The results from February started to reveal some cracks in the bull market as the growth segments of the market, particularly the Nasdaq, turned down a bit. While the overall results for the first two months are still pretty strong, concerns exist, as evidenced by the terrible market action so far this month. Chief among my concerns is the continued joblessness of this recovery. Each month I've highlighted jobs and deficits as my two greatest worries. I think the stock market is finally beginning to share my concerns. The recent terrorist attacks in Spain have further spooked the markets as fears of further acts of terror weigh on the minds of investors.

For the past two months I've mentioned that it will be important for the Dow to stay above 10,000 in any pullback and that it will be critical for the Dow to eventually crack 11,000 in order for this rally to have legs. Last month the Dow set a new high of over 10,750. It never did make it to 11,000. Instead the market has fallen about 650 points in the past five weeks. As I write today, the Dow closed at 10,102. This could simply be profit-taking and consolidation, or it could augur something more ominous. On a technical basis, the market looks bad; the Nasdaq has fallen below 2,000, the S&P 500 is rapidly approaching 1,000 and the Dow is sliding towards 10,000. Pay careful attention to the Dow. If it drops below 10,000, it could be a slippery slope to far greater losses.

As stocks have weakened in the face of mediocre economic news, bonds have gained strength, pushing yields down even further. The brief sell-off resulting from the comments made last month by the Federal Reserve has been completely reversed and mostly forgotten. I don't think any reasonable analyst expects a Fed tightening any time soon. Let me reiterate a point I made last month, because it is even more true today: the lack of job growth and corporate pricing power, the deflationary effects of China and India and the growing personal and governmental debt loads are all working to keep rates low. If this keeps up, you may again see articles in the press expressing concerns about deflation as fears of inflation abate.

The bond market's recent surge has dropped the yield on the 10 year treasury to about 3.75%. The differential between the treasury and the TIPS remains under 2.5%. This means that the bond market sees little to no inflation ahead. I happily maintain my prediction that 10-year treasury rates will stay below 4.5% for the first half of the year. In fact, it now appears that rates may stay below 4.5% for the entire year.

I'm growing more cautious about the market with every passing day, especially in light of the precipitous drop over the past week or so. I think the downside risks are greater than the upside potential right now. I've continued to take profits in some of my biggest winners while focusing the bulk of my investments on certain key defensive sectors. This strategy of dynamic sector rotation has my clients well-positioned to handle whatever the market can throw at us. Feel free to give me a call to find out how you can benefit from this strategy.

Rather than just focus on gold here, I thought I'd expand this section to other commodities because that's where the action is in the market today. Whether it be oil, copper, gold, steel, nickel or natural gas, the prices of commodities are soaring right now for a variety of reasons. One big reason is the drop in the value of the dollar, which makes it more expensive, in dollar terms, to import raw materials. The prices of commodities are soaring thanks in part to increased worldwide demand and diminished supplies (this is especially true of oil and gas). Much of that demand is due to the voracious appetite in China for raw materials of all kinds. Although inflation is quiescent in most sectors of the economy, inflation is rampant in commodities as prices are rising across the board.

As a result, I think that all investors should have a core position in commodities right now. This can be done with equities, ETF's, mutual funds or futures. How the investment is made can differ from investor to investor, depending upon the dollars involved and the risk tolerance. As with any investment, it should be done after consulting with your financial advisor.

It was announced this week that the US trade deficit for fiscal 2003 hit a record high of $489 billion. That was 17% higher than the highest previous record. Then in January, the deficit hit a new monthly record of $43.1 billion. If we hold that level, the trade deficit will exceed $500 billion in 2004. Below is a graph that clearly demonstrates the growing problem.

One would think that the volume of imports would be falling along with the value of the dollar, but that just isn't the case. In fact, as the graph clearly shows, imports are growing at a much faster pace than exports. Sooner or later, we will have to pay the bill for these deficits. Other countries will not finance this trade gap forever.

