds - What Goes Up Must Come…
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/15/AR2009061502710.html

Where To Turn If You Lose Your Job

Gary D. Halbert — Tue, 09 Jun 2009 21:09:58 GMT

IN THIS ISSUE:

The JOHNSON O'CONNOR Research Foundation
Helping People Find The Best Careers For 87 Years
Scientific Testing To Determine One's Natural Aptitudes
Matching Aptitudes & Careers For Success & Happiness

Introduction

As you read today's E-Letter, be advised that the Democrat-controlled Congress is working furiously this very week on restructuring our nation's health care system based on orders from President Barack Obama. Obama has ordained that the do-over of US health care must include a "government-provided" health care option that will compete with the private sector health care system that we have had for decades.

President Obama's road map for our nation's future would eventually have all Americans enrolled in his nationalized health care plan, and this may well come to be over the next few years given the fact that the government has a blank check (printing press), unlike the private health care system we currently have. Obama's takeover of our health care system will make his takeover of the banks, AIG, the carmakers, and whatever else is to follow look miniscule.

As I warned often during the presidential campaign last year, President Obama comes from a political persuasion that has no problem with the federal government owning and controlling vast amounts of the private sector. There is now no question about this (actually, there never was, if you did your homework). But even I didn't foresee that Obama would spend and/or commit tens of trillions of dollars in just his first four months as president.

I will have much more to say in the weeks and months ahead about Obama's systematic takeover of health care and his massive expansion of government, but for this week we return to a theme I have advanced frequently over the years that is not directly investment related. I have received more positive input on what follows than just about any topic I have written about since I began this weekly E-Letter.

In the pages that follow, we will revisit the Johnson O'Connor Research Foundation which I have recommended for years. This update is timely in that the national unemployment rate is racing higher (now 9.4%) and may hit 10% or higher by the end of the year. If you or others you know have lost their jobs, or are likely to lose their jobs soon, a trip to Johnson O'Connor to find out what field you/they are naturally best suited for can be invaluable.

As always, the sophisticated aptitude testing at Johnson O'Connor is great for helping your kids or grandkids determine what career path they should (or should not) pursue. My daughter will be a senior in high school next fall, and her test results were extremely helpful now that we are deep into the college selection process for her.

A visit to the Johnson O'Connor Research Foundation can be one of the greatest gifts you can ever give your children, grandchildren or others who are dear to you (or maybe even yourself). What I am about to describe is something that has literally changed the lives of dozens of my friends and relatives over the last 30+ years. Some of you may have heard of Johnson O'Connor, but most of you probably have not.

Don't jump to any conclusions: this is not my favorite charity; in fact, it's not a charity at all; and I am not going to ask you to donate any money. What I am going to do is tell you how Johnson O'Connor helps people decide which career fields they are most naturally suited for, based upon scientific testing of their unique set of individual aptitudes. Everyone in my family has been through the testing, including me.

So, I urge you to read the following article, especially if you have any loved ones who have lost their jobs or are struggling to find a career path. Ideally, Johnson O'Connor is geared toward high school students who are trying to decide what to do when they grow up, and more specifically, which direction to go in college. But it can be equally helpful to those who are already on a career path but aren't happy or successful.

How I Learned Of Johnson O'Connor

Before I discuss the specifics about Johnson O'Connor ("J-O") and how they change lives, let me tell you how I found out about this unique organization. Even before I got out of college and graduate school, I knew exactly what I wanted do. Yet most college students are unsure of what they want to do after school and end up taking the best (or only) job offer they get. All too often, that first job (or series of jobs) doesn't work out, for various reasons. The problem is, bouncing around the job market for a year or two or more right after college can leave people way behind their peers who get on the right career path to begin with.

I had a friend I went to college and graduate school with who had trouble with her initial jobs after grad school. She had been a science major in college (as was I), and then shifted to business in graduate school. We both got our Masters Degrees in 1976. She landed a good job in Houston after grad school but was just never comfortable in the corporate world.

I was working in Dallas in the investment business in 1978 when I first learned about Johnson O'Connor, which has an office in Dallas. I requested information on their testing service and subsequently recommended that my friend go there. She went, and to her surprise, she learned that her natural aptitudes were not at all suited for either the corporate world or the science field.

Based on the assessment of her aptitude tests, Johnson O'Connor recommended she consider the field of interior design. While shocked at first, she ended up changing careers and was quite successful. I haven't kept up with her in recent years, but the last time I did, she had bought and renovated several old buildings into bed and breakfasts, and was happy and successful.

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.

I Had To Try It Myself

Given my friend's results, I referred several other friends (and my younger brother) who were struggling or unhappy in their careers to Johnson O'Connor. In every case, the result was the same: a seemingly radical change in career path that led to a happy and successful end.

While I was very happy and enjoying early success in my career in the investment field, I couldn't help but go to Johnson O'Connor myself. Actually, I was a little nervous about what I might learn. As it turned out, my test results of my natural aptitudes showed that I was well suited for several fields. Here were Johnson O'Connor's recommendations for me, in order:

1. Stock Broker
2. Investment Banker
3. Journalist
4. Fortune 500 CEO
5. Real Estate/Land Developer

[Before you jump to any conclusions, let me tell you that Johnson O'Connor does not allow you to tell them anything about what you may already be doing, career-wise, prior to the testing and analysis afterwards. Only after they have given you the test results and career recommendations do they allow participants to divulge their current occupation – or desired occupation if a student.]

Obviously, I was pleased with my results and somewhat relieved that I was already working in the investment field, as suggested by Johnson O'Connor's #1 and #2 recommendations. At first, I couldn't figure out where the "Journalism" aptitude fit in. But then, in my final exit interview, I happened to mention my weekly client newsletter, which I had begun in 1977. "There you go," the analyst replied, "your newsletter is where your journalistic aptitudes are coming out."

As for the Fortune 500 CEO option, the analyst noted that while I tested to have the aptitudes to be a big-time CEO, he also stressed that I would never make it that far up the corporate ladder, because my aptitudes also showed that I was (am) too impatient and needed to be in control of my own destiny. As for the real estate part, years later I became involved in several real estate developments.

An Invaluable Store Of Personal Information

As noted above, I have referred dozens of people to Johnson O'Connor over the years. In every adult case but my own, the results have suggested a change in career path, sometimes a dramatic change. While I haven't kept up closely with every person I referred to Johnson O'Connor over the years, I can tell you that everyone benefited significantly from the experience.

The information gleaned from the Johnson O'Connor aptitude tests and analysis is tremendously helpful. Not only does it help greatly with career selection, but it also helps to understand one's personality, the reasons for one's desires and all sorts of little "quirks" we all have. It is a unique learning experience that can help throughout one's lifetime.

Tremendous Help In Selecting The RightCollege

Last year about this time, we took our daughter to Johnson O'Connor in Dallas at the age of 16. Interestingly, her test results were quite different from her older brother who tested at J-O in 2006. My son who graduated from high school last year is quite the math whiz, so we were not surprised that he scored very high in the math-related tests at J-O when he was tested three years ago. But what we did not expect was that he also scored very high in the tests related to "spatial visualization" – an aptitude that is very important to engineers, architects, medical researchers, etc.

For example, when I look at a building, I just see walls (one dimensional), whereas for my son and others with high spatial visualization, they envision the same building in three dimensions in their mind. Likewise, they can look at a blueprint and easily envision what the completed structure will look like. In retrospect, I shouldn't have been surprised since my son has been one of those take it apart and put it back together kids since he was very young.

Based on my son's scores, Johnson O'Connor recommended that he consider a career in engineering, medicine/medical research, scientific research or architecture. He is majoring in engineering in college and absolutely loves it.

When you consider how much money it costs to go to college today, it is extremely valuable to know that you are sending your son or daughter or grandchild to a school that offers degrees in those areas they are naturally suited for, and where they'll have a much better chance of succeeding.

The "Personality" Test At Johnson O'Connor

Johnson O'Connor believes that all of us fit into one of two broad personality characterizations: "objective" or "subjective." Generally speaking, people with ‘objective' personalities are those who enjoy working with groups, enjoy working with different people, and are what we often refer to as "people people." Over two-thirds of those tested at Johnson O'Connor are objective personalities (as am I).

‘Subjective' personalities, on the other hand, generally prefer to work as individuals rather than in large, fluid groups. They like to advance in their careers based on their own individual work, or that of a small group or team headed by them. Subjective personalities can usually work alone for long periods of time and do not need as much recognition or encouragement as their objective counterparts.

My son tested solidly subjective, and quite frankly, that explained more to me about my son and his personality than I had learned in the 16 years of raising him! While my son gets along well with his school friends, and plays football, basketball and baseball, when it comes to his studies or school projects, he usually prefers to work alone – which is typical of subjective personalities. While he has lots of friends, he is not the "social butterfly" like his younger sister, who tested objective in her visit to J-O last year.

So, What Is The Johnson O'Connor Research Foundation?

The Foundation is a non-profit scientific research and educational organization that was founded in 1922. They have two primary commitments: 1) to study human abilities; and 2) to provide people with specific knowledge of and about their aptitudes that will help them in making decisions regarding which colleges to select and which careers to pursue.

Each of us has a unique combination of personal aptitudes. Some of our aptitudes are stronger than others. Johnson O'Connor (as well as others) believes that unless we are able to "exercise" (use) at least our stronger aptitudes in our work or elsewhere, we are very likely to be frustrated.

Hundreds of thousands of people have been to Johnson O'Connor and used their service to learn more about themselves and to derive more satisfaction from their lives and careers. Johnson O'Connor's unparalleled specialty is testing and identifying one's natural, inborn APTITUDES. In their own words:

"Aptitudes are natural talents, special abilities for doing, or learning to do, certain kinds of things. Manual dexterity, musical ability, spatial visualization, and memory for numbers are examples of such aptitudes. In a comprehensive battery of tests available only through the Foundation, these and many other aptitudes are measured. These measured traits are highly stable [always present] over long-term periods.

Every occupation -- whether it is engineering, medicine, law or management -- uses certain aptitudes. The work you are most likely to enjoy and be successful in is work that uses your aptitudes. For example, if you are an engineer but you possess strong aptitudes that are NOT used in engineering, your work might seem unrewarding, difficult and unpleasant.

Aptitude testing is one tool for career selection. It can help you find where your aptitudes lie, what type of work uses those aptitudes, and why certain occupations may be more rewarding for you than others… What the Foundation does is give you an inventory of your aptitudes and examples of types of work suggested by the combination of these aptitudes… The Foundation, however, does not provide employment counseling services."

Why Johnson O'Connor Is So Different

As noted above, Johnson O'Connor has been doing aptitude testing continuously since 1922. Over the years, they have pioneered (and continually improved upon) aptitude testing. Participants who take the tests will wonder, I assure you, how certain of the tests can be so revealing. Some are very simple tests, while others are more difficult for certain people. My brother, for example, breezed through all of the engineering tests that I could not begin to complete. That explains why he is a successful engineer and I am an Investment Advisor.

The tests are just one critical part; the analysis of the test results is equally important. The experts at Johnson O'Connor have the benefit of 87 years experience in evaluating the test results and making career recommendations accordingly. While they do not recommend only one career path (usually they include at least three or more), each recommendation is suited for the participant's unique set of aptitudes and abilities.

There are times, especially among older participants who are already entrenched in the workforce, when it is simply impossible to make a career change as suggested by the test results and analysis. In these cases, Johnson O'Connor often suggests certain hobbies or other non-work related activities that may help exercise one's stronger aptitudes which are not used in the workplace.

Johnson O'Connor's time-tested theory is that if one has strong aptitudes (and most people do), they need to be used and challenged on a regular basis, preferably in the workplace where we all spend a great deal of time during our lives.

Not An IQ Test, But Does Test Vocabulary

It is important to understand that Johnson O'Connor's aptitude tests are NOT designed to measure or determine IQ. There are various organizations that offer IQ tests (beware: not all IQ tests are accurate or valid). Most experts agree that IQ tests are not inherently helpful when trying to decide on a career path. Two people can have identical IQ scores but very different aptitudes.

Also, Johnson O'Connor's tests do not consist of written or oral questions. They maintain that it is too easy to answer a written question as one feels inclined at the moment, or as they feel it "ought" to be answered. So, J-O does not administer question/answer tests. Again, some of their tests may seem unusual, but they are time-tested and extremely effective.

Johnson O'Connor's battery of tests does include a vocabulary test. It is widely accepted that one's vocabulary is an indication of his/her general knowledge. Most experts, including Johnson O'Connor, agree that one's vocabulary level is one of the best predictors of overall success in school and of performance on the SAT-Verbal and other similar tests. A good vocabulary is also a common characteristic of successful people in many occupations.

Vocabulary knowledge is not an aptitude, however, in that anyone can learn new words and increase their vocabulary. Thus, as part of Johnson O'Connor's program, they teach participants the importance of increasing their vocabulary and provide some specific study materials that are very helpful in doing so. Parents, you will love this!

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.

Time Involved, Cost & Locations

Normally, the process involves two half-day testing sessions, followed by a third half-day when the results and analysis are provided. It is also possible to accelerate this to one full day of testing and a half-day of analysis.

In the last appointment, participants are given a transcript of their scores, including charts and graphs, as well as a book and other explanatory materials. All test results are strictly confidential. A staff member explains in detail each of the scores and what they mean. And they explain each of the career recommendations and why they were selected.

If participants have questions at any time (before, during or after testing), Johnson O'Connor is happy to answer them. One of the best features is the option of follow-up meetings and discussions after testing and evaluation, which are free in the first year after testing (afterward only $100 per follow-up session). I have several friends who went back for follow-up discussions regarding jobs they were considering and how those opportunities might fit their aptitudes and/or what adjustments they would likely have to make in that particular job. My daughter and I did a follow-up meeting for her late last year. This is an excellent opportunity!

The cost for the Johnson O'Connor testing and evaluation is currently $600. While this might seem pricey at first glance, I can't tell you how many times I have seen this testing pay off in spades. This is especially true for high school students who don't know what they want to do. It can save years of expensive college costs if the student knows in advance what he/she wants to pursue.

Just as important, it can change the life of an adult child, loved one or close friend that is stuck in an unhappy or unsatisfying job situation, or anyone who has recently lost their job. Johnson O'Connor tests many adults who are in their thirties, forties and even fifties. Actually, this information on your aptitudes is very useful and very interesting to know at any age. With older people, naturally, they should have a real willingness to make a change.

Johnson O'Connor has testing centers in major cities around the country. The locations and phone numbers are listed at the end of this E-Letter.

Conclusions

I could not recommend Johnson O'Connor more highly! Whether you are a parent, a grandparent or whatever, you can give a young person a big advantage by having them tested at Johnson O'Connor. Even if you are not related, you can "gift" the testing fee to the minor, generally with no tax implications, or just pay it directly.

With the kids out of school for the summer, now may be a great time to plan to have your high-schooler tested. You'll be glad you did. Likewise, if there is an adult person that is close to you (spouse, relative, in-law, friend, etc.) who is struggling in his/her occupation, this is a chance to possibly rescue their career.

Even if you are happy and successful in your career, you will find it very helpful to know what your natural aptitudes are and are not. And if you have recently lost your job due to the recession, getting tested will greatly help you to know where to look for work. Either way, you will understand a lot more about yourself.

I encourage you to learn more about Johnson O'Connor Research Foundation at: http://www.jocrf.org.

In closing, let me remind you that I am not associated with Johnson O'Connor in any way. I receive no compensation or anything else for recommending them. I am merely one of hundreds of thousands of grateful folks who have been through their program over the years.

** Feel free to forward this to anyone you feel might benefit from it.

Johnson O'Connor Locations:

Atlanta	404-261-8013	Los Angeles	213-380-1947
Boston	617-536-0409	New York	212-269-0550
Chicago	312-787-9141	San Francisco	415-772-9030
Dallas	972-991-8378	Seattle	206-623-4070
Denver	303-388-5600	Washington, DC	202-828-8378
Houston	713-462-5562

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Obama Tells American Businesses to Drop Dead (read this)
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_hassett&sid=aaaBdVMkjPnU

Obama's 'Jobs' Numbers Are Phony
http://online.wsj.com/article/SB124451592762396883.html

Obama vows to speed up stimulus spending
http://www.latimes.com/news/nationworld/washingtondc/la-na-obama-stimulus9-2009jun09,0,5788007.story

Coming From Behind - Investment Lessons From Sports

Gary D. Halbert — Tue, 02 Jun 2009 19:06:29 GMT

IN THIS ISSUE:

Update on My "Coaching Career"
Investors Playing Catch-Up
Remember The Object Of The Game
Don't Forfeit The Game
Have A Good Offense And Defense
Player Selection

Introduction

Back in 2006, I wrote an E-Letter that applied sports analogies to the investment world in an attempt to create a better picture for how you should manage your investments. Because of the extent to which I have been involved as a coach in my son's and daughter's sporting activities over many years, I found that E-Letter to be both very interesting to write, and it was popular with my readers.

This week, I want to revisit the sports analogy because the investment world has changed substantially since 2006. After reaching a peak in October of 2007, stocks were hit by a bear market that continues even as this is written. Between October of 2007 and March of 2009, the S&P 500 Index lost over 50% of its value. Even worse, 2008 saw most bonds suffer losses right along with stocks, something that Investing 101 tells us shouldn't happen.

As a result, many investors have had their portfolios decimated. Putting it in terms of our sports analogy, they are losing the game and have no idea how they might stage a comeback. With that in mind, let's revisit some of the analogies I discussed in my previous E-Letter, as well as some new ideas that might apply to your more recent investing experience.

A Personal Coaching Update

Before launching into a comparison of sports and investing, I thought I'd update you on my personal coaching activities that served as the springboard to the original sports analogy E-Letter article. My long-time clients and readers will recall that I got involved in coaching youth sports over a decade ago, and it has been one of the greatest blessings I have ever had in my life.

It all started when I took my son to his first tee-ball practice many years ago, and I noticed that there was only one coach and about 15 kids, some of whom didn't even have their gloves on the correct hand. So I stuck around to help until the other coaches arrived. No one else ever showed up. Soon, I was given a cap and tee shirt and was designated as the assistant coach. Little did I know that I would go on to coach not only baseball but also football and basketball for years thereafter.

I was not a jock in college, so I was hardly a candidate to become a good or successful coach. As a result, I have stacks of videotapes on coaching youth sports in my closet, which I used to educate myself on how to coach the various sports. Thus, whenever I say that you should "do your homework" in relation to investments, this is the kind of thing I'm talking about.

I continued to coach my son's baseball team in high school at the private Christian school he attended and where my daughter still attends. I even helped out with the football team for several years, which went on to win a State Championship. However, when my son graduated high school last year, I thought that would be the end of my coaching career. To my surprise, the school asked me to help coach the baseball team again this year, and I happily agreed. See photo of "Coach Halbert" with some of the baseball players and coaches at the end-of-season party late last month. Needless to say, coaching sports has been a real joy in my life.

All of this background is to say that I am more than just a casual observer in regard to the nuts and bolts of coaching, and have found that my coaching activities are sometimes similar to my role as an Investment Advisor. In other words, the role I play in my clients' financial planning is that of an investment coach. For the last 30+ years, I have been helping clients with their investments, educating them and steering them toward professionally managed investment products.

In essence, I'm trying to do the same thing with investors that I try to do in sports practices and on the playing field: coach them to be more successful. This has never been more important than now, when many investors are finding themselves at the brink of defeat at the hands of the worst bear market since the Great Depression.

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.

Investors Now Playing Catch-Up

One of the most frustrating parts of coaching is getting way behind in a game. It not only takes scoring a lot of points just to catch up, but can also lead to emotional reactions by players who give up and simply want the game to end. It goes without saying that many investors now have a lot of lost ground to make up, and I am concerned that many of them seem to be giving up on meeting their investment goals.

As the recent bear market has led to significant losses, some investors have started to focus on their own emotional reactions and have taken their eyes off of the ultimate goal. Emotions can be the enemy of sound investing just as they can lead to defeat on the field. I'm sure all of us have witnessed overconfident teams that build a big lead only to eventually lose the game, or teams that get so far behind that they hang their heads and just wish for the game to be over.

In sports, attitude is a big part of a successful program, and it can be a big part of recovering from an economic setback in the investment game. No, having a positive attitude won't miraculously lead to market gains, but it can lead to taking proactive steps to continue toward your investment goals. Some defeated investors sit and mope about past losses and feel unable to take action, while the winners take steps to learn from their experience and seek out options.

Just as it's not easy to come from behind in a ball game, there's no quick way to make up investment losses. There are things you can do to help get back on track, but there are other actions you can take that may actually hamper your progress toward your investment goals. In the remainder of this E-Letter, I'm going to suggest ways for you to "get back into the game."

Don't Forget the Object of the Game

Whether in sports or while investing, it's vitally important that you remember the object of the game. Perhaps the funniest, yet most frustrating years of coaching were the early ones, where many of the kids did not realize what the game was all about. If you have ever attended a beginners' tee-ball game, you know what I mean. Whenever the ball is hit, it seems that every player on the field takes off after it. They completely forget about playing their positions.

As odd as this may sound, there are many adults who are doing exactly the same thing in relation to their investments. They do not take the time to sit down and determine their long-range goals, and they opt for chasing after the latest "hot" stocks or funds or investment fads, without a long-term game plan or a disciplined strategy.

Other investors think that they have a better understanding of the game, but their focus is misguided. Like the baseball player who ignores his coach's signals and "swings for the bleachers" every time he's up to bat, some investors concentrate on hitting investment home runs and take on way too much risk. A classic example was the "dot-com" boom in the 1990s, and we all know how that turned out.

The same can be true today, as many investors are trying to find investments that can help them "make it all back" quickly. In doing so, they sometimes take on more risk than they would otherwise be comfortable with. While aggressive strategies may be the key to higher future returns, they could also result in losing even more of an already smaller nest egg. I'll discuss more about how to use aggressive strategies later on, but they should never make up your entire portfolio, no matter how good their past performance may be.

Focus on the Fundamentals

I have heard many professional coaches with teams in a losing slump talk about how they are directing their team to focus on the fundamentals. While I realize that the term "fundamentals" already has a meaning in the investment industry, for purposes of this discussion the term "fundamentals" will refer to the basic skills that are required to play any given sport – or construct a diversified portfolio.

In baseball, fundamentals include pitching, fielding and hitting, among others. Football, soccer and all other sports have their own set of fundamental skills. Professional coaches know that it is improbable that any team will be successful unless all players have a grasp of the basic skills necessary to play the game. Sometimes, however, there are pressures and distractions that take players' minds off of the basics.

So, how does this relate to investments? First of all, it means that outside influences can sometimes divert an investor's attention from the basics of good investing. Accordingly, getting back to the fundamentals means to focus on how you got the money to invest in the first place. For most of us, that means working hard and saving money. Until recently, saving money was out of style in the US. As recently as 2005, the savings rate was actually in negative territory. Apparently, many Americans mistakenly decided they could spend their way into a comfortable retirement.

