THE POWER, POWER, POWER OF LEVERAGE

A few moments ago, CAL was up 46 cents or 1.42%. In margin accounts, the equity was up 2.84%. The January '09 $35 call option was up 8.82%. The December '07 $35 call option was up 12.73%.

The risk of losing money is difficult to quantify but it is safe to say that the risk of a 100% loss of principle is very high for the December '07 call option but very low for the non-margined stock.

The higher the risk, the greater the potential reward. This basic economic reality must be faced by each individual. The major problem concerning acceptable levels of risk is that individual attitudes about risk change dramatically at just the exact wrong time. When stocks are going wild, the perceived risk tends to fall dramatically when the real risk is in fact rising rapidly. Modern portfolio theory includes the concept that money managers should "take money off the table" each time relative prices of holding rise. If you study the actions of "professional mutual fund managers", "professional hedge fund managers", brokers and especially individuals, you find that people follow crowds and not logic. The higher the prices go, the more inclined people are to take risks. Right now, the "psychology of the market" is very negative. It has been at worse levels before but not at such negative levels with stocks so near the all time highs. This tells me that stocks are likely to go much higher. Fundamentally, stocks are cheap. It is indeed an unusual time for stocks to offer earnings yields much higher than yields on bonds. Finally, we have monetary policy turning very positive toward stocks. The above three, psychology, fundamentals and monetary conditions are the three legs to the Don Hayes investment stool. Don has been pounding the table, telling his readers to get into the market, 100%. He is a tough old buzzard who has followed the market for better than 40 years. He does not try to out guess the market in regard to short term moves but he climbs aboard and holds on for dear life when these indicators are all screaming BUY, BUY, BUY!

Again, I would not be at all surprised if Congress were to fail to pass the budget before October 1. I would not be at all surprised if the auto unions do not reach a settlement for a couple of weeks beyond today's contract expiration. I would not be at all surprised if congress must pass a continuing resolution to keep the government running. I would not be at all surprised if a big fight is fought over every thing from troops in Iraq to eliminating the alternative minimum tax while raising the tax on stock market gains. All of these things are a part of the WOW! (Wall of Worry). The market must have a WOW to climb. We have one in place. It is evident by the sentiment figures. Congress and the president both get very low readings in opinion polls. They need to do something! The President's ratings have bounced a little. Congress is down at a rock bottom level of 29% approval rating. I even believe the odds are good that an immigration compromise will once again be voted upon. A court has put a stay on booting millions of hard working emigrants out of the country. These folk are paying social security taxes but their social security numbers do not clearly match with their identities. The country will be hurt if these people are forced to leave. The pressure is once again on Congress to do the right thing. The next couple of weeks could be very choppy. The move by the FOMC on September 18, no matter what it is, will not solve all these political questions. The Democrats will push hard for a cap and trade carbon tax. They will not call it a tax but the effect of it will raise the cost of fuel to all American individuals and most businesses and it will increase the revenues of the government.

The next few weeks will be full of political rhetoric. When it is all said and done, I believe the power of the Bush veto will force reasonable compromise. Congress cannot over power the president without 60 votes in the Senate. A number of Republicans are tired of the war in Iraq but most will continue to support the president.

The next couple of weeks could be a roller coaster ride but as soon as the market sniffs that Bush will hold firm, the market could take off before the final deals are complete. Those who are speculating on China stocks might want to consider trading for US growth stocks.

Have a great weekend and be sure to tell your friends that the big mid cycle turn is upon us!