CONSUELO MACK: On "WealthTrack" this week, we are following two investment trends, one is the dismal performance of the overall stock market, the other, an expected event with unexpected consequences. First, as the half of the year comes to a close. The major stock market indices are all lower. The Dow, down nearly 5% is back where it was at the end of 2003, a level it first crossed six years ago. That doesn't mean some investors haven't been making money.
  In fact, mid-cap stocks have broken out to new highs and real estate and energy companies continue to deliver strong returns. The other development this week is the ninth straight interest rate hike by the Federal Reserve board.
  The short-term federal funds rate is up to three and a quarter percent.
  That means you will get a little more income on your savings accounts and money market funds. But the unexpected is happening to long-term interest rates… they keep going down, helping boost bond portfolios and making mortgages cheaper...
  The yield on the ten year Treasury note is now about two-thirds of a percentage point below what it was a year ago. And the rate on the 30-year fixed rate mortgage sank to it lowest level in more than a year, to just about five and a half percent...
  What's going on? Let's find out from our assembled experts.
  Joining me to track the trends we are tracking this week are three top pros in their respective fields.
  If you want to know about the Fed, interest rates and managing bonds, you want to talk to
  Paul McCulley. He is fed strategist, portfolio manager, and head of the short-term trading desk at bond giant Pimco.
  Mary Farrell, is one of the most trusted names on Wall Street. She is chief investment strategist at UBS wealth management USA and the author of "Beyond the Basics, How to Invest Your Money Now That You Know a Thing or Two."
  She will teach us a thing or two, I'm sure!
  And Frank Gallinelli, founder and president of Real Data, the real estate industry’s leading software investment firm. His software helps individuals invest in real estate. His book, “What Every Real Estate Investor Needs to Know about Cash Flow” is a best selling book right now.
  Welcome to all of you.
  Paul, I'll start with you.
  The Fed and this interest rate conundrum i just explains where short-term rates are going up and long-term rates are going down.
  Why is that happening?

PAUL MCCULLEY: Actually I don't think it's nearly as much of a conundrum that Mr. Greenspan does.
  The long-term interest rate is reflecting the global economy and the global flow of funds and the global arrangement among currencies which implies that we will have low real interest rates in the United States and also low inflation.
  I think that's what the long end is discounting. In contrast, Mr. Greenspan is driving up short-term interest rates.
  He is marching to a domestic drummer. So I think the conundrum is explained by the fact that the long end is determined by global influences, which are disinflationary and the short end is determined by Mr. Greenspan, who is actually quite frankly secretly trying to get after the real estate market which he thinks is a little bit on the bubble side.

CONSUELO MACK: How long is this going to continue?
  For instance as a home owner, which I am, are there going to be many more opportunities to refinance mortgages - are long-term rates going to continue to go down?

PAUL MCCULLEY: I don't think they have much further to go down now. Just today long-term interest rates backed up after Mr. Greenspan beat us about the head and shoulders for the ninth time yesterday. So I think the yield curve is about as flat as it can go.

CONSUELO MACK: The yield curve being the difference in long and short term interest rates.

PAUL MCCULLEY: The whole compression of yields has been amazing and every maturity has almost got a 3% as its first number. So I think it is about as far as it can go but there is no question this is the definite most important issue in the financial markets is to explain whether or not this configuration of low long rates and a tightening Fed can hold or not or if something is going to break out here.

CONSUELO MACK: And right now you think it is going to hold.

PAUL MCCULLEY: I think it’s going to hold. It will hold until Mr. Greenspan does his semi annual testimony before Congress. This will be his last because he will be retiring in January. The next big date on the capital market's agenda is Jan 20.

CONSUELO MACK: Mary Farrell, halfway into 2005, another dismal performance in most of the stock markets and we try to think long-term here on "WealthTrack" as well.
  I made the mistake of looking back over the last five years as well and stock returns have been except for the small cap sector and some energy stock and housing stocks have not done well either. What is going on and what is the outlook?

