A BEAR CASE OVERVIEW
by Bill Fox
VP/Investment Strategist, American First Trust Financial Services
February 28,2003

There is strong evidence that America's economic trends and outlook may be far more serious than has been generally reported in the national media. Prudent investors need to be aware of the full spectrum of bear case arguments, even if it is hard to prove the validity of certain trends or understand when or where they might reach a "tipping point" where they could fully impact the economy and market. All of that having been said, this report explains why I think it is likely the market will continue to significantly decline over the next couple of years or longer.

Numerous key macroeconomic indicators look bad with no near term recovery in sight.

Debt is at historic highs and keeps growing while credit quality is deteriorating.
According to Doug Noland, author of "Credit Bubble Bulletin," Total indebtedness (corporate, personal, and government) is currently about three times GDP compared to 2.6 times during the Great Depression. Corporate and individual bankruptcies are at record highs. Consumer spending, which comprises about 75% of GDP, now appears to be slowing down as a result of higher debt levels eating into discretionary funds, while credit creation by Government Supported Enterprises such as Fannie Mae, GNMA, and Freddie Mac outside the banking system continues to grow by as much as 20% a year. The national strategy of outsourcing manufacturing and emphasizing services through a very liberal approach to "free trade" has distorted our economy in both directions. The mortgage refinance boom has been an important element to provide consumers with liquidity and keep the economy going, but this can not last forever. (cf. Noland interview ).

The economic activity pulse is weak.
Consumer sentiment is low, production is in a slump, and hiring is at its worst point in twenty five years. The U.S. personal savings rate has dropped to nearly zero. cf. Jim Puplava "What Ails Our Economy."

The balance of trade deficit is over the 5% of GDP "danger zone" and keeps growing.
The U.S. has gone from being the net creditor of the world to the world's greatest debtor nation. In the recent past, foreigners have used their excess dollars generated by the balance of trade deficits to buy around 15% of America's stocks and about 40% of its Treasuries. America consumes 6% of the world's savings to finance its deficit.

Dollar slide trend shows no sign of reversing.
The dollar has lost about 20% of its value against the Euro in the last year, and looks likely to continue sliding much further. Normally a dollar slide could be simply a cyclic corrective process that will make exports cheaper and imports more expensive, decreasing imports and increasing exports to bring things back in balance. Bears fear that something more ominous has taken place; that is, America has exported so many jobs and facilities overseas that it has seriously hollowed out its manufacturing base and does not offer enough quality products to eliminate its trade deficit problem even at lower prices. In classical economics, over the long run, a strengthening currency is a good sign that a country is increasing its manufacturing base, productivity, innovativeness, standard of living, and quality of its products (from this viewpoint, a unit of currency is roughly like holding a share of stock in an entire country). Countries such as Argentina that went from being a first world country at the beginning of the 20th century to a third world country by its end suffer from continuing currency slide problems.

A sliding dollar tends to scare foreign investors, encouraging sell-offs of their shares in the U.S. equity markets and their holdings of U.S. bonds. If the dollar continues to slide, the Fed may need to raise interest rates to attract foreign investors to help finance America's burgeoning deficits. Rising interest rates can crimp business recovery and reduce stock values further.

Earnings growth for American companies is still lackluster.
Analysts continue (as they have since 2000) to revise earnings growth estimates downward from initial rosy projections such as a 20% growth rate looking forward a year to well below 8% as the projected time periods arrive. High tech companies complain again that inventory channels are backing up.

The global economy is still stalled out with no near term turn around in sight.
There is no major advanced industrial nation around to act as an "global economic engine." Japan and Europe are both in recession. If the Japanese economy becomes more distressed and Japanese start pulling investment funds out of the U.S, that could hurt the dollar and U.S. markets further. China has the world's fastest growing major economy with a large balance of trade and currency surplus, and the national media usually portrays this as wonderful news. But there is an important dark side to the "free trade" miracle of China that American business magazines and business school professors rarely mention in their discussions about free trade. (On the benefits side, the basic idea is that if all nations focus on their comparative advantage through free trade, a global version of the division of labor concept will supposedly make nations wealthier, and wealthier peoples tend to be happier and friendlier to each other). The Chinese work force is effectively engaged in a labor price war with American, Japanese, and European workers, working long hours for almost nothing to gain global manufacturing market share. India is trying to play the same game as China, but is not nearly as significant.

