Friday, November 16, 2007


These unusual times beg the questions, how low? and how high?

How high will profits go? Corporate profits have been running at around 9.2% of GNP! One would expect profits to slow by this point in the economic cycle but this one is a doozie. At the peak before the mid cycle turn in the 1990's, profits peaked at around 7.5% of GNP.

How low will interest rates go? The ten year bond is trading around 4.16%. The 90 day t-bill is trading around 3.33%. Such low interest rates will encourage all kinds of economic activity, or will they. Recent numbers suggest rates will go lower still. In the mean time, the flood of effects continues. For example, the Brits are taking their holidays in Las Vegas and other US destinations. The Brits are showing Americans in New York how to go on a shopping spree. The traditionally tight Canadians are even showing Americans a thing or two.

How high will the Yen go? The carry trade is unwinding. The spread between the lending rates in Japan and the earnings rate in the US has collapsed. A lot of "free money" was available for as long as the Yen stayed steady. Now the turn has come. Expect a shift away from emerging growth stocks in the months ahead. Japanese and American stocks will outperform many a developing nation stock over the next several years.

How low will the % of bulls go and how high will the % of bears go? The average investor is now bearish on the market. Time to buy stocks aggressively.

How slow will the money base go and how fast will the total money supply grow? One of the frequent misstatements made on the financial shows and in the financial press is in regard to the money supply. Numerous guests say that the government is printing too much money while others suggest that the government should restrict the printing of money because the price of gold is too high. Those who remember the contributing factors to the great depression are not eager for the government to repeat the mistake of moving interest rates higher to fight the rise in gold prices. On the other hand, those who remember the 70's do not want the printing presses to run so wild that interest rates go to 21%. The good news is that the government has reduced the rate of printing to well below economic growth. The government presses are not printing too much money. Instead, the public is running scared. Cash is being hoarded. There are signs economic activity is slowing as a result of fear. It appears that the FOMC will need to cut rates at least one more time to jump start the next cycle. By the way, a chart of the money base and MZM looks very much like 1996, just at the start of the "second half boom of the 1990's". MZM is growing rapidly. There is room for the FOMC to cut rates before year end, most likely at its December 11 meeting.

How high will the insider buying charts go? Executives at thousands of companies are buying shares.

How high will the unsold inventory of homes go? In the mid cycle turn year of 1995 the ratio hit 7.2%. This cycle we have already hit 10%. The confidence of "public bears" has grown. "Public bears" are saying things on TV that you don't often hear, the possibility of the worst recession in years (even public bears try to avoid using the word depression as it is unspoken public policy not to incite panic). Dramatically lower new home construction will contribute to a quick drop in this ratio once the turn hits the home market. Many a potential home buyer is now waiting for the "smoke to clear".

How low will the GDP deflator go? The most recent reading was one of the lowest in 60 years. Inflation is dead. On the other hand, the most recent CPI index showed headline inflation running at 3.1%, much too hot for Bernanke and crowd. The headline number misses a lot of stuff. For example, if 1% of the public stops paying for the newspaper, the deflator captures this lower spending level. I like deflators because measuring the price actually paid for any service is tricky. Those buying a new car today are likely to include nice features such as satellite radio or a GPS mapping system. The total price of the car may have been higher than the previous car but a car with a GPS map is a much superior car to one without. The total savings, over the 17 year average life of a car, achieved by including a GPS system might be many times the price of the GPS; the savings could possibly be as much as the price of the whole car! Going the wrong direction for 10 miles is certainly not a productive pursuit and such actions do harm to ones standard of living.

How low will the stock market go? How high will the stock market go? The current market is a tough market. The great majority of stocks have gone down in price. A very few highly visible stocks have gone up and up some more. The advance decline lines show the accumulation of more and more stocks going down and net new lows have swamped net new highs. Novice investors pay too much attention to what the Dow, S&P and NASDAQ did and assume the broad market is up or down as indicated. The Dow Jones Industrial Average is composed of a total of 30 stocks. Because most indexes are capitalization weighted, the price movement of a few big stocks determines the movement of the index even when the majority of the stocks move in the opposite direction. One important change in recent days has been the recognition that higher oil prices hurts refinery margins. It is no longer automatic that when the price of oil goes up that the price of oil stocks goes up.