Fortunately, the savings rate is now rising, so the first fundamental that I would encourage you to work on is increasing your savings. Or, said another way, decrease your discretionary spending and live below your means. This also means reducing your debt load along the way. It doesn't do much good to save money while piling up credit card debt. The net effect is still low (or no) savings, since the creditors will always have to be paid off.

Others among us have amassed wealth by building a business. While it's not always possible to rebuild a business from scratch, or start a new business after one has been sold, some entrepreneurs are doing just that now that their nest eggs have been eroded by the bear market. It is rarely an easy path, but it is one that can prevent outliving your money in retirement.

The next fundamental skill of investing is to diversify. Here, unfortunately, many investors have had the misfortune of having some poor coaching in years past. That's because they were led to believe that "Modern Portfolio Theory" (MPT), asset allocation and various other buy-and-hold investment strategies somehow provided sufficient diversification.

Over the course of my coaching career, I have had the opportunity to coach with several very successful former professional athletes. I can tell you, it didn't take long for us non-professional, volunteer coaches to figure out that we had a lot to learn. To this day, I still see volunteer Dads teaching kids things that are either wrong or outdated.

Much the same is true, in my opinion, when it comes to most stockbrokers and financial planners who broadcast Wall Street's buy-and-hold mantra across the country. Accompanied by flashy proposals and sophisticated sounding reports like "correlation matrices" and "Monte Carlo simulations," these promoters sold an entire generation of investors on the idea that allocating assets among a group of stock and bond asset classes would protect them in a market downturn.

What they didn't count on was that many of these historical relationships often break down in a bear market, just when they're needed the most!

As we now know, this poor attempt at diversification didn't work in the 2000 – 2002 bear market nor has it worked in the one we're in right now. Yet, many of these buy-and-hold adherents continue to counsel their clients to "keep running that play until you run it right." In other words, stay invested and hope that you don't need your money until the market recovers.

Fortunately, many investors have now realized that true diversification means having a variety of investment strategies in a portfolio, not just a collection of securities that happen to fit in different sections of the Morningstar style box. Specifically, active management strategies that can move to cash or hedge in down markets are catching on like wildfire because they have historically offered true diversification, many with low correlation to the equity markets.

Monitor Performance Regularly &
Make Changes When Necessary

Professional sports franchises spend a huge amount of time, effort and money to monitor and evaluate the performance of their superstar athletes. They know that a weakness, if left unchecked, can mean the difference between winning or losing a game – or even a championship! Likewise, investors should make it a priority to monitor the progress of their investments, but I have found that this important step is often overlooked.

Over the years I have been surprised at how many investors don't monitor the performance of their various investments regularly. It is very important to continually monitor your investment performance to insure that you are on track to meet your investment goals. Monitoring has always been an important part of the investment process, but today it is even more critical. Unfortunately, many investors learned this lesson too late to help prevent past losses, especially in the case of the current bear market.

Too many just assume that their broker, advisor or planner will make or recommend changes if they are needed. Unfortunately, this is often not true. Ask yourself, what broker or advisor is going to tell you that you should close your account and move the money elsewhere? Answer: probably none.

Also, many brokers are restricted to selling only those products offered by their firm. In such cases, the broker is not likely to tell you about other investment opportunities that may be performing better, or that may offer much-needed diversification in your portfolio. As noted above, the last thing they want is for you to move your money elsewhere.

Whenever possible, you want your broker, advisor or planner to be independent, with the ability to analyze and recommend a variety of investments or funds from different sources. Typically, such independent advisors are "fee-based" rather than "commission-based." Put differently, you want someone who is on your side of the table, and will not hesitate to recommend a change, if needed.

Here's where my firm can help. We are truly independent. We not only recommend third-party money managers, but we also monitor the performance and trading of each manager on a daily basis. Since I have my own money with every single money manager and program that we recommend, it is easy for us to track their real performance daily.

We compare the performance of my accounts to the published "official" track record and evaluate trading patterns to see that they comply with our expectations for each strategy. We are also in frequent contact with each manager we recommend to make sure that they have not made material changes to their strategy or system.

And finally, because we are independent, we do not hesitate to recommend that you "fire" a manager if the performance does not live up to reasonable expectations, or if they do make material changes to the strategy or system that are untested.

ENDORSED ADVERTISEMENT

Add a Little "Razzle-Dazzle"

Almost every football team I have ever observed has at least one "razzle dazzle" play. Also called "trick plays," the term refers to plays that are out of the ordinary and totally unexpected by the defense. Examples have names like the Statue of Liberty play, guard-around play, halfback pass play and my favorite, the flea-flicker.

Plays like this are designed to catch the defense off-guard and, hopefully, lead to a score. In my experience, I have seen such plays shift the momentum in a game and lead to a victory for the underdog. However, just as often, I have seen these plays blow up and lead to a score for the opposing team. In other words, they are risky.

Earlier on, I mentioned that I would discuss how to use aggressive investment strategies to help diversify an investment portfolio. Shifting our focus to the investment world, a good analogy to the razzle-dazzle play would be aggressive investment strategies that employ sophisticated trading techniques. I originally wrote about this concept in my April 14 E-Letter, and I feel that such strategies can bring needed diversification to a portfolio in the right circumstances.

Just as a razzle-dazzle play in football contains something unexpected by the opposing team, aggressive investments often employ sophisticated trading strategies that used to be confined mostly to the secretive hedge fund industry where only the wealthy had access. Today, however, advances in mutual fund design make it possible for money managers and investors alike to access funds that employ leverage, that can "short" various stock indexes and even provide access to markets such as commodity futures and currencies.

These investment strategies are often based on a quantitative trading model developed by a professional Investment Advisor. Using a variety of indicators such as trend analysis, momentum, technical analysis and a host of others, these trading models seek to anticipate and capitalize on shorter-term market moves. To be honest, most of these aggressive programs provide lackluster results, and can have severe losing periods, but there are some such as Scotia Partners and Third Day Advisors who have produced favorable returns over a number of years. Of course, there's no guarantee that they will continue to do so.

When these programs are on a winning streak, they often win big. However, just like the razzle-dazzle play in football, they are risky and can also lead to significant losses. Thus, just as no sports team could get away with running trick plays all of the time, allocations to aggressive investment strategies should be limited, no matter how good their past performance may be.

Have A Good Offense And Defense

Another important analogy between sports and investments is the idea that you can't concentrate on just offense or defense, you have to play both. If you focus too much on one and not enough on the other, you're not likely to win many games. There's an old football saying: "Offense wins games, but defense wins championships."

Over my years of coaching, I have witnessed sports teams that have a fantastic offense, but their defense could not keep the other team out of the end zone. On the other hand, I have also seen teams with strong defenses that couldn't seem to put a score on the board. It just makes logical sense that being strong in one or the other does not necessarily mean you'll win the game.

While this is a common sports analogy, it may surprise you that a number of popular investment strategies used by millions of investors are all offense and no defense. I think most "buy-and-hold" investment strategies Wall Street offers could be described this way. Only if the market goes up do you make money, and when it goes down, you can lose big.

If you have read my E-Letters for long, you know that my main emphasis is on avoiding large losses in your investments. Likewise, you've probably already seen the table below (we publish it often), but it can't be repeated too often in my opinion. The breakeven table below illustrates just how devastating large losses are, and how difficult it is to recover from them.

Amount of Loss Incurred	Return Required To Break Even

10%	11.1%
15%	17.7%
20%	25.0%
25%	33.3%
30%	42.9%
35%	53.9%
40%	66.7%
45%	81.8%
50%	100.0%

This breakeven table is why I like to emphasize active management strategies that can play both offense and defense. Most active management strategies include the flexibility to exit the market (partially or fully) or "hedge" long positions if market trends turn ugly. This is one good way of playing defense in your investments. However, they also have ways to put the offensive unit back on the field through sophisticated strategies for getting back into the market.

Player Selection

Now that we have established that both offense and defense are necessary ingredients on your investment team, it's time to turn our attention to player selection. In baseball, you see teams that can hit the ball well, but lack a good defense in the field – and vice-versa. But it is generally agreed that to win championships, you need a balance of both. On the defensive side, you must be able to field the ball well and make good throws.

In many ways, investing is no different. You are usually best served by a diversified portfolio with multiple investment strategies. However, this is easy to say, and sometimes hard to do. After all, how and where should you invest? What investment strategies should you include or exclude from your portfolio? How do you evaluate the various players to select the best team?

The investment industry is truly one of the most confusing places to try to navigate, sometimes even for experienced investors. There is an overload of investment and market information out there, and much of it is conflicting or outright wrong. We are constantly bombarded with investment information from the mainstream media, cable networks and the Internet, not to mention our mailboxes.

So, how should you go about selecting the most appropriate players for your investment team? Where should you send your scouts? What analysis should you run on each? What performance statistics are the most meaningful, and what "intangibles" exist that might mean the difference between success and failure?

I think most people realize that they do not have the ability to evaluate an athlete's strengths and weaknesses to determine if they should be on a sports team. Yet, these same individuals often feel that they should be qualified to select investments for their portfolio. Why should this be? After all, very few people try to be their own banker, lawyer or doctor, but they seem to have no problem trying to be their own investment manager.

From my 30+ years in the investment business, I think the primary reason many people take on their own investments is that there is an expectation that they should be able to do it, even though there is no good reason why. Perhaps it's the flood of investment information in the broadcast and print media and the Internet that causes this. Or maybe it's a matter of thinking that we should have picked up investment knowledge somewhere during our education.

Unfortunately, this sense of self-direction has led many to adopt "canned" buy-and-hold approaches from the Internet or any of the hoards of "how-to" investment books. Don't get me wrong, some do-it-yourself investors have done quite well, often by applying some form of active management to their portfolios. However, many of the do-it-yourself investors who have contacted us have not fared well over the past decade.

Going back to our sports analogy, what do team owners or schools do when they need someone to evaluate players and put the best team on the field? That's right, they hire a coach!

Good Coaching Makes All The Difference

And now we're back to where I began, with the realization that much of my sports coaching experience relates, to a certain extent, to the investment management services my company offers. As an investment coach, an independent professional Investment Advisor can help investors by:

Scouting out and evaluating various investment managers representing a number of different approaches to the market;
Using detailed investor questionnaires and discussions to develop a playbook designed to work toward his or her individual investment goals;
Assembling a team of independent, professional money managers whose strategies have the potential to work together over time to help moderate the risks of being in the market; and
Monitoring the performance of each Advisor as the game progresses to know when it may be best to send in a substitution.

In sports, it is often true that the best-coached team wins the game, rather than the one with the most talent or ability. The same can be true in the investment world. Many of the funds and investment programs we recommend never hit the "Top 10 Investments" list. Yet, when used to create a diversified portfolio, they can work together in such a way as to provide meaningful risk-adjusted returns and limit losing periods.

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

Imagine the following scenario: You are attending a football game and the home team is struggling against a worthy opponent. Suddenly, a fan jumps out of the stands, walks onto the sidelines, fires the coach and takes over the team. Not long after, the self-appointed new coach becomes disappointed in his players, so he suits up himself and goes onto the field to play in the game.

Sounds ridiculous, doesn't it? Yet, this kind of thing happens every day in the investment game. Investors often take over the reigns of their investments for one reason or another. Sometimes, they do well, but in many instances, they do not. In my opinion, investors are usually best served when they focus on their jobs or businesses, doing what they like to do and allowing professionals to handle most or all of their investments.

To that end, it would be a pleasure for Halbert Wealth Management to serve as your investment coach. We have been evaluating professional money managers for over 30 years, and we have a team of quality managers just waiting to get on the field for you. And I have an excellent staff of Assistant Coaches (Investment Consultants) that are standing by to help you evaluate your goals and get started. Together, we can handle all or part of your investment portfolio.

If you'd like to learn more about the investment management services we offer, just give us a call at 800-348-3601 or e-mail us at info@halbertwealth.com. Or, you can request that we call you by clicking on our online contact request form.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Obama considers a new "Value-Added Tax" to fund
out-of-control spending & Nationalized Health Care
http://foxforum.blogs.foxnews.com/2009/05/27/kerpen_vat_obama/

Health Reform's Saving Myths
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/29/AR2009052903235.html

Cap & Trade: All Cost, No Benefit
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/31/AR2009053102077.html?hpid=opinionsbox1

Why This Recession Could Last Another Year

Gary D. Halbert — Tue, 26 May 2009 21:37:42 GMT

IN THIS ISSUE:

Is the US Economy Turning Around?
The Housing Blues Getting Bluer
Adjustable Rate Mortgage "Resets" To Soar
Commercial Real Estate - The Next Shoe To Drop?
Conclusions - This Can't Be Good For Stocks

Introduction

It's time that we had a talk about the "conventional wisdom" making the rounds in the financial media. We are constantly reminded that the US economy always comes back and that the frozen credit markets will return to normal. We are also assured that the stock markets always recover and go on to new highs. Yet there is little disagreement that we are in the worst economic downturn since the Great Depression and the worst global credit crisis in our lifetimes.

Despite that, dozens of well-known economists and forecasters now tell us that the US economy will be out of the recession and back into positive growth in GDP by the end of this year. They must assume that the serious housing slump is somehow going to go away this year. It won't. In fact, the housing slump looks to get worse before it gets better and is likely to drag on for several more years.

Most troubling is the fact that the home mortgage foreclosure rate spiked 46% in March from a year ago, hitting a record high. A record 5.4 million Americans are delinquent on their mortgage loans, or are already in foreclosure. A record 20 million Americans now owe more on their mortgage loans than their homes are worth. Home prices plunged a record 19% in the 1Q.

These foreclosure numbers are almost certain to get even higher over the next year or two at least as millions of adjustable rate mortgages ("ARMs") are scheduled to "reset" to higher monthly payments, as I will discuss in detail below. Then there is the question of whether the commercial real estate market will follow suit as developers try to refinance their loans over the next year or two. Defaults and foreclosures are already rising rapidly in commercial real estate.

It is for these reasons that I believe the housing slump will get worse before it gets better. If correct, that is not good news for the credit markets or the stock markets. Therefore, it is quite possible that this recession could drag on for at least another year. Let's talk about it.

Is the US Economy Turning Around?

As the stock markets have continued to move higher, more and more economists and analysts have been revising their forecasts upward. Some polls show that a majority of forecasters now believe that we will be out of this recession by the end of the year. Fortunately, there has been some encouraging news over the last couple of months. The major stock market indexes have rebounded by 35-40% since early March, and many analysts conclude that this is a sure sign the recession will end later this year.

This rosy outlook is helped along by what Fed Chairman Bernanke called "green shoots" (good news on the economy) suggesting that the worst of the recession is behind us, and that the economy should be back in mildly positive territory by the end of the 4Q.

Barring any further major shocks in the credit markets, I would agree that we have probably seen the worst of the recession. GDP plunged 6.3% annual rate in the 4Q and -6.1% in the 1Q based on the latest Commerce Department estimate. A growing number of analysts seem to believe that the economy (GDP) will only dip by 2-3% in the 2Q, improve more in the 3Q and then be flat to slightly higher in the 4Q. Obviously, I think such forecasts are too optimistic as I will discuss as we go along.

But we have seen a few encouraging signs of late. The Index of Leading Economic Indicators rose 1.0% in April, the first monthly increase in seven months. The Consumer Confidence Index rose from 29.7 in March to 39.2 in April. The government announced today that the confidence index jumped to 54.9 in May, the highest level in eight months, and stocks are up sharply as this is written. We have also seen a rise in business confidence over the last month or so.

Unfortunately, the rise in consumer confidence has not led to an increase in consumer spending. Retail sales fell .4% in April after falling 1.3% in March. This is another reason I do not believe the economy will be out of the recession this year. Consumer spending accounts for 65-70% of GDP. Yet consumers are still reducing debt and increasing savings in the wake of the credit crisis, and this trend is likely to continue for at least the rest of this year.

The ISM services index (non-manufacturing sectors) edged slightly higher in April from 40.8 to 43.7, but keep in mind that any reading below 50 is an indicator that the economy is still contracting. That's about it for the good news of late.

On the manufacturing front, the news continues to disappoint. The ISM manufacturing index stood at 40.1 in April, thus marking the 15th consecutive month of manufacturing contraction. Factory orders declined .9% in March (latest data available), and durable goods orders fell almost as bad at -.8% during the same period.

As everyone knows, the rate of unemployment continues to spiral upward, rising from 8.5% in March to 8.9% in April. Initial claims for unemployment insurance have been well over 600,000 in each of the last two reporting weeks. I continue to believe the official unemployment rate will hit 10% sometime this year.

Despite this, some forecasters still seem to believe we will be out of this recession by the end of the year. Some point to the recent improvement in several foreign economies and conclude that the US can't be far behind. But as I will discuss in the next section, the US could be well behind these foreign economies in recovering.

Therefore, while there have been a few positive economic reports over the last several weeks, the news is still quite negative on balance. As a result, I am still doubtful, and you should be as well. As I will discuss below, the housing slump - which sparked this recession and credit crisis - is not over, and in fact is getting worse. Home foreclosures skyrocketed 46% from a year ago in March. And most of the other economic indicators and reports continue to point downward.

I continue to believe that this recession will be with us all year. If I am correct, it suggests that the rally in the stock markets will roll over to the downside soon. I continue to recommend that you move some money to the sidelines, put on hedges or at least use stop-loss orders.

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 Housing Blues Getting Bluer

Even though some of the economic reports coming out show signs of hope for a recovery, I think it is important to revisit what got us to where we are in the first place - housing. After all, it was escalating foreclosure rates on subprime loans that started this recession and credit crisis, and a number of forecasters (myself included) are still convinced that we will not see the end of this recession until housing begins to recover.

Unfortunately, I do not see the housing sector improving anytime soon. In fact, I think it will get even worse before it gets better, despite the trillions of dollars Obama is spending to jump-start the economy and stimulate jobs via liberal programs. This is news you're not likely to hear from government officials or the mainstream press.

The US housing market has two fundamental problems that look to get worse before they get better. As noted in the Introduction, the home mortgage foreclosure rate spiked 46% in March from a year ago, hitting a record high, as reported by RealtyTrac on April 16.

The sign for a foreclosed house for sale sits at the property in Denver, Colorado March 4, 2009. (REUTERS/Rick Wilking)

A temporary freeze on foreclosures by major banks and government-controlled home finance companies Fannie Mae and Freddie Mac ended in February. Filings, which include notices of default, auction sale or bank repossession, jumped 17% in March from February. Foreclosure filings for the 1Q also marked a record high, jumping 24% from the same period a year ago.

RealtyTrac also reported that one in every 159 US households with mortgages got a foreclosure filing in the first three months of this year. Filings were reported on more than 803,000 properties in the quarter. California, Florida, Arizona, Nevada and Illinois accounted for nearly 60% of US foreclosure activity in the first quarter, with a combined 479,516 properties receiving filings.

In the transition from industry freeze to new government rescues, the foreclosure filing floodgates reopened. RealtyTrac vice president Rick Sharga noted that after the foreclosure moratoriums ceased, "We saw an onslaught of notices of default, which is the first stage of foreclosure… The rise in filings suggests a backlog had built up due to the moratoriums."

RealtyTrac predicts that home foreclosure rates will continue to rise and possibly not peak until near the end of the year. Mr. Sharga continued, "We still anticipate that we'll see upward of 3 million households receive a foreclosure notice this year, up from 2.4 million last year."

One does not have to be a real estate expert to know that this is very bad news for home prices in general. Mr. Sharga added, "But unfortunately, these well-intentioned delays in [foreclosure] processing might have the unintended consequence of extending the housing downturn, and further dragging down home prices."

Meanwhile, US home prices are still falling, down over 27% on average from their peak in 2006. In many areas, it is much worse. Even worse still, the Wall Street Journal reported earlier this month that a record 5.4 million Americans are delinquent on their mortgage loans, or are already in foreclosure. Making matters even worse, Bloomberg reported the following day that 20million Americans now owe more on their mortgage loans than their homes are worth.

The National Association of Realtors reported last month that the median existing home price across the nation fell to $169,000 in the 1Q, down from $196,000 a year earlier. Sales of new and existing homes were both down again in March, well below expectations. Housing starts and building permits were both worse than expected in March, with both coming in well below 500,000 units for the first time since such records have been kept going back to 1959.

While these declines will ultimately help to bring an end to the housing glut, it is clear that things will get worse before they get better. This is one of the main reasons I don't see us coming out of this recession later this year.

Adjustable Rate Mortgage "Resets" To Soar

The other big negative facing the housing slump - and the credit crisis - is the flood of Adjustable Rate Mortgages ("ARMs") that are due to have their interest rates and monthly payments "reset" to higher levels over the next several years. The riskiest of these loans include subprime mortgages, Alt-A loans, interest-only loans and so called "no documentation" loans. These are collectively called "Option Arms." It is reported that 90% of all Option ARMs in 2006 were "no-doc" mortgages.

Option ARMs usually reset after five years, at which point the monthly payment typically increases 50% or more. About 38% of option ARMs originated in 2005 are still outstanding, 63% of the 2006 vintage are outstanding, and 82% of the 2007 loans remain outstanding, according to Barclays Capital. And about a third of the outstanding loans in these years are deeply delinquent.

All of these loans are scheduled to reset over the next few years if they are still outstanding (ie - have not defaulted). Unfortunately, most of these homeowners cannot qualify for traditional 15 or 30 year mortgages. That's too bad since today's mortgage rates are below 5% in some parts of the country. The bottom line is that many of these option ARMs are going to default, especially given that home prices continue to slump - down a record 19% in the 1Q alone.

The chart below is reprinted from a major study published recently by Credit Suisse which projects the dollar amounts and timing of upcoming option ARM resets. Note that the vertical axis is in billions of dollars. As you can see, the amount of option ARM resets will explode over the next several years, thereby dumping millions more foreclosed homes on the market.

Source: Credit Suisse

I should note that in February President Obama carved up to $75 billion out of his $787 billion stimulus package for what he called a new Federal Loan Modification Plan. This plan would make money available to banks and mortgage lenders so that they can modify loans to distressed homeowners. However, since most option ARM loans are paying no principal (and many not even 100% of the interest), this latest bailout is not likely to make a significant dent in the rising foreclosure rate. Ditto for the $2.2 billion rescue plan passed by Congress last week.

I should also mention President Obama's $8,000 tax credit for first-time home buyers in 2009. Earlier this month, it was reported that first-time home buyers accounted for over 50% of home sales in March. Yet as reported above, new and existing home sales have declined each month so far this year. There are simply way too many homes on the market, and many more are coming in the next few years as implied by the chart above.

ENDORSED ADVERTISEMENT

Commercial Real Estate - The Next Shoe To Drop?

The drumbeat of bad news in the commercial real estate sector continues to worsen, and many are worried that this could be the next big shoe to drop in the credit crisis. The US commercial property market is huge and is widely estimated at apprx. $5.3 trillion, of which apprx. $3.5 trillion is financed.

Foresight Analytics, a California-based consulting firm that serves institutional investors and lenders, estimates that close to $1trillion of the outstanding $3.5 trillion in commercial real estate loans is due to mature between now and the end of 2011. Not only is the default rate on commercial loans rising, the credit crunch has made such loans very hard to obtain when it comes time to renew them.