At the same time, the US budget deficit is projected by the Congressional Budget Office (CBO)to be $480 billion for fiscal 2004. I'm sure it will end up far exceeding $500 billion due to the war effort and homeland defense issues. As the budget deficit grows, so does the amount of treasury debt held by foreign countries. In December of 2003, foreign investors held $1.53 trillion of US debt, up from $1.24 trillion only twelve months earlier. That is about 36% of the total outstanding issuance of treasuries. Almost 50% of that $1.5 trillion is held by Japan and China. Japan in particular is doing everything in their monetary power to maintain low interest rates in America because they need our economy to be humming along in order to support their economy. Japan has bought $250 billion worth of treasuries since November. Again, at some point, these debtholders may want their money back if they find our interest rates too low, or if they get fed up with losing money due to the falling value of the dollar. For the time being though, they remain willing and able to keep buying our debt.

You may be asking what all of that means to you. It means that sooner or later, the bill for all of this borrowing is going to have to be paid. That bill can come in a number of possible ways: higher taxes, higher interest rates, higher inflation, dramatically lower imports, a lower standard of living and a substantially lower stock market. I'm not saying that all of these things will happen, just that some of them will happen. I also don't know when they will happen, but I do believe that eventually, they will happen.

• Total non-farm payrolls increased by a meager 21,000 in February, after increasing by 112,000 in January (although 90% of those were seasonal jobs in retail and construction). Over 150,000 new jobs need to be created each month just to keep up with the population growth, and that is far below the 300,000 new jobs per month estimated by the Bush adminstration.

• The unemployment rates remains a seemingly low 5.6%. Yet 8.2 million people remain unemployed, and another 1.7 million people are considered "marginally attached" to the labor force. They are not employed, yet they are not considered unemployed either because they haven't looked for work recently. So we really have about 10 million people that are unemployed. Add to that the 4.4 million part-time workers who would like full-time work, and the "underemployment" rate skyrockets to 11.8%.

• The Consumer Confidence Index fell sharply to 87.3 this month from 96.8 last month, indicating that people are growing more concerned about the economy.

• The current national debt is over $7 trillion. That's not a typo.

• The American Association of Individual Investors bullish sentiment fell from 56.9% to 47.8%. The average investor is growing increasingly uneasy.

• According to the US Census Bureau, sales of new single family homes in January fell 1.7% from December to 1.1 million units. While the overall numbers are still historically strong, they have fallen to their lowest level in seven months. With the recent return of incredibly low interest rates, I think we'll see a pickup in the housing market shortly.

• The Fed continues to open the monetary floodgates. The problem is that the money does not seem to be circulating enough to truly benefit the economy. The rate at which money is exchanged from one transaction to another is called "velocity". Without velocity the economy doesn't reap the benefits of the increased money supply.

• The dollar has improved slightly, as it now trades at around 1.22 Euro's, up from 1.28 Euro's a few weeks ago.

• The yield on the 10-year treasury closed today at 3.76% while the 10-year TIPS is priced to yield 1.45%. The spread of 2.3% tells us that inflation fears are minimal.

• Mortgage rates have fallen to new lows. 30-year fixed rate mortgages are back down to around 5.0% and 1-year ARMs can be had for under 3.0%. This should spur a new round of refinancing for those who missed out last time.

So what does all this mean to you? The housing market should continue to be very strong, and refinances should boom again. The economy continues to show strength and weakness, but trouble looms. Sooner or later, we must reduce the federal budget and trade deficits. We must create more high-paying jobs. And we will have to maintain incredibly low interest rates. Unless these things happen the economy, along with the stock and bond markets, will fall.

This month I'm going to revisit some old topics and offer some important reminders. The most important thing to consider is that you should review your various insurance policies every year to make sure that you have the proper coverage. And what coverages should you have? Depending upon your age and marital situation, you could have auto, homeowner's (or renter's), an umbrella policy, life, disability and possibly long-term care (which I spoke about at length last month, and will therefore not write about today). A good insurance agent can help review all of this with you to determine the appropriate amount of coverages.

The easiest policy to review is probably your auto policy. I suggest to each of my clients that the first thing they should do is adjust their deductible to $1,000. There is really no reason to have a smaller deductible, because it is unlikely to be able to do any damage to your car that will cost less than $1,000 to repair, and if it happened, you'd probably repair it yourself rather than put in a claim. You should also look at window replacement, a car rental provision and the proper levels of personal injury coverage. For older cars, you can potentially adjust or even remove collision coverage.