MARY FARRELL: It has been very tough time for investors.
  It's not like the good old days. You can't get the stock gains very easily. One of the problems is that we finished that disinflationary environment that drove stocks in the '80s and '90s. We had the bubble that ended up with a bear market.
  We are very slowly getting back to normal but investors have to understand normal is a much slower rate of growth and much slower rate of returns than the 1990s.

CONSUELO MACK: How much lower rates of return?

MARY FARRELL: If you look at virtually all the fundamentals, whether it's economic growth or above trend earnings growth, this year is right in line with trend, inflation a little above trend. Those are really decent fundamentals but unfortunately the market is not cheap. So I think we'll see gains with the market aligned with earnings gained going forward.

CONSUELO MACK: Which are?

MARY FARRELL: Probably 8%, maybe a little above that.
  Next year we are probably looking at a slowing significantly from that to somewhere maybe in the 3% area.

CONSUELO MACK: Is the market going to get bailed out in the second half like it was last year by the election?
  I don't know what is out there to bail it out.

MARY FARRELL: I wish I knew what was out there.
  It is important for investors to understand, market movements tend to be contained in much shorter time frames. Last year we went through the first ten months of the year with a flat market, a post election 15% rally ended with the year up ten.
  This year the same range bound market and I think June 20, if we got some good news from Mr. Greenspan or if we got a suddenly better than expected earnings for next year, say oil prices came down and it looked like that would be a benefit, we would see some market movement.

CONSUELO MACK: Frank Gallinelli, real estate is the hot market right now. How concerned are you about the kind of appreciation we've seen in the real estate market five straight years of record home sales and record home prices?

CONSUELO MACK: We are all about building wealth on this program. I'll ask each of you the same question.
  Paul the question is - I'll start with you, what is the one investment that you would make today for a long-term portfolio?
  What would you put your son into now that you think would pay off in the next ten or 20 years?

PAUL MCCULLEY: My single favorite area is in the emerging markets. And for the long term, in the equity side.
  And even though I'm a bond man in my day job, from the standpoint of personal investing, a nice slice of emerging market equities managed by a competent manager is the single best idea I have because I think the emerging markets, since the crisis of '97 and ‘98, have done a miraculous job of getting their houses in order.

CONSUELO MACK: We had graphic up that showed three really well managed mutual funds by very highly respected fund families. So the T. Rowe Price Emerging Markets, the Vanguard Emerging Markets Stock Index, and American Funds New World. But go ahead about the equity funds which is fascinating as you said from a bond guy.

PAUL MCCULLEY: You think in terms of being a long term investor you want a portion of your portfolio in the assets that an option on capitalism.

CONSUELO MACK: And that's stock.

PAUL MCCULLEY: The upside on a bond is that you get your money back.
  I want some exposure to equity, I want it in the emerging markets who have recovered from '97 and '98 and have their houses in order and are becoming members of the global capitalist community. That is a long-term investment.
  Not market to market the next few days and figure out whether you are smart. But 20 years later, you are going to look back and say wow.
  That was huge.

CONSUELO MACK: Mary, quickly what is your response?
  You still like stocks right?

MARY FARRELL: I'm not going to return the favor and recommend bonds. Let me quickly say dividend growth is an outstanding way for investors to build wealth. Dividends historically accounted for 42% of the total return of the market. We lost sight of them when the market was yielding less than two percent. But you buy companies with low yields now but history of increasing dividends every year, you get a bigger check, great inflation hedge, and most important with the 2003 tax act you get to keep more. 15 %

CONSUELO MACK: We at WealthTrack have promised you access to the best minds in the business. You've just heard from three of them. Some of them are well publicized.
  Many are known only to their peers or individuals and companies that can afford to consult them. Our featured guest, Ed Hyman has built a firm that is one of Wall Street’s best kept secrets, ISI Group. "Smart Money Magazine" recently called them the smartest folks on Wall Street.
  Prominent money managers read their research religiously because in the financial world ISI is one of the highest sources of independent research and strategy…, so well regarded that institutional investors have voted cofounder and CEO Ed Hyman, the number one economist on Wall Street for an unprecedented 25 years in a row.
  Hyman accurately predicted what he called the perfect storm of conditions that led to the economic downturn in 2001. He then also forecast the recovery that followed after 9/11. ISI stands for international strategy and investment. The words behind the name are one of the keys to ISI’s success. Its think tank-like team tracks events from a global perspective from US home prices to overseas government actions to oil production shortages, and they analyze how all of these far flung events will affect investments at home and abroad.