In one sense, this really is a "war," that is, rather than operate in muddy trenches while sacrificing lives, the contestants work grueling hours under substandard conditions with low paychecks to achieve the same ultimate goal as in most shooting wars, that is, gain market share or command of natural resources that translate into enhanced national economic, military, and political power. Please remember that a manufacturing base is part of the total power equation, which is why Sherman's troops in the Civil War and Allied bombers in World War II leveled every manufacturing facility they could strike at. If being an American citizen is comparable to belonging to an American "union;" Chinese workers are analogous to "strikebreakers" in the global economy. As a point of fact, the Chinese "miracle" has had a militaristic/nationalistic struggle tinge to it, to the extent that the Chinese government has made it a practice to place active duty Red Chinese Army officers in charge of newly privatized industries. A Chinese firm controls both ends of the Panama canal, and American "free trade" goods have gone into Chinese ICBMs that can now incinerate our major cities. (c.f. the video interview of global investment gurus Jim Rogers, Marc Faber, and Daniel Yergin which validates many of the key points in this Bear Case Overview, and includes an extensive, albeit "gushing" discussion of China. Marc Faber claims the U.S. dollar has to drop 80% before the U.S. will become competitive with the Chinese RMB currency. Click to the "Riverside Conversations" interview. Although this has a Dutch language introduction, the interviewees speak in English.)

The overall U.S. stock market valuation remains high.
Despite the S&P's decline by nearly half since March 2000, according to State Street Global Advisor strategist Diane Garnick, the S&P 500 still trades at 30.4 times trailing GAAP earnings, well above its 53-year average of 16.2. Most prolonged bull markets have been followed by bear markets that are proportional to them. From 1982 to 2000 the U.S. had the longest secular bull market in its history, capped by the greatest mania in history from 1995 to 2000. We are only two and a half years on the backside of all this. Please note the PowerPoint presentations "Buy & Hold?" and "Why the Bear Market Is Not Over" (Prudent Bear Library) Also, Bill Gross, head strategist of PIMCO Funds, thinks the Dow must drop below 5000 before it is positioned to offer reasonable risk-adjusted returns. (c.f. "Dow 5000").

The stock market decline has hurt business and government.
A further downward market spiral could threaten to increase the "negative wealth effect" in which eroding portfolio values reduce consumer confidence and consumer spending. The "negative wealth effect" is already impacting corporations, for example IBM now has to devote 20% of its cash flow for the last year to bringing its pension plan back up (cf. Paul Kasriel) Lack of capital gains tax revenue and recession is now causing about half the states in America to talk about raising taxes: http://www.nytimes.com/2003/02/14/national/14TAX.html. This could threaten to choke off business profits and capital investment required to create jobs and sustain economic recovery.

Interest rates are at historic lows and seem to have no way to go but back up.
So far dramatic drops in interest rates by the Fed have been "pushing on a string" to revive the economy. The problem is that if interest rates start moving back up, rising debt service could help push America into a liquidity trap. (Fed Chairman Alan Greenspan voiced concerns about reaching a "point of no return" in his recent Congressional testimony, discussed at CBSMarketWatch.

America's money supply is growing at torrid pace threatening to ignite serious inflation.
According to Jim Puplava (www.financialsense.com), the money supply grew at 16% in the 4th quarter of 2002. Its growth has averaged at least two to three times the officially reported inflation rate of 2-3% over the last five years. Historically, inflation runs parallel to money supply growth. From 1995 to 2000 the U.S. was able to ramp up the money supply and run balance of trade deficits and get away with it, largely because foreigners were willing to sop up excess dollars as a global reserve currency or invest their dollars in America's roaring stock market. Now the global demand for dollars is holding constant or even reversing, and meanwhile the money pump keeps going. Russians have started dumping dollars for Euros, and many Islamic countries plan to dump dollars for a revival of the ancient Arab gold coin the Dinar as a reserve currency. Dollars washing back at the U.S. would encourage inflation. Critics voice concern that by ramping up the money supply to stave off the impact of the Asian crisis beginning in late 1997, followed by similar actions regarding the Russian default and LTCM crisis in 1998, followed by the Y2K concerns of 1999, followed by efforts to stave off a U.S. market and economic collapse since 2000, the Fed has created additional bubbles in the economy besides the stock market bubble, such as bubbles in consumer finance, the bond market, and the mortgage finance/real estate market.

