Greetings and a hearty "Happy New Year" to Bears and Bulls alike.

The year 2003 is an even 4700 on the Chinese calendar. Starting on our February 4th, 4700 will be the "Year of the Black Sheep."

To those of us in the Western world, a black sheep is "a member of a family or other group who is considered undesirable or disreputable." Unfortunately, we think 2003 has the very real potential to be the most "undesirable" year in American stock market history, at least for the bulls. We think it may be more like the "Year of the Black Bear."

In order to know where we're going, we need to know where we've been, so we'll begin with a review of the carnage inflicted by the "Great Bear Market of 2000-200[?]" in 2002. To state that it was another Year of the Bear is stating the undeniable.

As you've no doubt heard by now, 2002 marked three consecutive down years for the markets, the first time that's happened in 60 years (since 1939-1941). The DJIA has fallen four consecutive years only once before, the infamous Great Depression years of 1929-1932. We'll discuss market sentiment in more detail below, but suffice it to say that the consensus of mainstream Wall Street is that after three losing years, the markets are "overdue" to bounce back. Unfortunately (for the bulls), we beg to differ and we stand firmly in the camp that says 2003 will tie the Great Depression's historic losing streak.

Of the major indices, the Nasdaq Composite led the way lower in 2002 with a 31.5% decline. It was the first time in its 22-year history that the Nasdaq lost ground in three consecutive years. At its year-end close of 1,335, the Nasdaq sits (it's too weak to stand) down a stunning 74% from its March 10, 2000 peak of 5,132.

The S&P 500 followed with a 23.4% loss. All ten of the industry sectors tracked by S&P lost ground for the year, the first time that's happened in the 21 years of sector reporting.

The DJIA held up the best, slipping "only" 16.8% in 2002. Still, it was the DJIA's worst yearly drop since 1977. Only 3 of the 30 DJIA stocks managed a gain for the year: GM, PG and EK.

Indeed, the Great Bear dined at a global smorgasbord in 2002: The DAX in Germany crashed 44%. The FTSE 100 in London and the CAC 40 in Paris both had their worst years ever. The FTSE dropped 24% and the CAC plunged 34%. The Nikkei 225 in Tokyo sagged 19% to a 20-year low. South America's largest market, the Bovespa in Brazil, tumbled 17%. The list goes on and on and on.

The U.S. dollar cratered in 2002, falling 10% against the yen and 18% against the euro. Add the exchange rate losses to the U.S. markets' losses, and many foreign investors are sitting on a 40-50% devaluation of their dollar assets.

According to CBS MarketWatch, 94% of all stock mutual funds lost money in 2002. Lipper & Co. calculates that the average equity mutual fund lost 21% in 2002.

When the bean counters finish tallying the data in a couple of months, 2002 will likely be the first year in 14 to show net fund outflows from equity mutual funds. Bond funds will show over $150 billion in inflows, a record high. (Smells like another bubble about to burst.)

The equity markets' most recent data shows the Great Bear's appetite is still voracious. The DJIA's 6.2% drop last month was its worst December since, ahem, 1931. Let's recall what ensued in 1932: The DJIA tanked another 46% before finally bottomed on June 28, 1932 (at 42.30)! We think a similar fate awaits the DJIA in 2003.

2002 wasn't all red ink for investors. Government bonds soared as interest rates approached absolute zero (more below). The average long-term bond mutual fund gained 5.5% on the year. Yet the interest-rate sensitive Dow Jones Utilities Average lost an unusually sharp 27%. (So much for safety in "conservative" dividend-paying stocks.)

Crude oil futures gained 50%, as the situations in Iraq and Venezuela worsened.

Gold was in the green by 23%, soaring to a five-year high at $348.50. Gold stocks rocketed higher by an average 71%. Gold mutual funds were the best performing sector for the second year in a row. According to preliminary data by Morningstar, eight of the top ten mutual funds in 2002 were gold funds. The other two were members of our Great Bear Funds roster: the Prudent Bear Fund and the Rydex Venture 100 Fund.

Here's the full table of results for our Great Bear Funds in 2002. Quite impressive, I think you'll agree.

On the Economics Front
It was really pretty simple in 2002. Despite the all-out efforts of Sir Alan of Greenspan & his Merry Monetarists, the economy is still stuck in first gear, if not neutral.

Are we boring you, Sir Alan?

The Fed's unprecedented eleven rate cuts in 2001 (a cumulative 475 basis points) failed to spark anything more than a flicker of recovery. The Fed's last cut, 50 basis points on November 6th, was perhaps the last rate cut arrow in its quiver. It won't make a bit of difference anyway. More grease isn't the answer when pushing on the proverbial string is the problem.

