Thoughts from the Frontline

My letter last week on Fed Governor Bernanke's speech drew a great deal of comment from readers. I still read every one of your letters to me, even though I cannot answer them all. Bill Gross of Pimco fame also weighed in on the implications of the speech this last week. Because I think this speech represents a defining moment for investors and our economy, we are going to touch upon points of it again, but from a different angle. I shall attempt to show why I disagree with some of the conclusions made by Gross.

Today we are going to look at a very important speech by new Federal Reserve Governor Ben Bernanke. I think this is one of the more important letters I have written in a while. The speech has received a lot of publicity for some of it's speculations about potential Fed policy. Some seem to find very dire and immediate negative implications in the speech. I, frankly, do not. However, I do think the speech is important because it gives us insight into the nature of the operational (and visceral) beliefs among the members of the Federal Reserve, and in giving us a roadmap for future Fed actions. It also gives us some hints as to future Fed actions.

Today we are going to look at the world economy, muse on why the dollar is holding its own and when and why it will drop. Then I make a few comments on the current stock market rally. Finally, in a departure from the normal letter, I am going to close the regular e-letter, but add a PS in the form of an essay on the risk of derivatives for those who find the subject interesting. The US Muddles Through The world economy is clearly not healthy. Let's look at the US, and then we will go around the world. The US economy grew at 3.1% for the last quarter, which ahs been loudly trumpeted by the cheerleaders on Wall Street. But digging down into the details, we find that if you take out the explosive growth in automobile sales caused by 0% financing, the growth was only 1.5%. The predictions are for a weak holiday buying season. Car sales are now down. Housing was down 11.4% in October, capacity utilization is almost back down to recession lows and the trade deficit widens. Retail store sales are slightly down.

Today we turn our attention to the question of retirement: Will the Boomer Generation be able to retire on time? Will Social Security go bankrupt? Is Harry Dent in his book The Roaring 2000s right when he asserts that we will have a boom until approximately 2008-9 because Boomers are saving and spending? And then watch as things go bust (an actual depression) because Boomers start selling stocks and retiring?

This week we will look at a fascinating debate between two well-known investment analysts, I show you how to spot a stock market cheerleader, and ponder the significance (if any) of what the surprising GOP win of the Senate portends for our investments. I am on the road as I begin to write this week's letter, speaking at the National Endowments and Foundations Symposium on the prospects for the economy and the markets for the coming year. Interestingly, when I spoke at this conference last year I was soundly taken to task by some pension/investment consultants for suggesting that the stock market would drop for a third straight year, even as the economy would Muddle Through.

Today we examine the deluge of month end data, which continues to confirm we are in the Muddle Through Economy. I politely respond to George Gilder (even after he called me a Keynesian and an economist) and look at the very long term implications of tax policy. There is a lot of very interesting ground to cover, so let's get started. As long time readers know, I am in the process of writing a book called Absolute Returns . The basic premise is that we are in a long term secular bear market cycle, which is likely to last for at least the rest of this decade. Therefore, investors will be wise to look for investment strategies that yield absolute returns. History and economic data suggest traditional mutual fund and index fund investors are likely to be disappointed over the rest of this decade, and perhaps longer.

Earlier this year I wrote that the deduction of option expenses and proper accounting for pension liabilities would become an issue, and that it was highly likely that when new accounting standards are adopted that these would be addressed. If so, then it would be a large drag upon future corporate earnings. These new accounting standards are going to create a glass ceiling, if you will, over the stock market.

Today we return to our assigned task of trying to find some patterns in the data to help us determine the direction of the economy and the markets. There are lots of bread crumbs on this trail, so let's see what conclusions they lead us to. First, the evidence mounts that we are still in what I call the Muddle Through Economy - a slow growth, no-new-jobs type of recovery that seems to be alternately teasing us with potential for growth and frustrating us with weakness. Weakness is winning.

Exactly what use is past performance? How can you spot a trend before it starts, and determine when it will stop? And when will the next big bear market rally start? This week we examine why so many investors fail, and why a few succeed over and over again. While I am sure that none of my regular readers make these mistakes, this will be a useful column to send to your friends who have not been as successful as you. Oh, yes, and I tell you how to know when the next big rally starts. Let's keep that detail to ourselves. No use tipping your friends on this one.

Today we are going to try and help you understand the strange action in the stock and bond markets. We are going to look into the future, and see if we can get a feel for what's around the curve in the road. Is it smooth driving, or are there some rocks in the road we need to avoid? Last week I asked, "What if they gave a Dollar Devaluation Party and no one came?" After a quick review, I am going to follow up on the implications of this theme, as I believe this is going to have a big impact upon the economy and your investments.

Today we are going to examine a war going on in the central banks of the world. The central banks of the world continue to do what is necessary to make their respective nation's products attractive to the American consumer, doing the best they can to make their currencies cheap. There are increasing calls for the US to let the dollar fall as a weapon in the war against deflation. Both can't happen at the same time. You don't want to let your investments get caught in the crossfire. There will be casualties. I am working later than usual on this letter, as thinking through the implications of a number of reports I have read this week is giving me some cause for concern. I am somewhat envious this evening of Roman soothsayers. I think it would be easier to analyze sheep entrails than the conflicting economic data coming out this week. At least we would have lamb chops afterward.

This week we are going to depart from the usual format of surveying the economic landscape for investment insights, and ask ourselves: "What type of returns should you expect from the stock market for the next 5, 10, or 20 years?" Over the long-term the Ibbotson study, used by stock market cheerleaders everywhere, says we should expect to make real returns of 6-7%. This statistic is used by brokers and fund managers who urge investors to buy and hold. Maybe more to the sales point, it is used by them to urge investors to buy some more stocks or mutual fund shares today and hold them as well. If you just keep buying, the study says you will get your reward, by and by.