Wednesday, September 05, 2007


After a few good days, the worry warts are out and about. The "bad news" is that the OECD says that growth rates might slow, that job growth to be announced this Friday might be lower than trend and that the Beige Book, a survey report by the FOMC, will show weakness.

What is news about a slow down during the mid cycle correction? This is what was "engineered" by the 17 rate hikes by the FOMC and a long list of others by central banks around the world. No surprise.

Another none surprise; the upgrades on CAL.

Three of the "big boy" upgrades were by JP Morgan, Credit Suisse and Lehman Brothers. In the past two weeks, CAL is up 22.1%. The "big boys" will take credit for "getting behind or getting out in front" of the stock but even the JP Morgan call was not a "pounding of the table" at "the market bottom". Don't take me wrong, I continue to believe it is a mistake to try to call tops or bottoms, no one gets this right but the "big boys" like to pretend that they do.

Still the calls are worth noting. CAL's numbers for August were excellent. Traffic was up 8.1% on a capacity increase of 4.4%. The load factor was up 2.9 points over the terrorist effected August 2006 numbers to a whopping 85.3%. You cannot fill more seats without giving away the return flight seats in the middle of the night. The most important number of all was the yield estimate increase of 6.5 to 7.5%. We must remember that while there was a cost associated with the 4.4% capacity increase, the 2.1 to 3.1 points above this cost is almost pure profit.

Credit Suisse read the numbers and made the obvious call to raise its third quarter estimate. Lehman also raised its numbers but I have not seen them. They were quoted as saying, "the entire airline sector has become a compelling buy". The Credit Suisse earnings forecast is now the highest on the street at $2.50. As best as I can recall, they had moved to $2.10 only a few weeks ago. Anyway, the street consensus was $1.68. Should the rest of the street move to the Credit Suisse area, the boost would be almost a 50% increase! The Credit Suisse one year price target is $53.


The futures markets indicate a lower opening this morning. Again, folks are worried about short term reports and do not have their eye on the long term ball. One of the upside down causes for concern is the 15% nominal growth in China. While this growth rate cannot continue for ever, it can easily continue through the 2008 Olympics. China is spending high powered capital goods dollars that are "bunny rabbit" dollars. These are the kind that are printed new and then spent again and again and again. Yes, the big expenditures are keeping the price pressure on everything from construction materials from concrete to copper but inflation continues to moderate.

The bad news, about the slow down in economies and jobs is good news for interest rate prospects. I have suggested that investors not get too hung up on "will the FOMC cut the Fed Funds Rate and by how much". The reason I urge caution is that rates will not go down a lot as a result of a mid cycle correction. Note the history of the 1995 turn. In that case, the last of the increases was a jump. As I remember a one half point jump. In that cycle, it was evident in just a few months that the jump was too much. The FOMC had to back off quickly but after they dropped rates once or twice they then maintained the relatively high level. Latter, Greenspan tried to "jawbone" the markets by talking about an "irrational state of exuberance" but he did not take action to prevent the stock market bubble. Big Ben is playing a "tighter game". Greenspan carefully parked the car after 17 quarter point nudges and then left the keys with Ben who has been very cautious. Ben wisely opened the discount window at a lower penalty rate in order to provide liquidity without letting go of his inflation brakes.


The price of anything is based on the price of the last item sold. In the old days, the greatest of the great economist struggled with this concept. Adam Smith was the founder of modern economic thought. His thoughts were published in "The Wealth of Nations" in 1776, a good year! One of the problems Mr. Smith tried to solve was the pricing of goods. He simply had a hard time understanding why goods that are essential for life, such as water, sells for much less than absolutely unnecessary goods such as diamonds. At the time, the terms, marginal utility of value or diminishing marginal utility of value were not in the lexicon. As such, it seemed to Mr. Smith that diamonds, being worthless in sustaining life were over priced. Of course, the answer lies in the scarcity of the one relative to the abundance of the other but it is the substitution effect is the key determinant of the price. If a water seller tries to charge much, it is simply too easy to find another source of water. On the other hand, if a person wants a diamond and if a cartel owns most of the mines then the cartel can ask a high price even after finding a rich mother load of new product. Yes, one can substitute other precious jewels such as emeralds or rubies but these are also held close by the dealers. Economist call these goods "complementary" instead of substitutes. Tea, coffee and lemons has been used to illustrate this point. If there is a freeze in the coffee bean crop, the price of coffee will go up. Coffee drinkers would likely substitute tea on the margin. In other words, at least a little bit of extra tea will be consumed as a result of the increase in coffee prices. Because lemon is often served with tea, the consumption of lemon would also tend to go up as well. Lemon is not a substitute for tea (ignore lemonade in this example) but it is a compliment of tea. Because the marginal cost of production of lemons might be more elastic than the marginal cost of tea, the percentage increase in the price of lemon might well be more than even the increase in the price of coffee.


Over the past 30 years or so, the consumption of coal in the USA has grown by more than 60%. During the same time, the consumption of petroleum products is just slightly better than flat. The annual energy consumption per person has actually fallen about 10%. Warren Buffet has been buying up shares in coal trains and the Canadian National Railroad just bought out a US western railroad. At the same time, universities from Pennsylvania to Wyoming to Texas and beyond are working on methods to "refine coal". There is enough coal in the state of Illinois to provide US energy needs for 200 years.

One political party incorrectly claims that US air quality is getting worse and worse and the other is looking to provide subsidies for selected energy providers (any who will contribute to campaign coffers). The reality is that US coal furnaces are cleaner on average than ever before (don't breathe the air in Hong Kong) and that more can and will be done to use this abundant resource.

The cost of lighting a street lamp has fallen by a factor of 10,000 times over the past 110 years. The price of electricity is currently up a little over the past 3 years while having fallen dramatically over any 10 year period for the past 110 years. Further relative declines will occur.


Iraq recently began pumping about 400,000 barrels of oil per day from its northern fields to terminals in the Mediterranean Sea. A deal has been reached to re-open an old pipeline that goes from Northern Iraq to Syria. The moderates in Iran just won a major election battle. The tribal chiefs in Iraq are now protecting the oil pipelines. I do not know the details of the deal with Syria but this pipeline would not be opening without the belief that the terrorist problem is diminishing. The price of the last barrel of oil is the price of all the oil. The addition of 400,000 barrels per day is a small number in relation to the grand total of about 80 million barrels per day but the market will tell us the price offered for the extra 400,000 barrels.

There are a number of very large oil projects set to come on line over the next 7 years. The process of substituting coal and other sources will continue. The addition of nuclear power plants will be a slow process. The first in the US will start construction in Tennessee next year. Still, as each additional supply comes on line and as each substitution is made, the price will be moved.

Like the tides of the ocean, energy will keep coming ashore. Energy is never destroyed. Energy consumption per unit of GDP continues to fall like a stone. We become more efficient every day.


Worry about the things that you can do something about. The world economy is too big for you or me. What we do or don't do will have little effect. However, it makes no sense to stand in front of an oncoming train. The world economy is moving rapidly. Profits are big, big, big. BUY, BUY, BUY because you should get your share instead of letting someone else have it.

Yesterday, I once again heard someone say that they could not afford to invest because they are on a fixed income. This person has a small fortune in bank CD's. She has made the conscious choice to be on a fixed income. If she were to put a substantial portion of her assets into stocks, she would be on an "economic growth income". Her earnings would go up in line with economic growth instead of being fixed. I hope and believe that I will never be on a "fixed income".

Best Regards, Jack
Thanks again for the recent deposits!