* Note: the orange bars in the chart represent the years 2009-2011.

Widespread defaults in the commercial lending market would be devastating, as they were for Lehman Brothers, whose bankruptcy was precipitated by nearly $30 billion troubled commercial loans. In a May 19 report, the Wall Street Journal estimated that commercial loan losses for the 19 major banks that recently underwent the government's stress tests could easily total $200 billion between now and the end of next year. In addition, the Journal estimated that smaller and mid-sized banks could suffer losses of another $100 billion over the same period.

Using the same scenario as in the government's stress tests, the Journal examined 940 small and mid-sized banks around the country, and the results are troubling. Using the stress test criterion (which are not all that bad), the Journal found that more than 600 small and mid-sized banks would see their capital shrink to levels that would be "worrisome" for federal regulators.

The Journal concluded: "The findings are a stark reminder that the U.S. banking industry's problems stretch far beyond the 19 giants scrutinized in the government stress tests. Regulators and investors have focused on too-big-to-fail banks such as Bank of America and Citigroup Inc. But more than 8,000 other lenders throughout the country are being squeezed by the recession and the real-estate crash."

Making matters worse, for several years commercial mortgage loans have increasingly been packaged together and securitized into "Commercial Mortgage Backed Securities" (CMBS), much like with residential mortgages. Banks, investment banks, insurance companies and others could trade these loans on the CMBX (Commercial Mortgage Backed Index) market to offset some of the risk. We've heard this song before (read: subprime).

Not surprisingly, the issuance of CMBSs imploded in 2008. Earlier this year, JP Morgan Chase reported that issuance of CMBSs plunged 95% in 2008. The CMBX market is all but dead today, which virtually assures that commercial mortgage defaults will continue to increase. The Mortgage Bankers Association estimates that at least $171 billion in commercial mortgages will come due in 2009 alone.

It's a vicious circle. The recession means lower consumer spending, which in turn causes problems for commercial businesses that rent space. In turn, rental income for commercial developers goes down. Then there is the fact that the value of commercial real estate is declining in general, and you have the perfect conditions for a spike in the default rate.

Then you throw in the credit crisis. Even developers that can prove their commercial properties are still profitable, despite the recession, are finding it next to impossible to find sources to renew their loans and maturing mortgages. We have just such an example right down the street from my office where a huge new "Galleria" mall recently filed Chapter 11 bankruptcy because it cannot find any lenders to renew its maturing construction debt. Yet the mall is teeming with customers, and most of the retailers, restaurants, etc. report that business is booming.

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 - This Can't Be Good For Stocks

While a growing number of economists are upgrading their forecasts, and more are predicting we will be out of this recession by the end of the year, I do not agree. While it is possible that we have seen the worst of the recession in the 4Q of last year and the 1Q of this year, I will be shocked if this economy is in positive GDP territory by the end of the year. There is simply too much bad news out there.

I do not believe that this economy will get back to positive growth until the housing crisis at least stops getting worse. Based on the discussion above, the housing crisis is set to get worse before it gets better. Maybe it starts to get better (ie - not getting worse) sometime in 2010. In any event, the housing slump will be with us for several more years as we work off a record large inventory of unsold homes, which will likely get even larger as option ARM resets lead to a continued spike in foreclosure rates.

Then there is the issue of commercial real estate defaults. As discussed above, most experts agree that the default rates on commercial real estate loans and mortgages will rise for at least the balance of this year, if not longer. We don't hear much about this in the news, but I think it is safe to say we will in the months ahead. And it won't be pretty.

I don't believe most investors and the markets fully understand the ominous implications of what will almost certainly be a $2+ trillion federal budget deficit for fiscal 2009 and $1+ trillion deficits for years to come (especially if President Obama is re-elected). This mind-boggling explosion in our national debt is quite bearish for America's economic and financial future.

For all these reasons, I believe the recession will last considerably longer than most forecasters have recently predicted. Likewise, for all these reasons and more, I do not believe that the recent strong rebound in the stock markets will last.

The S&P 500 Index has heavy overhead resistance at the point where is began to struggle two weeks ago. We may be witnessing the rollover to the downside again. For several weeks, I have recommended that you use this rally to move some money to the sidelines, put on hedges or at least use trailing stop-loss orders.

This may also be an ideal time to consider one or more of the professionally managed programs I recommend that have the flexibility to move out of the market and/or hedge long positions should the trend turn down once again. More aggressive investors may want to consider one or more of the professionally managed programs I recommend that will "short" the market.

Over the past year as the stock markets imploded, we have seen the fastest pace of new account openings in several years. More and more investors are finally coming to realize that "buy-and-hold" simply does not work in these unprecedented times, and are putting some of their investment money with the managers I recommend (and who manage my money).

If you would like to discover how active money management strategies might affect your portfolio, please feel free to call one of our Investment Consultants at 800-348-3601, send us an e-mail at info@halbertwealth.com or complete our online information request form (your personal information is strictly confidential). As always, our consultations are available to you at no cost and there is never any obligation to invest.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Home prices fell a record 19% in the 1Q
http://www.realclearmarkets.com/news/ap/finance_business/2009/May/26/
s_p__home_prices_fall_by_record_19_1_percent_in_1q.html

Roubini - Don't Believe the Optimists
http://www.forbes.com/2009/05/20/depression-recession-green-shoots-housing-
jobs-opinions-columnists-nouriel-roubini.html

Cheney bests Obama in speech duel
http://www.nydailynews.com/opinions/2009/05/24/2009-05-24_obama_gets_schooled_
on_terror_cheney_bests_him_in_speech_duel__by_sticking_to_th.html

Our president is not quite as advertised
http://online.wsj.com/article/SB124286200693341141.html

Retirement Focus: Spotlight on Good News

Gary D. Halbert — Tue, 19 May 2009 20:34:00 GMT

By Mike Posey

IN THIS ISSUE:

Yes, There is Some Good News Out There
New Retirement Perspectives
New Investment Opportunities
A New Opportunity for 403(b) Participants

Introduction

I'm sure that many of you reading the title above think I have lost my mind. What good news could there be when 78 million Baby Boomers are bearing down on retirement with retirement portfolios that have been decimated by the recent bear market? What's good about the recent Social Security Trustees report that said that Medicare and Social Security will run out of money sooner than expected because of the current recession? And what's good about the federal government printing money to fund massive bailouts of the financial sector and others?

Granted, there's more than enough bad retirement news circulating out there, but I'm not going to dwell on that. You can find plenty of gloom and doom articles on the Internet with very little effort. Instead, I'm going to bring out some positive issues related to retirement planning in this week's E-Letter.

I recently attended an industry conference and one of the speakers really got my attention. She was from a communication firm and noted that many Investment Advisors are focusing too much on bad news and not enough on the positive aspects, and she's right. Negative news often allows us to identify with others, as in “misery loves company.” However, it can also lead to depression and inaction, which is often the wrong thing to do.

Focusing on the positive aspects of our situations can, on the other hand, lead to taking action to better our financial position. I often tell my wife, a chronic worrier, that she should worry only about things she can do something about. I suggest the same for investors. Like it or not, you can't single handedly solve the Social Security crisis, nor can you go back in time and replace lost retirement funds.

You can, however, change your perspective and focus on the beneficial things happening in the retirement market, even though they may be a bit hard to find. This E-Letter will focus on some of the positive things going on in the retirement market and show you how you might be able to participate. If you currently participate in a 403(b) plan at your employer, I have especially good news about a new way for you to access active management in your retirement account.

New Retirement Perspectives

Many of the positive things happening in relation to retirement do not involve investments or markets. Instead, they are readjustments of existing programs and ideas in order to fit the new reality facing retirement planning. In the section below, I'll discuss some of these concepts and how they may help you reach your own retirement goals.

Increased Savings – Lo and behold, it only took two bear markets within a decade to convince Americans that they should save some money. Since the onset of the most recent bear market, the US savings rate has gone from below zero to over 4%, and many believe it will continue to go higher as the economy recovers.

Actually the savings rate turned negative back in 2005, something that hadn't happened since the economy was in the throes of the Great Depression. A negative savings rate means that savings were actually being depleted in order to finance the purchase of big-ticket items such as homes, cars, boats and other material possessions. Of course, most American's weren't worried at the time because their homes were consistently rising in value. What a difference a few years and a credit crisis make.

I learned the importance of savings right out of college. I got a job offer from a company in Houston at a starting salary that was more than my father was making before he retired. He took me aside and told me that when he began his career in 1936, he was bringing home $35 per month and saving $10 of that. Of course, he and my mother lived with my grandparents and didn't own a car. Still, he left me with an indelible lesson that it's not what you make but what you save that counts. It now seems that the rest of the country is taking this lesson to heart.

The increase in savings is significant for several reasons. First, it means that individuals are taking charge of their own retirement destiny. Over the years, there has been no shortage of experts calling for Americans to save more, especially those in the Baby Boom generation nearing retirement. However, for a long time, these warnings went unheeded.

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.

Increased saving is also significant in that it means Americans may be spending less for material goods in the future. Ironically, this might make the recovery from the current recession more difficult. Since approximately 70% of the US economy is related to consumer spending, an increased savings rate could have a major impact on future economic growth, a situation sometimes referred to as the “paradox of thrift.”

Finally, the increase in savings usually means that debt loads are being reduced. As Americans have chased material possessions over the past couple of decades, debt loads have increased significantly. Many used the increasing values of their homes as piggy banks through the use of home equity loans and credit card companies inundated all of us with attractive offers of easy credit. Hopefully, those days are gone and family balance sheets will again become healthy.

The question now is whether this new urge to save will continue after the recession is over and jobs are plentiful. In light of the recent warnings about the solvency of Social Security and Medicare, let's hope so. In keeping with the theme of this article, I'm going to be positive about the future of Americans' savings habits and believe that this new focus on saving money will continue. After all, you cannot consume your way into a comfortable retirement.

New Savings Programs and Incentives – One thing that our representatives in Washington do know is that the retirement security of many of their constituents is on the line. As a result, there have been a number of proposals to liberalize various rules to make saving for retirement even easier. Of course, with Congress you sometimes have to wonder how good intentions can result in really lousy proposals.

A good example is the proposal to hijack 401(k) plans floated by Democrats last year, which Gary discussed in detail in his November 4, 2008 E-Letter. Fortunately, this proposal got so much negative response that it never saw the light of day. Even though this idea was dead on arrival, I believe that future legislative action should make saving for retirement much easier.

However, it's also important to make sure that you are already taking advantage of all of the current programs available to you. For example, are you maximizing your 401(k) contributions and employer matching benefit? Do you make a non-deductible IRA contribution even if you're already covered by a retirement plan? Are you eligible for 403(b) or Section 457 deferred compensation plans where you work? Consult with your Human Resources Dept. to make sure you are taking advantage of all of the opportunities that may be open to you.

A New Look At Defined Benefit Plans – Once the backbone of employee benefits at large companies, defined benefit plans guarantee a pre-determined monthly benefit upon retirement without regard to fluctuations in investment returns. In other words, the employer assumes the market risk for these plans and must contribute whatever is necessary to make sure the plan is fully funded.

As you might imagine, many existing defined benefit plans are under stress right now. Plan investments have suffered losses and employers are being required to pay larger contributions at a time when the recession is cutting into revenues. So how is this good news, you ask?

It's good news because, in the right set of circumstances, the defined benefit plan may be an excellent way to build back a retirement nest egg with tax-deductible employer dollars. Since defined benefit contributions are based on actuarial assumptions of the amount necessary to fund a guaranteed monthly benefit, deductible employer contributions can be far greater than the maximum contributions allowed under a 401(k) or other defined contribution plan. Plus, the older you are, the greater your contribution must be to fund the benefit.

This weighting of contributions to older workers usually benefits owners and key employees more than rank-and-file employees, since they have less time to accumulate money for retirement. Fortunately, plan provisions and actuarial assumptions are somewhat flexible, usually allowing for a high degree of customization for the specific needs of an employer.

Amounts necessary to fund promised benefits must be calculated and contributed each year. Therefore, these plans should only be adopted by employers with steady cash flows. Defined benefit plans are also usually more expensive to administer than a 401(k) or defined contribution plan. However, for the employer who can direct most of the contributions to owners and key employees, the price may be well worth it.

One of the good things about defined benefit plans is that the funds are invested by the trustees of the plan and not by the individual participants. Since owners and key employees are usually the decision makers and trustees, a wide range of investment opportunities are available, including the actively managed programs that Gary frequently writes about.

New Investment Opportunities

Some of the positive aspects of retirement planning are in the form of new opportunities available to investors, while others are established ideas for which the timing may now be right. Below I will discuss just a few of the opportunities that I see opening up for IRA account holders and retirement plan participants.

Maximize Contributions – Actually, this is an old concept with a new emphasis. In what is going to sound heretical for a firm that promotes active management strategies, younger participants in 401(k) plans should be maximizing contributions and place them into quality mutual funds that have good long-term track records.

Obviously, I would prefer that 401(k) participants include actively managed strategies in their retirement portfolios, but most 401(k) plans do not have such options available. Instead, they usually have a list of mutual funds from which participants can choose. Some plans have more than others, but most usually have some well-known funds with generally good track records as well as index-based funds.

Even though investing in such funds is an exercise in buy-and-hold investing, participants with many years before retirement have several things going for them. First, the period of time between now and eventual retirement means that they will likely go through a variety of market cycles. While the current market malaise may last for a long time, it won't last forever. The economy and the stock markets will eventually recover which should be good for those with a long enough time horizon to wait around for it.

Younger participants also have the benefit of something known as “dollar-cost-averaging,” or DCA for short. This term simply refers to the fact that your monthly contributions buy shares at different prices over time. When the market is high, you buy expensive shares but when the market is down (like it is now), your contributions buy more shares. When the market does eventually break into a new bull phase, these “cheap” shares tend to have greater gains than those purchased in normal market conditions.

Finally, younger participants tend to have lower account balances in the plan since they are at the beginning of their accumulation phase. Thus, the magnitude of any bear market losses may not seem as great. Think of it this way – it's usually easier to deal with a $10,000 account dropping to $5,000 when you're in your twenties than to see a $500,000 account fall to $250,000 when you're in your fifties. DCA can help young participants rebuild their accounts over time, but may be of little help to an older participant. Active management strategies are usually best at helping to manage the risks in large portfolios, as I will discuss in more detail below.

Thus, even though we have had a market rally as I will discuss below, the major market indexes are still far under where they were in October of 2007 at the peak of the last cyclical bull market. Now is the time to contribute as much as you can each month into your 401(k) and buy shares while they're relatively cheap.

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The Market Has Bounced – In Gary's May 5 E-Letter, he discussed that the market's recent bounce may be an opportunity for investors to take some money off of the table by moving it away from failed buy-and-hold strategies. This is especially true for older retirement plan participants who have significant account balances and less time to recoup investment losses. Many account values have bounced back since the market lows in early March and now may be a good time to lock in some of that gain.

The idea behind selling into this rally comes from the possibility that this may just be a temporary bear market rally and not the beginning of a new bull market. As Gary also pointed out in the May 5 E-Letter, historical bear markets have often had substantial rallies only to resume their downward plunge later on.

Of course, the recent rally could mark the beginning of a new bull market. If that is the case, then taking money out of the market will mean you'll miss out on possible future gains. That's why we recommend that you consider moving only part of your account to cash and not all of it. You might start with 25% of your account and then see how the market performs in the future before taking any further action.

And I'll go ahead and warn you that your buy-and-hold broker or Advisor is likely to become apoplectic should you decide to move some money off of the table. He or she will point to the market's recent rally as evidence that buy-and-hold works (it doesn't) and that moving part of your account to cash will mean that portion of your account will miss out on the new bull market sure to come. Don't fall for their line of bull, do what's best for your future retirement.

New Investment Options – Whether you are already in cash or take the advice above to liquidate part of your buy-and-hold portfolio, the investment options available to you depend upon the type of plan you have. If you participate in a 401(k) plan, your options are usually limited to a set group of mutual funds, with some plans providing more choices than others. For less aggressive investors, cash or fixed income investments may be the best alternative. While earnings will be small, safety of principal is high.

More aggressive 401(k) investors may want to see if specialized “bear market” funds are available in your plan in case the downtrend resumes soon. These funds could act as a hedge of sorts on the remainder of the portfolio since they tend to move in the opposite direction of the market. Thus, if the market goes down, these funds actually have the potential to gain. Of course, if the market goes up, these funds will generally lose money, which is why this strategy is usually best only for aggressive investors.

You can find such funds on the Morningstar database (www.morningstar.com) listed under the Bear Market Fund category. Be aware that most 401(k) plans will not have this type of fund available, and that some bear market funds are better than others. Bear market funds should never make up the bulk of your portfolio, even if you think the market is destined for a downturn.

There are also other types of mutual funds that actively manage their assets, with some even moving to cash in bear markets. Thus, it pays to do some homework on the funds available to you before making a decision on how to allocate your contributions. It's also a good idea to consult with a qualified Investment Advisor before using any of these specialized funds in your portfolio.

If you are in a self-directed type of account such as a traditional or Roth IRA, you have even more options for money that you may want to move out of buy-and-hold positions. You can also move to fixed rate investments or bear market funds, as noted above, but you also have the flexibility to explore other alternatives that might not be available to 401(k) participants. I have listed just a few of those below for you to consider:

First, several of the professional money managers we recommend are available to manage self-directed IRA accounts. These active managers have become increasingly popular in light of the latest bear market, as you might imagine. Some of these active managers have seen a flood of new accounts in recent months, as an increasing number of former buy-and-hold brokers and Investment Advisors are seeking out actively managed programs to offer to their clients.

Our company is a member of the National Association of Active Investment Managers (NAAIM), which is an organization dedicated to the promotion of active investment strategies. I recently attended NAAIM's national conference and was surprised to see that a third of the attendees were new members. Most of the new members I talked to were former buy-and-hold believers who are now seeking out new strategies.

What do they know that you may not know? Simple, they know that buy-and-hold strategies only tend to work in bull markets when virtually all stocks are going up. In bear markets, however, the underpinnings of asset allocation and Modern Portfolio Theory fall apart, leaving investors vulnerable to potentially huge market losses.
Another possible alternative available to those with self-directed IRAs or other qualified retirement accounts is that of purchasing real estate. REAL ESTATE!! Are you crazy, Mike??

Well, not quite. It's no secret that real estate prices in certain markets have been hammered, possibly below what might be considered a reasonable valuation. It's also no secret that during tough economic times, those with cash can often make very good deals on real estate. Unfortunately, many investors have most of their cash tied up in an IRA and think that direct real estate investments are not possible.

While the subject of buying real estate in an IRA is somewhat complicated and far beyond the scope of this small newsletter section, I do want to make you aware of some ways in which you might use your IRA money to purchase real estate. The first way to do so is to purchase real estate as an asset of your IRA. Since your IRA is a trust entity, it can hold title to real estate just as it can own financial assets. You can even have rental property that spins off monthly income into your IRA.

The trick is to find a corporate IRA trustee or custodian who will agree to hold real estate in a self-directed IRA. To be honest, there are not many firms that will do this, but a few of the more specialized companies will agree to hold real property. The requirements and fees to purchase and hold real estate vary by custodian, and some will even allow you to debt finance property in your IRA as long as you can find a willing bank to lend you the money through your IRA. Just be aware that debt financing property in your IRA may bring about unrelated business taxable income (UBTI) issues.

Also be aware that there are significant restrictions on what you can do with the property held by your IRA. The “prohibited transaction” regulations applicable to IRAs dictate that you or your close relatives cannot use the property yourself and that property management must usually be handled by an unrelated third party.

In other words, you cannot buy yourself or your kids a house with money from your IRA, nor can your kids move into a rent house owned by your IRA. You also can't buy raw land with your IRA and then build your house on it. Likewise, you cannot use personal funds to pay upkeep expenses, property taxes, etc. on property held by your IRA since doing so is considered to be extending credit to your IRA under the prohibited transaction rules. All expenses must be drawn from your IRA and all income must be paid to your IRA.

I have actually purchased a piece of rental property through an IRA I had with Sterling Trust Company in Waco, Texas. While it was a good investment, I found the hassles of dealing with property in an IRA to be more than I wanted to put up with. However, if you are willing to put up with the paperwork and procedures necessary, this might be an attractive alternative for you to consider.

A second way to use IRA assets to purchase real estate eliminates some of the headaches of having the IRA actually hold the asset. Under what is known as a Section 72(t) distribution, IRA account holders can take distributions from their IRA without the 10% penalty tax even if they are under age 59½ as long as certain conditions are met. The distributions must be calculated over the life expectancy of the account holder and must continue for a specified period of time.

Some savvy IRA account holders have figured out that taking such a distribution and using the proceeds to purchase a second home or vacation property is a beneficial use of IRA funds. Since some wealthy individuals can experience disproportionate taxation on IRA assets upon their death, any way to transfer assets from the IRA to another asset is welcomed.

The mechanics of how this works are somewhat complex, but a thumbnail sketch is that the IRA account holder calculates an amount necessary to fund the purchase of a property. Then, an experienced tax professional helps to determine the amount of IRA assets necessary to be moved to a separate IRA to produce a distribution sufficient to cover monthly payments. While the IRA distributions are taxable, account holders under age 59½ will escape the 10% penalty tax as long as the requirements of Section 72(t) are met. In addition, an offsetting deduction for mortgage interest and taxes on the second home should reduce or eliminate any taxation on the IRA distribution.

The result is a tax-efficient transfer of money from the IRA to a hard asset without penalty taxes and without the prohibited transaction restrictions associated with holding property in your IRA. It can also be a valuable estate planning tool in the right situation. Obviously, your IRA must be a certain size in order to fund distributions sufficiently large to cover the mortgage costs, and you shouldn't do this if your IRA money is all you have for retirement.

There are a number of drawbacks to using a 72(t) distribution, not the least of which are severe IRS penalties if the rules are not followed, so don't try this on your own. It's important to consult with a tax professional who is experienced in calculating these distributions under all of the allowed methods before deciding to proceed. In addition, the tax benefit relies on an offsetting deduction for mortgage interest and property taxes on a second home, which could be eliminated by Congress in the future.

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.

New Flexibility for 403(b) Participants

As I noted above, employer retirement plans can sometimes box participants in by offering very limited investment choices. Nowhere is this more evident than in some 403(b) programs established for schools, hospitals, charitable organizations and other qualifying employers. Many 403(b) participants have a variety of mutual funds and annuity contracts available to them, but with little direction as to how best to use them in a diversified portfolio, much like a 401(k).

For 403(b) participants who are feeling boxed in, we have some exciting news. Potomac Fund Management, our oldest and most established active money manager relationship, has made us aware of a new program that has been especially developed for investors with 403(b) accounts. The only requirement is that the employer must have made the Fidelity family of mutual funds available to 403(b) investors.

The new investment alternative works like this: 403(b) participants move an amount of money that they want Potomac to manage to the Fidelity funds platform. At the same time, they execute an investment management agreement with Potomac Fund Management that authorizes Potomac to trade the account on behalf of the participant. Potomac then uses its trading model based on years of experience and expertise to manage the investor's account.