Next, take a look at your homeowner's policy. Again, the first thing to do is probably to adjust the deductible to $1,000. Next, make sure you have the appropriate amount of coverage. If you haven't looked at your policy in the past couple of years, chances are you are underinsured. The higher the value of your home, the more important your choice in carriers. For expensive homes, or unique homes, there are only a few carriers that provide the type of coverage that will protect that investment. Also keep in mind that not all "replacement value" policies are the same. Be very careful to study the language. The policy is a contract and details exactly what the coverage is. In the case of catastrophic loss, do you want your home rebuilt as it was or do you want a check? Are you sure that your current coverage will even rebuild your house?

As you update your home and auto policies, you should also write, or maybe adjust, an umbrella policy. The umbrella liability policy performs two separate functions, the net effect of which is to superimpose a blanket of added protection on top of the individual's other liability coverages. The first function is to provide coverage in excess of that provided by your basic insurance. For example, if you were sued for $500,000 after a car accident, and your maximum coverage was only $300,000, the umbrella coverage would pay the remaining $200,000. The second function is to provide broader coverage than that provided by your basic contracts. This would give you coverage when your basic contracts may exclude certain claims. The nice thing about umbrella policies is that they are relatively inexpensive to purchase. In fact, you might be able to buy coverage with the savings earned by increasing the deductibles on your home and auto policies.

Next is life insurance. For the purpose of this discussion, I'm going to ignore whole or variable life policies and just focus on term. The reason is that, for those who qualify, term life insurance has become incredibly inexpensive. If you have a spouse, children, or any other loved one, buying term life insurance is the easiest, most inexpensive way to insure that they will be taken care of if something should happen to you. So if you don't yet have any life insurance, or you have an old policy, now is a great time to shop around for a new policy and reap the benefits of the low rates.

The last type of insurance I'm going to talk about is disability. In this case, I am talking about disability income insurance, not medical expense insurance, which many of us receive through our employer. Broadly speaking, disability coverage provides for periodic payments to the insured person when he or she is unable to work because of illness or injury. Generally speaking, I suggest that you purchase individual disability insurance rather than rely on whatever group disability policy may be available to you through your job. There are many different provisions and coverages in a disability policy; make sure you purchase the coverage that is best for you.

I can't emphasize enough how important it is to have the right insurance coverage. You may never need it, but can you afford not to have it? Imagine having to write a check for $150,000 to make up for the lack of coverage on your house. Or $500,000 to settle a lawsuit that an umbrella policy would have covered completely. If you don't already have a good insurance agent, please ask your friends for referrals to someone that they know and trust. As always, if I can help, please don't hesitate to give me a call.

I managed to survive the "all-Martha" coverage during my last appearance on Fox News the day she was convicted. I was supposed to talk about unemployment but ended up discussing the merits of her conviction and her stock. I would rather have talked about unemployment. If you missed the show, I hope to have the video posted to my website shortly.

I have begun writing my chapter on dynamic sector rotation investing for "The Black Book On Personal Finance". Now that this newsletter is finished, I can focus more of my time on that effort. The publisher hopes to have the book in stores this Spring. I expect each of you to pick up a copy (or two!). I'll share more details with you over the next couple of months as publication gets closer.

This week I commenced a project to create an all new website for WAM. I expect to have that site up and running in May. I will be looking for some beta testers to help me create the best possible experience for my clients, prospects and readers. If you are interested in helping, please let me know.

I will be heading up to Boston the weekend of March 25 - 28. If you live in the area, and would like to schedule a meeting, please send me a note or give me a call. I will also be spending a week in California the week of May 17 - 23. My time will be evenly split between Los Angeles and San Francisco. Again, if you would like to get together, please let me know. I don't make it out West too often, so this would be a great opportunity to schedule a face to face meeting.

As always, I thank you for your interest and consideration, and invite you to write or call me if you have any questions or if I can be of service to you in any way. By the time I write to you again, I hope the snow will be gone for good and that Spring will be in full bloom.

Best regards,

Greg Werlinich
President
Werlinich Asset Management, LLC
400 Columbus Ave.
Valhalla, NY 10595
914-741-6839
800-746-6929
greg@waminvest.com
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