Monday, June 05, 2006


Friday mornings government data was GREAT BAD NEWS! The stock market is now ripe for a major move! Neither I nor anyone else can consistently call the market in the short run, but conditions are becoming more and more favorable for equities. THE BIG BULL IS PAWING THE GROUND; HE IS PREPARING TO CHARGE AGAIN!

Friday's numbers showed the economy is not over heating. Employment growth has slowed. Inflation expectations have moderated. Thursday's productivity numbers were very strong and wage price pressures have moderated. Gold and other commodity prices have fallen. Bush is pressing hard for a deal with Iran, which would be an anti-terror coup. An Iran deal will be positive for lower oil prices, helpful toward peace in Iraq and great news for the airlines. The public is about as skeptical and frustrated as you are likely to find; a very positive environment for stock price appreciation. The infamous WALL OF WORRY is standing tall for the market to climb.

The big reaction today has been in the bond market. Long bonds have jumped 2% in value. This is a huge move! When ever an 11 trillion dollar asset increases by 2% in value, the net worth of a lot of folks (including their pension funds) goes up. one Because we have our bond accounts levered at 10 to 1, the move is one 20% one day gain in equity!

The FOMC has all but finished the difficult task of turning around a huge battleship. The world economy is indeed more cumbersome than the largest of aircraft carriers. The "Good News" is that the psychology of the market will now start to feed on itself. The decline in inflation expectations is an automatic increase in real interest rates which in turn makes hoarding commodities more expensive which in turn puts downward pressure on the price of commodities which further lowers inflation expectations. DON'T STAND IN THE PATH OF THE BULL STAMPEDE!

It is typical for the bond market to react more strongly to economic news than does the stock market. Because bonds can be levered 10 to 1, traders take advantage of BIG NEWS to jump on bonds hard. However, the stock market is mathematically joined at the hip with the bond market. Lower bond yields make stocks more attractive. The big move in bonds today will flow through to the stock market in the coming days and weeks.

The current economy is somewhat similar to the economies of the mid 1980's and mid 1990's, in those cases when employment growth slowed, bonds rallied and then stocks took off. Stocks have historically done very well during periods of moderate inflation. The recent numbers show the fear of inflation is over blown. Investors continue to read the headlines about the price of gas and gold and they forget that the internet has made price competition on fierce. Consumers complain about immigration and the outsourcing of jobs without appreciating that globalization has been a blessing to all who want to enjoy a higher standard of living. There are two ways to increase your standard of living, make more money or buy goods cheaper.

The slow down in employment favors bonds in the short run. Slow monetary growth, slowing home sales, slowing auto sales, dropping metals prices, high short term rates, the commitments of commercial traders and, yes, even high energy costs all favor bonds in the short run.

While the Fed Model shows that stocks are very cheap relative to bonds, the flat yield curve has caused a "traffic jam". Stocks need bonds to get out of the way. The move today is an indication that the road is about to clear. Psychology has been adding to the road block as the over-whelming majority of folks in America today are very pessimistic about interest rates. This excessive pessimism has gradually become the solution to the problem. Folks have been preparing for "seven lean years". Of course "seven lean years" never comes if you are fully prepared. By not borrowing to buy homes and cars, folks contribute to the process of keeping interest rates from going as high as they fear and even to causing rates to decline.

As always there are concerns that suggest cash will out-perform stocks or bonds in the near term. ISM production figures show that manufacturing is still strong and whole sale price pressures still exist. Wages year over year have grown at the highest pace in several years. Unemployment is very low as work force participation is low. Many folks are "working" full time on internet "hobbies" that don't show in the official employment statistics. Resources suppliers have been pushed hard by new demand in developing nations.

I discount these concerns because day by day suppliers and consumers are reacting to high prices. The list of reactions is endless. Last Thursday (6/1), a Canadian refiner finished a two year retrofit project. The Shell Mars Platform will be restarting production in the Gulf next month. More and more freight is moving by train versus fuel hungry trucks. Americans are flying more but driving less; jet fuel consumption is up but gasoline consumption is down. Construction of power plants and refineries is moving forward around the world. There is a migration of people back to the city. More and more Americans choose to not even own a car. Small non-hybrid fuel efficient cars are selling like hot cakes while expensive hybrid sales are slowing and SUVs and trucks are parked. Common sense is winning. It makes no sense to over-pay for a hybrid vehicle. Those who do it for the environment do not understand the laws of economics. The topping in the price of copper shows that the price of batteries is destroying hyper demand.

The bottom line is that Americans of all people should trust free markets and the laws of supply and demand. The law of substitution is huge. Right now, stocks are cheap relative to bonds and real estate. The law of substitution says consumers will sell bonds and real estates to buy stocks until equilibrium is reached. The neat thing for investors is that momentum will carry stocks to the other extreme. Buy now, ride the move to equilibrium and then you will have the tough task of deciding how long to let your profits run! RIDE THE BULL!