Best of all, it is not necessary to have the employer approve Potomac to manage the account. If Fidelity funds are already available under the employer's program, then Potomac can manage the account without any further approvals. Potomac will manage the account using the same model employed in their Guardian Program that we have been recommending since 1996. The main difference is that Potomac must limit its choices to the available Fidelity funds in the 403(b) program, while Guardian can use virtually any mutual fund family.

We are still in the process of finalizing our due diligence review of this new product, but since we are already very happy with Potomac and their Guardian program, we anticipate that this will take only a short time.

If you have a 403(b) program and the Fidelity funds are offered as investment alternatives, we want to hear from you. Click on this special 403(b) Information Link to register your interest in this program. Once we complete our due diligence process, we will rush information to you with complete details about Potomac's 403(b) alternative, including a strategy description and actual track record.

If you are unsure about whether your employer has authorized the use of the Fidelity funds, check with your Plan Administrator or your employer's Human Resources Dept. If you have any questions about this program or would like to see if it may be suitable for you, please give us a call at 800-348-3601, send us an e-mail at info@halbertwealth.com or complete the online request form at our 403(b) Information Link. As always, Potomac's past performance is not necessarily indicative of future results.

Action Items

As I noted above, my philosophy has always been to worry only about things that you can do something about. While there's no shortage of bad news today, my article this week provides a number of positive ideas that may apply to your retirement situation. I urge you to seriously consider any of the following items that might fit your individual circumstances:

Maximize your participation in any retirement plan and take advantage of dollar-cost-averaging where available;
If you are older and your retirement portfolio has increased in value due to the recent bounce in the market, consider taking some money off of the table;
Follow congressional action on retirement plan issues to see if new programs are created that might benefit you. If you are an business owner looking to rebuild your retirement portfolio, consider adopting a defined benefit plan for small employers;
When considering the options available to you in your retirement plan or IRA, don't be afraid to think outside of the box. This means you may want to consider new types of bear market funds, active management programs and even real estate. Just make sure you are comfortable with the risks, special characteristics and administrative requirements for each; and
Finally, if you have felt trapped inside a 403(b) program with limited choices, consider Potomac's new 403(b) managed account program if your plan offers the Fidelity family of mutual funds.

Very best regards,

Mike Posey

Carbon Emissions: Environmental Or Political Issue?

Gary D. Halbert — Tue, 12 May 2009 19:41:57 GMT

IN THIS ISSUE:

EPA Takes Action on CO2 Emissions
"Bound to Burn" by Peter Huber
The Law of "Intended" Consequences

Introduction

The climate change issue is one that I have had a great deal of interest in for a long time, but at the same time one that I have not written much about due to the complexity of the issues and the polarizing nature of the discussion. Many people seem to be firmly convinced that man-made climate change exists and we are ruining the environment; yet others adamantly believe climate change is not man-made, and there's nothing to be done about it. There seems to be very little middle ground.

On April 17, the EPA tried to clear up all of this ambiguity by naming carbon dioxide and five other gasses as official threats to the "…health and welfare of current and future generations…" You may recall that the road to the EPA's latest action was paved by a 2007 Supreme Court decision that found carbon dioxide to be a "pollutant" under the Clean Air Act, and ruled that the EPA had the power to regulate it.

There is no question or debate that CO2 is a naturally occurring gas in our atmosphere. For example, it's a by-product of normal animal and human respiration. In light of the EPA's latest decision, are we to assume that every air-breathing creature is now a potential source of pollution subject to regulation? Well, it probably won't come to that, but a recent Wall Street Journal article noted that the EPA's latest decision could "touch every corner of Americans' lives, from the types of cars they drive to the homes they build."

Thus, this decision, coupled with my recent discussion of Obama's "cap-and-trade" proposal, clearly indicate that climate change is on the front burner in Washington. We'll now see what a liberal administration and a compliant Congress can concoct to correct a problem that may or may not exist, depending upon which "experts" you want to listen to. Whatever ends up happening, I can promise you that it will cost us all a lot more money.

Aside from that, the one thing that has always confused me the most is whether or not the global CO2 problem (assuming it is a problem) will be solved or improved if Western nations and the US in particular significantly reduce their carbon emissions. We know without a doubt that CO2 emissions are exploding in the emerging nations. In many ways, it seems to me that spending a huge amount of money to reduce US carbon emissions will simply cost American consumers and business a ton of money, while having little impact, if any, on the global environment.

To address this concern, I have reprinted below an excellent article from Peter Huber of the Manhattan Institute that weighs in on the many factors at play in any attempt to regulate greenhouse gasses. I find it interesting that he doesn't even try to argue whether or not global warming exists. Instead, he takes on the feasibility of trying to solve this problem without the help of countries that produce 80% of the greenhouse gasses. While Huber's article was written prior to the EPA's action, it now has even more significance for all of us who will end up paying the price. I suggest you read the following carefully and think about it seriously.

QUOTE:

Bound to Burn
by Peter Huber

Like medieval priests, today's carbon brokers will sell you an indulgence that forgives your carbon sins. It will run you about $500 for 5 tons of forgiveness—about how much the typical American needs every year. Or about $2,000 a year for a typical four-person household. Your broker will spend the money on such things as reducing methane emissions from hog farms in Brazil.

But if you really want to make a difference, you must send a check large enough to forgive the carbon emitted by four poor Brazilian households, too—because they're not going to do it themselves. To cover all five households, then, send $4,000. And you probably forgot to send in a check last year, and you might forget again in the future, so you'd best make it an even $40,000, to take care of a decade right now. If you decline to write your own check while insisting that to save the world we must ditch the carbon, you are just burdening your already sooty soul with another ton of self-righteous hypocrisy. And you can't possibly afford what it will cost to forgive that.

If making carbon this personal seems rude, then think globally instead. During the presidential race, Barack Obama was heard to remark that he would bankrupt the coal industry. No one can doubt Washington's power to bankrupt almost anything—in the United States. But China is adding 100 gigawatts of coal-fired electrical capacity a year. That's another whole United States' worth of coal consumption added every three years, with no stopping point in sight. Much of the rest of the developing world is on a similar path.

Cut to the chase. We rich people can't stop the world's 5 billion poor people from burning the couple of trillion tons of cheap carbon that they have within easy reach. We can't even make any durable dent in global emissions—because emissions from the developing world are growing too fast, because the other 80 percent of humanity desperately needs cheap energy, and because we and they are now part of the same global economy. What we can do, if we're foolish enough, is let carbon worries send our jobs and industries to their shores, making them grow even faster, and their carbon emissions faster still.

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We Don't Control the Global Supply of Carbon

Ten countries ruled by nasty people control 80 percent of the planet's oil reserves—about 1 trillion barrels, currently worth about $40 trillion. If $40 trillion worth of gold were located where most of the oil is, one could only scoff at any suggestion that we might somehow persuade the nasty people to leave the wealth buried. They can lift most of their oil at a cost well under $10 a barrel. They will drill. They will pump. And they will find buyers. Oil is all they've got.

Poor countries all around the planet are sitting on a second, even bigger source of carbon—almost a trillion tons of cheap, easily accessible coal. They also control most of the planet's third great carbon reservoir—the rain forests and soil. They will keep squeezing the carbon out of cheap coal, and cheap forest, and cheap soil, because that's all they've got. Unless they can find something even cheaper. But they won't—not any time in the foreseeable future.

We no longer control the demand for carbon, either. The 5 billion poor—the other 80 percent—are already the main problem, not us. Collectively, they emit 20 percent more greenhouse gas than we do. We burn a lot more carbon individually, but they have a lot more children. Their fecundity has eclipsed our gluttony, and the gap is now widening fast. China, not the United States, is now the planet's largest emitter. Brazil, India, Indonesia, South Africa, and others are in hot pursuit. And these countries have all made it clear that they aren't interested in spending what money they have on low-carb diets. It is idle to argue, as some have done, that global warming can be solved—decades hence—at a cost of 1 to 2 percent of the global economy. Eighty percent of the global population hasn't signed on to pay more than 0 percent.

Accepting this last, self-evident fact, the Kyoto Protocol divides the world into two groups. The roughly 1.2 billion citizens of industrialized countries are expected to reduce their emissions. The other 5 billion—including both China and India, each of which is about as populous as the entire Organisation for Economic Co-operation and Development—aren't. These numbers alone guarantee that humanity isn't going to reduce global emissions at any point in the foreseeable future—unless it does it the old-fashioned way, by getting poorer. But the current recession won't last forever, and the long-term trend is clear. Their populations and per-capita emissions are rising far faster than ours could fall under any remotely plausible carbon-reduction scheme.

Might we simply buy their cooperation? Various plans have circulated for having the rich pay the poor to stop burning down rain forests and to lower greenhouse-gas emissions from primitive agricultural practices. But taking control of what belongs to someone else ultimately means buying it. Over the long term, we would in effect have to buy up a large fraction of all the world's forests, soil, coal, and oil—and then post guards to make sure that poor people didn't sneak in and grab all the carbon anyway. Buying off people just doesn't fly when they outnumber you four to one.

Might we instead manage to give the world something cheaper than carbon? The moon-shot law of economics says yes, of course we can. If we just put our minds to it, it will happen. Atom bomb, moon landing, ultracheap energy—all it takes is a triumph of political will.

Really? For the very poorest, this would mean beating the price of the free rain forest that they burn down to clear land to plant a subsistence crop. For the slightly less poor, it would mean beating the price of coal used to generate electricity at under 3 cents per kilowatt-hour.

And with one important exception, which we will return to shortly, no carbon-free fuel or technology comes remotely close to being able to do that. Fossil fuels are extremely cheap because geological forces happen to have created large deposits of these dense forms of energy in accessible places. Find a mountain of coal, and you can just shovel gargantuan amounts of energy into the boxcars.

Shoveling wind and sun is much, much harder. Windmills are now 50-story skyscrapers. Yet one windmill generates a piddling 2 to 3 megawatts. A jumbo jet needs 100 megawatts to get off the ground; Google is building 100-megawatt server farms. Meeting New York City's total energy demand would require 13,000 of those skyscrapers spinning at top speed, which would require scattering about 50,000 of them across the state, to make sure that you always hit enough windy spots. To answer the howls of green protest that inevitably greet realistic engineering estimates like these, note that real-world systems must be able to meet peak, not average, demand; that reserve margins are essential; and that converting electric power into liquid or gaseous fuels to power the existing transportation and heating systems would entail substantial losses. What was Mayor Bloomberg thinking when he suggested that he might just tuck windmills into Manhattan? Such thoughts betray a deep ignorance about how difficult it is to get a lot of energy out of sources as thin and dilute as wind and sun.

It's often suggested that technology improvements and mass production will sharply lower the cost of wind and solar. But engineers have pursued these technologies for decades, and while costs of some components have fallen, there is no serious prospect of costs plummeting and performance soaring as they have in our laptops and cell phones. When you replace conventional with renewable energy, everything gets bigger, not smaller—and bigger costs more, not less. Even if solar cells themselves were free, solar power would remain very expensive because of the huge structures and support systems required to extract large amounts of electricity from a source so weak that it takes hours to deliver a tan.

This is why the (few) greens ready to accept engineering and economic reality have suddenly emerged as avid proponents of nuclear power. In the aftermath of the Three Mile Island accident—which didn't harm anyone, and wouldn't even have damaged the reactor core if the operators had simply kept their hands off the switches and let the automatic safety systems do their job—ostensibly green antinuclear activists unwittingly boosted U.S. coal consumption by about 400 million tons per year. The United States would be in compliance with the Kyoto Protocol today if we could simply undo their handiwork and conjure back into existence the nuclear plants that were in the pipeline in nuclear power's heyday. Nuclear power is fantastically compact, and—as America's nuclear navy, several commercial U.S. operators, France, Japan, and a handful of other countries have convincingly established—it's both safe and cheap wherever engineers are allowed to get on with it.

But getting on with it briskly is essential, because costs hinge on the huge, up-front capital investment in the power plant. Years of delay between the capital investment and when it starts earning a return are ruinous. Most of the developed world has made nuclear power unaffordable by surrounding it with a regulatory process so sluggish and unpredictable that no one will pour a couple of billion dollars into a new plant, for the good reason that no one knows when (or even if) the investment will be allowed to start making money.

And countries that don't trust nuclear power on their own soil must hesitate to share the technology with countries where you never know who will be in charge next year, or what he might decide to do with his nuclear toys. So much for the possibility that cheap nuclear power might replace carbon-spewing sources of energy in the developing world. Moreover, even India and China, which have mastered nuclear technologies, are deploying far more new coal capacity.

Remember, finally, that most of the cost of carbon-based energy resides not in the fuels but in the gigantic infrastructure of furnaces, turbines, and engines. Those costs are sunk, which means that carbon-free alternatives—with their own huge, attendant, front-end capital costs—must be cheap enough to beat carbon fuels that already have their infrastructure in place. That won't happen in our lifetimes.

Another argument commonly advanced is that getting over carbon will, nevertheless, be comparatively cheap, because it will get us over oil, too—which will impoverish our enemies and save us a bundle at the Pentagon and the Department of Homeland Security. But uranium aside, the most economical substitute for oil is, in fact, electricity generated with coal. Cheap coal-fired electricity has been, is, and will continue to be a substitute for oil, or a substitute for natural gas, which can in turn substitute for oil. By sharply boosting the cost of coal electricity, the war on carbon will make us more dependent on oil, not less.

The first place where coal displaces oil is in the electric power plant itself. When oil prices spiked in the early 1980s, U.S. utilities quickly switched to other fuels, with coal leading the pack; the coal-fired plants now being built in China, India, and other developing countries are displacing diesel generators. More power plants burning coal to produce cheap electricity can also mean less natural gas used to generate electricity. And less used for industrial, commercial, and residential heating, welding, and chemical processing, as these users switch to electrically powered alternatives. The gas that's freed up this way can then substitute for diesel fuel in heavy trucks, delivery vehicles, and buses. And coal-fired electricity will eventually begin displacing gasoline, too, as soon as plug-in hybrid cars start recharging their batteries directly from the grid.

To top it all, using electricity generated in large part by coal to power our passenger cars would lower carbon emissions—even in Indiana, which generates 75 percent of its electricity with coal. Big power plants are so much more efficient than the gasoline engines in our cars that a plug-in hybrid car running on electricity supplied by Indiana's current grid still ends up more carbon-frugal than comparable cars burning gasoline in a conventional engine under the hood. Old-guard energy types have been saying this for decades. In a major report released last March, the World Wildlife Fund finally concluded that they were right all along.

But true carbon zealots won't settle for modest reductions in carbon emissions when fat targets beckon. They see coal-fired electricity as the dragon to slay first. Huge, stationary sources can't run or hide, and the cost of doing without them doesn't get rung up in plain view at the gas pump. California, Pennsylvania, and other greener-than-thou states have made flatlining electricity consumption the linchpin of their war on carbon. That is the one certain way to halt the displacement of foreign oil by cheap, domestic electricity.

The oil-coal economics come down to this. Per unit of energy delivered, coal costs about one-fifth as much as oil—but contains one-third more carbon. High carbon taxes (or tradable permits, or any other economic equivalent) sharply narrow the price gap between oil and the one fuel that can displace it worldwide, here and now. The oil nasties will celebrate the green war on carbon as enthusiastically as the coal industry celebrated the green war on uranium 30 years ago.

The other 5 billion are too poor to deny these economic realities. For them, the price to beat is 3-cent coal-fired electricity. China and India won't trade 3-cent coal for 15-cent wind or 30-cent solar. As for us, if we embrace those economically frivolous alternatives on our own, we will certainly end up doing more harm than good.

By pouring money into anything-but-carbon fuels, we will lower demand for carbon, making it even cheaper for the rest of the world to buy and burn. The rest will use cheaper energy to accelerate their own economic growth. Jobs will go where energy is cheap, just as they go where labor is cheap. Manufacturing and heavy industry require a great deal of energy, and in a global economy, no competitor can survive while paying substantially more for an essential input. The carbon police acknowledge the problem and talk vaguely of using tariffs and such to address it. But carbon is far too deeply embedded in the global economy, and materials, goods, and services move and intermingle far too freely, for the customs agents to track.

Consider your next Google search. As noted in a recent article in Harper's, "Google . . . and its rivals now head abroad for cheaper, often dirtier power." Google itself (the "don't be evil" company) is looking to set up one of its electrically voracious server farms at a site in Lithuania, "disingenuously described as being near a hydroelectric dam." But Lithuania's grid is 0.5 percent hydroelectric and 78 percent nuclear. Perhaps the company's next huge farm will be "near" the Three Gorges Dam in China, built to generate over three times as much power as our own Grand Coulee Dam in Washington State. China will be happy to play along, while it quietly plugs another coal plant into its grid a few pylons down the line. All the while, of course, Google will maintain its low-energy headquarters in California, a state that often boasts of the wise regulatory policies—centered, one is told, on efficiency and conservation—that have made it such a frugal energy user. But in fact, sky-high prices have played the key role, curbing internal demand and propelling the flight from California of power plants, heavy industries, chip fabs, server farms, and much else (see "California's Potemkin Environmentalism," Spring 2008).

So the suggestion that we can lift ourselves out of the economic doldrums by spending lavishly on exceptionally expensive new sources of energy is absurd. "Green jobs" means Americans paying other Americans to chase carbon while the rest of the world builds new power plants and factories. And the environmental consequences of outsourcing jobs, industries, and carbon to developing countries are beyond dispute. They use energy far less efficiently than we do, and they remain almost completely oblivious to environmental impacts, just as we were in our own first century of industrialization. A massive transfer of carbon, industry, and jobs from us to them will raise carbon emissions, not lower them.

The grand theory for how the developed world can unilaterally save the planet seems to run like this. We buy time for the planet by rapidly slashing our own emissions. We do so by developing carbon-free alternatives even cheaper than carbon. The rest of the world will then quickly adopt these alternatives, leaving most of its trillion barrels of oil and trillion tons of coal safely buried, most of the rain forests standing, and most of the planet's carbon-rich soil undisturbed. From end to end, however, this vision strains credulity.

Perhaps it's the recognition of that inconvenient truth that has made the anti-carbon rhetoric increasingly apocalyptic. Coal trains have been analogized to boxcars headed for Auschwitz. There is talk of the extinction of all humanity. But then, we have heard such things before. It is indeed quite routine, in environmental discourse, to frame choices as involving potentially infinite costs on the green side of the ledger. If they really are infinite, no reasonable person can quibble about spending mere billions, or even trillions, on the dollar side, to dodge the apocalyptic bullet.

Thirty years ago, the case against nuclear power was framed as the "Zero-Infinity Dilemma." The risks of a meltdown might be vanishingly small, but if it happened, the costs would be infinitely large, so we should forget about uranium. Computer models demonstrated that meltdowns were highly unlikely and that the costs of a meltdown, should one occur, would be manageable—but greens scoffed: huge computer models couldn't be trusted. So we ended up burning much more coal. The software shoe is on the other foot now; the machines that said nukes wouldn't melt now say that the ice caps will. Warming skeptics scoff in turn, and can quite plausibly argue that a planet is harder to model than a nuclear reactor. But that's a detail. From a rhetorical perspective, any claim that the infinite, the apocalypse, or the Almighty supports your side of the argument shuts down all further discussion.

To judge by actions rather than words, however, few people and almost no national governments actually believe in the infinite rewards of exorcising carbon from economic life. Kyoto has hurt the anti-carbon mission far more than carbon zealots seem to grasp. It has proved only that with carbon, governments will say and sign anything—and then do less than nothing. The United States should steer well clear of such treaties because they are unenforceable, routinely ignored, and therefore worthless.

If we're truly worried about carbon, we must instead approach it as if the emissions originated in an annual eruption of Mount Krakatoa. Don't try to persuade the volcano to sign a treaty promising to stop. Focus instead on what might be done to protect and promote the planet's carbon sinks—the systems that suck carbon back out of the air and bury it. Green plants currently pump 15 to 20 times as much carbon out of the atmosphere as humanity releases into it—that's the pump that put all that carbon underground in the first place, millions of years ago. At present, almost all of that plant-captured carbon is released back into the atmosphere within a year or so by animal consumers. North America, however, is currently sinking almost two-thirds of its carbon emissions back into prairies and forests that were originally leveled in the 1800s but are now recovering. For the next 50 years or so, we should focus on promoting better land use and reforestation worldwide. Beyond that, weather and the oceans naturally sink about one-fifth of total fossil-fuel emissions. We should also investigate large-scale options for accelerating the process of ocean sequestration.

Carbon zealots despise carbon-sinking schemes because, they insist, nobody can be sure that the sunk carbon will stay sunk. Yet everything they propose hinges on the assumption that carbon already sunk by nature in what are now hugely valuable deposits of oil and coal can be kept sunk by treaty and imaginary cheaper-than-carbon alternatives. This, yet again, gets things backward. We certainly know how to improve agriculture to protect soil, and how to grow new trees, and how to maintain existing forests, and we can almost certainly learn how to mummify carbon and bury it back in the earth or the depths of the oceans, in ways that neither man nor nature will disturb. It's keeping nature's black gold sequestered from humanity that's impossible.

If we do need to do something serious about carbon, the sequestration of carbon after it's burned is the one approach that accepts the growth of carbon emissions as an inescapable fact of the twenty-first century. And it's the one approach that the rest of the world can embrace, too, here and now, because it begins with improving land use, which can lead directly and quickly to greater prosperity. If, on the other hand, we persist in building green bridges to nowhere, we will make things worse, not better. Good intentions aren't enough. Turned into ineffectual action, they can cost the earth and accelerate its ruin at the same time.

END QUOTE

Peter Huber is a Manhattan Institute senior fellow and the coauthor, most recently, of The Bottomless Well. His article develops arguments that he made in an Intelligence Squared U.S. debate in January.

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 – The Law of Intended Consequences

Over the years, I have often noted how some well-intentioned legislation sometimes morphs into a detrimental force never conceived by its original supporters (ie – unintended consequences). The Alternative Minimum Tax often comes to mind as a case in point. While intended to be a "fix" for a very limited number of super-rich taxpayers, the AMT now puts the tax bite on millions of middle-class families that were never the target of the original legislation.

However, I do not think this is the case in regard to the EPA's latest declaration about CO2 and other naturally occurring greenhouse gasses being "pollutants." I also believe we are going to see very negative (and costly) consequences come about in the future, and I think this is exactly what the radical environmentalists would like to see.

Don't get me wrong, I truly believe in using the earth's resources responsibly. Likewise, I believe in doing whatever we can to protect the environment, so long as we are sure such actions will in fact work, and they are not just some environmentalist theories or part of the liberal agenda purely bent on advancing government controls.

It is unfortunate that some natural processes cannot be taken as just that – natural. Many respected studies agree that concentrations of carbon dioxide have fluctuated wildly over billions of years, and that CO2 was once the dominant gas in the atmosphere, yet the world survived and flourished. But the hard-core environmentalists choose to conveniently ignore these facts and lay the blame solely on mankind.

