Monitor These Developments Closely

November 28, 2003
Mark Boucher

I
wish all investors a very happy Thanksgiving holiday period.
We all have so many gifts to be thankful for. It is during this time of year
that we especially need to remind ourselves that every day of life is a magical
miracle to be thankful for. I am also thankful to have such wonderful readers.
Enjoy the holidays.

The column below may seem somewhat
inconsistent with the good feeling of being thankful. I believe that recent
actions need to be carefully understood by investors as quickly as possible,
despite the poor timing of the topic.

In my book, The
Hedge Fund Edge I discuss the importance of what I call the long-term growth
paradigm: Increased savings leads to increased capital leading to increased
capital investment. Increased capital investment plus the mobility of capital
and the size of technology gaps (created by new innovations) lead to increased
marginal productivity of capital. And increased productivity of capital is the
magic formula that leads to increasing growth, increasing wages, increasing
employment, and decreasing poverty rates. I also discuss how negative tax policies
and policies limiting free trade and capital mobility (economic freedom in essence)
can cut potential growth for a country. I look at how those countries with the
lowest economic freedom are the poorest and those with the highest economic
freedom are the richest and have the most robust growth, and how trends toward
more free trade and free economics correlate highly with strong stock markets
in each country, while trends toward less free trade and less free economies
correlate with negative periods in a country stock market.

In my monthly letter, Portfolio
Strategy Letter, I keep track of our ELPC (Economic, Liquidity, Policy Composite)
which attempts to quantify government policy shifts relating to taxes, regulation,
free trade, and a whole host of other areas. For the first time since Reagan
was elected, our policy composite is flashing SIGNIFICANT
warning signs for the US that may have negative global impact . This may or
may not effect your portfolio today or tomorrow, but in the long-run it could
be very critical to the growth potential of the economy and the market as whole.

In three very important long-run
categories of policy that we keep track of in our ELPC, the US is displaying
worrying signs that investors should now begin monitoring carefully.

The first is the mobility
and freedom of capital, the essence of freedom itself. Iâ€™m about the farthest
thing from being a fan of Al Gore. But Al Gore hit the nail on the head last
week with his comments about the negative effects of the Patriot Act. The Patriot
Act has made moving capital internationally a nightmare around the world. The
increase in regulation for US and offshore financial institutions at US insistence
is staggering. Honest US taxpayers who want to bring $10,000 or more out of
the country privately are turned into â€œterrorist smugglersâ€ and
the Supreme Court ruling that seizure of such assets is punishment beyond the
damage of the crime has been overridden by legislature in the Patriot Act. The
government has claimed the ability to spy on and monitor your financial movements
without any need to show cause in a truly Orwellian sense.

And the US is pushing other
nations to help it in this financial police state. Freedom of mobility of capital
to find whatever investment in whatever country it sees fit is a necessary component
of global growth and global economic efficiency. Recent policy is deteriorating
this inalienable right for all Americans and for all global economic participants
in a way that investors need to monitor carefully. When you canâ€™t move
your money freely, you canâ€™t grow nearly as fast. Itâ€™s that simple.
Not one dollar of terrorist money came from honest peaceful US citizens trying
to move their money out of the country, yet this group is being attacked. Further
Patriot Act moves to violate your privacy and to impede your ability to move
your after-tax money wherever you please with ease, will only denigrate the
growth potential of America.

The second frightening category of
US policy is the budding mini trade war. Free trade is the veins through which
global growth flows. The Bush Administration, for some unknown reason, is starting
mini trade wars with China and Europe. Japan, Europe, and China have all threatened
retaliation. Steel tariffs and bra tariffs will not help fuel global growth.
One of the pillars of the global growth expansion since the early 1980â€™s
has been the expansion of global free trade. One of the pillars of the depression
was trade wars and contraction in global trade. Bush is probably playing an
election-time game of chicken in a ploy to get votes, but further expansion
of this trade war will be a huge potential negative for decades to come.

The third category of negative
US policy is the Medicare bill. The newly signed Medicare bill represents the
biggest expansion of the welfare state since the disastrous Great Society programs
of the 1960s. It is a return to Statism and Socialism in a way that the US has
not seen since Lyndon Johnson. At exactly the time when the medical system needed
leadership to privatize it before the demographic bomb of baby-boom retirement
hits, government is nationalizing much of the prescription drug market for seniors.
In the 1960s, estimates of the original Medicare program proved to be 400% understated
in the first decade alone, and substantially worse thereafter.

This time, government projections
are that the new drug program will cost $400 billion over the next decade. But
the real explosion in costs will come after more of the baby boom begins to
retire in the second decade ahead. With the Medicare â€œtrust fundâ€
already chronically in the red, the solution needed was a cut-back in government
and privatization of the system, not the most massive expansion in Medicare
proposed since the 1960s. Especially when biotech and nanotech revolutions are
being developed, what is most needed is to allow the free markets to work their
miracles on the health care system and what is least needed is an expansion
of the role of government further into health care.

The National Taxpayers Union
reports that the new Medicare system will consume nearly 40% of the nationâ€™s
GDP after several decades, requiring vastly higher payroll taxes on younger
workers. Yet another transfer from the unrepresented youth of America (what
happened to â€œno taxation without representationâ€?) to the politically
influential older Americans has developed at a time when the opposite action
is so badly needed. Entitlement programs need to be reversed and privatized,
not expanded, and especially not now, just before the boomers retirement impact
is felt on the economy.