Risks of "shocks" is high, particularly related to oil, terrorism, and financial system meltdown.
Oil shocks helped to induce the stagflation of the 1970's. Marshall Auerbach explains how we might see higher overall oil prices even if the U.S. quickly occupies Iraqi and its oil fields. (See) Oil prices are sensitive to relatively small supply disruptions, and last year the Alaska pipeline was shut down for two days to fix damage from a hunter's rounds. Al Qaeda has targeted the global oil industry for sabotage, as reflected by a recent attempt to attack the world's largest refinery in Saudi Arabia. Another point on oil: global demand is escalating, particularly from China, while North America and other areas outside of the Middle East face a production decline curve. "War for oil" will probably become an increasingly familiar theme in the 21st century. Check out Jim Puplava's "PowerShift" series on oil, politics, and war.

As for a possible financial system meltdown, many bears believe that there are still a lot of other "Enrons" and "LTCM's" out there waiting to happen (Long Term Capital Management is the hedge fund that blew up in 1998). A prime suspect is Dow Company JP Morgan Chase, implicated along with Citigroup in suspect dealings with Enron, and which has over 20 trillion (twice America's GDP) in derivatives exposure, whose counterparty risk and deal structure quality is open to question. The LTCM blow up required a coordinated Fed/bank bailout to avoid a financial meltdown. The problem is that JP Morgan Chase is on an order of magnitude 100 to 1000 times larger and may not be "containable" if it blows up. (J.P. Morgan is being sued along with Citigroup for allegedly helping Enron set up bogus offshore entities, also, as mentioned elsewhere, it is being sued by Blanchard &. Co. for alleged gold market manipulation. The company has been experiencing profitability problems in its retail banking operations, and many critics claim that they can only guess what is going on in the derivatives area).

...This does not include American bank exposure to third world countries such as Brazil and Argentina that are unlikely to ever repay their debts. Pat Buchanan wrote about the most recent crisis in "Bailing Out Brazil or Robert Rubin?" (Aug 14, 2002) in which the Bush Administration stepped in on behalf of the big banks to stave off the day of reckoning one more time. As Buchanan points out, although the third world debt problems started with prior administrations, no one wants to be in the wheelhouse when the ship hits the reef. This is actually ominous information, because it implies that we have top policy makers who are in fact desperately trying to "keep up appearances" at all costs while sweeping major problems under the rug that only get larger and messier over time and morph and reemerge in other places. Pat Buchanan wrote on January 27th that he thinks the global economy could be on track to crash.

Financial risk to American corporations has increased because the high amount of debt they have absorbed in their capital structure. As an example, according to Adam Barth in "The Collapse of the Inverse Pyramids," in regard to the thirty "blue chip" companies that make up the Dow Jones industrial average, "The Dow�s net tangible assets are presently leveraged at a 6/1 ratio- a capital structure bearing far greater resemblance to a hedge fund than a prudently financed corporation."

Policies on a government, corporate, Wall Street, and national media level
may still be adding fuel to the fire, driving us deeper into crisis.

Symptom suppression and feedback distortion.
Critics charge that in the late 1990s the Fed and U.S. Treasury intervened to artificially build a strong dollar and suppress the price of gold and silver to mask underlying economic problems and disguise inflation, and now we are beginning to experience pent up whip-lash as the smoke-and-mirrors act begins to unwind. Among other things, an artificially strong dollar increased demand for the exports of third world countries struggling to pay their debts to major U.S. banks. As part of this pattern, the U.S. bailed out Mexico in the mid-1990's following the Peso crisis. An artificially strong dollar and artificially low inflation rates also helped fuel the greatest speculative stock market in history and make money for major Wall Street firms.

