VERY SMART MAN SAYS, “BUY, BUY, BUY”

Last Wednesday the 90 day T-Bill rate declined by more than 9% in the one day. The rate fell below 4% even though the Fed Funds rate is still pegged at 5.25%. The Fed Discount rate was lowered to 5.75% last week.

HISTORY SAYS BUY, BUY, BUY! THE AVERAGE GAIN IN THE STOCK MARKET IN THE 12 MONTHS FOLLOWING A DECLINE OF 9% OR MORE IN THE 90-DAY T-BILL RATE HAS BEEN 22%!!! (THANKS TO MARK DODSON FOR THIS NICE STATISTIC)

Friday, a very smart man said BUY, BUY, BUY. The man, Arthur Laffer, is a "common sense" professor, my kind of guy. I like smart people who know what to do with their smarts. Art, was an economic advisor to Ronald Regan but most famous for his discovery of what is called "The Laffer Curve". The Laffer Curve shows that governments can increase tax revenues by raising taxes only to a certain point. If tax rates get too high, revenues go down. There are several reasons that excessive taxes hurt. Two of the key problems are that economic activity is penalized and "games" are begun for the purpose of avoiding taxes. It is simply human nature to resist government when it becomes oppressive.

Economic freedom is key to a prosperous world. You can find a number of "poverty" maps that show the strong relationship between wealth and economic freedom. The relationship is obvious as common sense tells us it should be. In countries where free markets are allowed, the average per capita income per person is very high. In countries where oppressive governments exist, per capita income is very low. In between, you have a highly correlated scale. You find that the direct relationship between economic freedom and income is highly correlated.

It is interesting to note that political freedom does not correlate as strongly as economic freedom to incomes. China is the prime example where economic freedom has opened the doors of prosperity to the common folk while political freedom does not exist. The good news here is that economic freedom fosters political freedom. A society of relatively wealthy people are not as easily "bull whipped" into going along with the whims of a dictatorial government.

In example after example, when a political leader gains too much power and takes away economic freedom, the people are soon worse off economically than before. Venezuela is a prime example, the oil companies were nationalized and theoretically the people were enriched by the oil revenues. It worked as a temporary measure but the incentive to produce more oil is gone. Who among us would spend billions to develop oil production if the "profits" were to be distributed to others?

Art Laffer says, BUY, BUY, BUY, but he says to avoid energy stocks. He says the law of substitution (which is a sub law of the law of supply and demand) has not been repealed. Day after day, trillions of decisions are made to substitute something else for oil. The list of substitutable items is a list of millions of items. We tend to think in grand terms such as the building of a nuclear power plant or on a family basis for the purchase of a 40 mile per gallon car versus a 15 mile per gallon car. Most of these trillions of decisions are much smaller in scope but together a powerful force. In thousands of factories per day, millions of relatively minor tweaks will cause a very minor increase in efficiency. When a home is built, scores and scores of minor changes are made to save. Just a little better insulation practice around windows has continued to lower the heat lost for years and years to come. The move to improve is constant. The urgency of the move to improve jumped when the oil price moved up sharply from 2000 to 2006.

The past two years, we have been in a "topping process". No one can say, which straw will be the one to break a camels back and no one knows exactly which new production facility will break the oil markets back but we all know that a camel can only carry so much straw and we all know that gas at $3.00 per gallon will cause some people to move closer to work, to walk to work, to bike to work or to stop going to work because the costs are just too much. In today's environment, $3.00 per gallon seemed to be an inflexion point. However, the guy that trades his truck for a Honda Civic will not be quick to trade back if the price drops only to $2. He will continue to brag about his high mileage to his neighbor who still drives a truck.

Art Laffer says, buy retail, buy technology and buy industrials. These all happen to be the next sectors on the "Market Cycle Wheel" posted on my office wall. Airlines are a subset of the industrials sector. Art made his statement to buy, buy, buy on Kudlow and Company this past Friday. He did not mention to avoid material stocks but materials and energy are the two sectors on the "down side of the Market Cycle Wheel" and they tend to trade together.

One should buy materials and energy during times of excessive strength in the economy. Over the past two years, central bankers one after the other have raised and raised again short term interest rates in their attempts to weaken excessive economic strength. The excessive strength is a two sided coin. It would have been impossible for China to grow by better than 10% average over the past several years had the rest of the world not been strong enough to import the products from China. Because hundreds of millions of low wage workers were employed, the super growth was in China and in other developing nations. Most recently, the higher interest costs finally started to slow more economies. Europe, which has enjoyed a very high Euro currency, has finally started to pay the price in economic growth. The slow down of the developed nations will cause the developing nations serious problems.

In the old days, when the US economy was very large relative to the rest of the entire world, the saw was that when the USA catches a cold the rest of the world catches the flue. After super strong global growth, it took more than slower growth in the USA to slow the rest of the world. Now that the USA and Europe have a cold, the rest of the world will slow down. The demand for energy will slow along with a moderation in world wide growth.

Because this is only a mid cycle correction, I believe the worst of the slowdown is already over in the USA. The slow down has arrived in Europe and it is yet to come in China. Investors should avoid international mutual funds!

It is not clear that the carry trade from Japan has been fully unwound. Indeed, from one perspective, the carry trade will never go away. Carry trades are part of the constant open market between nations. Global economies are linked together today like never before in history. The carry trade is really nothing more than an important part of the currency market. For smooth commerce to occur between foreign governments, an active currency market must exist. Do you remember the days when Jimmy Carter bartered millions of bushels of wheat to Russia? Russia used to trade its oil and natural gas for specific products, often agricultural goods (collective farms never worked well). Today, Russia holds billions of foreign reserve credits. It can trade in the open market just as easily as you and I can buy at Wal-Mart. Getting paid a dollar in wages and using that to buy goods is a currency trade at work.

BUY, BUY, BUY!

With commodity prices on the way down, inflation rates will moderate, allowing Central Bankers to ease off on the credit brakes, allowing users of commodities to enjoy extra profits (businesses) or extra disposable income (consumers). Low inflation is a key ingredient to real economic profits. The best of this economic cycle is yet to come. Those who positions their investment accounts properly will do very well.

INVESTORS LOOKING FOR GROWTH (ESPECIALLY THOSE WITH 5 YEAR OR LONGER TIME FRAMES) SHOULD ALLOCATE 100% OF ACCOUNTS TO STOCKS. BONDS ARE NOT THE PLACE TO BE! WHILE LOW INFLATION RATES WILL HELP BONDS, STRONG ECONOMIC GROWTH WILL CAUSE REAL INTEREST RATES TO HOLD UP OR TO RISE.

BUY STOCKS, BUY STOCKS, BUY STOCKS!