DUMB, DUMB, DUMB

Presidential candidates are apt to propose anything in hopes of getting elected. John Edwards, a former NC country boy, is a case in point. At the most recent Democratic debates, he and other hopefuls proposed raising the Social Security Tax dramatically. The idea is popular among those who hold the socialist idea that the primary purpose of taxes is to take from the rich while giving to the poor. There is a reasonable argument for a certain amount of this "income redistribution", there is also a powerful argument against killing the goose that lays the golden eggs.

The economic argument for income redistribution is that the marginal value of a dollar to a person who is hungry is much higher than the marginal value of a dollar to someone who is wealthy. On the other side of the issue, tax the heck out of wealth and several bad things happen. One is that the incentive to work more than a minimum goes away. Another is that the entire economic pie shrinks over time. The average size of each piece of pie goes down and down some more even while the pieces are closer and closer to the same size.

There are other "external effects" not seen immediately. A big one high US taxes results in a high loss of US jobs.

John likes to talk as if he would only raise taxes on the top 1% of Americans. In fact, by raising the tax on social security he would impose a significant extra burden on the small businesses of America. In particular, labor intensive businesses would see a significant increase in taxes. Adding an extra cost to American businesses is a good way to send more jobs over seas.

I am a strong support of free trade because in the long run, everyone wins by following the path directed by the law of comparative advantage. Under free trade, wheat will be grown in Nebraska, oranges in Chile, computers will be designed in silicon value and computers will be assembled in China. However, increase the tax on labor in America and less investment and economic activity will be performed in America relative to what is performed overseas and even those in Chile who trade oranges for wheat will see their costs go up. In particular America will be hurt by the confiscation of income. If it were true that the government used tax dollars more efficiently than those from whom the dollars are confiscated, the pie would not shrink. Surely you are not among the few who actually believe the government is efficient.

I encourage all of you to visit the blog written by Karl Fisch. The URL is www.thefischbowl.blogspot.com (a hat tip to Keith Hayes of HayesAdvisory for suggesting the site to me).

An interesting set of data is presented on this site and on several YouTube Videos. A couple of key points made that relate to the issue raised above is that if all the jobs in America were sent to China, there would still be millions of unemployed Chinese. And if you think that only the low skilled manufacturing jobs will leave for China, the number of people graduating from college in China is a much higher number than in America. Perhaps the most interesting point is that in about 10 years, there will be more English speaking people in China than there will be in all of North America.

The tax increase proposed by John would take the top marginal rate up to 47%. Of course, such a burden would result in lobbying for loop holes and the tax system would gradually become all the more complicated. The competitive position of America would be damaged. Ironically, countries all over the world have begun to understand that high taxes kill the golden goose. Other countries are lowering their taxes. Should the US raise its taxes at the same time that others are being lowered, the hit to the US economy would be extra severe.

Some like to argue that the increases in taxes during the Clinton years prove that taxes do not hurt as much as "economic libertarians" argue. The fact is that fiscal policies have a delayed effect. A business that has made huge capital investments in plant and equipment is not going to throw his investment away. He will continue to operate for as long as his marginal revenues exceed his marginal cost, however, he will look elsewhere when making new investments. By the end of the Clinton years, the boom had turned to bust.

Over the past few weeks, many have argued that the excessively low interest rates set by Greenspan in 2003 led to the sub prime mess. Monetary policy certainly played a roll but central bankers work within the framework established by the fiscal policies set by the President and the Congress. Extremes in interest rates are typically the result of mistakes made in fiscal policy and in monetary policy. Greenspan had to "row the boat" very hard, upstream, to counter the lagged effect of the tax increases made in the Clinton years. Latter, he had to start holding back the fast moving boat when the Bush tax cuts kicked-in. The wild ride did not need to be.

Life would be easier for all if tax policy were tweaked instead of jerked all over the place. The huge tax increases proposed by John Edwards and the similar increases proposed by his competitors are exactly the wrong policies needed.

Yes, an increase in taxes would raise revenue to the government and the budget might be balanced (of course it would not be balanced if most of the additional revenues were spent on health care or any other government programs), however, if you want to see a recession indicator, look at all the times the government came even close to balance. Nixon actually came close to balancing the budget before he left office. Yes he came close in 1973. Would you like to live through another recession as tough as the 1973-1974 recession. Bill Clinton balanced the budget before he left office but the recession was already baked into the cake when he left. The fact is that the budget never has to be balanced. The debt could possibly grow for ever and, as a result of growing less fast than the economy, it could remain at a law percentage relative to our total net worth.

