Robert Boshnack, Chairman Vision LP.

The major stock indices ended 2003 on a strong note, with the venerable Dow Jones Industrial Average rising an impressive 25%. Might this be construed the beginning of a new bull market? Putting things in proper perspective, the across-the-board gain in the major indices comes after three years of severe losses. The Nasdaq, in one glaring example, still down approximately 55% from its peak in March 2000, will have to rise over 100% just to get back to its pre-bear market high. The sobering fact: Investors are back to where they were approximately five years ago, and even with the sturdy gains of 2003, they have almost nothing to show for their efforts over the past five years!

The Year That Was

In 2003, we witnessed consumer demand on steroids, fueled by tax cuts, an extremely accommodative monetary policy, record low interest rates and massive mortgage refinancing. This potent brew interacted nicely, launching an economic rebound underpinned by strong corporate earnings.

The 25% rise in the Dow in 2003 is in line with historical secular bear market rallies. The stock market has risen, often by more than 20%, in half of the years of every secular bear market in history. The U.S. market experienced 13 rallies in excess of 30% during its secular bear markets of 1902-21, 1929-49 and 1966-82. Correspondingly, since the market topped in 2000, we've had at least 6 strong rallies.

Fierce rallies are typical in bear markets. They serve to convince investors that the old bear market is over and a new bull market is on the way, eventually providing fuel for the next big decline, as disillusioned bulls exit the market. For example, during a 27-month span that began in April 1930, there were seven major market rallies. The average rise was 24%. Even with the rallies, it took the market 25 years to recover to its previous highs.

The Stuff of Real Bull Markets

The stimuli that propelled the market in 2003 convince us even more that we remain mired in a long-term secular bear market. Why?

Let's analyze the factors that led to the market rally in 2003, and it's current fundamentals. The market was propelled in 2003 by a steroid-like mix of tax cuts, highly accommodative monetary policy, record low interest rates and massive mortgage refinancing. Steroids, as most of us have learned, provide short-term solutions for optimizing an athlete's performance, but they also come with long-term consequences. Likewise, "market steroids" amount to no more than temporary band aids, obscuring a problem that will not disappear so easily.

True bull markets are long-term in character, drug-free and based on a "pink" economy able to produce sustainable growth in capital investment, yield corporate profits and create jobs. Unfortunately, the conditions in this economy dictate the opposite.

The By Products of a Short Term Fix

When he said "Give me a trillion dollars and I'll show you a good time, "Warren Buffet was adroitly describing the current economic recovery. Buffet, of course, was alluding to the highly accommodative monetary policy of the Federal government whose budget went from surplus to deficit -a swing of more than $700 billion- over an 18-month period. Aggressively cutting interest rates in rapid succession, the Federal Reserve Board ignited the housing market, which injected hundreds of billions of dollars into the economy through mortgage refinancing and new construction.

All this easy money from deficit spending is quite worrisome longer term for the market and the economy. By mortgaging their homes to the maximum, Americans have transformed assets into liabilities, trading real wealth that has been built up over generations for the quick fix of debt. Home equity has fallen to its lowest level since the government began tracking statistics in 1965. American debt is now over 100% of income and three times the size of the U.S. economy. This is clearly unsustainable! The consumer is the engine of the U.S. economy. Where will he get the money to keep the economy strong, when job creation is faltering, and when the money available from tax cuts and spent from mortgage refinancing is no more?

Current government deficit spending is now the largest in U.S. history. Is it any wonder why the U.S. dollar has lost 20% of its value in 2003? The last time the trade deficit reached record levels was in the mid-1980s. This chapter in our history produced a 57% fall in the dollar, starting in 1985. With 2004 an election year, we doubt the government, hoping not to derail the economy, will practice fiscal restraint. Rather, we see a repeat of what occurred during the Nixon administration when, in 1970, the White House ramped up federal spending in a pre-election bid to juice up the economy and financial markets. It worked, but soon afterward, "judgment day" came, and the economy, stock and bond markets imploded.

The Nixon era taught us that artificial stimulation of the economy via big tax and interest rate cuts can backfire; and running big deficits can be particularly dangerous when foreigners finance them. (Today, foreigners hold roughly 40% of all U.S. debt!)

