Wednesday, June 07, 2006


This morning, CNBC played the "news game" according to script. With the market in a rotational correction, CNBC invited on a guest who is as negative as they come. This is the stuff that induces irrational behavior. It is a play on fear. Only fear can make folks sell right after the market has dropped 10%. This particular chap discussed how bad inflation is. He mentioned housing and oil in particular.
A few moments later, in response to a bond market question, he said the "slow down in the economy" means that he is increasing bond market duration. What a joke? Does he believe there is inflation or not? If inflation is going to be very bad, the last thing one would want to do is to increase bond duration. The fellow is saying that interest rates are going up and that interest rates are going down and both are reasons to run for cover. Besides, he is keying off inflation which is a lagging indicator. Indeed, the two specific examples he used, housing and oil crested months ago. In fact, the price of oil is about the same as it was in August of 2005. Yes, oil price inflation is still seeping into the core rate but this is very old news. The more recent pertinent news is that the price of copper, gold and other metals, mining and energy stocks have all taken a tumble. The pressures on prices are dying. In the May 29 issue of Fortune magazine, there was a neat article about the huge savings being realized at truck stops. Truckers are required to stop for 10 hours in the middle of a long haul. Many still sit with their engines idling to run heat, air, etc. However, truck stops all over the country are installing a "pipeline" service that bring fresh conditioned air, touch screen on-line computer, unlimited VoIP telephone, and 120 volts AC current; all for the price of $1.85 per hour. I have forgotten the projected fuel savings number but it is a very large number! The touch screen computers even have required education certification software to confirm that the truckers have completed the required hours. I mention the law of substitution often because while it is one of the most powerful and important economic laws, it is the most under appreciated. The above trucking story is an example of the law of substitution. The price of fuel has gone up and millions of trucks will stop running their engines at truck stops. The coal being burned to provide the cool air and other services cost about 20% of the price of the oil being replaced. At the current price of oil, there are millions times millions of ways that the market will find substitutions. I must repeat one of my favorite examples about metal substitution, after the run up in copper prices in the late 70's and early 80's, the government got very busy. It moved faster than normal and by 1986 the US penny was changed from virtually 100% copper to 98% zinc and 2% copper. The government had seen the point almost reached where it would have paid consumers to take their pennies to a recycling center. Just a few weeks ago, the price of zinc almost reached the level at which it would have made since to take your pennies to a recycling center. I suspect that in another five years, after the speculative craze is long passed and when zinc prices are making a bottom, the government will change the composition of pennies again. The good news is that the market is many times faster than the government. Investors around the world have spent billions of dollars in the past 3 years to expand energy supplies. On the drawing board are plans to spend 100's of billions over the next 5 years. At the same time, the cars being sold like hot cakes are tiny little cars that get 30 to 50 miles per gallon. The list of other substitutions in progress is too long to recount but even government is prepared. President Bush started negotiations with Iran about 5 years ago. Understanding the concept of negotiating from strength, the president has pushed our strategic petroleum reserve to 700 million gallons. Iran can threaten to cut off oil supplies if they like because the US is in the position to survive long after Iran will go bankrupt. Iran is between Iraq and a hard place and needs to make a decision soon. In the mean time, a number of sentiment indications show how much fear there is in the market. The levels are consistent with the fear present at or near market bottoms. Now is the time to invest aggressively. Now is the time to add to your account. No one can tell you which way the markets will move in the short run but the odds are very high that big cap stocks will out-perform bonds, emerging markets, small caps and most real estate over the next several years. BUY BUY!