Thursday, September 06, 2007


Paul Samuelson, the MIT Professor who wrote Econ 101 text, tells the story of spending an hour explaining the concept of marginal utility of value. At the end of the lecture he saw the look of confusion on a number of faces but one student was relaxed. The Professor asked this student if the lecture was clear and he said sure, "the tail wags the dog".

The short term tail is currently wagging the dog, again. The total amount of money lost or gained in the short run on futures contracts will be small in relation to the total long term money made or lost. It is a mistake to focus on the wagging tail of this dog and to conclude that this is a risk free dog. The wagging tail is a distraction from what is real.


Leading up to the last mid cycle correction, stocks and bonds fought with commodities for leadership from mid 1994 to mid 1995. On balance, commodities beat out bonds as the FOMC raised rates to try to slow down inflation. The increase in rates (short rates and commodity rates trade tend to rise and fall together) finally started to bite toward the end of 1995 which only sucked the momentum out of the commodity rally. Prices did not fall much but they did stop going up. The final bounce took prices to peaks in 1996. Futures contracts peaked first, during the second quarter of 1996 and spot prices peaked during the third quarter. Commodity prices did not fall hard until the 4th quarter of 1997, long after the stock market had taken flight.

At the turn, the stock market was only down a little over a month starting in September of 1995. By late October of 1995, stock prices were off and running for a five year jaunt. Do you see that history is in the process of rhyming with the past. History does not repeat but it often comes close. The swoon in July and early August was similar to the swoon in September of 1995. The run up in futures contracts is making news but there is little oil trading at these prices.

The price of big oil stocks reflects the markets longer term projection that oil is going to average less than $55 per barrel over the next 10 years or so. The current price of $76 is the tail wagging the dog.

The tail has grabbed hold of China. China bankers have upped their reserve requirements again. The increase is a restriction of credit done for the purpose of slowing an over heated economy. The inflation rate in China just hit a 10 year high. The restriction of credit is in concert with the other central banks of the world. The ECB and the Bank of England have each decided to hold rates at current levels but their prior moves in coordination with many others including the USA, Australia, South Korea and Canada have done enough to slow the pace of expansion in the "rest of the world". China still has work to do but as its policies begin to bite, the marginal demand for resources will be reduced.



Over the next several years, consumers will spend their gasoline "savings". BUY RETAIL!

Jim Kramer gets a lot of stories right but he often is fickle in his execution. He jumps on an idea one day and is quick to move onto another idea the next. He is currently on a "buy retail" kick and I believe he is "on the money".

This does not mean investors should sale other sectors to buy retail. As a general rule, investors want to avoid trading as much as possible. However, with new money in accounts, it makes sense to buy retail.

As I wrote a couple of weeks ago, Art Laffer gave two thumbs up to the "buy retail idea". He is also a bull on technology and industrial stocks which typically do well right after an economic slowdown.

The numbers this morning show once again the resilience of the US economy. Inflation is low and growth is strong. BUY BUY BUY!