For what it's worth, I do believe that climate and weather patterns change over time, but I have to admit that I'm a global warming agnostic. To me, the issue is not whether the earth is warming or cooling, but whether it is human activity that is causing the changes. I think the jury is still out on this issue, and I hate to see laws and regulations (and taxes) enacted to address a problem that may or may not exist.

At the end of the day, the quest to lower US carbon emissions will mean substantially higher costs to industry and therefore consumers in the years ahead. Meanwhile, the construction of coal-burning facilities will continue to rise rapidly in the developing and emerging economies around the world, as coal is the cheapest, most abundant and easiest fuel to burn.

Put bluntly, global carbon emissions will continue to rise no matter what the US does. Keep this in mind as President Obama presses ahead with his plans to cost US industry hundreds of billions over the next 4-8 years. Whatever it costs industry, they will surely pass these costs on to us.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES:

California's Potemkin Environmentalism (Just in case you missed the link above - a must-read!)
http://www.city-journal.org/2008/18_2_californias_environmentalism.html

Climate Change Science Isn't Settled
http://www.theaustralian.news.com.au/story/0,25197,25376454-7583,00.html

Obama and the Clinton Legacy
http://online.wsj.com/article/SB124208471345908641.html

On The Economy, Bonds & Bear Market Rallies

Gary D. Halbert — Tue, 05 May 2009 21:15:55 GMT

IN THIS ISSUE:

First Quarter GDP Falls More Than Expected
Stocks Always Outperform Bonds, Right? Wrong!
Should You Put All Your Money in Bonds? No!
Is the Current Market Rally Too Big to Fail?
Conclusions – Not Out of the Woods Yet

Introduction

Last Wednesday the government reported that 1Q GDP declined at an annual rate of 6.1%, thus confirming that we are still in a deep recession. While the GDP report was worse than the pre-report consensus, it was very much in line with what I predicted in my April 21 E-Letter. I continue to believe that we will be in this recession all year.

Several recently released studies highlight the fact that long maturity Treasury bonds have outperformed stocks over the last 40+ years, and by a substantial margin over the last 28 years. I will examine these reports as we go along. Does this mean you should put all of your money in bonds now? I'll tell you why I believe that would be the wrong move to make at this time.

Finally, we get calls every day asking if the recent rally in the stock markets means that the bear market is over, or if this is just a bear market rally. While no one knows for sure, we will take a look at some past bear market rallies to keep things in perspective. I think you'll find this week's letter interesting.

GDP Falls More Than Expected (But Not to My Readers)

The Commerce Department reported last Wednesday that 1Q GDP fell at an annual rate of 6.1%. The pre-report consensus called for a drop of 4.7%, so the actual report came as a negative surprise to the markets (but not to those of you who read my April 21 E-Letter). The decrease in real GDP in the 1Q primarily reflected negative contributions from exports, inventory investment, equipment and software, and decreases in commercial and residential construction.

There were, however, a few bright spots in the latest GDP report, particularly in regard to consumer spending. The GDP report last Wednesday noted that personal consumption expenditures (consumer spending) increased at an annual rate of 2.2% in the 1Q in contrast to a decrease of 4.3% in the 4Q. That number seemed unusually high to me in light of the continued plunge in consumer confidence in the 1Q (more on this below).

Durable goods orders increased 9.4% in contrast to a decrease of 22.1% in the 4Q. Nondurable goods orders increased 1.3% in contrast to a decrease of 9.4% in the 4Q. These are encouraging signs but were overwhelmed by the bad news in the 1Q.

Commercial construction plunged 37.9% year-over-year in the 1Q, even worse than the 21.7% decline in the 4Q. Residential construction decreased 38.0% in the 1Q compared with a decrease of 22.8% in the 4Q. Equipment and software purchases decreased 33.8% compared with a decrease of 28.1% in the 4Q. Exports of goods and services decreased 30.0% in the 1Q compared with a decrease of 23.6% in the 4Q. Imports of goods and services decreased 34.1% compared with a decrease of 17.5% in the 4Q.

The bottom line is that if we had not seen the pickup in consumer spending and durable goods orders, the 1Q GDP number could well have been down 8-10%. The recession is still quite severe, and I continue to predict that it will be with us all year.

It remains to be seen if the next 1Q GDP update on May 29 will include a downward revision from the -6.1% number reported last week. If so, that may not be good news for the markets.

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.

Stocks Always Outperform Bonds, Right? Wrong!

The conventional wisdom going back over a century is that stocks outperform government bonds over time, right? Surely most everyone reading this has been taught that axiom over the years. It's your basic Investing 101 gospel. It's also the financial planning gospel. It goes like this: stocks are more volatile than bonds, but they deliver a fairly significant return premium over bonds in the long-term. Since government-backed bonds are considered safer, if held to maturity, then it only stands to reason that they would deliver somewhat lower returns than stocks over time.

So as a general rule, you should invest more heavily in stocks over bonds when you are younger and have lots of years to ride out the occasional bear market. Then, as you get closer to retirement age, you begin to scale back your equity allocation and invest more in government bonds. Many traditional asset allocation and financial planning models suggest something in the range of a 60/40 stocks/bonds split when you are younger and over time moving to a 40/60 stocks/bonds split – and then even more in bonds as you hit retirement.

Yet this conventional wisdom has come under increased scrutiny recently. Why? Since we've had two serious equity bear markets in the last decade, Treasury bonds have now outperformed equities over the last 30-40 years. Many financial academics and Investment Advisors are now seriously rethinking their long-held beliefs about bonds. (You might note that yours truly never believed you should have all of your money in stocks and bonds only, but that's another story for another time.)

Given the severity of the recent stock market debacle, with the benchmark S&P 500 Index plunging almost 45% since the peak in late 2007, the long-term performance numbers for stocks-versus-bonds have changed. Government bonds now have somewhat higher returns than stocks, especially over the last 30-40 years. Let's look at the numbers.

If we look back from 1801 (for some reason this is a popular historical date) to today, stocks did beat government bonds by apprx. 2.5% per year on average, which is huge considering the compounding effect over more than two centuries. This is the basis for claims that stocks beat bonds over the long-term. But these days, the “long-term” is hardly measured by multiple centuries. Today, a long-term investment horizon is more typically three to five years, or 10 at tops.

But even if we are to look back 200+ years, we see several long periods in which Treasury bonds beat stocks, including the last 30-40 years. Bonds outperformed stocks in the following time windows: 1803 to 1871 (68 years); 1929 to 1949 (20 years);and yes, 1968 to 2009 (41 years).

The implications of this are quite interesting. While Treasury bonds can be quite volatile at times, they always pay off in full if held to maturity. Stock investors have no such guarantee. As a result, stocks are supposed to provide a “risk premium” of a couple percentage points or more, at least historically, to pay for that chance their price could drop (potentially to zero).

Yet as noted above, stocks have not lived up to that historical expectation over the last 30-40 years, not to mention the current bear market. Based on the actual returns in stocks and bonds over that period, you could have chosen one of the safest investments in the world and performed better than those following Wall Street's buy-and-hold forever mantra (which I have never believed should be one's only strategy).

Bonds Really Outperformed Over the Last 28 Years

Economist and author A. Gary Shilling recently published an interesting study on the performance of stocks versus bonds over the period from 1981 to early 2009. For purposes of illustration, Shilling assumed that one bought a 25-year zero-coupon T-bond at the all-time low in October 1981 when long-bond yields were well above 14%. Each year thereafter, he rolled it into another 25-year bond to maintain the 25-year maturity and reinvested the income.

By comparison, Shilling assumed that one bought the S&P 500 Index at its low in July 1982 and reinvested the dividends each year. Then he tracked the performance of both investments through the end of March 2009. The results are quite surprising! Of course, keep in mind that we have seen one of the largest declines in interest rates and inflation in history over the last 28 years, along with two major bear markets in stocks in the last decade.

Shilling found that the 25-year zero-coupon bond delivered an average annual return of 20.4% over the 28 years, while the S&P 500 gained an average of only 10.7% annually over the period from 1981 through March 2009.

If you would like to review Shilling's study (that was printed in Forbes recently) in more detail, I have provided a link to it below in SPECIAL ARTICLES.

Actually, you can go all the way back to 1969 and long-bonds (Treasuries with 20-year or longer maturities) still beat the S&P 500, but only by a marginal amount.

So, Should You Put All Your Money in Bonds? No!

Given that bonds almost doubled the returns of the S&P 500 over the last 28 years, and given that the S&P 500 fell 37% last year and is still down in 2009, you might think it's time to put all or most of your money in Treasury bonds. I do not recommend doing so. First of all, interest rates today are the lowest in many years.

The 20-year and 30-year Treasury bond yields are currently well below 4%, which is extremely low. The 10-year T-bond is well below 3%. Sooner or later the inflation threat will sink in, and bond rates will rise, possibly significantly.

With trillion dollar budget deficits as far as the eye can see, and with other trillions being spent on bailouts, toxic asset purchases, etc., there is little doubt that the US will experience a significant increase in inflation in the years ahead. Some fear we will see hyperinflation given the unprecedented spending by President Obama. Therefore, now could be one of the worst times to load up on Treasury bonds.

Stocks, on the other hand, remain quite depressed. The S&P 500 Index is down apprx. 45% from the highs back in late 2007. While no one knows if the early March lows are “the bottom,” stocks are much cheaper in terms of value today than are bonds, which are in my opinion over-valued.

The question before us is not what happened over the last four decades, but what might happen in the future. One Internet blog entry that I read noted that a call to invest in bonds right now may be similar to John Bogle's (of Vanguard fame) advice in the late 1990s to buy a S&P 500 Index fund and hold it for the foreseeable future. Given that we have experienced two major bear markets since then, that advice was obviously wrong!

There are several bond studies coming out that basically reach the same findings as Gary Shilling's numbers quoted above. So bonds are getting a LOT of attention of late. While all this attention is almost sure to drive more investors to bonds, I would not follow the crowd by selling stocks and equity mutual funds to buy Treasury bonds, which will go down in value if interest rates rise.

ENDORSED ADVERTISEMENT

Is the Current Market Rally Too Big to Fail?

We have heard a lot since last year about institutions that were deemed “too big to fail” and were thus eligible for billions in government bailouts. While it's admittedly a bit different in the stock market, there are market analysts and investors who are claiming that the sheer size of the recent market rally means that the bear market is over and happy days are here again; in other words, this 25% rally is “too big to fail.” While all of us would like to believe that the bear market has run its course, I'm afraid that we can't make that judgment based on the size of the recent rally.

To illustrate this point, I'll reference an excellent example that I came across the other day. The illustration begins with a question: What would an investment of $100,000 be worth if it was invested over a three year period that benefited from the following stock market rallies.

+48.0%
+23.4%
+27.6%
+35.0%
+24.6%

The natural inclination is to assume that the $100,000 would be worth far more at the end of the three-year period. Compounding the original $100,000 investment by the returns above results in an ending value of almost $400,000. However, we know that markets don't go straight up, and there were also some down periods during this timeframe. So we have to reign in our guess to something less. So, what about $200,000 to $250,000? That sounds like a reasonable range, doesn't it?

Well, the correct answer is only $10,800! Yes, over this particular three-year period, $100,000 invested in the Dow Jones stocks would have lost almost 90% of its value.

Surprised? Shocked? I have to admit that this illustration is somewhat of a trick question because it conveniently leaves out the fact that these market rallies occurred over the three years between September 1929 and July of 1932, the darkest period ever for the US stock markets. During this time, the down periods were far worse than the market rallies, so a $100,000 investment in the stock market lost over 89% of its value.

While the above illustration is designed to generate a surprise reaction, it also makes a very important point in regard to bear market rallies. Very rarely do bear markets go straight down, just as no bull market goes straight up. There are almost always “corrections” in the short-term trends, and these reversals are frequently large enough to convince investors that the major trend has changed as well. This can be very costly, especially if they make a change, only to find that the correction was just that, and then the major trend continues.

After the Crash of '29, there were several powerful market rallies that followed. Just as now, I'm sure there were stock market pundits back then claiming that a new bull market had surely begun during some of these rallies, especially the one in late 1929 to early 1930 that gained 48% over the course of 22 weeks.

While the 1929–1932 period was the most prominent example, other notable bear markets have had strong rallies that proved to be false alarms. One Internet source I consulted noted that the 1973–1974 bear market had two bear market rallies of apprx. 10%, and the 2000–2002 bear market had three substantial rallies with the smallest being 19%.

Even the current bear market that began in October of 2007 has had four double-digit rallies, including the one we're in right now. Each of the preceding rallies has provided hope to market participants and drawn many of them back into the market, only to see their investments dwindle further.

As I have mentioned in these pages several times, I am not sure that we have seen the end of this bear market, especially if we learn in the coming weeks that some or many of the largest insurance companies are in trouble. While I am willing to consider the possibility that the March 9 low was the bottom of the market, I also believe that we are very likely to at least retest this low again in the future.

A good example of the market retesting its prior lows is the period of time from July of 2002 to March of 2003. The statistics on the 2000–2002 bear market indicate that the S&P 500 Index hit an intra-day low of 768.67 in October of 2002. However, when you look at a chart of the S&P 500 Index during that period of time, you see that we came very close to the October 2002 intra-day low in July of 2002 (775.96) and again in March of 2003 (788.94). Chartists call this a “triple bottom.” I would not be surprised to see a similar situation occur in 2009.

What Should You Be Doing?

There's an old saying that you should “hope for the best but plan for the worst.” I think that's where we are today in the stock markets. With the unprecedented government intervention in the credit markets and even corporate ownership, we are sailing in uncharted waters. Politicians, who are always happy to see a healthy stock market, now have an even greater incentive to make sure the economy pulls itself out of the ditch. No one wants to run for re-election with the stock market in a slump, especially when the government controls some of the nation's largest banks and corporations.

Therefore, while we all hope that the March 9 low set the bottom of the current bear market, we have to plan as though there's more pain to come. There are a number of ways you can do so, including:

If you are fully invested in the market, you have experienced a nice bump in the value of your portfolio recently. Not knowing what lies ahead, you may want to consider taking advantage of the rally and moving some of your investments to cash. This way, if the market continues to rally, you'll still participate in the gains but with less exposure. However, if we retest the March 9 lows, you'll have some money on the sidelines out of harm's way.
If you are totally on the sidelines in cash, then you have probably been spared some of the bear market's losses, depending upon when you cashed out of the market. However, you have also missed out on the recent market rally. Don't let this regret grow into an emotional need to jump into the market. You could be setting yourself up for losses if we retest the March lows.

If you feel you must get back into the market in some way now, I would suggest that you “dollar cost average” into the market. This is a strategy that calls for making partial investments over time rather than committing your whole portfolio at once. That way, if we retest the March lows, not all of your portfolio will be affected.
Finally, I suggest that you consider the actively managed strategies I recommend that have the flexibility to move to cash or hedge long positions during market downturns. This professionally managed approach takes away the worry and hassle of deciding whether to be in or out of the market. Since I have written about some of these managers in the past, I'll not go into detail here. Suffice it to say that professional active money managers seek to position your portfolio to participate in up markets but become defensive during market downturns.

In light of the current stock market situation, I am reminded of a conversation I had many years ago with a very successful active money manager. We were discussing the higher management fees charged by active managers, typically in the 2-2½% range annually. I made the comment that I believed such fees were justified in return for getting investors out of the market during serious downturns. The manager responded as follows (more or less verbatim):

You know, most people think they pay us our fees to get them out of the market to avoid the big declines and bear markets. But getting out of the market is the easy part. What people really pay us for is to get them back in the market – that's the hard part.

That conversation comes to mind because we hear from so many people who got out of the stock market late last year or early this year, and they have no idea when to get back in. That's when having a time-tested mechanical timing system directing a portion of your portfolio can be very valuable.

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 – Not Out of the Woods Yet

Following the release of the 1Q GDP report last Wednesday, the Dow Jones promptly rallied 200 points, and the S&P 500 gained 22 points – even though the overall GDP report (-6.1%) was worse than expected. People reacted to the increase in consumer spending in the 1Q as a sign that the recession may be ending.

Yet if we dissect the numbers within the GDP report, as I did above, we find that most sectors of the economy declined at an even faster pace in the 1Q. These facts suggest that this recession has not hit bottom and will be with us for some time to come.

It may be that the 1Q proves to be the worst part of the recession. Most economists expect the decline in GDP to be smaller in the 2Q and even smaller in the 3Q. While those estimates may prove to be correct, we saw no convincing evidence that the recession was starting to bottom in the 1Q. Given that, I think we can dismiss forecasts calling for a return to positive GDP in the second half of this year.

Also keep in mind that there may be more bad news for the credit crisis just ahead. As I discussed at length in my April 7 E-Letter, there is plenty of evidence that some of the largest insurers in the US are in financial trouble. Some are pleading for bailouts, and it is probably reasonable to expect they will get them. But this news is getting hardly any media attention thus far. So this could be the next shoe to drop in the credit crisis.

Obviously, it is very difficult to know what to do with your investments in times like these. Investors who are on the sidelines wonder if they should jump back in. People who rode the market all the way down are wondering if they should now get out. Based on the calls we get, most investors are still very nervous, even though the stock markets have recovered somewhat.

In my Investment Advisory business, we have found that investors mostly want to talk to someone they can trust and explore all of the options. They don't want to talk to someone who is automatically going to tell them to sell all of their investments and transfer their money to a new Advisor or program, nor do they want to be hounded on the phone or via constant e-mails. Fortunately, we don't do any of those things at my company.

I would like to offer you the ability to talk to any of our Investment Consultants about your investment needs with no cost or obligation to invest of any kind. My company is very different in that all my Investment Consultants are paid a salary, and do not receive commissions or incentive compensation of any kind. Thus, their marching orders are to make sure that our clients' investment needs are met, even if it means not participating in any of the investment programs we recommend.

If you would like to discuss your current investments and/or retirement planning with someone who is not going to pressure you to invest with them, then you are welcome to call one of my experienced Investment Consultants, at no charge to you. You can call us at 800-348-3601, or if you prefer, you can send an e-mail to info@halbertwealth.com and your questions will be immediately routed to one of our staff members.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Gary Shilling Study: Stocks vs. Bonds
http://www.forbes.com/2009/04/22/treasury-deflation-stocks-personal-finance-guru-insight-gary-shilling.html

More on the Financial Stability Board
http://spectator.org/archives/2009/05/04/the-fed-fails-upward

The End of America's Financial Independence?

Gary D. Halbert — Tue, 28 Apr 2009 19:59:44 GMT

IN THIS ISSUE:

Obama Endorses Global Regulation For U.S.
Quotes From G-20 Communiqué
This Just Cannot Be True, You Conclude
FSB Will Be a Giant Bureaucracy - How Will They Fund It?
Is There Any Reason To Think It Won't Happen?
Conclusions – Could This Really Happen?

Introduction

President Barack Obama recently set the wheels in motion to render the ultimate control of our large financial institutions, large insurance companies, large hedge funds and quite possibly our financial markets as well, to a foreign entity. A new international regulatory agency was created at the recent G-20 Summit in London, and all G-20 countries signed onto it. Sadly, you probably have not heard a word about it until now.

Prepare to be outraged as you read what follows. And I will tell you how to confirm it on your own. Every freedom-loving American - whether conservative, moderate or liberal – needs to be aware of the information in this week's E-Letter. Please read it carefully and consider forwarding it on to those who would want to know.

Obama Endorses Global Regulation For U.S.

On April 2 at the recent G-20 summit in London, President Barack Obama endorsed handing over the regulation of all major US financial companies, including large insurance companies and large hedge funds, to the newly created international “Financial Stability Board” (FSB) which is headquartered in Europe. The FSB's predecessor organization was the Financial Stability Forum which primarily included the central banks of the G-8 countries.

At the April 2 Summit, the Financial Stability Board was expanded to all of the G-20 nations, plus Spain and the European Commission, and all member countries will be subject to the FSB's rules, regulations and enforcement.

The FSB will be allowed to regulate and enforce its will on all financial entities (and financial markets if need be) that are deemed to have “systemic risks,” meaning that they are so large that their failure could pose a threat to the world financial markets and/or global credit flows.

The Financial Stability Board's powers can supersede those of our own regulatory agencies such as the Securities and Exchange Commission, FINRA (formerly the National Association of Securities Dealers), the Commodities Futures Trading Commission and all other US securities regulators, and even the Federal Reserve if it is successful.

Yet it gets even worse. The FSB will also have the power to set executive compensation at financial institutions and any other entities and companies deemed to have systemic risk. The FSB has the power to regulate the “corporate social responsibility of all firms.”

What – you didn't hear about this? Other than a brief mention on FOX News, Bloomberg online and a piece by Newsmax.com, I have not seen any other mainstream media outlet touch this story. If you are suddenly feeling outraged, you should be! Why on Earth would Obama do this? One commentator noted that perhaps Obama feels so guilty for the US role in triggering the international credit crisis that he felt obliged to agree to put our financial industry under the FSB's control.

It is not as if the agreement to form the Financial Stability Board was a tightly kept secret. It was announced publicly in the official G-20 Communiqué which summarized and concluded the London summit on April 2. But the mainstream media has, with the exception of FOX, failed to bring this issue to the attention of the American people.

What follows are verbatim excerpts from the G-20 Communiqué that pertain to the new Financial Stability Board (be sure to read the bullet points below).

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

Major failures in the financial sector and in financial regulation and supervision were fundamental causes of the crisis. Confidence will not be restored until we rebuild trust in our financial system. We will take action to build a stronger, more globally consistent, supervisory and regulatory framework for the future financial sector, which will support sustainable global growth and serve the needs of business and citizens.

We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires. Strengthened regulation and supervision must promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify the financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk-taking. Regulators and supervisors must protect consumers and investors, support market discipline, avoid adverse impacts on other countries, reduce the scope for regulatory arbitrage, support competition and dynamism, and keep pace with innovation in the marketplace.

To this end we are implementing the Action Plan agreed at our last meeting, as set out in the attached progress report. We have today also issued a Declaration, Strengthening the Financial System. In particular we agree:

to establish a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF), including all G20 countries, FSF members, Spain, and the European Commission;

that the FSB should collaborate with the IMF to provide early warning of macroeconomic and financial risks and the actions needed to address them;

to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks;

to extend regulation and oversight to all systemically important financial institutions, instruments and markets. This will include, for the first time, systemically important hedge funds; [emphasis added]

to endorse and implement the FSF's tough new principles on pay and compensation and to support sustainable compensation schemes and the corporate social responsibility of all firms; [emphasis added]

to take action, once recovery is assured, to improve the quality, quantity, and international consistency of capital in the banking system. In future, regulation must prevent excessive leverage and require buffers of resources to be built up in good times;

to take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of tax information;

to call on the accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of high-quality global accounting standards; and

to extend regulatory oversight and registration to Credit Rating Agencies to ensure they meet the international code of good practice, particularly to prevent unacceptable conflicts of interest.