CONSUELO MACK: So which events is Ed Hyman focusing on now and what does it mean for your investments? It's great to you have here, Ed.

ED HYMAN: Nice to be here.

CONSUELO MACK: You've been following the economy for a couple of decades now and one of the things you told me is that you think this year is an important year for the economy. Why?

ED HYMAN: This is the middle of the business cycle.
  We had a recession in 2001. We'll have another one I think in 2010. The expansion is every decade. This is the mid-course correction. The Fed is making the correction. This correction will be over this year and then we'll be set for, I would say three years of trouble free growth. Growth without inflation. That’s why the stock market, in my view has been unchanged for a year and a half. It's because we are going through this correction. We don't know what the risks are exactly. But we'll find out soon and then the market, I think, will have a nice leg up, discounting growth in '06, '07 and '08.

CONSUELO MACK: A trouble free economy which means no inflation means the Fed won't have to raise interest rates, right?

ED HYMAN: That's their goal. They don't do this every week. Or every month or every quarter. They do it once every five years. And this is their tune-up and they always succeed in getting the right conditions in place. The question is how much pain do we have to go through to get the tune-up. But once you have it, you have the goal is to have another part of the business cycle before you get to the inflation that will most likely come on a cyclical basis in '09 or 2010 or whatever when it heats up again.

CONSUELO MACK: So from an investment point of view, just tell us what you are looking for? Because I know you are predicting a global slowdown, a slowdown in the US but not enough to really cut off the growth and just enough basically to make it a good investment environment for both stock and bond investors?

ED HYMAN: Obviously by calling it a mid-cycle slowdown, I'm not including the chance of a recession. Which I frankly don't think is that high an odd. In this period, I think bonds will do fairly well. As the economy slows down. And the event we are trying to get to is when the event you talked about earlier is when does the Fed stop tightening?
  And as that becomes... We can speculate about that is when the stock market will start to go up.
  At this point it is a little early, apparently, to speculate, although the market is up about 5% from the low in April, which is the first sort of beginning of the speculation.

CONSUELO MACK: I know that Tom Gallagher, your analyst at ISI went out on a limb a few months ago along with Paul McCulley in saying the Fed would stop tightening soon.
  Are you still sticking with that.?

ED HYMAN: By soon that means September at 3.75.
  At that point we think there will be a convergence in your chart with the short rates going up and the long rates coming down and they will be about the same level, which is, I think is the new era pattern for long rates and short rates. It happened in 1995 in that mid-cycle slowdown and it has happened in the UK and Australia.

CONSUELO MACK: Outlook for housing in this interest rate environment you are describing?

ED HYMAN: The key in our view is what the regulators do because if long rates stay at 4% or go down a little bit, housing is going to continue to look pretty good. And it seems to us, particularly to Tom Gallagher, who does our work in Washington on this topic that the regulators are going to try to cool risky lending off. I think that would be enormously helpful if they could succeed at that. I don't think you get a bursting of the bubble. And I think we are in a housing bubble. I don't think you get a bursting of the bubble until you get a pickup in inflation on a cyclical basis and a rise in interest rates to say 5 or 6%. Then I think you have a chance of getting a real smack on housing.
  But I don't see how it happens in this environment.

CONSUELO MACK: Let's bring the group into this.
  Paul, do you have a question for Ed?

PAUL MCCULLEY: Ed and I agree on so much, it's hard to ask him questions.

CONSUELO MACK: Wait a minute. Good outlook for bonds? Do you agree?

PAUL MCCULLEY: We've had a good outlook for bonds so therefore it is difficult to go to heaven twice for the same good deed. And we disagree on the margin, but only on the margin. My question for you, Ed, is a good chunk of our career, we have been working under Alan Greenspan, not for Alan Greenspan, but under Alan Greenspan and then Paul Volcker before that. Who is going to be the next Fed chairman, and would you like to throw your name in the ring? I'd vote for you, Ed.