Misleading inflation reports.
The topic of inflation can be complicated by the process of netting out pockets of deflation resulting from cheap imports from China and lower cost chips from the microcomputer chip revolution with pockets of inflation elsewhere, such as in basic commodities, consumer durables, and asset prices (stocks and real estate). But step back and look at the big picture, and Jim Rogers sees plenty of snake oil in the way "inflation" is being presented overall to Americans. Go to his archives at JimRogers.com, click on "articles," scroll down to "22 March 2002 They Are Lying To Us Again." (This was published in a summer 2002 issue of Worth Magazine).

How policymakers may have put the gold and silver barometer of inflation to sleep for a while.
John Embry, chairman of investment committee for the Royal Bank of Canada, has accused the Fed and U.S. Treasury of artificially suppressing the price of gold through coordinated central bank sales. You can find his internal report that got leaked to the public by clicking on 'The Embry Report" archived at Chris Temple's National Investor "Other Experts" web site at: http://www.nationalinvestor.com/experts.htm

In Dec 2002, Blanchard & Co., the largest retailer of physical gold in America, filed a $2 billion anti-trust law suit against Barrick Gold Corp and J.P. Morgan Chase for "unlawfully combining to actively manipulate the price of gold" and making $2 billion in short-selling profits by suppressing the price of gold at the expense of individual investors.

James Sinclair, lauded by Forbes magazine as a successful CEO of a precious metals trading company and gold mining firm, accuses the Fed and Treasury of using an Exchange Stabilization Fund and other tools to manipulate gold as well as currencies. He provides a brief history of the ESF, created by Congress in 1934, and some insight into how it manipulates markets in his Dec 5, 2002 guest editorial "What is the Difference between Stabilization and Manipulation?" Go to www.jsmineset.com and type the title of the article in the search box.

Manipulation of commodities markets and general stock market.
Jim Puplava describes how "gearing" may be behind "flag pole" rallies that have periodically bolstered the markets: http://www.financialsense.com/Market/archive/shortsilver_1.htm According to Puplava, the gold and silver markets are among the most heavily "geared" markets of all. He claims there are about three times as many short positions in derivative contracts on gold and silver as there is physical gold and silver to cover. Most long contracts get rolled over rather than delivered on the commodity exchanges. If the longs all demanded delivery, some financial observers think that this could possibly cause panic and possibly bring down some exchanges...and maybe even J.P. Morgan Chase, which some sources believe is heavily exposed in this area. Bill Murphy, head of the Gold Anti Trust Action Committee, provides important insights in his interview with Jim Puplava at: http://www.financialsense.com/transcriptions/Murphy.htm.

...a quick editorial remark...
when the price of gold steadily declined under the pressure of central bank sales and other influences from 1996 to 1999, it threatened to put half of the world's gold mining companies out of business. Back in 1996, many investors responded to Alan Greenspan's comment about "irrational exuberance" regarding overall stock market valuation (the Dow then was at 6500) by seeking to diversify into gold as a safe haven, only to see it collapse underneath them as internet stocks without earnings kept moving up. "Prudence" was punished and recklessness was rewarded. This is a theme I will return to later in my comments in the "grid-lock" section about social values getting turned on their head. Ironically, back in 1966, during his more Bohemian days as a member of Ayn Rand's inner circle, Dr. Alan Greenspan wrote a paper titled "Gold and Economic Freedom" in which he stated towards the last two paragraphs: "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value...The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

So in other words, if John Embry is correct, Alan Greenspan's Federal Reserve policy has been a major adversary of gold, yet in his younger years Dr. Greenspan was an ardent supporter of gold. Ayn Rand's laissez faire, libertarian capitalist philosophy is generally against big government and Fed intervention, yet Dr. Greenspan's Fed has presided over one of the most proactive Feds in history in terms of money expansion and support for deficit Federal spending. This dovetails with a theme I reinforce at the end of this report about the need for the American people and their policymakers to resolve inconsistencies, establish credibility, and sort things out. (Jim Rogers thinks Greenspan's policies as Fed Chairman have been a disaster, as pointed out in his excellent 22 Oct 2002 article "For Whom the Closing Bell Tolls" archived at www.jimrogers.com).