The current super-growth
in the US is encouraging and is in line with what we had been advising investors
to expect. We continue to believe that employment growth is not far behind.
Yet investors need to understand that this growth is fueled mainly by fiscal
and monetary stimulus and not by a solid foundation for long-term growth. It
is most troubling to see government policy errors of the type listed above occurring
with alarming frequency, while PEs are at nosebleed levels and the long-term
non-inflationary growth levels of the US remain a question-mark.

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-06.gif” />

Investors need to beware
of George W. Bush becoming not a new Reagan, but a new Lyndon Johnson instead.
Watch for further such actions as an indication to move money out of stocks,
into gold and inflation hedges, and out the dollar and the US. In the meantime,

letâ€™s not forget that when Clinton tried to socialize the medical system
even more comprehensively he got a clear message from the voters that this was
not what they wanted and he switched tacts. Perhaps enough opposition to these
policies can work wonders on Bush as well, before too much damage is done.

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-05.gif” />

The market situation remains
unchanged. The main trend continues to be up for both US and global equities,
but things are overdone in most markets and they are therefore vulnerable to
setbacks at any time. Massive fiscal and monetary stimulus has worked its magic
in terms of starting the fire of recovery â€” now lets see how that fire
catches in terms of profit-growth.

Letâ€™s add to the dangers
most likely to could derail the recovery that investors need to watch: 1) a
global bond route, 2) a dollar crash, 3) a renewed oil crunch and price surge,
4) a major terrorist action that breaks the back of consumer confidence, 5)
continued expansion of negative trade wars, 6) further deterioration in capital
mobility from Patriot Act expansion, or 7) negative impacts from socialist entitlement
expansion.

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-07.gif” />

Our US long/short model
is doing reasonable well considering the low level of allocation it has had.
We have long encouraged investors to supplement this strategy with or favorite
foreign and global asset plays. Investors should continue to cautiously add
stock exposure as trade signals are generated that meet our strict criteria,
as well as allocate to our favorite segments. Our model portfolio followed in
TradingMarkets.com with specific entry/exit/ops levels from 1999 through May
of 2003 was up 41% in 1999, 82% in 2000, 16.5% in 2001, 7.58% in 2002, and we
stopped specific recommendations up around 5% in May 2003 (strict following
of our US only methodologies should have portfolios up over 11% ytd by our calculations)
â€” all on worst drawdown of under 7%.

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-01.gif” />

Last week in our Top RS/EPS
New Highs list published on TradingMarkets.com, we had readings of 24, 16, 58,
81, and ??, accompanied by 13+ breakouts of 4+ week ranges, no valid trades
and no close calls. Internal strength has come back SOME, but still remains
slightly suspicious. Position in valid 4 week trading range breakouts on stocks
meeting our criteria or in close calls that are in clearly leading industries,
in a diversified fashion. Bottom RS/EPS New Lows remained nearly non-existent
with readings of 3, 2, 3, 2, and ?? with two breakdowns of a 4+ week ranges,
one valid trade in
(
DO |
Quote |
Chart |
News |
PowerRating) and no close calls.

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-02.gif” />

For those not familiar with
our long/short strategies, we suggest you review my book The
Hedge Fund Edge, my course “The Science Of Trading,” The
Science Of Trading,” video
seminar, where I discuss many new techniques, and my latest educational
product, the interactive training module. Basically, we have rigorous criteria
for potential long stocks that we call “up-fuel,” as well as rigorous criteria
for potential short stocks that we call “down-fuel.” Each day we review the
list of new highs on our Top
RS and EPS New High List” published on TradingMarkets.com for breakouts
of four-week or longer flags, or of valid cup-and-handles of more than four
weeks. Buy trades are taken only on valid breakouts of stocks that also meet
our up-fuel criteria.

Shorts are similarly taken
only in stocks meeting our down-fuel criteria that have valid breakdowns of
four-plus-week flags or cup and handles on the downside. In the U.S. market,
continue to only buy or short stocks in leading or lagging industries according
to our group and sub-group new high and low lists. We continue to buy new long
signals and sell short new short signals until our portfolio is 100% long and
100% short (less aggressive investors stop at 50% long and 50% short). In early
March of 2000, we took half-profits on nearly all positions and lightened up
considerably as a sea of change in the new-economy/old-economy theme appeared
to be upon us. We’ve been effectively defensive ever since.

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-04.gif” />

src=”https://tradingmarkets.com/media/2003/Boucher/mb112803-03.gif” />

The tightrope just keeps
being pulled tighter and tighter and the path toward long-term growth grows
narrower and narrower. We suspect a correction or further consolidation looms
soon, though the main trend remains up. Risks have risen substantially however.
Yet if rates stay down and negative long-term stories donâ€™t become too
overpowering, a mini-mania could develop. On the other hand a shock could tank
this market so quickly it would make you dizzy. Thus investors need to remain
very watchful and very nimble and be willing to pull the plug at any time. Investors
are advised to remain extremely flexible.

Mark Boucher

Monitor These Developments Closely

BUY THE FEAR, SELL THE GREED

Quick Links

Company Info

Contact

Company Resources