Thursday, November 01, 2007



Condi Rice has been involved in negotiations concerning the "two state solution" in the Middle East for several years. She is preparing to hold a big pow wow with representatives of several Middle Eastern Countries. We know that big pow wows are not held to negotiate an agreement but to announce agreements that have already been reached. It seems unlikely that great progress has been made, but we should know more by November 14th.

We should all say an extra prayer or two for peace in the Middle East. Many of the battles in this part of the world have their roots in battles fought centuries ago. Some say there will never be relative peace in this part of the world but the truth is that peace has broken out in large parts of this area. Several countries in the area are progressing rapidly up the economic scale. One lesson from history is that well fed prosperous people are not as likely to initiate war with their neighbors. One of my reasons for believing so strongly in free trade is that neighbors who trade seldom go to war.

Negotiation Number 2

The negotiations continue between Iran and the International Atomic Energy folk. I never can remember the full name of the agency that is in the thick of the negotiations or even the head of the negotiations but progress has been made. Under the latest sanctions, the pressure on Iran to "make a deal" has increased. There is room for compromise. Russia, which is the supplier of nuclear equipment to Iran, does not have any desire for Iran to have nuclear weapon capability. Even China is too close to Iran for comfort. Over in North Korea, the USA will supervise the dismantling of the nuclear facilities. The world is a safer place when rouge governments are kept from having nuclear weapons. On September 6, 2007, Israel bombed the start of facilities in Syria. While the USA would prefer to reach a negotiated settlement, there is no doubt that either the USA or Israel will bomb the Iranian nuclear facilities before nuclear bomb capability is reached. As usual, an aerial campaign has limitations and the Iranian facilities have been spread out and hardened. I do not believe the situation will require bombing because I believe the Iranians have more to gain by negotiating peace. Scores of major projects, including projects to build out Iranian oil fields, will start soon after a compromise is reached. The USA has no problem with Iran use of uranium for the production of electricity. Russia has offered to supply the fuel for the plants. Countries such as Pakistan and India, which have nuclear capabilities, make leaders in Iran jealous but adding additional nuclear bombs in Iran does not solve other problems. Negotiations between the USA and India in regard to nuclear capacities are in progress.

Negotiation Number 3

The Bush administration is apparently focusing its budget and tax negotiations with Nancy Pelosi. Nancy has become know in the House of Representatives as the "Committee of One." She does not support the proposals made by Charlie Rangel's Ways and Means Committee. The word is that she especially desires to pass an energy bill this session. The problem is that the democratic solution to energy is the piling on of wasteful incentives. Hillary, for one, has openly declared war on oil company profits, saying that she will use these profits to fund alternative energy sources. As we know from Econ 101, the market will automatically find the most efficient resource allocation. Again, the current energy bill in Congress is an add on of CAFE standards, additional payments to farmers and other programs that actually harm the long term progress toward energy independence. For example, when the government forces people to buy cars that use less gas, they encourage people to drive more miles. A regulated price does not produce the same results as a free market price. Indeed, one of the seeds of the current problem is the price controls on US oil that were in place during the late 60's or early 70's. Can you imagine that at the time it was thought to be good policy to hold the price of US drilled oil to $4 per barrel!!

A statement was just released from the United Nations saying that the use of corn for fuel is a crime against humanity. I think I heard the official say that the 100 bushels required to make 13 gallons of ethanol is enough to feed a starving child for one year. The exact numbers do not matter because the point is valid; children are starving because wealthy people are paying to convert human food stocks to auto fuel.


One month after the start of the 2008 fiscal year, Congress has yet to submit a single budget bill to Bush. Obviously, there is still hope for a significant break through of some kind. It could be that democrats believe that they will ultimately force through the budget busting SCHIP bill (it was passed once again by the Senate late yesterday). Once Bush is defeated once, the logic goes, he will be weak and Congress can then steam roll through other measures. I doubt that the SCHIP will pass in its current form.

The more likely scenario is that a major compromise is still a possibility. The budget negotiations have been in progress for many months. Hank Paulson left his job at Goldman, one in which he reportedly earned about $200 million per year, in order to pass the real "mother of all tax bills." This would be a repeat of the big Regan (Kemp-Roth) compromise. As you may recall, in that case, Don Regan left a similarly powerful job as Chair of Merrill Lynch to negotiate what was the "mother of all tax bills" at the time.