We instruct our Finance Ministers to complete the implementation of these decisions in line with the timetable set out in the Action Plan. We have asked the FSB and the IMF to monitor progress, working with the Financial Action Taskforce and other relevant bodies, and to provide a report to the next meeting of our Finance Ministers in Scotland in November.

END QUOTE

You noticed that I highlighted the key word “all” in the bullet points above from the G-20 Communiqué. If the FSB, in its international wisdom, considers a financial institution or company or a hedge fund “systemically important,” it may regulate and oversee it. This provision extends and internationalizes the recent proposals by Treasury Secretary Geithner and the Obama administration to regulate all firms that are deemed to be “too big to fail,” in whatever sectors of the economy they so choose.

You no doubt noticed the fifth bullet point above where the FSB says is will create and enforce “tough new principles on pay and compensation.” This means that the FSB will regulate how much executives are to be paid at financial firms – including US firms - that are deemed to have “systemic” risk.

The chairman of the new Financial Stability Board is Mario Draghi, Italy's central bank president. In a speech on Feb. 21, 2009, Draghi noted:

“The progress we have made in revising the global regulatory framework... would have been unthinkable just months ago… Every financial institution capable of creating systemic risk will be subject to supervision.”

“It is envisaged that, at international level, the governance of financial institutions, executive compensation, and the special duties of intermediaries to protect retail investors will be subject to explicit supervision.”

It is painfully obvious that these people lust for oversight and control of major US financial institutions and markets, and it appears that President Obama is willing to give it to them, sadly. Here is how Bloomberg described the FSB on April 3:

“Global leaders took their biggest steps yet toward a new world order that's less U.S.-centric with a more heavily regulated financial industry and a greater role for international institutions and emerging markets.

At the end of a summit in London, policy makers from the Group of 20 yesterday delivered a regulatory blueprint that French President Nicholas Sarkozy said turned the page on the Anglo-Saxon model of free markets by placing stricter limits on hedge funds and other financiers. The leaders also pledged to triple the resources of the International Monetary Fund and to hand China and other developing economies a greater say in the management of the world economy.”

This Just Cannot Be True, You Conclude

I'm quite sure many of you are thinking that this just cannot be true. Well, it is. Just Google the words “Financial Stability Board” and you'll find dozens and dozens of articles on this issue. Or you can go directly to the Financial Stability Forum's website at www.fsforum.org and find the information there, including the recent G-20 Communiqué, straight from the source.

Unfortunately, some of the articles you'll read online simply reprint the “talking points” that the G-20 put out there for public consumption, which all sound lofty and necessary, of course.

I'm sure many of you are also thinking that the President of the United States would never sign on to such a plan granting sovereignty over US financial firms and large hedge funds to a global regulatory agency dominated by European members – not even Barack Obama. But he did.

Some of you may be thinking that there's no way Congress would authorize such a dramatic shift in power that would subordinate our financial system and markets to a foreign body. I don't profess to know all the legalities that will be involved, but some analysts believe that President Obama may not have to gain congressional approval for this giant action; rather, that he will simply order our US financial regulators (SEC, FINRA, CFTC and others) to adopt the rules and regulations promulgated by the Financial Stability Board. This is really scary!

Finally, some of you may be thinking – in light of this terrible housing meltdown and credit crisis – that it's high time for some type of international agreement and standards for financial regulations. And I might agree. However, international rules and regulations could be agreed upon by the G20 members and put in place by each country's own regulators, not some foreign body dominated by Europeans. The same goes for regulating executive pay.

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FSB Will Be a Giant Bureaucracy - How Will They Fund It?

If the G-20 Financial Stability Board is going to regulate financial institutions (and markets if need be) pretty much around the world, it will have to be a massive organization. Let's take our own Securities and Exchange Commission as an example for comparison. The SEC reportedly has over 3,500 employees, and it is only responsible for overseeing the various US securities markets.

Just imagine how many employees the FSB will need to oversee, regulate and enforce its rules in the securities markets in 20+ countries. It would likely require offices, staff and enforcement personnel in each of the regulated member countries. The FSB could easily grow to an organization of 10,000-15,000 employees over the course of just a few years.

Likewise, we can only imagine how intricate and convoluted its regulations and enforcement proceedings would be to encompass so many different financial institutions and securities markets, especially since the FSB will be largely dominated by Europeans who have a socialist view of the markets and capital.

Then, of course, is the question of who will pay for it? The G-20 Communiqué was oddly (perhaps purposely) vague on the details of how this massive international regulatory agency will be funded. However, as best I can tell, it will be funded largely by the International Monetary Fund (IMF).

At the G-20 Summit in early April, the members agreed to increase the IMF's capital base by apprx. US$1 trillion in a combination of US$750 billion in new contributions from the G-20 members, and another US$250 billion in new Special Drawing Rights (SDRs), all of which will have to be printed out of thin air. You can bet that the US will be the largest contributor by far.

This new Financial Stability Board is so alarming in so many ways, and there may be no way to stop it now that Obama has signed onto it. And the worst part is that virtually no Americans have any idea about it. This is unbelievable!

Bad News For Hedge Funds

If you ask large hedge fund managers what is their secret to success, most would respond with one word – privacy. They go to great lengths to keep their various positions in the markets secret and unavailable to their competitors, and even their own investors in most cases. They don't want to give anyone information that can be used to trade against them.

Yet if the FSB deems a large hedge fund to have “systemic risk,” they could force the fund manager to disclose all of its positions, which could be very detrimental to its performance. The FSB will have this authority over any large hedge funds domiciled in any of the G-20 countries.

It remains to be seen what the FSB can do with the thousands of offshore hedge funds that are domiciled in places like Bermuda, Turks and Caicos, the Caymans, etc. that are not G-20 members. However, it is clear in the G-20 Communiqué that the Financial Stability Board intends to crack down hard on these so-called “tax haven” countries.

As discussed above, the other big hammer the FSB will wield is the ability to regulate and limit executive pay in financial institutions and large hedge funds that are deemed to have systemic risk. Large hedge fund managers typically receive an annual management fee, usually 1% of assets, with most of their compensation coming in the form of “incentive fees.”

Incentive fee compensation is a percentage of any profits that the manager generates. Often, incentive fees run 15%-20%-25% of net profits. Thus, a really successful fund manager of a very large hedge fund can make hundreds of millions of dollars a year. Yet the FSB will have the authority to put an arbitrary ceiling on what large fund managers can make if they are deemed to have systemic risks.

My prediction is that if the Financial Stability Board grows into the powerful entity that is clearly envisioned, we will see many very successful hedge fund managers close their doors and send the money back to their investors. The really successful managers have made tons of money over the years, and would likely not stand for such potentially onerous regulation.

Is There Any Reason To Think It Won't Happen?

President Obama promised a new era of “transparency” in governance during the presidential campaign. Whether you are a liberal or a conservative, I think you must conclude that the transparency promise was just an empty campaign slogan, when in fact just the opposite has been true, especially in the case of the FSB.

That point aside, are there any reasons to think that the international Financial Stability Board won't come to fruition, or that it will fail? Well maybe. The first point may sound way too elementary to be made, but it is probably valid. Do we think an international body made up of more than 20 countries will really be able to agree on anything substantial?

Compounding the problem is the nature of the new members. Whereas the FSB predecessor, the Financial Stability Forum, was a smaller, mostly-Western club in years past, the new membership will include China, Argentina, Russia, India, and Mexico, among others. If the US and Germany have been unable to agree on stimulus for the sagging economy, chances are that the inclusion of these new members will only make it more difficult for the G-20 to agree on its over-arching global regulatory mandates.

I would venture, however, that the newly admitted G-20 nations will have little to no serious input on the Financial Stability Board's rules and regulations. In fact, a broad set of mandates and guidelines have already been drafted, including those highlighted above in the G-20 Communiqué excerpts. The drafters of the rules were reportedly instructed to have them in near-final form by the next meeting of the G-20 finance ministers in Scotland in November. This thing is moving fast.

Next, some analysts have concluded that while the FSB may prove to be a lively debating forum for central bankers, it is unlikely to move beyond that unless member states can somehow be legally bound to follow its mandates. It remains to be seen if the FSB can come up with such legally binding international authority, even if Obama has given it his blessing.

And lastly, at some point the Financial Stability Board's onerous, cross border powers will have to come into the public view. It remains to be seen what the public backlash will be, not only in America, but in each country that may be asked to surrender its financial sovereignty to a multi-national regulatory body. Maybe that's the point when the public gets outraged. I hope so!

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 – Could This Really Happen?

The current weakened state of the global economy and the ongoing credit crisis unfortunately make the chances better for the FSB to become a reality, and for US financial markets to come under its control. President Obama went to the G-20 meeting knowing that they expected some concessions on his part to “make up” for the perceived unilateral actions by the Bush administration over the years. I'd say he more than lived up to their expectations. No, I'd say he gave away the farm!

Say what you will about former President George W. Bush (I've certainly criticized him often in these pages), but I don't think the new Financial Stability Board would have had a snowball's chance of becoming a reality when he was in office, at least not with the US signing on.

Enter President Obama. Armed with blame for the financial crisis, stories of bank failures and collapsing economies, the G-20 members were able to browbeat Obama into making concessions that would open up our financial institutions and markets to international regulation.

While I could support well thought out guidelines for financial institutions that are agreed upon by an international body like the G-20, such rules and regulations should be implemented by our own regulatory agencies like the SEC and others. President Obama should have never relinquished control of our regulatory agencies to a foreign entity.

There are those who believe that Obama wants to set the US on a course of submission to a new global government and a move toward socialism. But many Obama supporters insist these claims are absolutely false. Yet with Obama signing onto the Financial Stability Board, which will put our financial institutions (and possibly our financial markets as well) under foreign control, what can these Obama supporters say now?

However the FSB issue plays out, I believe that it bears watching closely by all Americans – liberals, moderates and conservatives – this is not a purely political issue. We are talking about nothing less than the national sovereignty of our financial institutions and financial markets and possibly a whole lot more if this move toward socialism is allowed to happen.

Unfortunately, it is not entirely clear if we can stop it. Hopefully, it is not true that Obama can commit the US to the Financial Stability Board without congressional approval. To me, the FSB is in fact a binding international treaty that should at least require ratification by a two-thirds vote in the Senate. The debate over whether the FSB is a treaty, or not, is where the fight will take place.

Freedom loving Americans need to get in this fight now! First, if you have any questions about the credibility of the information I have provided this week, get on the Internet and confirm it yourself. Type in Financial Stability Board and you will find plenty of information. Second, let your representatives in Washington know: 1) surrendering our financial sovereignty to the FSB is outrageous; 2) that it IS a treaty that must be ratified by the Senate; and 3) they had better not vote for it.

Let's not give up control of our financial institutions and markets to a new international regulatory body dominated by European socialists! We should all be able to agree on that, even though I'm sure I'll get some nasty responses to this week's letter. So be it.

Lastly, feel free to forward this E-Letter widely.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES:

Moving Towards Europe – but Do Americans Want to Go?
http://www.realclearpolitics.com/articles/2009/04/28/moving_towards_europe_--_but_do_americans_want_to_go_96208.html

How to Spend $6.5 Trillion in 100 Days
http://aei.org/publications/filter.all,pubID.29769/pub_detail.asp

Obama: The Global Apologist In-Chief
http://www.latimes.com/news/opinion/la-oe-kirchick28-2009apr28,0,4218519.story

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).

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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

How to Recover From the Bear Market

Gary D. Halbert — Tue, 14 Apr 2009 20:05:16 GMT

IN THIS ISSUE:

Editors Note – The Fed Bails Out Insurance Companies
The Case for Aggressive Allocations
Third Day Advisors
Scotia Partners
Combining Both Programs

Editor's Note - Bailouts for Insurance Companies

Just hours after I sent you last week's E-Letter which alerted you to the serious financial troubles among the nation's largest insurance companies, the Treasury Department announced that TARP bailout monies will now be available for insurance companies. As I indicated, the insurance companies have desperately lobbied for bailouts, and now it looks like they will get them, at least for those that have recently bought up banks or other chartered financial institutions to qualify. I can't say I'm surprised.

Stay tuned as your insurance company may soon be controlled by the Obama administration, along with the banks, General Motors and who knows what else will follow.

Introduction

When you write a weekly E-Letter such as this one that goes out to over one million people, you can expect to get criticized from time to time. After all, people who disagree are more likely to respond than those who agree and appreciate the information provided – nothing new about that – especially since some of my weekly commentaries are devoted to political issues which are almost certain to draw responses from those who disagree with my conservative views.

Recently, however, I have received some criticism from a few readers regarding the fact that I include discussions about the investment programs that my firm recommends in these E-Letters. This comes as somewhat of a surprise, since this E-Letter is provided free of charge, and no one is forced to read it. Still, some readers insist that I should not write about the investment programs I believe in, as to them it somehow taints the integrity of the E-Letter.

I could not disagree more, especially given that we have just witnessed one of the most severe bear markets in history and two bear markets in less than a decade. The active management investment programs I recommend have served to significantly reduce losses in this bear market, and thus they are more relevant than ever. I can only guess that the criticism is coming from those who don’t want to be reminded that their buy-and-hold, low fee portfolios were recently gutted (50% or more) by the Bear Market Express.

This aversion to investment topics may also be indicative of how so many have been misled for so long, and feel they must now stay the course and hope that the market returns to its historical norms. They may make adjustments to their overall portfolio but, as I see it, this is tantamount to rearranging the deck chairs on the Titanic. Of course, everyone is entitled to their opinions.

My firm, on the other hand, is offering a lifeboat to those mired in the clutches of buy-and-hold strategies that have not only failed to meet their investment needs, but in many cases, have resulted in huge losses that have pushed investors even further away from their eventual goals. The reason I mention the investment programs we recommend is that I firmly believe that they offer a viable alternative to some of the failed buy-and-hold strategies that have been so prevalent in the marketplace for many years.

Apparently, many of you are coming around to my point of view regarding active investment strategies that have the flexibility to move to cash or hedge long positions in bear markets. We were pleasantly surprised when about 300 of you who read this E-Letter registered for our March 25 Webinar with Scotia Partners and hundreds more have viewed the recorded version on our website since then. And we have seen the largest influx of new clients and new money in many years in just the last 3-4 months, sadly thanks to the bear market.

Even some mainstream financial advisory firms are now dipping a toe in the active management waters. I am amused at some of the commercial ads that urge investors to come in and visit with an investment counselor to learn of “new” strategies for the current market. In all likelihood, you’ll learn about some of the same strategies I’ve been recommending for almost 15 years.

So, let it be known that from time to time I will continue to discuss how active management strategies can fit into your portfolio. This week, I will revisit two of the money managers that we recommend. You can either read on and see how these two managers have made money this year, despite the bear market, or settle back in your buy-and-hold deck chair and disregard the remainder of this week’s E-Letter. It’s your choice.

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.

Aggressive Programs May Help Recovery

As I have mentioned many times in this E-Letter, the goal of basic active management is to attempt to move to cash in down markets to reduce portfolio risk. However, some investors seek out programs that use leverage or can go both net long and net short in the market for the aggressive portions of their portfolios.

In such programs, the potential for profit (or loss) exists no matter what the market’s direction. As I have written before, I characterize this type of program as being one where the best defense is a good offense. Unfortunately, many of these programs are available only to wealthy investors through hedge funds.

Fortunately, there are aggressive investment programs that are open to virtually any suitable investor. In light of how many retirement portfolios have been decimated by two bear markets in less than a decade, even moderate investors may want to consider having an aggressive investment or two in their overall portfolio. Of course, these allocations should be only a small portion of the assets, but it IS possible to include small allocations to aggressive investment programs and still end up with an overall moderate-risk portfolio.

With that in mind, I’ll spend the remainder of this E-Letter highlighting two aggressive money managers that you have previously read about in these pages. In the discussion below, I’ll briefly summarize the strategy employed by each manager as well as update their performance information.

After that, I’ll show how a combination of these programs might be a viable alternative for aggressive investors who want to diversify their portfolios by including two leveraged, long/short active management strategies. If you would like to learn more about active management strategies in general, see the link to my Absolute Return Special Report in the Conclusion section below.

Third Day Advisors Long/Short Programs

Back in January of 2005, I first introduced Third Day Advisors and its founder, Ken Whitley. The original Third Day program we recommended was the Aggressive Strategy, which allowed aggressive investors the ability to have a leveraged long and short exposure to the Nasdaq 100 Index. Over time, Ken has applied his signal to other market indexes, but all are based on the same underlying trading model.

Ken’s money management strategy is a proprietary blend of momentum, trend-following and overbought/oversold indicators. There are ten basic indicators that Ken uses to analyze the market, with a number of sub-indicators that also factor into each trading decision. Each indicator “votes” on whether to be long, short, or neutral in the market. The model is 100% mechanical, though Ken does reserve the right to override his system’s signals in the case of a national emergency.

Depending upon the market index, Third Day selects among index mutual funds available from the Rydex family of mutual funds. These funds are part of the Rydex Dynamic class of funds that seek to provide investment returns that correlate to 200% of the daily performance of the underlying index. Separate funds are provided for positive and negative (inverse) correlations.

The Third Day investment strategy does not currently employ any traditional stop-loss techniques to automatically exit losing trades. To limit risk, Ken varies his allocation based on the relative strength of his trading signal and market volatility. As a general rule, his allocations may range from a low of 15% to a high of 100% of the account value, depending upon the program. However, maximum allocations are rare and Ken’s various programs are projected to be in cash (money market fund) an average of 42% of the time in any given year based on historical performance.

The lack of a formal stop-loss trades and frequency of trading are additional reasons why Third Day’s investment programs should only be considered for the aggressive portion of an investor’s portfolio, where high volatility and significant periodic drawdowns can be tolerated.

Performance Evaluation

Both the Third Day Aggressive Strategy and S&P Plan have turned in strong performance so far in 2009. As of the end of March, the Third Day Aggressive Strategy posted a gain of over 13% for the first quarter of 2009, while the S&P Plan gained 11.20% over the same period of time. This is even more impressive when compared to the S&P 500 Index which was down over 11% (including dividends), even after an impressive March rally. Of course, past performance is not necessarily indicative of future results.

The Third Day Aggressive Strategy has the longest track record of all Third Day programs with actual trading beginning in November of 2001. This strategy trades the NASDAQ 100 Index, which is often seen as a proxy for the high-tech market sector. Over the course of our experience with this program, we have seen that the heavy high-tech weighting of this particular stock index results in it sometimes deviating from the direction of the overall market. Therefore, investors who elect the Aggressive Strategy should do so with the knowledge that it may be more of a tech sector program than one that is based on the broad market.

In light of the tech sector concentration in the Nasdaq 100 Index, Third Day also began to apply its trading signals to other market indexes. In 2006, the Third Day S&P Plan began actual trading. After watching its performance for a while, we began recommending it to our clients who wanted an active management strategy based on more of a broad-market stock index. Though the S&P Plan had a shorter actual track record than the Aggressive Strategy at the time, we were comfortable recommending this new program because we knew it was traded based on the same signal that Ken Whitley had been producing since 2001.

The actual performance information below provides detailed monthly returns and time window analysis for both the Aggressive and S&P Plan programs. This format will help you to more easily compare the two Third Day programs based on their actual performance. Keep in mind that all of the performance information shown is net of management fees and expenses.

Please see Important Notes at the end of this E-Letter.

As you evaluate Third Day’s performance, it should become clear to you that Ken’s Aggressive Strategy performed much better in the 2000 – 2002 bear market than in the most recent market downturn. Based on our research, we feel that this difference is largely due to a “disconnect” between the tech-heavy NASDAQ 100 Index and the broad market stock indexes.

Third Day’s S&P Plan, on the other hand, was better able to maintain more value during 2007 and 2008 than the Aggressive plan, again owing to the fact that this program is based on the broad market S&P 500 Index rather than the NASDAQ 100 Index. Remember, however, that past performance is not necessarily indicative of future results.

While we would like to have seen the S&P Plan pick up more gains from inverse (short) trades during the worst of the bear market, we have realized that Ken’s trading model is not as adept at handling high-volatility markets as are other programs, such as the Scotia Growth S&P Plus Strategy that I will discuss below.

However, we feel that the Third Day S&P Plan may be a good alternative for the aggressive portion of your portfolio when the market eventually bottoms out and volatility decreases. Also note that both the S&P Plan and Aggressive Strategy have posted double-digit gains as of the end of March. Past performance, however, does not guarantee future results.

The minimum investment for the Third Day program is $50,000 and it is custodied at Rydex Investments. You can obtain more detailed information about Third Day’s strategy and performance on our website at the following link:

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

At this link, you can also learn about an even more aggressive Third Day program called the Ultra Aggressive Strategy. This program also trades the tech-heavy Nasdaq 100 Index, but does so with trade allocations that can be as high as 100% of the account value. As always, read all descriptive and disclosure information on these programs before deciding to invest.

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.

Scotia Partners – Riding the Waves of Volatility

As I mentioned earlier, Third Day’s investment programs experienced difficulty when faced with the high volatility that has characterized this bear market. Scotia Partners’ investment programs, on the other hand, have seemed to almost embrace the increased volatility, performing much better in the bear market than during the previous rally phase of the market.

In 2008, the Scotia Growth S&P Plus Strategy gained over 77% net of fees and expenses, when the S&P 500 Index fell 37%. So far in 2009, the Growth S&P Plus Strategy has posted a gain of over 28% as of March 31, while the S&P 500 Index is still under water. Since its inception in August of 2004, the Growth S&P Plus Strategy has produced an annualized return of 38.83% as of the end of March, while the S&P 500 Index can muster only a negative 4.76% over the same time period. Past performance, however, cannot guarantee future results.

Based on our daily monitoring of Scotia’s performance and trading, we feel that its success has come largely due to portfolio manager Cliff Montgomery’s trading strategy that seeks to trade only on those days that offer the best statistical probability of success. Otherwise, he’s content to sit on the sidelines in the money market awaiting the next opportunity.

Scotia’s Growth S&P Plus investment strategy is a combination of two proprietary trading models developed by Scotia’s owner, Cliff Montgomery. The objective of the strategy is to provide positive returns regardless of market conditions, with significantly reduced risk due to limited market exposure. Of course, there are no guarantees that Scotia can continue to achieve this objective.

Using technical analysis, the basic model seeks to determine a long-term market trend (6-12 months) for the S&P 500, which then sets the overall direction for any trades. Once the long-term trend is identified, the intermediate-term trend is then determined using similar analysis. Only when the intermediate and long-term trends are in agreement will the basic model issue a trading signal.

With the overall market trend identified, the basic model looks for short-term movements against the trend. In other words, the strategy seeks to take advantage of the possibility of a “reversion to the mean.” Cliff’s model views a contra-trend market movement as an opportunity, since future market action should move back in line with the overall trend. Thus, Cliff describes his model as being trend-following in the long term, but contrarian in the short term.

In addition to the basic trading model, the Scotia’s Growth S&P Plus program also incorporates a proprietary overbought/oversold indicator that overlays the basic model. This added signal seeks to identify long or short trades that have a high probability of success, without regard to the direction of the long-term trend indicator. Accordingly, this overlay generally results in more trades per year than would be possible under the basic model.

