BE THE BULL!

It is time to Be the Bull! Join the stampede that is about to resume.

For weeks, the market has looked for signs that inflation is not going to be a like a monster rising up out of the sea. The pre-Katrina evidence is here.

The Beige Book has confirmed a slowing of the economy. Average unemployment claims have risen for the past 4 weeks. The employment cost index year over year percentage change is dropping like a stone. Greenspan's favorite measure of inflation, the Consumer Price Deflator has headed down. Inflation around the world is subsiding and, indeed, Japan continues to experience deflation.

The sources I am using for this report include Economy.com and a report from Ed Hyman of the ISI group. Ed has been one of my most favorite prognosticator for many years. Economy.com appropriately uses the monikor "The Dismal Science". But one should remember that bad news is often good news for the stock market.

A lot of folks who are whining about inflation forget to mention the 16.3% drop in the average price of the average computer. Dell is a super efficient manufacturing and distribution company. It operates at about a 60% gross margin. The stock has been having a difficult time because retail prices continue to drop like a stone. But computers do not furnish the only incredible numbers.

Many folks have bought houses in the past year and paid a 5% interest rate on 80% of the funding. The value of the houses have gone up 10%. Ed Hyman produces a great chart that deflate mortgages by home sale prices to show a record low in "real mortgage rates". Home buyers are being paid 5% to borrow money! I know, you think it is a housing bubble and that the price of a house will crash one day. In 1952 my parents were appalled to have to pay $2,000 for a two bedroom house. Years later the house was expanded and the cost to add two rooms and a bath were over $3,000. Had my parents rented the house instead of buying it, the current annual rent would be several times the total cost of the home.

No matter how much your friendly broker, neighbor or relative likes to whine about the price of gas, inflation is not bad at all. Indeed, there is considerable evidence that the spike in commodity prices is ready to subside. It does not matter, the total inflation number is a weighted average and the price of much of what we buy is not going up much. Consider dairy products and cars. Dairy products are down 3.2% since last year. The major car companies have cut prices to the employee discount rate.

If you have not noticed, unions are on the run. The AFL-CIO is no more. Northwest airlines resumed negotiations with the mechanics union today with the opening salvo that they need to lay off two thirds.

A decent push in the S&P could cause the shorts to scramble. The forward PE for the S&P 500 is about 15. While not particularly low by historical standards, one must remember 15 is a low number relative to core inflation of 1.8%. Believe it or not, it is a realistic probability that the 10 year government bond total return will be upwards of 15% over the next year! If the 10 year bond were to manage a 15% return, the S&P 500 could easily produce a 25% return.

With the impact of Katrina in mind, Greenspan and company may skip a quarter point move. I hope he does not. In the longer term Katrina rebuilding will provide serious stimulus to the economy and it will add to the inflation rate. Barry and others may say that Katrina will not prove to be a stimulus but the rebuilding is like any massive project where billions are borrowed and spent. No, it would not make sense to tear down an entire city just to borrow and spend but now that the destruction is real, we will borrow and spend to rebuild. One more quarter point move would convince the market that Greenspan and company are serious about "nipping demand pull inflation in the bud". Another quarter point would cause an outcry of "pain" but long bond rates and long mortgage rates would decline, inflation would be declared dead and the stock market would enjoy about a 30% move over the next 4 to 6 months!

BUY THE BULL! BE THE BULL! ONE SHOULD NEVER EXPECT TO CALL SHORT TERM MOVES IN THE MARKET. HOWEVER, ONE SHOULD BE ABLE TO IDENTIFY WHAT IS UNDERPRICED RELATIVE TO OTHER INVESTMENTS. STOCKS ARE CURRENTLY UNDERPRICED.

NOTE: HOMES AND BONDS ARE NOT AS EXPENSIVE AS THEY APPEAR. BONDS ARE NEAR HISTORIC HIGHS BUT INFLATION IS NEAR HISTORIC LOWS. NEW HOME BUYERS ARE LOCKING IN PAYMENTS FOR 30 YEARS THAT WILL PROVE TO BE WELL UNDER AVERAGE RENTS FOR THIRTY YEARS. STILL STOCKS ARE CHEAP RELATIVE TO BONDS AND REAL ESTATE.