Thursday, April 21, 2005


Bill Cara: Capital Markets & Social Equity

I love to read Bill Cara's work because he does not mince words. If you have been reading his blog and mine, you know that he is bearish and I am bullish. The reason for the difference in our posture is highlighted in his article today.

He and others continue to wonder why long rates go down every time Greenspan raises short rates a little. There are a couple of simple answers. The key is that the market sees that there are numerous dis-inflationary forces at work and an increase in short rates is an obvious brake on the economy. We are still in a long-term down trend in inflation and in interest rates. This trend began back in the days when Paul Volcker was Chairman of the Fed. The trend has been aided and abetted by the opening of trade and the invention of the internet.

The fear of an inverted yield curve reminds me of the old saw that economist have predicted 15 of the last 5 recessions. If the market believed that inflation was out of hand, long rates would be going up, regardless of the quarter point moves by Greenspan. Greenspan's tiny little quarter point moves would only irritate the markets if inflation were really a problem. The reality remains that the costs of many products and services is going down. Even more importantly, labor costs are well under control.

The steep decline in unemployment claims is a bit troublesome. It is an indication that inflation may become a problem. The crazy thing is that one day investors are worrying about the "soft patch" and the next day they are worried about inflation. Today, when Greenspan was asked about the risk of stagflation, he laughed!

Today, when Greenspan was asked about the risk of stagflation, he laughed! GDP is growing at a fast rate and the PCED shows that inflation is historically low! In other words, the numbers are too good! In case you missed it, when Greenspan was asked about the risk of stagflation, he laughed. We are so far from a stagnant slow growth inflationary economy that it is laughable to worry about growth and inflation in the same breath.

Historically when GNP growth has been extremely strong, smart investor knew it couldn't stay strong without causing inflation and when inflation has been low, smart investors knew that the economy must be weaker than thought. The current numbers are too good!

The economy is strong and inflation is low! The environment for stocks can't get much better. Stop worrying about every bump up and down, buy good American companies and hold on for a great ride for about 4 years. There will be plenty of bumps along the way but at the end of the ride your account will probably be worth more than double its current size.