The Growth S&P Plus Strategy is exceptional in that it has historically been in the safety of a money market account over half of the time and trades only on days when Cliff’s proprietary strategy indicates chances are optimal for a gain. As I have said in the past, this is one of the most interesting trading strategies I have ever seen, and it has certainly done extremely well in a market environment reeling in the wake of the subprime/housing meltdown. Remember, however, that past performance does not guarantee future favorable results.

Like the Third Day programs, Cliff’s methodology is 100% mechanical with no discretionary input, and no provision for Cliff to override any trading signal. However, unlike Third Day, the Growth S&P Plus Strategy does not make graduated or partial investments. Instead, the model will be 100% long in the Rydex S&P 500 2X Strategy Fund, 100% short in the Rydex Inverse S&P 500 2X Strategy Fund or 100% neutral (money market), depending upon the signal.

Because of the selective nature of the trading models, the Growth S&P Plus Strategy has historically been in the safety of a money market fund approximately 65% of the time. Scotia does not employ any formal stop-loss techniques to limit risk other than the relatively short duration of trades. If a trade makes money, the model automatically retreats to cash. If a trade loses on its first day, the model may stay long or short for an additional day. However, if even one indicator disagrees with the others, the model exits the market and goes to cash.

The performance information below tells the whole story. As you review this information, again remember that all numbers are actual returns and are net of fees and expenses, and that past performance cannot guarantee favorable future results.

Please see Important Notes at the end of this E-Letter.

As you evaluate Scotia’s performance, you see that its performance has increased dramatically since mid-2007. If you superimpose a graph of the CBOE Volatility Index (VIX), you will find that Scotia’s jump in returns coincides with a big jump in market volatility, as measured by VIX.

Initially, we thought that this might be an indication that Scotia’s programs were somehow “short-biased,” meaning that they entered into predominantly short trades, which would be favorable in a bear market. However, such a bias would be detrimental in a bull market, so we analyzed the individual trades to determine if there were any bias patterns. Our findings were significant:

Over the period of time from the inception of the Scotia S&P Plus Strategy (August of 2004) through December of 2008, Scotia had the following trading history:

165 Long Trades vs. 113 Short (Inverse) Trades
Win/Loss Ratio – Long Trades - 72%
Win/Loss Ratio – Short Trades - 65%
Win/Loss Ratio – All Trades - 68%
(Past performance does not guarantee future results.)

As you can see, there were actually more long trades than short trades, and a higher number of long trades were successful. The conclusion to be drawn is that Scotia’s Growth S&P Plus Strategy does not appear to have any specific long or short bias. However, because of the increased volatility generally associated with bear markets, such periods have the potential to produce greater relative performance than bull market periods.

The minimum investment for the Scotia Growth S&P Plus Strategy is $25,000 and funds are also held at Rydex Investments. You can obtain more detailed information about Scotia’s programs, including a less aggressive option known as the S&P Moderate Growth Strategy, on our website at the following link:

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

As I noted above, literally hundreds of my readers have heard Cliff Montgomery personally explain the specifics of Scotia’s money management strategy via our recent webinar. If you missed it and would like to watch and listen to the full webinar discussion (including all charts), click on the link below:

http://www.halbertwealth.com/webinar/sco20090325/scotiawebinar.php

A Combination Approach

As you have no-doubt observed as you reviewed the above performance information, returns in any given time period can be significantly different – even among aggressive investment alternatives that are traded in a similar manner. Third Day’s Aggressive program did better than Scotia during some years in the up markets between 2003 through 2006, but not in others. Scotia has outperformed Third Day during the volatile bear market that began in 2007, but who knows how long this increased volatility may last?

If we had a crystal ball and could know exactly what kind of market environment to expect in the coming months and years, it would be easy to determine which of these programs to include in your portfolio. However, since we don’t have a crystal ball and most of the “experts” have been horribly inaccurate in their forecasts of what market conditions to expect, we have to find another way to take on the possibility of changing market environments.

If you feel that Scotia and/or Third Day would be suitable for a portion of your portfolio and are within your risk tolerance, I suggest that you consider combining the two programs within your aggressive portfolio allocation. While the past performance of these programs cannot guarantee success, we have seen that each has shown the ability to excel during certain types of market environments. Plus, these programs are not correlated with each other, with an R-squared value of only 0.02.

I would like to be able to provide a hypothetical illustration of these two programs together, but the disclosures necessary to do so would be too onerous in an already long E-Letter. Suffice it to say that, in some cases, combining programs can produce a smoother performance with lower drawdowns. While it’s granted that no combination would outpace Scotia’s recent performance, it is also important to realize that no market environment lasts forever, which is why it’s important to have a combination of programs in a diversified portfolio.

While it is difficult in this E-Letter setting to illustrate a combination approach, you can get an idea of how a combination of these two programs would behave by contacting one of our Investment Consultants at 800-348-3601 or by e-mailing info@halbertwealth.com. Plus, our Consultants can also show you how to incorporate less aggressive actively managed programs into your portfolio.

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

I hope that by now you have seen that allocating a percentage of your portfolio to aggressive investment programs may help you to recover from the ravages of the bear market. Just keep in mind that aggressive allocations are not suitable for everyone and that such allocations should be kept to a small percentage of the overall portfolio, especially for moderate-risk investors. Never take on more risk than you should in an attempt to quickly recover all of your investment losses.

If you would like to receive more information about any of the programs I have discussed this week, give one of our Investment Consultants a call at 800-348-3601 or e-mail us at info@halbertwealth.com. You can also request information via our online request form. We also have other programs more suitable for less aggressive investors, so be sure to ask about them as well.

If you would like to learn more about active management strategies in general, I invite you to download my Absolute Return Special Report. This informative document explains the difference between active and passive management in much more detail, and also provides expanded descriptions of active management strategies you may want to consider for your own portfolio.

I hope that my discussion of the various actively managed programs available to you through my company is of benefit to you. I realize that some may not be in a position to invest right now, but it’s still important to know about these strategies for the future. We sometimes get calls from long-time readers who suddenly find themselves the recipients of a retirement plan rollover, inheritance, proceeds from the sale of a business or other large lump sum and are glad that they learned about active management before they had the money to invest.

In closing, I want to make it clear that my comments regarding complaints are not in any way an indication that I do not appreciate your feedback. I and my staff go over every response generated by my E-Letters, and I always appreciate your thoughts, concerns and questions. However, in regard to discussing the active management strategies we recommend, I feel it necessary to be outspoken for a number of reasons.

First, I feel that these strategies embody some of the best active managers in the country, and all have undergone our strict due diligence review before being recommended. Second, my firm has been evaluating and recommending active money managers for close to 15 years, so we’re not the new kids on the block. Keep this in mind when your buy-and-hold broker has a sudden revelation about active management strategies.

A final reason that mentioning these programs is important is that the financial media are now catching on that investors are leaving buy-and-hold strategies in droves. In some respects, that’s good. However, it also concerns me because some investors may become the victim of scam artists or enter into investments they don’t understand, all for the promise of making up all of their losses.

It’s a dangerous world out there for the investor, and there is no shortage of individuals who would be more than happy to separate you from the remainder of your nest egg. Therefore, to the extent that I can prevent that from happening, I feel it is my duty to do so and I make no apologies for it. As always, please read the Important Notes and disclosures that follow my signature below.

Offering hope for investors bitten by the bear,

Gary D. Halbert

IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM), Scotia Partners, Ltd. (SPL), Third Day Advisors, LLC (“TDA”) and Purcell Advisory Services, LLC (PAS) are Investment Advisors registered with the SEC and/or their respective 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. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from PAS and TDA in exchange for introducing client accounts. For more information on HWM, SPL, TDA or PAS, 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.

As benchmarks for comparison, the Standard & Poor’s 500 Stock Index (which includes dividends), the NASDAQ Composite Index and the NASDAQ 100 Index represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of these benchmarks may differ materially (more or less) from those of the Advisors and these Indexes cannot be invested in directly. The performance of the S & P 500 Stock Index, the NASDAQ Composite Index and the NASDAQ 100 Index is not meant to imply that investors should consider an investment in these trading programs as comparable to an investment in the “blue chip” stocks that comprise the S&P 500 Stock Index or the stocks listed on The NASDAQ Stock Market that comprise the NASDAQ Composite Index or the 100 NASDAQ stocks that comprise the NASDAQ 100 Index. Historical performance data represents actual accounts in programs named Scotia Partners Growth S&P Plus, Third Day Aggressive Plan and Third Day S & P Plan, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Since all accounts in these programs are managed similarly, the results shown are representative of the majority of participants in each of these programs. The signals are generated by the use of proprietary models developed by Scotia Partners and Third Day Advisors with the objective of participating, on a leveraged basis, in trading days with the highest probability of success. 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.

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 these trading programs.

In addition, you should be aware that (i) these programs are speculative and involve a high degree of risk; (ii) the trading programs’ performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in these programs; (iv) Purcell Advisory Services (for Scotia) and Third Day Advisors 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 trading programs’ 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, custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. Management fees are deducted quarterly, and are not accrued on a month-by-month basis. 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. Dividends and capital gains have been reinvested. 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.

Insurance Companies - The Next Shoe to Drop?

Gary D. Halbert — Tue, 07 Apr 2009 19:25:50 GMT

IN THIS ISSUE:

Are Insurance Companies The Next Shoe to Drop?
2008 Was a Bad Year All Around for Insurers
Credit Crisis Severely Impacts Some Insurers
Reinsurance Companies Facing Similar Problems
Insurance Companies Look to States For Help
Look Out For Hurricane Season This Year
What to Look For in the Financial Reports

Introduction

Some observers now feel that we’ve seen the worst of the recession and the credit crisis, and that things should slowly improve in the second half of this year. People in this camp believe that the massive bailouts of major banks and President Obama’s huge stimulus package should work to unfreeze the credit markets later this year. Others like myself are not so sure.

While most of the attention has focused on the major banks in recent months, there is another potentially huge problem that I will bring to your attention in this E-Letter. The major insurance companies, with a few exceptions, may be in financial trouble. The recession has meant a large drop in premium income for all but a select few large insurance companies.

Furthermore, the credit crisis has delivered a serious blow to the major insurers who are big players in derivative instruments such as Credit Default Swaps and Collateralized Debt Obligations and others. Expect to hear much more about this in the weeks and months ahead.

Another serious problem for the major insurance companies is the bear market in stocks. A.M. Best reported recently that stock portfolios for the top 25 insurance companies fell 28% on average in 2008. Even with the latest rebound in the market, these portfolios are almost certainly down more this year. For all these reasons, insurers are looking to their home states for relief, and some states are cooperating. But will it be enough?

Next on the list of concerns is the upcoming hurricane season. As I will discuss later, the Texas and Florida hurricane catastrophe funds are dangerously under-funded. Neither the Texas nor the Florida legislatures have taken action to recapitalize these emergency funds. If we have major hurricanes this summer or fall, the major insurance companies could be very hard hit.

The major insurance companies will be releasing their financial reports for the 1Q (10-Qs) and for all of 2008 (10-Ks) over the next few weeks. It is widely expected that most of these reports will be disappointing and may well raise some red flags. I will tell you what to look for in these reports as we go along, in case you want to check up on your own insurance companies. This may be one of the most important and timely E-Letters I have published.

Insurance Companies – The Next Shoe to Drop?

As the recession and the credit crisis unfolded over the last year, most of the media attention and Congressional hearings have focused largely on the big banks. But we also know that the nation’s large insurance companies (property/casualty/life/health) are not immune from the recession or the credit crisis or the bear market in stocks. We hear from sources close to the industry that 1Q financial reports, which will be released over the next few weeks, and revisions to 4Q numbers, are likely to raise concerns that some large insurance companies may be in trouble.

We don’t tend to hear a lot about these big companies because they are largely regulated by the states, not the federal government, although that may change before long, especially if these upcoming financial reports set off alarm bells at the Treasury Department. A recently released A.M. Best Statistical Study suggests the upcoming reports could be quite ugly. A.M. Best is a worldwide credit rating agency for insurance companies and banks.

In March, A.M. Best reported that total “admitted assets” for the top 25 US life/health writers declined 10.1% at the end of 2008 to $3.6 trillion and declined by 8.7% for the entire industry to $4.6 trillion. Admitted assets include both general account assets and separate account assets. The study also shows just two insurers out of the top 25 with year-over-year profits in 2008.

A.M. Best noted that the main reason total admitted assets declined by over 10% at year-end 2008 from 2007 for the top 25 insurers was the substantial decline in separate account assets, down 28% year-over-year, largely due to the significant downturn in the equity markets. The S&P 500 declined 37% for calendar year 2008.

The companies in the top 25 showing the greatest declines in admitted assets were: Nationwide Life Group, down 21.7%; Hartford Life Group, down 21%; Axa Financial Group, down 20.6%; Lincoln Financial Group, down 16.4% and Ameriprise Financial Group, down 15%. AIG Life Group and Principal Life Group tied for the next spot, with both showing 14.9% drops in admitted assets.

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.

2008 Was a Bad Year All Around for Insurers

Insurance company problems and losses in 2008 affected not only life/annuity insurers, but also property/casualty writers. Losses were not only attributable to the recession, the credit crisis and the bear market in stocks, but also natural disasters. A.M. Best notes the following in regard to life/annuity insurers:

“The year 2008 was among the worst in memory for life/annuity operating performance – the key drivers being substantial realized and unrealized losses on investment portfolios, higher costs of capital and a declining revenue base. These trends clearly are continuing and could deepen well into 2009. The severe decline and volatility in the equity markets are causing capital strain for many life companies, especially large variable [annuity] writers.

A.M. Best has taken a number of negative rating actions in the life insurance sector, triggered primarily by investment concerns and expects the pace of these negative rating actions to accelerate as it reviews life insurers’ year-end results. Increased sales of less creditworthy products, erosion of earnings power and reduced capital flexibility has led A.M Best to conclude that the life/annuity segment is of lower credit quality.

Individual Life [insurance] – The most direct impact of the recession, so far, has been the accelerating decline in annualized new business premium. Individual life sales were down 3% through the third quarter and, given the economy, this trend clearly will continue through at least the first half of 2009.

Individual Annuities – Many VA [variable annuity] writers are reviewing their product designs, leading to more restrictive choices and higher prices for guaranteed benefit riders –if offered, at all. Trends in VA net assets, sales and net flows are negative, but are being somewhat offset by increases in fixed annuity sales.

Life Reinsurance – Demand for reinsurance for variable products continues to outstrip supply, driven by larger net amounts at risk and higher hedging costs due to volatility in the equity markets.

Mergers and Acquisitions (M&A) – M&A activity is likely to accelerate in 2009 as the need to raise capital clearly is a concern. Investment losses also are motivating companies to find strategic partners.”

A.M. Best goes on to highlight concerns and challenges facing property/casualty insurers:

“Natural catastrophes and financial upheaval drove a sharp reversal in the property/casualty industry’s fortunes in 2008, and the effects spread to A.M. Best Co.’s rating activity… Several destructive tropical storm systems and continued turmoil on Wall Street marked the fourth quarter of 2008. These factors drove up combined ratios and put a dent in policyholder surplus for the U.S. property/casualty industry.

Net income was down and the combined ratio was up for 2008, as investment losses took a toll, a soft market [recession] cut premium income, and natural catastrophes drove up underwriting losses. Downgrades of property/casualty insurers totaled 57 in 2008, up from 43 in 2007… Downgrades may reflect adverse reserve development; shortfalls in profitability; imprudent growth; or capitalization dropping below that needed to maintain a company’s rating level.”

2008 was a higher than normal year for natural disasters such as hurricanes, but it was certainly not the worst we have seen. But combined with the recession and the bear market, most property/casualty insurers are really hurting financially.

Credit Crisis Severely Impacts Some Insurers

The recession and the bear market may have created the “perfect storm” for insurance companies, but the news gets even worse. As it turns out, many of the largest insurers have been heavily impacted by the credit crisis, since many have been and are sizable players with large portfolios of derivative instruments such as Credit Default Swaps (CDSs) and Collateralized Debt Obligations (CDOs) and others. As you know, it was some of these same derivative securities that got many of the big banks in trouble. Can the insurance companies be far behind?

The Wall Street Journal posted an online article on April 1 which focused on Hartford Financial Services Group, the fourth largest insurer in the US. A research report from Credit Suisse called on Hartford to post collateral on $400 million of its CDS portfolio, following Hartford’s latest senior debt rating decline by Moody’s to Baa3, just one level above junk bonds.

Reuters reported on March 31 that following Hartford’s debt rating decline by Moody’s, its cost for insuring its senior debt increased significantly:

“The cost of insuring the debt of Hartford Financial Services Group (HIG.N) jumped on Tuesday after Moody’s Investors Service cut the ratings on the insurer's debt to the cusp of junk territory. Moody’s late on Monday cut Hartford’s senior debt ratings two steps to Baa3, the lowest investment grade, and gave the company a negative outlook, indicating an additional downgrade may be more likely over the next 12 to 18 months.

A downgrade into junk territory can significantly increase a company’s borrowing costs. Credit default swaps insuring Hartford’s debt rose to 19.25 percent of the sum insured as an upfront payment, or $1.92 million to insure $10 million for five years, plus annual payments of $500,000, from 16.25 percent upfront at Monday’s close, according to Markit Intraday.

The downgrade ‘was driven primarily by the credit deterioration of the life insurance subsidiaries, as well as a reduction in financial flexibility,’ Moody’s said in a statement. The group’s financial leverage and earnings and cash coverage are expected to deteriorate further and be constrained over the medium term due to potential realized losses and reduced earnings capacity at the operating units, Moody’s said.

Hartford, the fourth largest U.S. insurer, in February posted a fourth-quarter loss and said it would slash its dividend by 84 percent in a bid to preserve capital.”

My sources close to the insurance industry tell me that other large US insurers are in similar financial straights as Hartford. Therefore, sophisticated investors will want to pay particular attention to the financial filings (10-Qs for the 1Q and 10-Ks for 2008) that will be released over the next few weeks by the publicly-traded insurance companies.

Reinsurance Companies Facing Similar Problems

Insurance companies traditionally offset some of their risk exposure by selling it to “reinsurers.” Reinsurance is a means by which an insurance company can protect itself with other insurance companies against the risk of losses. Individuals and corporations obtain insurance policies to provide protection for various risks (hurricanes, earthquakes, lawsuits, collisions, sickness, death, etc., etc.). Reinsurers, in turn, provide insurance to insurance companies.

The main purpose for reinsurance is to allow the company to assume greater individual risks than its size would otherwise permit, and to protect the company against losses. Reinsurance enables an insurance company to offer higher limits of protection to policyholders than its own assets would allow. For example, if the principal insurance company can write only $10 million in limits on any given policy, it can reinsure the amount of the limits in excess of $10 million.

Reinsurance companies have highly refined their policies in recent years to include applications where reinsurance was used as part of a carefully planned hedging strategy. Reinsurance can help to make an insurance company’s results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage.

The largest reinsurers include Swiss Re, Munich Re, Berkshire Hathaway/General Re (Warren Buffet), Hannover Re (Germany) and Reinsurance Group of America. The problem is, due to the recession, the bear market and the credit crisis, more and more insurance companies are looking to reinsure more of their books to free up capital. Yet the reinsurance companies are facing all of the same problems, plus in some cases, adverse currency exchange rates.

Reuters reported on April 1 that reinsurance rates for property catastrophe insurance rose by an average 8% worldwide based on January renewal rates. Reuters also reported in the same news release that reinsurance costs for US catastrophe risks rose by as much as 40% in 2008. So, it is clear that insurers around the world, and especially in the US, are struggling to find ways to reduce their risks in this very bad economic and financial time.

Insurance Companies Look to States For Help

When former Treasury Secretary Hank Paulson made it clear last year that TARP and federal bailout monies would not be made available to insurance companies (with the notable exception of AIG), dozens of insurers have approached their state regulators for relief from “capital and surplus requirements.” The various states which regulate insurers have capital requirements that the companies must meet or exceed.

If insurers fail to meet these capital and surplus requirements, the states can put these companies under “supervision.” If the deficits continue, the states have the power to put such companies into receivership (bankruptcy). The last time this occurred with a life insurance company was in the case of Executive Life back in 1991. More recently, property and casualty giant Reliance Insurance Company was placed in receivership by the state of Pennsylvania in May 2001 and filed for bankruptcy a month later.

The worst news is that a number of large US insurers have fallen below their capital requirements and have lobbied state regulators for changes in the accounting rules for how they value their assets and liabilities. Surprisingly, several states are obliging. The Washington Post reported on March 10 that several well-known insurers have been granted financial relief:

“State regulators trying to help life insurance companies cope with the financial crisis have granted $6 billion of relief from requirements meant to ensure financial stability, according to data released yesterday.

The top recipients were Allstate Life Insurance Co. with $1.4 billion; Jackson National Life Insurance Co. with $825.6 million and Hartford Life Insurance Co. with $655.2 million, according to the National Association of Insurance Commissioners.

The relief typically came in the form of accounting changes that allowed companies to pad their financial cushions, in effect making them appear stronger than they otherwise would. Insurance companies are required to maintain such cushions, known as capital and surplus, to absorb losses and pay claims.

Much of the padding involves increased counting of potential tax benefits that could end up being worthless to the companies.

Like other investors and financial institutions, life insurance companies have seen the value of their investments reduced by the financial crisis. Unlike banks, though, insurers have yet to receive federal bailouts to replenish lost capital.

Industry leaders have argued that regulatory relief could help insurers weather the crisis. They have expressed hope that it will stave off downgrades to their credit ratings, which can be damaging to their business. They also want to avoid having to raise capital from investors, which could cost a lot of money and dilute the value of shareholders' stock.

Critics such as the Consumer Federation of America have argued that the relief could weaken insurance companies and leave policyholders at greater risk… Some state regulators said they wanted to make sure their home-state companies weren't left at a competitive disadvantage. The result is an accounting hodgepodge that makes it harder to compare insurers and gives some companies an edge over others.

Other big recipients included Pacific Life Insurance Co. with $529.8 million, Transamerica Life Insurance Co. with $505 million, Metlife Insurance Co. of Connecticut with $396.1 million, and Lincoln National Life Insurance Co. with $313.4 million, according to the NAIC data. Many of the companies listed are part of larger families, such as the MetLife group, that operate multiple insurers.”

We can certainly argue whether giving large insurance companies breaks on their capital and surplus requirements in order to keep them afloat is a good or a bad thing. But what we should be able to agree on is the fact that these accounting changes were granted because the companies are in trouble. Further, it is all but certain that many more insurers will seek the same sort of relief from their states, if for no other reason than to remain competitive with those who have already received such breaks.

Look Out For Hurricane Season This Year

The insurance industry, especially property and casualty, is bracing for this year’s hurricane and storm season. The hurricane and windstorm emergency funds in Texas and Florida are dangerously under-funded, and this could be particularly bad news for many large insurance companies if either state is hit by a serious hurricane(s) later this year.

