Tuesday, June 06, 2006


My good friends at Hays Advisory have gone all-in! Yes, for growth investors, Don Hays and company now recommends 100% stocks! The call is based on cheap relative valuation and on the negative psychology of the market place. In today's newsletter, Don Haysincluded a wonderful bond indicator that shows that bond yields are probably going to roll off this intermediate term peak. If he is right, then the current earnings of the S&P 500 must drop like a rock or stocks have to go up in price like a rocket! The current Thompson survey suggest that earnings are continuing to surprise to the upside. The S&P now trades at 14.3 times earnings, below the 20 year average PE at a time when bond yields are well below the 20 year average! Stocks are ready to blast off!

As you should already know, I do not believe in any one's ability to make short term market calls. Having said such, it is my opinion that Hayes is a little early. I believe we still have a few more weeks of market churn before the big lift off. SO WHAT? IF YOU ARE NOT "ON-BOARD", YOU MAY MISS THE EARLY STAGE OF THE BIG MOVE AND THEN BE HESITANT ABOUT CLIMBING ON BOARD A RISING ROCKET SHIP AT HIGHER AND HIGHER PRICES!

Besides, the current market crunch is a market rotation not a market crash. Emerging country stocks, small cap stocks, metals and basic materials have taken the bulk of the crunch. Of course, our airline positions have pulled back after an incredible run but this volatile group is prime for another big run when the disconnect in oil prices and oil inventories is corrected. When it becomes clear that the FOMC must stop raising rates, probably by the June 28 meeting, then hold onto your hat.

Signs of the end of rate increases are every where (as one pundit said, many of the signs are homes for sale). One available sign is the chart of ISM Manufacturing Growth. The growth rate dropped below 57 March 1979, June 1984, February of 1989, February 1995, April 1997 and February 2000. In each instance, bonds rallied. This indicator just dropped to 54. Feb 24, 1989 and Feb 1, 1995 were the "dates of last increase" in these two cycles. The dates also correspond with the beginnings of large positive moves in bond prices and stock prices.

Employment growth has slowed, home sales have fallen, auto sales and retail sales are hurting. All signs that the FOMC needs to stop raising rates. At the same time, a huge capital spending cycle is underway in energy and mining. Under normal circumstances, this huge demand for capital would be pushing long bond rates up much more, however, as Bernake points out, there are huge cash surpluses around the world. The "big spend" is going to bring on new supplies of energy and commodities at an increasing rate. Sooner or later, somewhere in the world, the extra energy supplied will be the cup that breaks the camels back.

The evidence is that while Saudi Arabia is participating in the "big spend", the country is already having to throttle back oil production because of the building global glut. Saudi is the one country that still has excess capacity (about 1.5 million more barrels per day could be pumped). When this excess reaches 2 to 2.5 million barrels per day, much of the $20 or so risk premium in the price of oil will disappear.

The public does not believe it but conditions are ripe for a deal with Iran. The Iranian economy, on the verge of collapse, is being held up by $70 oil. Even with $70 oil, the country is not able to attract capital to build out needed infrastructure. I believe Iran is the only oil producing country in the world that did not complete at least one new oil well in the past 12 months. The country re-imports a significant portion of its on oil after paying for the crude to be refined into usable products. With an influx of capital, the country could rapidly increase production by one or two million barrels per day. Seventy million dollars a day or 25 billion dollars per year is not chopped liver.

Back to stocks: those who "move all-in" will be pleased sometime in the near future. The down side risk is not as great as is the perceived down side risk. For example, should it become necessary to boycott oil from Iran, the US could re-institute 55 mile per hour speed limits and other conservation measures and save more oil that Iran produces. If the current leadership in Iran wants to stay in power, it needs to make a deal. Furthermore, corporate cash flows are going off the chart. Many a technology company has buckets of new cash pouring into full coffers. Company after company will soon decide to buy back shares, increase dividends or take over another cash rich company.

Many a company is in the position to issue bonds, use the cash to buy back shares and increase earnings over night! Last year, a new record was set for stock buy backs. This cash is being recycled time and again, keeping interest rates relatively low. As you might expect, the public view is just the opposite. It is nearly impossible for 80% of Americans to agree on anything, however, Gallup finds that 80% of Americans believe interest rates are headed higher. This is the best indication of all that rates are near a peak.

Conditions are never perfect and worry warts can always find a fly in the ointment. While portfolio theory suggest that investors always keep solid allocations to fixed income, "to be on the safe side", reality is that STOCKS OR BONDS? is the big question. The majority of the time, 19 out of the last 30 years, one should have been in stocks or bonds not both. The allocation one makes to stocks or bonds is the most important factor in portfolio performance.

The signs of economic slow down suggest that bonds will do well in the immediate future. In my largest accounts, I have purchased bonds on 10 to 1 leverage. On the other hand, valuation measures argue strongly that investors should jump all over big cap stocks now, before the pending lift off.

Please, please, please, do not let the current market rotation cause you to avoid action. Now is the time to open or increase your stock accounts. Those who want to make serious money should avoid the 401-K trap and invest aggressively in taxable accounts. Taxable accounts allow leverage and tax management and make funds available for "the big scores" that are present when recessions reduce prices.

I know I am beating a repetitive drum but Hays is absolutely right. Conditions are ripe for a major market move. No one can tell you the date of the lift off, but I believe it is soon, very soon!