Loss of American Jobs

Job creation is an important part of any strong economy. Jobs supply a steady on-going money stream that feeds the economy long-term, unlike the short-term temporary support afforded by tax cuts and mortgage refinancing. A very alarming trend is developing that is having an unsettling effect on the economy. According to the bureau of Labor Statistics, since 2001 the private sector has lost 2.9 million jobs. At first the jobs were primarily blue collar manufacturing jobs. Now, white collar, high tech and service sector jobs are being lost to overseas workers. This "off shoring" of jobs to countries like India, and China, where even skilled labor is cheap, is ominous for the U.S. economy and stock market in the years ahead.

Understanding the Big Picture

It's important investors realize in 2000 we ended one of the biggest, speculative bull markets in history, where stocks rose to absurdly high levels that were nowhere near justified by their earnings. And secular bear markets traditionally follow "super-bull" markets. The key to understanding the stock market is to understand that the bigger the boom, the bigger the bust and the longer it takes for the market to recover. We've seen this in the "new era" bull markets that peaked in 1901, 1929 and 1966.With regard to each of these, post-peak, returns averaged 1.9% to a negative 0.2% for a period of almost 20 years. In retrospect, when the bear market began for each of these secular markets, few investors realized or ever imagined a 20-year period of famine would ensue -one that would post average returns from a scant 1.9% to a negative 0.2%!

Why, we ask, should we assume the present recovery will be any shorter than it was for each of the three bear markets described, especially in light of the fact that the bull market leading to this bear market was even stronger, more excessive and financially more damaging than all of its predecessors? For investors' financial well being we urge them not to delude themselves, or be swayed by self-serving "cheerleaders." The excessive over capacity and debt caused by the biggest financial bubble in history will take many years to unwind, contributing to the stock market's overall underperformance for the foreseeable future!

Overvaluation: Too Much Price, Not Enough Earnings

According to John Mauldin, the well-respected editor of "John Mauldin E-Letter," the stock market's valuation is higher than the previous tops achieved during any previous bull market. According to Mauldin:

"There has never been a secular bear market cycle in history that has ended with P/E ratios at the level they are today. That is why I believe the market has a long way to go on the downside, and why this cycle will probably last for years"

Mauldin also notes, "there has never been a time in history when the P/E ratios were in the range they are today, that 10 years later, investors in the broad stock market made a penny. None!"

Yale professor Robert Shiller, who called the top of the market in his famous book, "Irrational Exuberance" supports Mauldin's research. According to Shiller, from today's high P/E ratios, ten years hence, there has never been a time when investors saw better returns than simply parking their money in a money market fund.

One of today's most successful money managers, Warren Buffet, also believes the market is seriously overvalued. In his 2003 annual shareholder letter, he states:

"Despite three years of falling prices, which has significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuation reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge."

Bear in mind, the market can be overvalued longer than logic dictates. We saw that in the 1990s go-go years of the stock market before the bubble burst. Once the bear market strikes again, the market's overvaluation will probably lead to significantly more downside risk, similar to what happened in 2000.

The Most Attractive Investment in 2004!

If you wanted to cause a mean batch of inflation what would you do? This was a rhetorical question answered by Jim Paulsen, chief investment officer of Wells Capital Management, in a December 2003 Wall Street Journal article, "Some Fear Inflation Is Ready for a Comeback." Said Paulsen:

"I would flood the system with money far in excess of economic growth. I would take interest rates to the lowest level possible. I would have the government spend like a banshee. I would drop the value of the dollar, and finally would take any capacity growth or additional supply growth and stop it. As a garish, add rising commodity prices and a growing trade deficit mixed with rising trade tensions."

An astute observer of current economic conditions knows Paulsen's inflation recipe has already been made!

Over the past two years we have had the "mother of all stimuli" impact the US economy. The government has kept the presses working overtime, printing money backed only by good faith. In the process, our budget, and trade deficits have reached record levels. Cutting interest rates to practically zero, the government lit up the housing market, adding hundreds of billions of dollars to the economy through mortgage refinancing and construction.

Due to the almost uninterrupted growth of the US budget and the trade deficits, the depreciating US dollar, strengthening global economies and ever increasing demand from raw material 'starved'? nations like China, we are at the beginning stages of what many believe will be a sustained major bull move in commodity markets.