Could a headstrong guns and butter policy drive us to double digit inflation?
According to my introductory economics textbook by MIT professor Paul Samuelson, societies can afford either guns or butter but not both. Go for both, and financially beleaguered governments eventually end up running the printing presses to make ends meet --and one gets serious inflation. (For example, in the 1970's Vietnam-related spending plus the Great Society Programs plus oil shocks helped to give us stagnation and double digit inflation that killed the stock market).

The Bush Administration has proposed a $500 billion deficit, or some huge number like that (it keeps changing, and the real number, that probably includes government "slush" accounts, is probably much larger). Our national debt is officially around $6.5 trillion (again, who knows what it really is, unless one can somehow uncover and figure out all of the "off balance sheet" and social security-related obligations) and is now perhaps somewhere around 65% of America's $10 trillion GDP. As a general rule of thumb, when a nation's debt gets over 100% of GDP, it runs into a serious danger of falling into a liquidity trap. In fear of this, in the late 1990's, Sweden and Canada slammed on the austerity brakes to bring down their national debt levels just in the nick of time. There is currently no sign this is happening in America, in fact, quite to the contrary. Fed Governor Ben S. Bernanke and Chairman Alan Greenspan have stated publicly that they are willing to err on the side of trying to inflate our way out of tight spots. As mentioned elsewhere in this report, Alan Greenspan recently expressed concern about a liquidity trap in his recent Congressional testimony. In the aforementioned video interview with Marc Faber and Jim Rogers, the two individuals claim that the Fed is clearly signaling that inflation is ahead.

Corporations need to rebuild credibility.
The article "Illusory Profits Cloud USA Inc" claims that profit growth may have been overstated by American S & P 500 companies by about 150% from 1995 to 2000. http://news.bbc.co.uk/1/hi/business/2075864.stm Warren Buffet stated in a November 1999 Fortune article that on average companies in the 1990's actually had below average profits and earnings growth, particularly compared to the 1950's. In other words, deceit was practiced far more widely than by just Arthur Anderson.

Major Wall Street firms still need to show they know what they are doing.
Back in late November 2002, Wall Street firms faced over $1.0 billion in fines over charges that they misled investors during the boom years. Post bubble performance has been problematic as well; according to David Futrelle, in "Rebuilding Credibility on Wall Street" (Business2.com, Feb 8, 2002): "Consider the results of a recent survey by Zack's Investment Research: For the second year in a row, researchers discovered that the stocks that were least popular with analysts ultimately performed the best. Stocks with the highest percentage of "sell" ratings moved up nearly 60 percent in 2001, while the stocks with the highest percentage of "buy" ratings (you guessed it) plunged more than 70 percent." Part of this could be due to herd instinct that exists in all industries, for example Forbes columnist Ken Fisher points out how the consensus year ahead forecasts of Wall Street strategists has tended to be consistently wrong in his studies that have gone back a decade.

The national media has been a big part of the problem.
Please note the Washington Post expose: "The Media Fueled New Economy and Vice Versa", read about Maria "Money Honey" Bartiromo and other cheerleaders in "On CNBC, Boosters for the Boom", and lastly, this article explains why the media tends to deny the reality of a bearish economy: "Why James Grant Will Never Be Louis Rukeyser" at Bloomberg.

Certain overall patterns may suggest something more serious
than a relatively short, self-correcting recession

A movie running backwards?
Morgan Stanley economist Steve Roach has commented that all of the "virtuous circles" that led to economic and market expansion in the 1990's seem to have now reversed into vicious circles, and it feels like the 1990's "movie" is now running backwards.

Worse than Japan?
Contrary to the current Wall Street consensus that America is different, Doug Noland in "Pondering Post Bubble America" argues that the U.S. is actually worse off than Japan and may emulate the tragedy of Argentina. Japan entered its decade of economic malaise as a net surplus, net creditor country, which has given it a cushion that the U.S. now lacks as a net debtor country with record trade deficits.