In Texas, we have what is known as the Texas Windstorm Insurance Association (“TWIA”). TWIA was created by the Texas legislature in 1971 to provide windstorm and hail coverage to those who are unable to obtain insurance from the traditional insurance market. TWIA was created in response to market conditions along the coast after Corpus Christi was hit by Hurricane Celia in 1970.

The public policy reasons for creating TWIA included ensuring the availability and affordability of insurance along the TexasGulfCoast, thereby supporting general economic development of the coastal area. TWIA issues insurance policies like an insurance company; however, it also functions as a pooling mechanism that allocates losses back to the insurance industry.

All property and casualty insurers licensed in Texas are required to become TWIA members as a condition of doing business in the state. Should hurricane or storm-related losses exceed the amount in the TWIA fund, then excess losses are assessed back to the member insurers. The greater an insurer’s share of the Texas market, the greater its potential for loss assessments.

In 1993, the Texas legislature created the Catastrophe Reserve Trust Fund (“CRTF”) as part of the state’s plan to specifically address catastrophic losses associated with major windstorms (ie – hurricanes). The CRTF is funded by the TWIA, which deposits all of its excess funds on an annual basis into the CRTF.

Over the last four years, the TWIA and CRTF funds have been especially hard hit by Hurricanes Rita (2005), Humberto (2007) and Dolly and Ike (2008). Hurricane Ike, for example, resulted in losses to TWIA/CRTF estimated at $2.3 billion. Ike was the Category 2 hurricane that decimated Galveston last September.

Even though TWIA made excess loss assessments of over $630 million to those P&C insurers operating in the state over the last four years, it remains dangerously under-funded. In fact, the CRTF currently has no money whatsoever. There is not nearly enough money left in TWIA to recapitalize the CRFT, and the Texas legislature has thus far failed to address this matter by appropriating new monies to the CRFT.

The Florida Hurricane Catastrophe Fund (“FHCF”) was reportedly under-funded by at least $14 billion as of the end of last year. As in Texas, the Florida legislature has thus far failed to address this issue. Florida residents are likely facing a significant increase in homeowners insurance later this year.

The bottom line is that if Texas and/or Florida are hit by a major hurricane(s) this summer or fall, insurers that do business in these states are going to get hit very, very hard.

My sources close to the insurance industry believe that if a major hurricane(s) hits Texas and/or Florida this year, a number of large insurance companies could be wiped out.

Clearly, some major insurance companies are in financial trouble already, but things may well get considerably worse depending on this year’s hurricane season.

What to Look For in the Financial Reports

As noted earlier, most of the publicly-traded insurance companies will be reporting their 10-Q financial statements for the 1Q over the next several weeks, along with their 10-Ks covering all of 2008. I am told by my sources close to the industry that these numbers, generally speaking, are going to look very bad, including a lot of downward revisions for 2008 profits and upward revisions to losses, largely as a result of the significant decline in the stock markets and shrinking premium income.

One of the simplest ways to evaluate these particular financial reports is to go directly to the “operating income” number and compare that to the total income. If the operating income is a small percentage of total income, it may indicate that the company’s core insurance business is in decline, and that it is relying on other sources for income. Also, if the operating income fell off sharply late last year and in the 1Q of this year, it may be a very good indication that the company was making much of its money from the bull market in stocks. This could also be an indication that the company may be in financial trouble already, or soon will be.

LIMRA, a well-know insurance industry consulting firm, reported in March that individual life insurance sales saw a 14% drop in the 4Q of 2008, ending the year with an overall 7% decline, according to its quarterly sales survey. The 4Q marked the single sharpest decline in premium income since the 4Q of 1951, according to LIMRA. The overall decline for the year erased the strong 7% gain in 2007, and was the largest one-year decline in the organization’s records.

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 should be obvious from the information above, we need to keep a close eye on the insurance industry in the weeks and months ahead. Look for the upcoming financial reports to be quite negative overall, with disappointing 1Q results and downward revisions to their 2008 financials.

This could be the next shock in the credit markets and the stock markets as well. While this may not be the most interesting topic to think about, virtually all of us have exposure to the major insurance companies, directly or indirectly. Certainly, the fate of the major insurance companies will impact the economy and in turn, the recession.

While the latest recovery in the stock market is impressive, I continue to recommend that you take steps to reduce downside risks in your investment portfolio. If you would like to discuss ways to do so, give us a call at 800-348-3601 or e-mail us at info@halbertwealth.com.

Hoping we can help you in these tough times,

Gary D. Halbert

SPECIAL ARTICLES:

States Give Regulatory Relief to Insurers
http://www.washingtonpost.com/wp-dyn/content/article/2009/03/09/AR2009030902964.html

Failure worries drag down life insurers
http://www.charleston.net/news/2009/mar/15/failure_worries_drag_down_life_insurers/

Aftermath of the Financial Crisis for Life Insurers
http://www.insurancenetworking.com/news/life_insurance_LIMRA_LOMA_financial_crisis-12098-1.html

Have We Turned The Corner On The Recession?

Gary D. Halbert — Tue, 31 Mar 2009 20:31:08 GMT

IN THIS ISSUE:

Finally a Little Good News for the Economy
Geithner's Latest Toxic Asset Bank Bailout
Does the PPIP Have Any Chance of Working?
Fed to Buy $300 Billion in Treasuries & a Lot More
CBO Assessment of Obama's Record 2010 Budget
Conclusions, Market Implications & What to Do Now

Introduction

Some weeks, it's tough to find a good topic to write about. Then other weeks, I'm overwhelmed with all there is to write about, as is the case this week. So, we'll touch several bases in this week's E-Letter. We'll begin with the latest economic news, some of which was surprisingly positive (especially housing). Unfortunately, the latest good news does not necessarily mean we've seen the bottom of the recession or the bear market.

On Monday of last week, Treasury Secretary Geithner announced the much-awaited new plan to take toxic assets off the books of troubled banks. The plan is called the Public-Private Investment Program. Under this new program, the government along with private investors would buy up toxic assets by way of auctions to get these loans off the banks' books. But will the plan work? I'm not optimistic. We'll discuss this in some detail as we go along.

As if the Obama administration is not spending enough already, the Fed recently announced that it will print and spend over $1 trillion in the months ahead to buy at least $300 billion in direct purchases of Treasury securities and at least another $750 billion for purchasing more toxic assets from banks and other sources. Where will it end? No one knows.

In my March 10 E-Letter, I predicted that President Obama's $3.55 trillion federal budget for fiscal 2010 would result in a deficit of more than $2 trillion, as opposed to the administration's estimate of $1.75 trillion. Turns out I was wrong – the Congressional Budget Office predicted last week that Obama's 2010 budget deficit will hit $2.3 trillion. Wow, this will be bad! The CBO agrees with me that Obama's economic assumptions are too optimistic.

Following those discussions, I will give you my latest thoughts on where we stand in the big picture. With the latest smattering of good news on the economy and the nice rebound in the stock markets, some analysts are concluding that we've turned the corner on the recession and the financial crisis. I think it's premature to make that call, and I will not be surprised if we see another downward leg before long. In fact, it may have already begun. 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.

Finally a Little Good News for the Economy

As everyone reading this is all too aware, the economic news so far this year has been horrible. Rarely has any good news been seen in recent months. But there was some good news last week, and it came in a very good spot – housing. Existing home sales in February unexpectedly rose by 5.3% above January levels to an annual rate of 4.72 million units. It was the largest monthly jump since 2003; still, sales were down almost 5% below yearago levels.

The increase in sales of existing homes was strongest in the West and in Florida, one of the worst hit markets. February sales of existing homes in Florida rose 20%. Florida Realtors also reported a 15% gain in statewide sales of existing condominiums in February, continuing a trend in recent months for higher statewide sales of both the existing home and existing condo markets compared to yearago levels.

The median sales price for existing homes nationwide rose to $165,400 in February, the first monthly increase in over a year, but it remains 15.5% below yearago levels. Unfortunately, the inventory of unsold existing homes rose again in February, despite the improved sales figures, thus putting the backlog at an estimated 9.7 months supply at the current sales pace.

New homes sales also increased by 4.7% in February to an annual rate of 337,000 units. Economists had expected new home sales to decline to a rate of 300,000 annualized units, so this was welcome news. While the unexpected rise in new home sales might be seen as a positive movement for the beleaguered housing market, the February rate for new home construction is still the second-lowest reading since the last recession in 2002. The median price of a purchased new home fell to $200,900 in February, down over 18% from a year ago.

Housing starts jumped well above expectations in February, rising 22% over January levels. Rising housing starts might not sound like a good thing, as that could mean even more homes on the market, but reportedly over 80% of the February construction starts were for apartment complexes, not new single family homes. Also, building permits climbed in February for the first time in over a year.

On another front, durable goods orders rose a surprising 3.4% in February following six consecutive monthly declines. This news was bittersweet because the Commerce Department revised January durable goods orders further downward from -5.2% to -7.3%.

Elsewhere, the economic news continued to disappoint. Last Thursday, the government reported that 4Q GDP fell at an annual rate of -6.3%, down from -6.2% as reported last month. Consumer confidence continued to plunge in February to only 25.0, a new record low, down from 37.4 in January. However, the latest Rasmussen tracking poll shows that consumer confidence has rebounded a bit in March.

The Index of Leading Economic Indicators fell 0.4% in February. The LEI has fallen very sharply since the last peak in July 2007. The unemployment rate jumped to 8.1% in February from 7.6% in January. The consensus is for a rise to 8.5% in March and at least 9% by yearend. These are just a few of the negative reports we've seen over the last month.

In summary, while we've seen a few positive reports on the economy and the housing sector in particular over the last month, we are far from out of the woods on the recession and the financial crisis. Now, let's move on to the latest bank bailout proposed by Treasury Secretary Timothy Geithner.

Geithner's Latest Toxic Asset Bank Bailout

After Treasury Secretary Geithner announced his new Public-Private Investment Program (“PPIP”) on Monday of last week, the Dow Jones promptly rallied over 500 points. That followed a rally of almost 1,000 points since the low in early March. The Dow and the S&P 500 bounced just over 20% from their recent lows – that is until the latest near 5% downward reversal over the last two trading sessions (Friday and Monday). While the equity markets clearly liked the government's latest bank bailout plan, serious questions remain – such as, will it work, and will private investor groups want to get in bed with the government, which threatened to impose a 90% tax on AIG executive bonuses?

We'll get to those questions and others as we go along, but first let's examine how the Public-Private Investment Program is supposedly designed to work. In an online article in FORTUNE, CNNMoney.com's Jon Birger provided the following summary on how the PPIP is expected to work as follows:

“The [PPIP] plan tries to fix the banking crisis by encouraging the very behavior that got us into this mess in the first place -- using buckets full of leverage to buy mortgages, asset-backed securities and other so-called toxic assets. Moreover, it requires the participation of the very folks -- Wall Street bankers and investors -- whom officials in Washington have spent the last two months threatening and vilifying.

At its core, the Public-Private Investment Program (PPIP) harkens back to what the original bank bailout bill was supposed to do when it was first passed by Congress last fall: remove toxic assets from bank balance sheets, thereby freeing up more money for lending. The mechanics of the program would operate somewhat differently for stand-alone loans than for debt securities (basically bundles of loans packaged as asset-backed or mortgage-backed securities), but the general approach is the same. The government will match, dollar for dollar, any private-sector funds put towards buying these toxic assets.

And if that weren't incentive enough, the government will also facilitate cheap loans -- think of them as FDIC-guaranteed margin loans -- to private investors who will be able to leverage their distressed-debt purchases six to one.

Here's how it might work: Say a bank has a pool of residential mortgages with a $100,000 face value that are deemed good risks by the FDIC. The pool is then auctioned off, and in this example, the winning bid is $84,000. Of that, the government puts up $6,000, the private investor another $6,000, and the remaining $72,000 is financed via a FDIC-guaranteed margin loan.

The goal is to jump start the market for toxic debt and put the prices of these loans more in line with the underlying interest payments (which in some cases have declined far less than the market valuation of the loans or debt securities). Theoretically, once the PPIPs start buying and selling this stuff, the valuations will become clearer, opening the door to other private investors who may see opportunity but have shied away up until now due to the lack of price transparency.

That's the upside. The potential downside is what happens if prices continue to fall. And if you think taxpayers are mad now, just wait till they find out that, on account of government-sponsored leverage, a further 15% decline in the debt markets caused them to lose 100% of their investment in PPIPs. Says Tom Atteberry, co-manager of the FPA New Income bond fund: ‘I do see some irony in the fact that the proposed government solution to the problem looks a lot like a hedge fund and a primary broker -- with the primary broker being the federal government.'

There's also a question of whether Wall Street money managers will play ball with a government that has been bad-mouthing them and threatening them with confiscatory taxes. ‘If they go ahead with the 90% tax, nobody is going to want to work with the government,' says a top mortgage-fund manager, referring to the bill passed by the U.S. House of Representatives that would slap a 90% tax on bonuses paid to employees of bailed-out financial companies. ‘It's a deal killer,' says Rick Hughes, co-president of Portfolio Management Consultants, which directs $70 billion in institutional and retail accounts.

Even if the bonus tax isn't implemented, the mortgage-fund manager worries what might happen if PPIP works too well. He envisions a scenario in which money managers are hauled before Congress and accused of making millions on the backs of taxpayers. ‘I'd rather be attacked by a pack of wild dogs,' he says. There are other, more conventional ways that government involvement could discourage money managers from participating.

FPA's Atteberry notes that under the Treasury Department proposal, the FDIC would provide oversight to the PPIP funds. Atteberry says that if he were putting his firm's capital at risk, he'd want to know more about what ‘oversight' entails. For instance, will political considerations prevent investors from foreclosing on certain homeowners or force them to offer generous loan modifications? Says Atteberry, ‘Those are details you need to flesh out if you want to get private investors to come on board.'

Of course, it could be that some on Wall Street -- hedge fund managers in particular -- are so desperate for any source of income, they'll gladly accept these risks.

Prime brokers are extending less credit to hedge funds and investors are pulling out their money. So if the government now wants to become hedge funds' new BFF -- their new prime broker as well as their biggest investor -- why quibble about the details? ‘The reality is that a lot of hedge funds really don't have a business model any more,' says veteran Wall Street strategist Ed Yardeni. ‘The government is basically putting Wall Street back in business with a whole new business model, which is to take all the toxic assets, repackage them and re-sell them at a discount.'

‘Wall Street is getting paid to re-arrange the deck chairs on the Titanic -- but hopefully with a better outcome.'”

Many thanks to Jon Birger of CNNMoney.com for that summary. Obviously, there are still many unanswered questions about the Public-Private Investment Program. Geithner's roll out of the program last week was very short on details, and many private investors are going to be very wary of getting in bed with the government to buy up these toxic assets, even if the discounts are very attractive.

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.

Does the PPIP Have Any Chance of Working?

If President Obama wants this plan to have any chance of working, he needs to make sure the Senate does not go along with the House in passing the 90% retroactive income tax on the AIG executives that received big bonuses. Hedge funds, private equity funds and the like will not want to pony up money to buy toxic assets if they fear that the government will change the rules on profit sharing in these PPIP transactions.

I have read several articles recently that indicated the Treasury was already planning to recoup the AIG bonuses by subtracting that amount from the next round of bailout money AIG will need. That would have been an easy way to get the money back and put the onus on top AIG management to claw back the bonuses. But the Democrats in the House couldn't resist the opportunity to grandstand in front of the American people with an illegal, retroactive 90% income tax on the AIG bonus money.

Political commentator Dick Morris has an interesting take on the PPIP. Morris believes strongly that President Obama wants the PPIP to fail. Morris is convinced that, while Obama says publicly that he does not want to nationalize the big banks, privately Obama and Rahm Emanuel would very much like to see the government take over these large money center banks that have taken bailout money.

Morris argues that this is precisely why the president has been lambasting Wall Street and the big banks for weeks now, in the hope that private investors will not jump into the PPIP with both feet. Morris also believes that this is why Obama packaged the PPIP as Geithner's plan, not his own, so that if it fails he won't get the blame. If it does fail, Morris predicts that Obama will then nationalize the troubled banks. I sincerely hope this assessment is wrong!

As noted earlier, the stock markets reacted extremely strongly following Geithner's announcement of the Public-Private Investment Program. If it is to have any chance of working, he needs to get the details out fast, including assurances that the government won't change the rules in the middle of the game. We'll see.

Fed To Buy $300 Billion in Treasuries & a Lot More

The Fed Open Market Committee met on March 17-18, and the policymakers approved some bold new (yet troublesome) actions. Citing that the economy continues to worsen and the credit markets are still dysfunctional, the FOMC voted unanimously to authorize the Fed to make direct Treasury security purchases of $300 billion over the next six months, with a suggestion that much more could be authorized later on if needed.

This move is controversial because the Fed will have to print the $300 billion to pay for the purchases of Treasury securities. Many fear that this action (and likely more to come) will further sew the seeds of significantly higher inflation when we emerge from this recession. But as I have written often in recent letters, the Fed is scared to death of deflation and will do whatever they feel is required to avert a debt deflation in the economy.

At the same FOMC meeting, Bernanke & Company also voted to double the Fed's purchases of mortgage-backed securities and take on more agency debt. That means the Fed will purchase another $750 billion in toxic mortgage-related securities this year. Between the Treasury purchases and the additional mortgage-related securities – all of which they will have to print money for - the Fed's balance sheet liabilities will skyrocket to well above $3 trillion this year.

Here are excerpts from the March 17-18 FOMC official statement:

“In these [bad economic] circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities… and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets.”

Following this announcement, yields on 10-year Treasury notes plummeted in the largest one-day decline on record to near 2.5%, down from above 3% just two days before. Stocks also rallied on March 18 and since then (at least until the last two days), a clear indication that many investors approve of the Fed's unprecedented actions in buying Treasury debt directly and doubling its purchases of toxic assets.

But it should also be noted that the US dollar plunged on the news that the Fed would be buying $300 billion in Treasuries and another $750 billion in toxic assets, and the implication that those numbers may well go even higher later this year. Keep in mind that these numbers are in addition to the $2+ trillion budget deficit we will have in fiscal 2010 (more on that below) and well over $1 trillion in each of the next several years.

Given the staggering size of these numbers, I don't see the US dollar going anywhere but down over the next several years. Maybe that's why China is threatening to stop buying US Treasuries and calling for a serious discussion of a new world currency at the upcoming G-20 Summit on April 2. I will discuss this issue more in coming weeks.

CBO Assessment of Obama's Record 2010 Budget

In my March 10 E-Letter, I discussed President Obama's record $3.55 trillion budget for fiscal 2010, with its projected budget deficit of a record $1.75 trillion. I also discussed why I believe the deficit next year will be well north of $2 trillion. Last week, the supposedly non-partisan (but Democrat controlled) Congressional Budget Office (CBO) released its own analysis of President Obama's proposed budget for 2010 and the next 10 years.

The CBO estimates the 2010 budget deficit at $2.3 trillion; the budget deficits for 2009-2011 at almost $5 trillion; with deficits of $1 trillion or more each year thereafter to 2019, and concludes that Obama's budgets would add $9 trillion to the national debt over that 10-year period, if enacted.

If you recall, I noted in my March 10 letter that I believe the Obama administration used economic assumptions that were too optimistic. I pointed out that Obama's projections for GDP growth were too rosy. Likewise, I noted that his assumptions for unemployment were considerably too low. I concluded that discussion by saying: But it will not surprise me if the deficit is $2 trillion or more in 2010. Now the Democrat controlled CBO agrees with me!

Interestingly, Obama has routinely criticized George W. Bush for out-of-control spending, which is a well-deserved criticism. In Bush's eight years, he – with the help of Congress – added almost $5 trillion to the national debt. Obama's budgets would add almost twice that amount - $9 trillion - according to the CBO.

I think most people reading this would agree that a 2010 budget deficit of $2.3 trillion is simply way too much, even in this economic and financial crisis. While Obama says his budget is necessary to get the economy out of the ditch, it could make things worse by ruining America's credit standing in the world. Unfortunately, it looks like he has the votes to get most of his budget passed.

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, Market Implications & What To Do Now

The 20% bounce in the stock markets and the latest smattering of good news on the economy have led some analysts to conclude that the worst of the recession and the credit crisis are behind us. That could be, but the forecasters I respect believe we will see at least another 1-2 quarters when GDP will fall 6-7% or possibly more. So, I am not convinced we've seen the worst of the recession or the credit crisis. I hope I am wrong.

The good news (if we can call it that) is that the US was the first major economy to go into recession; it has suffered a more severe contraction than most other sizable economies, with the notable exception of Japan; and it would therefore be reasonable to assume the US will be one of the first major economies to turn the corner.

Yet in many ways, calling the bottom in the recession misses the point. Unlike past recessions that were followed by a strong recovery, I believe (and my best sources agree) that we face at least a couple of years of very slow growth when this recession ends. Yes, the government and the Fed are spending trillions like drunken sailors, but this economic and financial crisis is likely to put a damper on growth for at least several more years.

With that backdrop, investors have to consider the likelihood (or unlikelihood) that the US equity markets bottomed in early March. With the major market indexes having plunged over 50% from their peak in late 2007 to early March, it is easy to assume that we've seen the bottom. I, on the other hand, am not so convinced.

But that, too, misses the point in my opinion. Whether the bottom is in or not, I fully expect the equity markets to at least retest the lows seen early this month when the Dow fell to 6,500 and the S&P 500 fell to 675. And there is no guarantee that those lows will hold. Therefore, if you are looking to exit failed buy-and-hold positions in stocks, and move to more defensive strategies, I would suggest doing so now.

My greatest concern at this point is that the new Public-Private Investment Program may not work. As I have written in several recent letters, it is clear that relatively little of Obama's $787 billion stimulus plan will be spent this year when it is needed most. Thus, that means that it is even more critical that the PPIP get started quickly and that it succeeds. As noted earlier, there is no assurance that it will get up and running quickly, or that it will succeed (or if President Obama is fully behind it).

If the PPIP does not succeed, I would expect the US equity markets to plunge once again, and if so, buy-and-hold strategies will get hammered again.

If you have been considering alternatives to the buy-and-hold strategy for a portion of your equity portfolio, such as the active management programs I recommend – which can move to cash and/or hedge long positions - now may the time to get such strategies in place.

Remember, it does not matter where you live; we have hundreds of clients all across America.

Finally, we hosted our second Webinar with Scotia Partners on March 25. I'm very pleased to report that almost 300 of you registered for this opportunity to learn more about Scotia's very successful investment program. If you missed it, you can watch and listen to the full Webinar discussion (including all charts) at www.halbertwealth.com.

Hoping we can help you in these tough times,

Gary D. Halbert

SPECIAL ARTICLES:

Obama Budget - $9.3 Trillion in Deficits says CBO
http://news.yahoo.com/s/ap/20090320/ap_on_go_pr_wh/obama_budget

Obama Sticker Shock (more CBO budget analysis)
http://online.wsj.com/article/SB123776518094909023.html

Uncle Sam's Hedge Fund (the Geithner bank bailout plan)
http://www.realclearpolitics.com/articles/2009/03/uncle_sams_hedge_fund.html