Friday, December 21, 2007


Brian Wesbury is right on target about a number of things. His work is available on the web, free of charge. He is a bit too hawkish as far as inflation is concerned but he is right that the US economy, with the exception of the housing market is on a big time roll. Yes, we all know that there was a housing bubble. Bubbles develop for a reason. Builders have been aware that the demographics are as good as they every have been for housing. Baby boomers are at the "move up, second home time" and echo boomers are at the "first home time". With productivity keeping interest rates very low, a lot of house can be bought for only a little money. At the same time, many of those who are 59.5 years of age have learned about the disadvantages of 401-K's and IRA accounts. With more and more people reaching the understanding that their tax rates will be higher in future years, more and more people are taking advantage of the "401-C". They are buying the bigger home or the second home and getting the benefit of income tax deductions while enjoying the "present benefit".

The constant news about the collapsing housing market is mostly hot air. More homes will sell in 2008 than in all years except 2004, 5 and 6. Sales will be down from the peak but sales will still be strong. Wesbury take the housing slow down out of the GNP numbers to show that the rest of the economy grew at about 6.5% this past quarter. The numbers already available for the 4th quarter show that there will be slower growth this quarter but no where near the negative growth that would mark the start of a recession.


Corporations are operating under the burdensome regulations put in place after Enron blew up. As a result, corporations have been forced to err on the side of extreme caution. As a result, mortgage pools that will ultimately pay off more than 95 cents on the dollar are being carried on the books at less than 40 cents on the dollar and pools that will pay off 75 cents or more on the dollar are being carried at less than 25 cents on the dollar. Don't hold me to these exact numbers (no one knows the exact numbers) but the point is that billions of dollars of write downs are happening that will result in billions of dollars or write ups next year.

The mistake investors will make is to focus on the ups and downs of the big financial stocks. Yes the Merrill's of the world will probably bounce but the time to buy these stocks was more than 5 years ago. Just because a stock has tumble 40% from its high does not make it cheap. If a stock has appreciated 400% over 5 years then a 40% decline leaves it at a high level.

Companies such as Microsoft, Ford and Wal-Mart have given low returns for 5 years. They are not bouncing around getting a lot of attention now but the cycle continues to move forward. As the over heated Asian markets cool, money will gradually find a home in big American companies.


For more than eighteen months, I have written that during the second half of the business cycle that commodities will roll over, that money being spent on high priced gasoline will be spent on consumer electronics, that American stocks will out perform international stocks and that large stocks will out perform small stocks. Despite delay after delay, I still believe these things to be true. I believe in the power of the law of substitution. I also believe that logic wins in the long run.

Tax loss selling is logical but pretty much over. The last few days of the year and the first few days of January should see a bounce in the stocks that have been hit hardest by tax loss selling.

Corn based ethanol is illogical. A University of Illinois professor has detailed the advantages of tropical maize plants over corn plants. To produce the big sugar bearing ears of corn, the plants must be fertilized heavily. Hundreds of square miles of water in the Gulf of Mexico have now become a "dead sea". Fertilizer runoff from the mid west has killed sea life up and down the coast near the mouth of the Mississippi. The tropical maize stalk holds 25% more sugar than a corn plant but requires much less fertilizer and produces much less side effects. Yes, sugar cane is an even better crop but Florida and Louisiana does not have the ear of the congress. Corn is being converted into fuel because of the political power of the corn farmers. But, what is said before is true, the law of substitution works and logic wins in the very long term. The key is that Americans need to "get the word". The average American has been brain washed by the "say it enough times and its true" mantra. The sad thing is that politicians on both sides of the isle win political games by exaggerating the truth. It is the job of Americans to discern the truth as best they can before the next election.


By understanding that the "housing credit crunch" is largely a man made exaggeration, you can appreciate that the current recession hysteria is just that. You can understand that the US economy is in the middle of a major boom. We are enjoying huge productivity gains, huge increases in personal wealth, huge increases in personal income, that are partially masked by a short term decline in home construction. In recent weeks, more new homes have been bought than have been built. Between now and the election, the housing fog will clear and the majority of Americans will suddenly come to the realization that big money is being made in real estate and in the stock market. BOOM, BOOM, BOOM!


Dick Morris believes that the Michigan will be the critical primary for republicans. He sees the moderate republican race to be between Rudy and John and he sees the conservative race to be between Mike and Mitt. He sees Mike as the champion of the social conservatives and Mitt to be the champion of the economic conservatives. Right now, the race in Michigan is a three way race between Mike, Mitt and Rudy with John in distant fourth. I believe the top four will survive Michigan but that only two or three contenders will leave Florida in good shape to score a win on Super Tuesday, February 5.

Obama is one of the smoothest politicians ever but despite his best efforts, the democratic race is still Hillary's to lose. Should Obama pull off a win in Iowa, Edwards voters, who are among the "anybody but Hillary crowd", will rally around Obama but Hillary has too many connections in too many states to lose easily.


In the republican race, the second choice of many voters is looming large. If Thompson drops out, who will benefit the most. If Rudy continues to fall, who will benefit the most. The betting sites still give Rudy the odds. The daily tracking polls show that Rudy is still falling. Should current trends continue, it will soon be a three man race between Mike, Mitt and John. The irony is that the dramatic improvement in Iraq has hurt Rudy and John relative to Mike and Mitt. The democrats made political hay off of Iraq in 2006 but now must rely on the economy for fodder. Between now and the election, many more people will understand that the surge worked and the economic boom will be in clear view. Under those circumstances, the odds favor a republican president and republican gains in both the house and senate.


Economic slow downs are inevitable. Incumbent politicians have some control over the timing of slow downs and the executive branch has the most power. The mid cycle correction we have just experienced did not need to be as severe as it was but, if you must have a slow down, incumbent politicians want to make things look very bad before "they fix the problems". The problems of this cycle are all being solved. On the other hand, the immigration problem has been left hanging because the most conservative of republicans believe they have a winning political issue as do the most liberal of democrats. It appears to me that the liberals are winning the game here. The percentage of Hispanics voting republican has fallen and will fall again. The right wing things they are right and are willing to shoot themselves in the foot to prove it.

Expect the final vote to be close. In the meantime, buy stocks. Day after day mouse clicks are being substituted for every thing from newspaper production to travel. The speed of a complicated response to a mouse click is as amazing as the concept of billions of stars. While we are incapable of fully understanding the power of the Internet that we use daily, we can surely understand that it cost us less to click on a word than to look the word up at the library. We are living through a marvelous time!