As mentioned in our reports numerous times over the past five years, near-zero interest rates haven't helped Japan recover from its burst real estate bubble, 21 years ago. The U.S. economy is acting every bit as comatose, and the U.S. equity markets are following Japan's example, too.

Aside from appeasing the politicians' need to "do something" about the economy, near-zero interest rates have their negative consequences:

• Savers and investors are penalized with near-zero returns on bank accounts, treasury bills and money market funds. The real return (after taxes and inflation) is negative.

• Low investment returns tend to encourage investors to chase higher yields in much riskier securities, such as junk bonds. This is not a prudent thing to do in a deepening recession (or worse).

• A collapsing dollar. The historic low returns on U.S. securities just can't compete with European rates. Moreover, the dollar's 15% drop in value in 2002 brings many foreigners' losses to 40-50%. We're nearing the "cry uncle" point, Foreign money will just stay home. According to Fox News, Europeans have reduced their purchases of U.S. stocks from $84 billion in 2000 to just $11 billion in 2002. 2003 will likely show a net outflow.

The U.S. trade deficit also has continued to inflate in its own Hindenburg bubble. The deficit has inflated nearly four-fold over the last four years, reaching a colossal $450 billion in the latest twelve months.

Personal bankruptcies have soared. CNN reports there is a shortage of federal bankruptcy judges!

There's one remaining sector that the bulls cite as evidence of continuing strength in the economy: real estate. Housing has been propelled to extreme valuations by the lowest mortgage rates in 40 years, This bubble will burst shortly after the Fed's next interest rate move, which will likely not be a cut but a hike, necessitated to defend the plunging U.S. dollar.

Now given that even the anal-ysts parading across CNBC can see the real estate bubble about to burst, it pains us to agree with them. But the evidence is building day by day:

• In many areas of the country, apartment and office vacancies have soared.

• Mortgage delinquency rates have doubled.

• Inventories of unsold properties have soared.

• Prices of those home that do sell have leveled off.

• Foreclosures have soared.

• Permits for new construction have plunged.

• More and more real estate agents are starting to talk about it being a "buyer's market," for the first time in a decade.

The Economic Outlook for 2003
We continue to be unequivocally bearish on the U.S. economy as well as the U.S. markets. This is not just another routine bear market for stocks, and it's not just another routine recession for the economy. Unfortunately, the potential for a "3D" scenario, a "devastating deflationary depression," is very real.

The good new is that we can not only survive but actual prosper if (when) the 3D scenario unfolds. Robert Prechter, the world's foremost authority on Elliott Wave technical market analysis, has written his tenth and most important book yet. It's called Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression. It's a Wall Street Journal #1 Business Bestseller.

Here's my standing review of "Conquer the Crash":

"In straightforward language, free of typical Wall Street econo-babble, Bob Prechter builds a bullet-proof case that a deflationary depression of historic proportion is underway. It will devastate the wealth of those who do not read this book and heed its advice. Bob Prechter calmly and rationally lays out the many options a prudent investor should consider at this juncture. Conquer the Crash could save your financial future."

We strongly encourage everyone to read this book. Buy it or check it out at your local library if necessary. The modest price of this book is a true investment in your financial future. If you need to protect your portfolio or if you just need to sleep well at night, you owe it to yourself to read Conquer the Crash.

One of the most astute economists out there is Dr. Kurt Richebacher, former chief economist for Dressner Bank. We generally concur with his poignant perspective. He believes "this is by far the greatest and worst credit bubble that the world has ever seen." Dr. Richebacher elaborates on his outlook in this must-read interview on http://www.investmentrarities.com/12-24-02.html.

The most recent batch of economic indicators offers no evidence whatsoever that a genuine recovery is underway. On the contrary, economic performance continues to deteriorate.

For example, holiday season retail sales were the weakest since they starting tracking such data in 1970. On New Year's Eve, the Conference Board reported that its consumer confidence index "unexpectedly" sank to 80.3 from 84.9 in November, just above the nine-year low of 79.6 reached in October. The economic anal-ysts were looking for the index to rise to about 85.3.

Yet sentiment regarding the economy remains decidedly bullish. According to the Bond Market Association, economists think GDP will grow at a 3.4% rate in 2003. CNN reports that the Wall Street consensus is for 14% growth in the earnings of the S&P 500 companies.

These economists need to get real. They don't get real because if they did, they'd be out of a job. It's just not politically correct to be bearish on the economy. It's bad for business, the business of economic forecasting that is.

We're sure to hear the choir break into their mythical "second half recovery..., second half recovery…" mantra, starting about mid-February.

Indeed, Sir Alan and his Merry Men have gone on record stating the Fed is standing by, ready to put the printing presses into high gear to keep the U.S. economic machinery well-lubricated. Just how worried are they about a deflationary depression?

continued on page 2
 

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