WSJ.com - Today's Markets

WSJ.com - Today's Markets

Historically consumer discretionary stocks have not been the ones to own during the second half of an economic recovery. The declines in Harley-Davidson yesterday and trades in Ford and GM has shown that this cycle is tracking the pattern much as one would expect.

All cycles vary but patterns do repeat. A mid phase correction is certainly part of the norm. The car bull that lasted from 1914 until 1929 stalled for two years in 1919 and 1920 and the big computer bull stalled from late 1961 and into 1963. Another example, the bull of the 1980's started out super strong in small stocks, died and was revived when the big caps kicked-in.

One difference this time is that the mid bull slow down is usually caused by a dramatic run up in long-rates. For example, the bull that kicked-off in August of 1982 was slowed when long rates rose to 13.75 in June of 1984. Long rates soared in 1994 to cause a mid course correction before the real boom began in 1995. But perhaps there is not a difference! Perhaps we have already seen the big mid course run up in long rates! After all, the interest rate trend has ratcheted down since 1981 but still has not reached the prior lows of the late 1940's and early 1950's.

The real estate market is simply too strong to suggest that long rates will go down all the way to 3% but was the June 2003 low the low of the cycle? Will it be tested? Will the test hold? The Friday night after the low was made I suggested to 6 card players that long rates were about to make a sharp V bottom. That night we had the son of one player, who was attending the MBA program at Wake Forest University at the time, substituting. He reported that one of his professors had suggested a V bottom that same day. We should have mortgaged our house to short bonds as the next month was one of the biggest moves in history.

But will the low be tested? The false inflation fears caused by the run up in commodities appear to be on the run. The Fed is even back tracking. Oil supplies are building quickly. Retail sales are anemic. A lot of folks have written about the real estate bubble. Barry Ritholtz wrote a humorous piece about the Bubble of Bubbles on his Big Picture site. It is my experience that there is a spike or blow off at the end of a long "big trend" move. Could it be that long rates break the 4.15% bottom of June 2003 leading the real estate market to a final wild ride?

How can Greenspan avoid a real estate bubble? How can the trade imbalance be solved without further declines in the dollar? The increases in short rates along with high oil prices have served to reign in economic growth and the results have been lower long rates. At the same time, the higher short rates have served to halt the sharp decline in the dollar. Imports are still soaring. Does the dollar need to decline further? The Fed is between a couple of rocks and a couple of hard places. Greenspan's remaining tool is the same jawboning he tried with the stock market bubble. (Do you remember irrational exuberance?). He is now stuck with "conundrum". It is entirely possible that we will see an inverted yield curve by the time short rates hit 3.75%; should they go up that much. The PCED will probably show lower inflation in the months ahead. Inflation by this Fed favorite measure is already very low. With inflation of maybe 1.5%, who needs increases in the discount rate above 3%? I suspect the Fed will back off the rate increases. The near term peak may be only 3% or 3.25%. A holding period might follow which should be a wonderful time for stocks and real estate.

Investors should remember the economy is now global. The ECB said this morning that they see few signs of growth acceleration. These "old economy" countries must stimulate their economies to avoid a protracted recession. Greenspan needs to keep rates competitive if the trade deficit is to improve. I am not a buyer of consumer discretionary stocks but I am a buyer of stocks. The next move in long rates is probably down but I choose not to play. The real estate market is too strong to expect a big move down in rates and the fed is up against international forces. The bottom line is a low inflation economy with stronger than average growth (though not as strong as recent years); a wonderful environment for stocks!