Are we overly "grid-locked" when it comes to handling the REAL problems?
(Are policymakers so encumbered with "hidden agendas", conflicts of interests, "super ordinate goals," and misperceptions that they are unlikely to adequately address and help "fix" our economic problems any time soon?)

Lew Rockwell argues that America's policy makers are too steeped in inappropriate Keynesian economic ideology to adequately diagnose and cure our economic ills (c.f. "George W. Keynes" and "Keynes Rules From the Grave" in his archives) Rockwell's "Austrian" school of economics (www.mises.org), whose proponent Friedrich von Hayek has been idolized by Forbes magazine, emphasizes saving, prudent investment, cost control, and free markets as the true path for viable economic growth. Keynesian economics emphasizes utilizing credit expansion and deficit government spending to stimulate overall demand. This can be great for pork barrel politicians and big money center bankers looking to boost loan volume, but tough on Joe Average American when he finds out that he is tapped out on unsecured debt while overextended business owners have to cut back on jobs. Lets rewind the tape here for a moment and recollect that "Deficit spending is simply a scheme for the confiscation of wealth" according to Dr. Alan Greenspan (as mentioned elsewhere in this report) performed by people who might hold the "shabby secret of the welfare statist's tirade against gold."

Forbes business writer and CBS Market Watch commentator Peter Brimelow argue that most Americans are ideologically blind to trends that are permanently altering the country's social fabric, undermining core values, increasing welfare and other "drag" costs to the economy while decreasing its overall level of social and economic efficiency (cf. reviews of his book "Alien Nation" at his site www.vdare.com)

From the left, Gore Vidal claims that policy makers are showing some serious inconsistencies in terms of their obligation to support and defend the U.S. Constitution: "The Enemy Within" and "The Last Defender of the American Republic?". (Somewhat paradoxically, there are commentators on the right such as Pat Buchanan and Ron Paul who have been making similar observations as Gore Vidal).

Since 1998, the U.S. has lost 13% of its manufacturing jobs, and NAFTA has exacerbated our trade deficits. Go to www.aflcio.org, click on "manufacturing," scroll down and click on "IUC Report: The Crisis in Manufacturing." Complete with narrative, charts, and graphs, this paper talks about the results of policymakers who may be so steeped in internationalist, free trade ideology (or just plain short-sighted greed) that they have forgotten that charity begins at home while they proceed to export manufacturing infrastructure, trade secrets, and skilled, tax-paying jobs overseas to countries that engage in dumping, gross worker exploitation, vicious human rights violations, and use of our technology for hostile purposes. Some "free trade" partners even threaten to become our military enemies, such as China, which makes angry noises at the U.S. over Taiwan and influences North Korea behind the scenes. Much of Saddam Hussein's chemical warfare arsenal (which he freely used in the Iran-Iraq War and is probably hiding right now), was supplied to him by American companies. As another paradox, it was a Democratic President and supposedly ardent friend of organized labor in America, Bill Clinton, who helped push through the North American Free Trade Agreement that organized labor decries as a major policy blunder.

Let me summarize here...
There are dozens of sources I could point to in this area, but what they all have in common is the following theme: sure, there have been manias and market booms and busts before; there were stock market booms surrounding canals, telegraphs, railroads, and electrification in the 1800s and the automobile and radio and aviation in the early twentieth century. In their day, these innovations seemed every bit as exciting and revolutionary to prior generations as the microchip and internet revolutions have been to our generation. However, the mania from 1995-2000 has dwarfed all prior manias hands down. The accounting scandals have dwarfed all previous periods of mass dishonesty. Because of the sheer scale and magnitude, a lot of social critics are wondering if there is something much deeper going on, that is, a society that has become too cacophonous in terms of its core values, and where it does show commonality in values, it appears to be deeply infected with immediate gratification and a socially irresponsible "devil take the hind most" and a "wise guy" approach to life. (Even among some of the sources I like, such as Jim Rogers and Peter Brimelow, they are at loggerheads on whether an open borders policy is an economic and social blessing or an economic and social disaster). Many bears believe America is: a) economically, ideologically, and ethically too deeply distorted to get back on the road to true prosperity any time soon and b) there is probably a lot more negative news and "settling of accounts" left ahead before things get sorted out and get put back on track.