How high will the relative NASDAQ volume go? Those who are "still actively trading" this market have piled into the AAPL's and Google's of the world. The current market is not a healthy one but the patient will jump out of bed as soon as it gets the next transfusion. Betting that the patient dies would be a losing bet. Within 6 months there will be lots of people asking, How high will this market go?

How low will the CRB go? The commodities index hit peaks in April and May of 2007, fell substantially and then tested those peaks in late October. The test failed well below the old peaks. In general, the world supply of materials is growing fast enough to meet the demand. The next leg in commodity prices will be down. Gold and oil (and to a lesser degree silver) have successfully tested the old highs but the turn has been made in wheat, beef, aluminum, copper, steel scrap, lumber, and computer chips (to name a few).

How low will the politicians go? Since the democrats took over congress a year ago, they have included 11,351 pork barrel spending projects in legislation. The extra spending has added about 300 Billion Dollars to the federal deficit. Prior to the take over, republicans were setting their own spending records. Is it any wonder that public support for congress is near an all time low? A few weeks ago, I said I could only see a few ways congress could "get out of town for Thanksgiving". They have chosen to quietly leave after having passed only two of 12 appropriations bills. They will come back for a two week December session. Investors Business Daily enjoyed poking fun at the attempts to pull out of Iraq in defeat even after it is clear the surge has worked. One IBD article says that at the current rate of passage, the last budget bill will not be passed until the year is over.

How high will the pending legislative compromise reach? When the conservatives were in charge of initiating legislation, there was no room for compromise. The bills republicans introduced were to the right of Bush. In the current situation, the great middle could pass a grand compromise. The left is being pulled hard toward the middle. So far, the left has fought over silly stuff in their attempt to stay as left as possible. Bush and the congress may still give us a before Christmas surprise. The alternative will be the meek passage of a few bills with a minor compromise over the "last $20 Billion". Will this congress "do nothing or something"? In any event, it will not be long before the exciting talk about the "Santa Claus Rally" and the "January Effect". Buy your stocks before the hype pushes them up.

How high will the Chinese reach to solve their fuel problem? On the steps of Mongolia a synfuel plant is 95% complete. Next year, the first of several coal to liquid plants will start production in China. Efficiency has been added to the Karrick process being used by using excess electricity during the night. The Chinese leader says that the plant will be profitable for as long as oil sells for $35 or more. The last US plant to process coal into other products (primarily grease and paraffin) was closed in 1873, long before various more efficient processes were developed in the early 1900's. Jimmy Carter pushed through synfuel subsidies in the 1970's that were similar to the ethanol subsides of today, all about votes and not about common sense. At the current price of oil, plentiful coal starts to look all the more attractive. The race is on to build better batteries or to convert the coal to liquid. The Chinese have been able to use a number of processes without paying royalties because a number of old patents have expired. The government just instituted a "slow down" mandate to give current plants under construction to prove their viability. In the USA, there is a trial, demonstration plant, now under construction in Utah. One of the new techniques eliminates the production of CO2!

How big high will air fares go? The SkyTeam alliance was just expanded by the addition of the largest airline in China. CAL will fly twice daily from Huston and from New York to London, Heathrow. China Southern will terminate a number of flights at the same concourse used by CAL and other SkyTeam members. Each SkyTeam member can earn commissions by selling one ticket that terminates in the final destination. It is a false premise that the new open skies agreements will lead to ruinous competition. In case after case, partnerships have developed to "feed one another". The big growth in air traffic is coming from developing nations. The USA will get half the growth to and from the USA by insisting on doing so. We will see years of increased traffic. BUY, BUY, BUY!