Carnegie Management Group

Q: What guides your overall investment outlook?

A: One thing about the stock market has always remained true:

“There will always be bull markets followed by bear markets followed by bull markets.” - Sir John Templeton

Interestingly, our most recent and painful bear market followed the longest bull market in history. That major bull market began in August of 1982 with the Dow Industrial Average at only 777. Falling interest rates and declining inflation ignited the first leg of that bull market. Sound familiar?

The second leg of the most previous bull market began in the fall of 1989 with the collapse of communism when the Berlin Wall was torn down. Most nations in Europe and Asia switched from a Cold War political strategy that spent billions on defense to an economic strategy as a means to produce continuous economic growth. Properly executed, this strategy builds the wealth of a nation and the net worth of its citizens by producing a stable economic environment. The collapse of communism was the single most important economic event of the 20th Century.

The third leg of what is generally recognized as our most historic bull market of all time began in 1994 when Congress ratified the North American Free Trade Agreement (NAFTA) and the General Agreement on Trade and Tariffs (GATT). Falling trade barriers and the elimination of tariffs produced faster economic growth around the globe. The ratification of NAFTA and GATT was the second most important economic event of the 20th Century. And, on July 28, 2005, Congress passed the Central American Free Trade Agreement (CAFTA).

When The White House and Congress refused to regulate the Internet, America raced into The Information Age. An explosion of technology accelerated economic growth and stock prices exploded in 1995, 1997 and 1998. Despite our current financial crisis, the USA is—and will continue to be—a high technology, computer, software, information, Internet-based telecommunications economy.

The Internet has changed the way the world communicates and conducts commerce around the globe. An explosion of Chinese logging onto the Internet will eventually free China from the shackles of communism and corruption. The explosion of eCommerce has already accelerated global economic growth.

Q: Why is it that when short-term interest rates fall, long-term rates do not necessarily fall? Please explain the relationship between the two and any correlation, if such exists.

A: Thirty-year bond prices and, hence, yields, are set by the free markets, not the Federal Reserve. Bond prices change minute-by-minute—even, second-to-second—depending upon supply and demand. Changing economic conditions around the globe cause bond traders to sell if they feel various events are inflationary. Selling bonds will push bond prices lower. As a result, yields move higher to compensate for the loss of value caused by perceived inflationary event. If traders feel various events are positive for the bond market or non-inflationary, bond yields will fall and bond prices will go up. Market interest rates have a historic tendency to rise in the first quarter and then fall for the balance of the year.

The Federal Reserve has no control over 30-year bond yields. The Fed uses the Federal Funds Rate (the overnight lending rate between banks) to execute monetary policy. If the Fed wants to tighten monetary policy for the purpose of slowing economic growth, the Federal Funds Rate will be raised. If the Fed wants economic growth to expand, the Federal Funds Rate will be lowered—as we experienced from 2001 to 2003, where the resulting one percent Fed Funds rate remained until the Fed again began raising the Fed Funds Rate in quarter-point increments in late-2004, and ending two years later in late-2006.

The current financial crisis has caused the Fed to aggressively lower rates again.

Q: What is the Smart Money Index? Can it actually move the market?

A: The Smart Money Index is one of the market's most reliable technical indicators. Watch what the Smart Money is doing and you can easily forecast where the stock market is headed.

The Smart Money does not buy or sell stocks at the opening bell. Traders reacting to what happened overnight in Asia and Europe account for most of the needless volatility in the futures before the market opens. Over the long-term, events that unfold in Europe and Asia have very little influence on corporate profits in America. The bottom line for American investors is rising corporate sales and profits. Most everything else is noise.

Very often, economic news is inaccurate, or has very little effect on corporate sales and profits. Even so, market volatility is caused by emotional, knee-jerk reactions of traders in the trading pits. During the day, the stock market either over-reacts or reacts improperly to the news. Stock prices usually fall between 11:30 and 2:30 EST because the traders go to lunch and leave the market vulnerable to the short sellers. If stock prices are falling between 3:00 and 4:00 EST, you know that the Smart Money is selling and it is time for you to run for cover. If stock prices are rising relentlessly between 3:00 and 4:00 everyday, a bull market is underway.

The Smart Money waits until 3:00 to either sell or bargain hunt. You've heard the expression, "Never fight the Fed." The same warning applies to the Smart Money. If you are buying when the Smart Money is selling, you are on the wrong side of the market. This is always very costly.

A: Say you want to own a lot of stocks, but don't have the time to carefully track each of them. Also, you know the cost of multiple trades can add up quickly.

In the past, your best bet was to purchase a mutual fund. Thanks to the emergence of exchange-traded funds (referred to as ETFs), however, investors now have a better, more efficient way to invest in groups of stocks.

Many ETFs track an index, giving people access to a big basket of stocks. For instance, the Standard and Poor's Depositry Receipts are based on the S&P 500 indexes, the Diamond Trust on the Dow Jones Industrials, and the QQQQ on the Nasdaq 100. The ETF universe also includes bonds and commodities, as well as funds that track other countries' indexes.