As I have mentioned, based on the very powerful real estate market cycle, we are over due for a massive tax reform bill. Mike Huckabee is moving up on the right. He has become a dark horse possibility for the republican presidential nomination. He has proposed the eliminating the IRS. He would substitute a consumption tax. The Regan tax revolution began about 26 years ago. It has taken a lot of work and a lot of compromise to reach the point where a move to a relatively flat tax would not be risky or potentially too disruptive. The Ryan proposal, 10% tax on the first $100,000 of income and 25% on all over $100,000, with standard deductions but no itemized deductions, is a doable compromise. It would do away with the AMT while producing tax revenues equal to the current law. Of course, democrats would insist on a third bracket for the rich and tax payers would be given the option to take itemized deductions by filing under the current system. Huckabee has a great idea but the risk of a massive conversion is too great. The wisdom of the framers of the constitution is always most apparent when the boldest and most risky ideas gain momentum.

In the current political climate, a great compromise seems impossible. On the other hand, democrats know that despite their massive lead in the polls, that they are vulnerable. The "big issue" that brought them into power has turned. Progress in Iraq continues. The death rate has collapsed. It is too early to know for sure but it appears that the war will be a positive for republicans by the time the election rolls around. The left is not happy with the democratic leadership. No real progress has been made since the last election. Without compromise, there will be no progress. The best of government policy has always been a result of "ruling from the middle." Negotiators have no reason to suggest a deal is close or not. There is nothing to be won by coming close and there is much to be lost if expectations are raised immediately before all deals fall through. In any event, a budget compromise of significant magnitude must be reached. If you want to see a massive dump the incumbents movement, just let Congress try to leave town after only passing a "continuing resolution budget."


A reader wants to know more about the "total world market funds" that I mentioned yesterday.

There are a number of funds that track the "total" world market. The word total might be inappropriate because there are always a few very small markets excluded. Vanguard is the market leader in very low cost index funds.

PLEASE NOTE: The US dollar is as cheap as it has ever been relative to the Euro and it is also very cheap relative to many other currencies. Even the Yuan has appreciated against the dollar during the past year. As such, I am a strong proponent of "buy the USA" right now. In particular I believe there are bubbles in the Chinese markets. As such, the "safe" way to invest right now is to focus on American stocks. Those who promote diversification on top of diversification disagree with concentrating on investments in any country but even most of these guys would say that if you are going to invest in only one country the USA would be the one.

Once again, I tell you that I am an aggressive investor. It is arrogant for anyone to believe that they are "smarter than the market" in the short run but history shows that there are those who can beat the market in the long run. I have made my share of mistakes but my record is strong. Over the next several years, the USA could prove to be the very best place to have all of ones funds.


In any endeavor, it is easy to get caught up focusing on offense. A church friend of mine just reminded me of this truth when he told me about all the big gains he is enjoying. He named a number of high beta stocks he owns that have soared in recent weeks. I cautioned him and will caution you: remember to play defense.

How does one play defense in the stock market?

Most people would answer the above question with talk about bond allocations, cash allocations or portfolio diversification stories. All good answers but not answers that lead to championship results. If you play not to lose, you will have a hard time winning any championship. The more powerful answer is that one should buy the bigger companies when one is trying to keep running up the score without risking multiple interceptions. The offensive move is to buy the smaller stocks in the country that has the advantage. The problem is that the best time for small stocks, the years immediately after a major recession, has already come and gone during this cycle. Some small stocks will do very well during the years ahead but the proportion will shrink.

Near the end of the 1960's cycle, successful investors piled onto only 50 stocks, these were know as the "Nifty Fifty". At the end of the tech bubble of the 1990's, relatively few stocks had extreme valuations. Companies such as AOL were priced as if they would never stop their rapid growth.

Today, the big bubble is in China. Who knows how high a mountain will be climbed? I missed the big move but will not compound the mistake by "getting in near the top."

The bottom line is that the writer of this letter is currently very aggressive while buying many "defensive stocks." Once again, this is a different definition of defensive stocks that the popular definition. I am not buying consumer staples. I am not saying a recession is near. I am saying that big cap growth stocks, such as the top 100 stocks at the NASDAQ, are likely to do well over the next several years. Yes, I still have a massive overweight in the airline area and not even I can call this investment defensive. My overweight is in the "best of breed", CAL, and it is in American stocks but the company is highly leveraged in a volatile business. Investors should always seek out volatility in the "good times." Of course, volatility is a pocketbook breaker in "tough times."

Small international stocks are among the most volatile but, because I believe we are within 3 or 4 years of "tough" times, it is time to overweight the relatively safe haven of the USA and it is time to under weight international.


I continue to be amazed at how all the democratic candidates have run to the left of Hillary. Hillary has been able to run toward the center and has become the "most attractive of the liberals". Investors should pay attention to the coming election. The potential for moving the markets is great.

Got to run! Have a great weekend.