Market Analysis...The Pause That Refreshes

The stock market slowed its ascent in November, pausing a bit to digest all the news and allow some profit taking. The broad equity markets were up between 1% and 1.50%, while the small caps gained another 3.5%. A positive quarter is now all but assured. Barring a bad December, which I don't think will happen, we can expect the Dow and S&P indices to be up over 20% for the year, and the Nasdaq to be up a blistering 50%. Shades of 1999. As I write this a few minutes after market closed on Friday, the Dow stands at 10,042, the highest mark in about eighteen months. While I expect the Dow to seesaw above and below 10,000 a few times, I think we'll be above that psychological barrier when we ring in the New Year. I said last month that the continuing benefits of economic and fiscal stimulus, rising corporate profits and the history of market outperformance during the third year of a presidential term, should result in a solid year-end. Add to that the strong historical performance in December and I think we're due for plenty of holiday cheer.

Earlier this week the Federal Reserve held short-term rates firm while repeating its commitment to keep rates low for a "considerable period" of time, but said that deflation fears had all but disappeared. They expressed the belief that the economy had an equal chance of inflation rates going up and going down. That is pretty much what I, and most experts, expected.

Bond investors continued to suffer in comparison to the high-flying stock mavens. Yields continued to trade in a narrow band. Bond prices appear to be discounting a very mild inflation rate of about 2.00% to 2.25%. I continue to believe that the yield on the 10-year treasury will remain under 4.50% through the end of the year. The problem for bond investors is that there is a greater likelihood of rate increases than rate decreases over the next year. I would stay away from the long end of the market right now.

I continue to believe that for the next few quarters the market will retain and maybe even build upon its gains. As a result, I remain heavily invested in stocks, albeit it in very defensive sectors. I remain very concerned about the future of our economy and our stock market. So while I am staying the course right now, I am prepared for the downturn that I believe is inevitable. Give me a call to find out what sectors of the market I favor and how I'm positioning my portfolios to capture the current gains yet protect against the potential decline.

Gold...Shining Even Brighter

The bull market in gold continued in October as prices traded up to $400. Early in December gold traded as high as $407. As good as those numbers are, I believe that this is just the tip of the iceberg. Gold continues to advance, consolidate, then advance further. Now that $400 has been broached, $450 is probably the next target. I continue to use price weakness to add to my positions in gold stocks.

Important Trends...Watch Those Deficits

The U.S. trade deficit rose another 4.4% in September to $41.3B for the month. The October figures should be released shortly. The trade deficit is now running at an annualized rate of $500B, and growing. At the same time, the federal budget deficit for the year ended September 30 was $375B. That is more than double the prior year. The deficit for 2004 is expected to top $500B, and will likely be much higher than that. The big question is how much longer this bill can be deferred before it is repaid? Who will eventually pay that bill? You and I? Our children? Our grandchildren? Right now, this debt is being financed by foreign countries who continue to buy our bonds. Foreign holdings of U.S. debt now tops $1 trillion. If that sentiment were to change for some reason, it would have a devastating affect on interest rates (which would go up) and our stock market (which would go down).

Concurrent with our growing national indebtedness is our growing personal indebtedness. The national savings rate is down to just over 2%. That is very ominous for the retail sector and the economy, which needs consumers to keep spending. Yet there appears to be no fear right now about the economy, and little discussion about how all of these debts will be repaid. You should know that by keeping short-term interest rates low, the government is giving you extra incentive to spend yourselves into debt now rather than save and invest for the future. Don't fall into the trap; the low interest rates means that you need to save and invest differently, not stop saving.

What does this all mean to you? It means that you should be more conscious of your personal debt levels. Are you at risk? Call me to discuss some of the options available to you. Try to avoid taking on any new unnecessary debt. Watch the national debt levels. If they get too high, interest rates may have to rise to draw further foreign investment from countries turned off by our low interest rates and worried by the falling value of the dollar. I'll talk more about the dollar next month.

Statistics to Watch...More Good News

• The annual growth in GDP for Q3 was officially pegged at 8.2%, up from the original estimate of 7.2%. While this suggests that the economy is running on all cylinders, growth in future quarters is sure to drop to more normal levels.

• New orders for manfuctured goods in October rose $7.3 billion, or 2.2%. This was the fifth increase in the last six months.

