Friday, October 26, 2007



Many investors are holding back because they fear the economy is entering a recession. For me, the economic question is, "Are we in the late stages of the mid cycle contraction or are we in the early expansion phase that follows the mid cycle correction?"

I could easily argue either case because in the late contraction phase the bond market rallies and in the early stage of expansion technology stocks lead the way up. The key point is that there is almost always an overlap in the bond market rally and in the move in stocks. For example, during the 80's mid cycle turn, the bond market rallied from June of 1984 until November of 1986. The stock market rally was slow to crank up but did well in 1985, not bad in 1986 and then exploded up in 1987.

The overlap is already here. The bond market has rallied for months. Indeed the current rally started all the way back in July of 2006. The excitement is in the stock market. The big move by Microsoft today shows that the next economic phase of expansion is underway.

The fly in the ointment has been the price of oil. In the typical cycle, the peak in commodity prices would occur just before the big up turn in stocks. The current blow off in oil makes it look too early for the big upturn in US growth stocks but the weight of the evidence is that the big turn is already here. The blow off in oil is just that. Oil option speculators are making such high returns that they are now giddy with delight. This is a sign of a top. As always, I must state that tops are impossible to call. They are much tougher to call than bottoms which are also almost impossible to call. Yes the infinite is even bigger than we think!

Just because the big turn is here, it does not mean that stocks will go up in a straight line. There is still much uncertainty about tax laws that congress would like to pass. The majority in Congress are hungry for new dollars to spend. The democrats in control desire to shift the automatic tax increase of the AMT to other taxes. The fact is that the government has done well without these new taxes. The 20 million or so taxpayers who have not been subject to AMT will not know the difference if the AMT was repealed. The game of substituting other taxes increases for these tax increases is nothing more than the power hungry wanting more power.

The good news is that the Bush veto will hold. Only minor tax increases will pass this year. I still believe there is a tiny chance that a major reform will be negotiated, but the more probable scenario is that this Congress will leave town as one of the many "do nothings". There has been thousands of hours of talk but so far no accomplishments. Gridlock at the federal level is often a good thing.

Given the likelyhood of no major damage to the economy, large US companies are in the sweet spot. Foreign investors will buy American once the dollar turns. Small profits will be amplified into big profits. There are BIG MARKET PROFITS AHEAD!