Monday, August 27, 2007


A year from now, don't say I did not tell you to BUY, BUY, BUY. I know I sound like a broken record but conditions are ripe for a three year market boom. Those who have significant amounts of money in money market accounts today will rue the day.


One mistake often made by novice investors is to focus too much on certain fundamental indicators. The PE Ratio is one of the numbers that is widely followed into blind dark alleys. Companies that reach the peak of their earnings cycles typically trade at very low PE ratios. Looking at PE ratios can be much like driving a car by looking in the rear view mirror. Take housing stocks as an example, two years ago the entire group was on a multi-year profit run and the stocks sold at 5 times earnings of less. The stocks are much better buys today even though earnings have collapsed. These stocks traded down because their estimated earnings over the next five years is low. Energy stocks are trading in a similar pattern. They are trading at low PE ratios. The world wide boom will keep upward pressure on oil prices but sooner or latter profits will decline after oil prices go lower. These are highly leveraged situations. Profits will decline at a higher percentage rate than will revenues.

Still, PE Ratios do provide a picture of history and we can learn from history if we are willing to invest the effort. Right now, one thing we can say about the average stock is that it is selling at the lowest PE ratio in 12 years. Twelve years ago, in 1995, we were working our way through a mid cycle correction, right before the big boom, boom, boom of the second half of the decade. In 1995, sentiment of the market place was sour. Today, the average investor actually believes we are close to a recession even when GNP is estimated to be growing at 4% or better. I expect the sub prime mess to slow growth a little but I also expect business construction and sales to pick up most of the slack. Market indicators show that inflation is slowing while real growth is hanging in quite well.

Pundits have argued that we are at the top of a profit boom. They wave-off the 13.5% profit increase of the last quarter by noting that this quarter was number 20 in a row of double digit profit growth. They see this profit as being similar to a gambler who rolls 20 straight 7's. A common mistake among gamblers is called the gamblers fallacy, in which the prior rolls supposedly change the odds on the future rolls. They would say that the odds of another seven are incredibly low because the odds of rolling 21 sevens is a row is in the neighborhood of a trillion to 1. I would strongly disagree. Indeed, if someone has rolled 20 sevens in a row, I would be inclined to bet the next roll is a seven. The real odds with a fair set of dice are 1 chance in 6 of rolling a seven, however, if someone has rolled 20 in a row he must be rolling a loaded set of dice.

This is the situation with the world economy today, the dice are loaded! Numerous technologies that did not exist 10 years ago have loaded the dice in our economic favor. Last year at Christmas, a homemaker and her husband agreed to try to live for one year without buying anything made in China. They have had to do without a lot of goods and in other cases they have had to pay as much as 15 times the price!


You know the story, technology is changing our world for the better. A recent story I enjoyed was about ocean going submarine robots. Scientists from around the globe are participating in deep ocean exploration from the comforts of their offices and homes. They take turns controlling an ocean robot that is exploring the deepest waters ever viewed by man. They spend hours videoing sea life and structures that have never been seen before.

One of the things that Al Gore and friends seem to miss is the size and scope of the earth's water cycle. One tree can release over 200 gallons of water vapor in a day. The human body is about 65% water. Water is the most common element on the planet. The cartoon page this past Sunday featured water. Given unbiased information, ten year old kids can appreciate that the earth and the water cycle are much bigger and more powerful than all the humans on the planet. Water is the only element on earth that is found in all three states of being, gas, liquid and solid. It is a resource that must be protected but it is also a resource that is to be used. Water is "automatically" recycled. It is entirely possible that you drank water molecules today that were previously drunk by an Egyptians some 5,000 years ago.


I have not lowered my target price for CAL to the 40's. Indeed, the purpose of buying options that only break even at $43 per share is because I believe the stock will go much higher. Buying options is a loser's game. It is a fool's game. Still, please don't make me out to be a total idiot. I would not buy the right to buy a stock at $43 if I thought it was not going much higher!

In 2005 and 2006, I wrote that I planned to "ride the bucking bronco" through the mid cycle correction. I said that the risk of being out of the market was greater than the risk of being in it. Now that the correction is in the sight of all market participants, some are ready to declare a recession is near and others simply want to sit in cash as they wait to see what happens next, BIG MISTAKE! Chances are that the next move of more than 5% is a move of 30% to the upside. The big splash has probably already hit the pond. The ripples are still in evidence and there is fear of another even bigger splash. However, the world economy is too strong for this splash to hurt much more. Central bankers have unleashed their money machines. MZM (the monetary base) was about flat 2 years ago, at the real start of this slowdown. In recent months, MZM has been growing at better than 9%! Money is available, sentiment is ripe and stocks are cheaper than at any time since 1995! BUY, BUY, BUY!