No evidence yet that we AREN'T headed towards costly boondoggles and "imperial overstretch."
For thousands of years Central Asia has been a graveyard for overconfident empires much like Russia was for Hitler and Napoleon. Empires that wage costly, prolonged military ventures without keeping their manufacturing and general economic base healthy have eventually imploded, such as the Spanish and British Empires. Larry Lindsay, President Bush's former economic advisor, lowballed an estimate of $200 billion to go to war with Iraq. The longer term tab for "nation rebuilding" and prolonged occupation for more than five years could exceed a trillion dollars. And of course we still have troops in Germany and the Balkans and South Korea other exotic places around the globe.

Just as in the case of buying a risky stock or mutual fund, when it comes to foreign policy, it can be a good idea to mentally model in advance the possible outcomes and envision double up, stop loss, or exit strategy points. As the Bush administration and media talk about going into Iraq and taking a hard line towards other countries such as Iran and North Korea, the report cards coming out of Afghanistan are hardly "straight A". (For example, numerous accidental bombings of civilians --to include a wedding, U.S. troops abandoning posts along the Pakistani border, increasing tempo of insurgent operations; (c.f. See SFGate.com also "Details of U.S. Victory are a Little Premature")

Are we up against a hydra?
Let me share a joke that circulated in Germany in the early 1980's when Israel invaded southern Lebanon with massive tank and aerial support. The attack was commanded by Ariel Sharon, Israel's current Prime Minister, nicknamed "the Bulldozer." The joke was that Adolf Hitler came back to earth from Hell to look around a bit. When he saw that is now the Germans who are making money and the Jews who were waging Blitzkrieg warfare, he couldn't deal with it and decided to go back down to Hell.

As you may recall, the Israeli blitzkrieg failed miserably in its principal objective to root out the PLO; ironically, the PLO is politically stronger and its headquarters is now physically located closer to Jerusalem. Hezbollah, which is funded by Iran and is considered by some to be as dangerous as Al Qaeda, developed the insurgent infrastructure to help eject the Israelis out of Lebanon, and Ariel Sharon has been tainted in the international community by associations with the Shatilla massacre. To make a reference from Greek mythology, the Israelis tried to slice off one hydra head and got three coming back at them.

America's quick victory against Iraqi troops in the Kuwaiti desert in the Persian Gulf War was a poster boy of blitzkrieg warfare, complete with massive air support and a huge left hook envelopment of Iraqi forces by massed tank formations. But will the same cookie cutter approach work in other situations? Will "blitzkrieging" and "bulldozing" our way through the urban areas of Islamic countries solve our problems, or will we end up creating more hydra heads like the Israelis did in southern Lebanon?

Imagine hearing this from a Texas Republican.
Congressman Ron Paul, thinks the Bush Administration has become an overly adventuristic bull in an international diplomatic china shop and its policy is creating more problems than it is solving; c.f. "The Heroic Ron Paul".

Before we try complex "nation-building" in Iraq, could our military first try to get it right in preparing for chemical warfare?
One of America's most heavily decorated veterans and well-regarded military authors, Col David Hackworth, U.S. Army (Ret) thinks the U.S. military has not adequately thought through likely chemical warfare scenarios in preparation for invading Iraq: c.f. http://www.sftt.org/dwa/2003/2/12/da.html. For starters, up until an outsider recently sent in an e-mail, the Pentagon was apparently unaware that the water inside its mobile water tanks ("water buffalos") used by troops to refill their canteens could be easily contaminated by chemical agents. Everything might have been fine until our troops had to start refilling their canteens in the desert. Hackworth claims that the military has failed to conduct prolonged large unit training exercises in a nonlethal chemical environment to adequately test its gear and chemical battlefield doctrine. He also claims that nearly 200,000 Gulf War veterans continue to complain of ailments that may be linked to indirect chemical contamination during the Persian Gulf War. (Please remember elsewhere in this report I mentioned that American companies once "free-traded" chemical agents to the Iraqis).

My own opinion.