There isn't any market to our knowledge that is more impacted, or better equipped to potentially capitalize on inflation than the commodities markets! Over the last century, we have experienced only five bull markets in commodities, or one, on average, every 20-30 years, usually caused by growing inflation!

Few investors realized the start of a major bull market in stocks in the 1980s. Similarly, relatively few investors realize a major bull market in commodities is just beginning. The fact is commodity indices have outperformed a variety of asset classes, among them stocks, bonds and even real estate over the past 5 years, where the Rodgers International Commodity Index as an example has risen 100%!

Bridgewater Associates, a well-known economic forecasting firm agrees, suggesting "We are in the midst of the most powerful commodity price move in the last 22 years."

Perhaps the most visible proponent of commodities comes from one of the least expected quarters-?Pimco's Bill Gross, the largest fund manager in the world! In his December 2003 "Investment Outlook," Gross's number one and two investment asset classes are commodities followed by foreign currencies.

Just the Beginning!

2004 Market Outlook

Although there are serious underlying problems that can spiral out of control, negatively impacting the market in 2004, we believe the "day of reckoning," won't occur until after the presidential election.

The key to the direction of the market will be interest rates. Historically most bear markets have been triggered by a reversal in interest rates. We feel that inflation is still low enough for the Federal Reserve Board to be accommodative in its monetary policy. Any interest rate increases, we believe, will not occur until the latter part of the year, and will be mild enough not to spook the markets and derail the economy. Historically, presidential election years have been positive for the stock market. We believe 2004 will prove true to form.

We caution, however, not to expect returns anywhere near the generous 25% bestowed upon the Dow in 2003! Instead, we expect to see more modest returns, closer to 7%. Please note that this is our view of the market for 2004. The results of the Dow could vary greatly from this projection.

Stocks are a leading indicator; they tend to rise in anticipation of economic recoveries, not in response to them. They increase the most when earnings first recover. Historically speaking, the largest market gains tend to come at the start of an economic rebound, where the market "prices in" future earning gains. This is precisely what we believe happened in 2003. Most of the gains in last year's stock market are already factored in!

However, we are of a mind that the gains achieved in many stocks will prove to be unsustainable, similar to when the market topped in the year 2000. Here is one glaring example, one that may prove more the rule than the exception: E-Bay sells for over 80 times earnings. The Street.Com calculates that E-Bay's earnings would have to rise 40% per year for the next 5 years to justify its price. That's what we mean by unsustainable!

The Federal Government, with the help of the Federal Reserve, has freely employed "market steroids" to pump up the economy and stock market, but at a tremendous cost to our national balance sheet. Unfortunately, we believe, as occurred in the Nixon presidency, the real bear market lies ahead of, not behind us. For now, the music is playing and everyone is dancing. Beware when the music stops!

We believe the stock market is in a secular bear market rally, with most of the gains from the rally already seen. On the other hand, the long dormant commodities markets are now in the throes of a major new bull market imbued with significant upside potential. For suitable investors, commodities are the place to be! Past performance is not necessarily indicative of future results. The risk of loss exists in futures trading. An investor could potentially lose more than the initial investment.

The commodities that are receiving the lion's share of press include gold, crude oil, the US dollar and the Euro currency. It is our feeling these markets will continue their current trends, with prices moving higher in gold, oil and the Euro, while the dollar continues to trend lower. However, a number of commodities remain near historic lows, presenting a potentially classic opportunity for investors. There are also several investment strategies available to qualified investors that attempt to capitalize on the commodity markets, including the limited risk use of buying options. 

Learn more about the commodities markets in our free $95.00 Investors Kit! Click here now!

This report is issued by Vision LP, a registered futures commission merchant, based upon reliable sources believed to be accurate. The views expressed herein may differ from those of Vision LP's brokerage or investment management affiliates, whose investment policies and outlook may not coincide with those of Vision LP or its officers and principals. The historical information referenced above is for illustrative purposes only and is not meant to forecast, imply or guarantee the future performance of the indices mentioned or any transaction. Futures traders should be aware that daily market volatility may cause loss despite prevailing trends in the stock market.