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Rocky Times Ahead for Investors

01/29/2008 12:00 am EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says earnings and the economy may be stronger than people think, while investors may earn negative real return from bonds.

For a long time we have kept a simple, but interesting, earnings model. Each day we record the number of companies reporting improving earnings versus the number reporting declining earnings.

The most recent earnings model downturn began at the end of 2006 and may have bottomed in the middle of last year, but is too early to tell; the decline has stopped, but the advance is not yet convincing.

In the old days the way to gauge the economy was to head over to a freeway overpass and count the trucks going by or go down to the railroad tracks to count the number of freight trains and their length as they lumbered past. Today it is easier to ask your UPS person how the package flow is running. I asked mine and the answer was “strong”; a friend in New Jersey and another in Wyoming also relayed “strong shipments.”

Although we are very much aware of the steady flow of downbeat economic news, we think the economy is not as badly off as it is being painted. What we are worried about is that people will start to believe the news and create a downturn. That is a very real possibility and with the politicians now chiming in, a less remote one at that.

Wholesale prices rose by 6.8% last year and consumer prices rose by 4.1%, yet the yield for a long treasury bond is 4.3% and a ten-year treasury note yields just 3.6%. If one looks back a year, the yield for a T-note was 4.71% and for a T-Bond was 4.81%. So, for the consumer the real rate of return for notes and bonds was 0.61% and 0.71% over the past year. Even the Standard & Poor’s 500 beat.

While real rates of return were near zero last year, negative rates of return loom by almost any standard unless inflation turns down sharply, and there is precious little evidence to support that possibility. The bottom line for US investors is that notes and bonds remain unattractive.

Taking a look at our Fed model we see steadily declining [short-term] rates in coming months. One piece of the model is the fed funds futures market, where the monthly average expected rates are:

January 4.14%
February 3.65%
March 3.52%
April 3.33%
May 3.10%
June 3.06%

And so on out to December, when the market is expecting the fed funds rate to average 2.64%. The trend is crystal clear: This market is forecasting lower interest rates every month for the rest of the year, calling for a decline of more than a point and a half.

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