• The productivity of U.S. non-farm workers rose at an annual rate of 9.4% in Q3, which is the highest rate in 30 years. Businesses continue to do more with less.

• Personal income rose a meager 0.4% in October and spending levels remained flat. Thanks to productivity improvements people are working more for less. Eventually salaries will have to rise for the economy to continue to grow.

• Non-residential business spending was up 14% on an annualized basis while inventories dropped $14B in Q3. Businesses activity seems to be accelerating.

• The unemployment rate dropped to 5.9% in November. The initial weekly jobless claims averaged about 360,000 for the month. Total unemployment dropped to 8.67 million. The problem is that job growth seems to be in low paid service sectors rather than higher paid manufacturing jobs.

• Thanks to slightly higher mortgage rates, new home sales decreased 3.5% in October from the prior month. On a year over year basis, new home sales are up 10%. Existing home sales dropped 4.9% from the record levels set in September.

• The Consumer Confidence Index surged to 91.7 in October from 81.1 in October. Americans are increasinly happy about the state of the economy and about their prospects for improvement.

• In the middle of August the American Association of Individual Investors Sentiment was only 45% bullish. Last week that figure had risen to 69.4%. The bearish sentiment was a meager 14.4%. If you believe that the herd is usually wrong, these figures should give you some pause.

• The yield on the 10-year treasury dropped slightly from 4.44% on November 7 to 4.19% on December 8. The differential betweeen the Treasury and the TIPS has fallen slightly to 2.30% from 2.39% over that period. There seems to be little fear of rising inflation.

• Finally, a Chinese company called CTRIP.com Int'l recently went public in the U.S. and surged 89% on its first day of trading. Does that sound familiar? Does it sound like 1999 all over again? I find this very worrisome.

So what does all this mean to you? It means that there continues to be upward momentum in the economy and the stock market. Therefore, I think the short-term outlook is positive. I'm more concerned about the longer-term, specifically, what the economy and the stock market will look like at this time next year. I am greatly concerned by the twin dangers of massive trade and budget deficits, together with a deteriorating dollar. But for now, just enjoy the gains.

Financial Planning Suggestion...Some Year End Preparations

As the year comes to a close, it is a good time to do a little financial housecleaning and prepare for next year. Here are a few simple suggestions:

• Whenever possible, match up capital losses with capital gains to minimize taxes. If you haven't already done so, speak with me, your financial advisor or your tax preparer to ensure that your tax bill will be as low as possible.

• Review the allocations in your investment accounts, especially your 401(k) and make sure that your investments are properly adjusted. If you are not sure what to do, give me a call and I'll help you out.

• If you have a company sponsored retirement plan, call the administrator and find out if you made the maximum possible contribution this year. If you didn't, consider increasing your contribution next year to take advantage of the pre-tax savings. At a minimum, make sure you capture any company matched savings. If you don't, you are throwing away free money.

• If you have a flexible spending account for health care expenses, see if you have any money left. If you do, spend it. Those accounts are "use it or lose it".

• Speak with your accountant to determine the proper amount of withholding for next year. The tax cuts enacted this year may affect your paycheck next year.

• Use any year-end bonus money to reduce or eliminate personal debt.

• Pull out all of your insurance policies and review them. Focus on your property and casualty policies. If they haven't been updated within the past two or three years, they probably don't reflect your current status. If you have an old term life policy, you could probably write a new one with a much lower premium. I'll be happy to review your policies with you.

• If you don't already have them written and up-to-date, consider writing a will, a living will and a health care proxy. These are important documents and deserve your careful and immediate attention.

You Are Important

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Personal News and Notes

On Friday, December 5, I again appeared as a guest analyst on "Your World with Neil Cavuto" on the Fox News channel. That was my second appearance in less than a month. Next week, from 11:30 - 12:00 on Saturday morning, December 20 I will appear on "Cashin' In" with Terry Keenan. I now have the video of the first appearance with Neil Cavuto on my website. I hope to have last week's up shortly.

With Hannukah and Christmas coming up quickly I'd like to wish each and every one of you a safe holiday season and a healthy, happy and prosperous New Year. I would also suggest that you take a moment and think about how you can make the holiday a little better for someone less fortunate. Whether it be a gift for child, a coat for a homeless person, a meal for someone hungry, or just a donation to a worthy organization, this simple act can be repaid to you many times over. I look forward to writing to you again in 2004.

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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