A Special Newsletter March 2003

Latest Signal in Model: 10/25/99 SELL, S&P; 1294

What we've done.

A picture is worth a thousand words but this chart speaks volumes. Yes, we've continued to grow our investments throughout this bear market and during a time when most advisors and their investor/subscribers have suffered enormous losses to their capital.

From the time my model issued its sell signal during the latter months of 1999 our replacement investments have continued to grow without using the dangerous practice of shorting stocks or using leveraged instruments. The recommendations that I made at that time were very low risk and readily available to any investor. As you can see from the above chart, the value of DJIA, S&P; 500 or Nasdaq stocks have fallen precipitously compared to the dramatic gains in our investments. As it stands now, they would have to make a return of 252% to catch up to us if they had the same returns as the NASDAQ. They would need a return of 111% just to get back to even! These are not challenges that I would like to have. Yet, even though many advisors have even worse records, they have the gall to say that investors should just jump back into stocks and forget about all the pain they have experienced.

How we arrived here.

As we look at the above chart, we learn some important lessons. First, we realize that stubbornly remaining in losing positions because you have been told to 'ride it out' is disastrous and may cause more damage than can ever be overcome. That obviously has been the fate of those that thought that stocks would always be the best investment. The second lesson we can take from the experience of our investments over the last three-plus years is that sometimes we do have to be willing to 'ride it out'. I cannot tell you how many times over the last three years that I have heard some 'expert' declare that bonds were dead. Furthermore, there certainly have been periods of time when bonds did decline temporarily. The difference between the two scenarios is that those that stubbornly held onto stocks over the last three years did so based on very bad information. They had been told for so many years, and so came to believe, that stocks were always the best investment 'over the long run'. We, on the other hand, had the benefit of knowing that sometimes stocks are not the investment of choice and that even if most others were ridiculing our investment choices we could ignore their proclamations because we were basing our investment decisions on something other than opinion and emotion.

I realize that many are nervous because of everything that is being said with respect to bonds lately and I am carefully watching these developments. We know that the PPI has spiked up recently, but this is primarily due to the huge increases of the crude oil components of the index and we know why that has occurred. We have also seen the dollar decline recently and many are proclaiming that will soon undermine the value of bonds. However, we must also remember that the dollar rallied substantially from 1995 until just recently and the recent declines have been much overblown by the financial media. We also have seen a lot of hand wringing about the re-emergence of deficits and how that would torpedo bonds. But the reality is that does not necessarily mean the demise of bonds, at least in the short term.

The Iraq Question.

The period of mid-1990 to early 1991 is one that is most often used as a forecasting tool of how geo-political events in the current timeframe are likely to work out. After all, many of the characters are the same; many of the repercussions are similar now to what happened then with rising oil prices, etc.; the timing itself (calendar-wise) is very similar. So, it is logical to assume that things will work out this time just about precisely as they did in 1991. The market basically chopped around throughout the fall of 1990 awaiting resolution of the Iraq situation. As is the case now, the market remained subdued as it awaited clarification. Then once the war began in January 1991 the market surged higher. That did not come as any great surprise to me because in the weeks leading up to the war, my model had issued one of the most powerful buy signals I had ever received from it. We used leverage and went fully into stocks with our core capital. That signal produced extraordinary returns for us and the conditions it was forecasting really set the stage for the beginnings of a strong recovery in the economy and a continuation of the bull market.

So, here we are at an eerily similar crossroads. It is clear that war looks almost inevitable. Oil prices have surged and the economy is stagnant. The stock market is churning around on low volume, ostensibly awaiting clarification. Many forecasters and analysts are advising that as soon as we attack Iraq, the stock market will surge just as it did in 1991. The question is, will things work out now exactly as they did then?

Inflation or Deflation?

I realize as we are awaiting clarification of our inflation/deflation scenario, many questions arise when we see certain price fluctuations. However, we should not confuse the cause of inflation with its effect, nor should we focus too much attention on what is very likely a short-term phenomenon.

Inflation, as I have often pointed out, is a monetary phenomenon----chiefly caused by too many dollars chasing too few goods. It is brought about by over stimulation in the monetary process at times when such stimulation was not necessary to the extent it was carried out. In past times, when inflation was really about to take off, the model issued an inflationary signal far enough in advance in order to exit those assets that would be hurt by inflation and re-deploy those resources into areas that would benefit from inflation. This happened in 1977, for example, when the Model issued a powerful inflation signal that told us we should exit all stock and bond positions and be fully invested in inflation hedges. As you may know, gold, silver and other commodity prices surged thereafter, making millions for those that had purchased the correct assets, and bankrupting many of those that had left their money in bonds and other assets that collapsed as interest rates eventually soared to never-before-seen levels in the U.S.

Where do we go from here?

I am acutely aware of our current profitable positions and am very much committed to not letting those profits erode. I am constantly watching the various developments in the markets and of course the progression in the model's readings. Yet, to give you further comfort if you are worried about some sudden decline in bond prices consider the following.

There are really only three scenarios under which we would exit our bond positions (not including a possible short-term exit I may recommend). Number one, if an inflationary environment were to emerge we would get out of bonds. But that kind of emerging environment has always been forecast by the model in plenty of time to readjust our portfolios. Number two, when we eventually get a new buy signal in stocks, we will likely exit most or all of our bond positions. Number three, when bonds have risen to the levels I believe represent their historical-based maximum potential. That's it. That really is all we have to be concerned about.

In spite of these considerable profits I still believe that some of the largest gains we will experience in our lifetime lie ahead.

Take care, Jim Shepherd.

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