PAUL MCCULLEY: You would be much better suited for that job than I. I think that in our shop of the three contenders, we would probably put Marty Feldstein as the leading contender. All three of them are terrific candidates.

CONSUELO MACK: The other two being...

ED HYMAN: Glenn Hubbard and Ben Bernanke.
  We are lucky to have three such qualified people.
  But I don't see Paul, any way that you can't view that transition as a risky situation for the market. Greenspan is the maestro, very well respected and that will be a risk to the system whoever they put in there.

ED HYMAN: Our view is that they are going to try and focus on the risky lending. Greenspan has a long approach to bubbles of saying I don't deal with the bubble itself, but unlike the NASDAQ bubble, the housing bubble involves the banking system. And that's a very critical difference that the Fed sees, we think. And we think the Fed will be looking strictly at the risky lending. And not trying specifically to deal with the average person buying a house with the regular mortgage. They're not trying to go at that. I would also say, as I'm sure you well know, that the strength in housing is an absolutely global phenomenon whether you're talking about South Africa or Australia or Switzerland.
  It is going on everywhere. And home prices in this country, relative to other countries, are still relatively low and so that's one of the reasons I think they could continue to go up further.

CONSUELO MACK: That's so interesting.

ED HYMAN: But I do think the fed and I would applaud them if they were to go in for the risky, the IPO housing market, as you coined it a second ago.

CONSUELO MACK: Mary?

MARY FARRELL: We have been talking about global conditions and other various topics here. What about the current account deficit of a record % of gdp?
  Are you concerned?

ED HYMAN: We are hitting the two big ones here.
  My belief is that the budget deficit, not the current account deficit, the budget deficit is not that out of line with where it has been in previous cycles at this point, say in 1995 and the middle of that cycle, in 1985, the middle of that cycle.
  The current account is totally off the reservation. And it looks as though it will get worse, whereas I think the budget deficit is getting better and will continue to get better. And so my guess is that in '09 or 2010, I hope we can meet many times before then, but between here and there, things will be pretty good and then inflation will pick up at some point.
  Interest rates will start to go up.
  There will be real pressure on housing for the average person, not just the speculative, and you'll also have a risk of a dollar crisis associated with the current account deficit which I think at that point could be 10% of gdp.
  It's currently around six.

CONSUELO MACK: I can't let you escape without asking the question I’ve asked everybody else.
  If there is one long-term investment would you buy for a portfolio, what would it be?

ED HYMAN: You won’t like this answer, but I would buy every one that they mentioned.

CONSUELO MACK: A safe response!

ED HYMAN: I happen to think that what we mentioned at the beginning, and it has worked for me, to be diversified is a good idea. We were talking about what is cheap. There isn't really anything that appears cheap. But knowing the future is a very difficult job. And things often happen that you don't expect. And so, for example, I think stocks could have a nice run here. Bonds could have a nice run. Housing could go keep going up. I don't know which of those... I like the emerging markets as well. I don't know which are the best. I'm pretty well exposed to all of them and that has served me well up to this point.

CONSUELO MACK: We’ll leave it here. A man after my own heart. The mission of “WealthTrack”.
  Great to have you here. We really appreciate it on our first edition.
  Every week on “WealthTrack”, we'll leave you with one action point, something you can do to help your long-term financial performance. All of our guests, except for Frank, just mentioned the opportunities they see in emerging markets. We concur… these developing markets might be volatile in the short-term but long-term many of them will pay off and they're a great way to diversify your holdings, the surest way to long term investment success.
  So this week's action point, buy a well run emerging markets fund. Highly regarded fund families including Vanguard and T.Rowe price and American Funds have them… in the coming years. They should boost your portfolio's performance. And concludes this first edition of “WealthTrack” Thanks for joining us. We hope to see you again every week at this time. Next week our guest will be a money manager, Robert Kessler, an internationally known bond fund manager… he’ll bring us what he calls the one investment you’ll ever need. For more information about “WealthTrack” and our guests, check out our web site WealthTrack.com. Have a great Fourth of July weekend.
  Make the week ahead a profitable and productive one.