Jim Puplava (financialsense.com) points out how "things" (commodities and precious metals) rather than paper claims (stocks in general) have been in a "stealth" bull market for the last two years, signaling current rising prices and inflation concerns. If we head towards a stagflatonary scenario similar to the late 1970's, these areas should continue to do well while the overall market may experience a steady slide until it ultimately reaches a historically low P/E and high dividend yield. In 1982 the average P/E was around 7 and the dividend yield on many "blue chip" stocks was around 6%.

The Wall Street consensus for the year ahead has been mildly bullish, and I think the odds are that it will be wrong again. The bear arguments I have outlined have not yet been openly absorbed by Wall Street strategists or the general public. My guess is that that full absorption will not be achieved until about two to three years from now. In the 1970's about 25% of American households were into stocks, at the bull market peak by 2000 it got up to 75%. Mutual fund withdrawals have remained relatively subdued despite the market drop. One hellish scenario I haven't even addressed yet is if the public starts to panic and pull their money out of mutual funds all at once. In the aforementioned video interview with Jim Rogers and Marc Faber, Faber claims that Japan's malaise for over a decade has cost Japanese mutual fund companies over 90% of their assets.

A couple of years from now, if the public mood starts to really get ugly, paradoxically the market may form its first major bottom and then it may time to start increasing ones exposure to on the long side to general equities. Until then, I would look at sitting on the side lines or leaning towards certain foreign bond funds, short funds, precious metals, commodities or "hard assets"-related funds.

America still has ample natural resources and in terms of demographics the equivalent of Germany, Britain, France, and Scandinavia inside its borders, so I do not see us necessarily turning into Argentina or Brazil within the next five to ten years. Once the bad debts get liquidated and the middle class gets unconfused (perhaps after a period of crisis and cynicism to finally figure it out how badly they have been misled), I think we will finally have the basis for a viable rebound. I am reminded of the observation of Friedrich Nietzsche that in order for civilizations to function, they start promoting "white lies" in their public discourse to avoid social conflict. The problem is that generation after generation, the white lies get built on top of each other (and the new generations take too much at face value) to the point that the value systems (and even religious theologies) become inverted and dysfunctional and removed from basic realities of life. Anyone who has watched the movie Gangs of New York knows that American leaders have been making extra efforts to "spin" and smooth over messy problems ever since the War Between the States. But sometimes the smooth talk gets too rich, and "putting your best foot forward" for corporations becomes outright fraud. "Free trade", carried to excess (depending on what kinds of concessions are made), can bleed away a country's competitive advantages and wealth and turn into outright "treason." A lot of this still needs to be uncovered and sorted out. Among other things, we need to motivate American business leaders to get a bit more interested in generating business income to benefit American workers rather than sweat shop operations run by active duty military officers of the Red Chinese Army.

Noting the jagged saw tooth downward chart pattern of the S& P 500 index (on a five year chart), some of my more adventuresome clients have tried to play the cyclic bull rallies within the context of the longer term secular bear market. Just remember if you want to be a trader to get out a few months after the market makes its most recent deep dip to avoid getting swept along in the next possible leg down.

Two outstanding sources for an in-depth explanation of the bear arguments, complete with charts, graphs, supporting data, and easy to read narrative are:

Jim Puplava's "Perfect Storm" and "Storm Watch" series. Although written from 2000-2002, the Perfect Storm Series has been on target so far in predicting the course of the market. It provides good background on how we got into our present state of woes: http://www.financialsensearchive.com/series2/perspectives2.html

His Storm Watch updates bring you up to date and are also very good. Archived at: http://www.financialsensearchive.com/stormwatch/oldupdates/main.html

David Tice's series of articles for "On Wall Street" magazine archived at: http://www.prudentbear.com/bc_library_RR_onwallstreet.asp. David Tice is manager of the Prudent Bear fund whose home page is www.prudentbear.com. As mentioned earlier, it is well worth scrolling through his PowerPoint presentations at: http://www.prudentbear.com/bc_library_bear_case_home.html.

© 2003 Bill Fox
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Bill Fox, VP
America First Trust Financial Services
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Vancouver, WA 98682
Phone: 360-882-5369
Toll Free: 866-945-5369 (866-WILL FOX)
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