By the way, one part of the explanation for the dramatic fall in the value of the dollar is the reaction to the probability of tax hikes in America. Markets look forward. When multi-national businesses see tax hikes being considered in America while they see tax cuts being considered in France, it is only natural for them to consider making their next investment in France.

The mind set that sends so many politicians down the wrong trail is that businesses set the price of their products or that the central bankers set the price of money. Markets are much more powerful than any business or any banker. Markets set prices. When taxes take a higher portion of profit margins in one country, the activity is encouraged to go elsewhere. Excessive taxes are simply a dumb, dumb, dumb idea!

DANCING AROUND THE INEVITABLE.

The congress continues to dance around the FAA funding bill. One idea after another has been discussed. Ideas like having government officials set the flight schedules. All of the ideas being floated by the congress are attempts to "fix the problem" without agreeing to fairly fund the system. It takes money to buy bread and money to provide air traffic control, there is no free lunch, someone has to pay.

The congress faces this problem because its past attempt to tax the rich and give to the "poor" has caused massive pain. In this case, the extra tax on the major carriers was partially to blame for sending these companies into bankruptcy and now it is partially to blame for forcing passengers to circle airports or to sit on tarmacs for hours. Of course, pointing fingers is not the way to correct the problem but a basic understanding of economics would help.

If the congress is going to continue to insist that the owners of small planes get "90% off" then small planes are going to consume the bulk of the service. Under the current system it is like the US government is operating a Starbucks where coffee is sold to all who do not have a job at 30 cents per cup. Those with jobs hate to go buy coffee because they must stand in line behind hoards of "free loaders". The big difference in this Starbucks and the FAA funding is that the government operates the only "store" for miles around. If you want coffee, you must stand in line or go the long way around. The really bad news is that your cost per cup is not the standard $3 but $8 because someone has to pay for the money lost on all the 30 cent cups! Even more bad news: the projected growth in the purchase of 30 cent cups is off the chart. In 2008, there will be more than 1,400 small jets added to the fleets of those who are enjoying the 90 percent subsidies. This is great for small plane manufacturers and for those who can make use of the small planes but it means millions of more delays for the passengers on commercial flights.

You see, even the $8 coffee is not enough to make up for the many cups of 30 cent coffee sold at a loss. The result is that the coffee must be rationed. There is demand to build many more stores to offer much more of this 30 cent coffee but there is a limit to what the traveling public will pay. The end of the John Edwards story above is that the "rich" small business must leave the USA or suffer and the end of the airline story is that the public must buy their own small plan or perhaps participate in protest marches in Washington. When planes loaded with hundreds of passengers sometimes sit on the tarmac for hours, while 20 million dollar private jets take off and land for pennies on the dollar, something has to be done and something will be done.

I don't believe the congress is willing to allow the airports to be partially closed even for a day or two. At some point, they must reach a workable compromise. The demand for air travel is growing rapidly, even while the horror stories created by congress are in the news daily. For a while, the finger of blame can be pointed at the carrier of the day that has had a problem. Sooner or later, the public will realize that the funding system is the problem and not the individual carriers.

Congressional leaders have tried to use health care for poor children as a foil to win sympathy votes. The congress has passed a bill to throw $35 Billion on top of a $5 Billion Dollar program. In terms of government spending the extra $30 Billion is small potatoes. Even so the congress has not been able to put together a veto proof majority. A continuing resolution has been passed. The government can continue to operate even though none of the 12 annual budget bills has been passed. Over the next several weeks, bills will be passed and the FAA will be funded. The big subsidy to "small jet owners" will not be eliminated but it will be reduced dramatically.

WHAT INFLATION?

One reader believes that his increase in his cost for food and gas have been far more significant than his savings from the Internet. As I mentioned yesterday, each of us has an individual inflation rate that is a little bit different from all others. Besides, while the Internet and other information technologies provide great examples of savings, lower prices are in products every where. The savings that a business achieves though the use of the Internet shows up in all sorts of products and services.

One of the problems we have in seeing the lower prices is that we often choose to pay more for a new product that is then compared to the price of the old product. For example, the price of TV's have fallen and fallen and fallen. The real cost of a black and white TV that offers a great picture relative to the one I started watching more than 50 years ago is a tiny fraction of the cost of that old TV; the price has dropped in real terms by more than 90%. The price of color TV's have gone through the same process and in recent years the price of digital high definition TV's has been falling like a rock. In like manner, in real terms our monthly phone bills average much less than the phone bills of the past but this is for a mobile phone; a phone that has given us huge savings in other costs but that by itself is seen as an expensive toy by many people.

If you want to see savings, productivity and dis-inflation, take a look at the cost of data storage. In 1981, electronic data storage cost $700 per megabyte. The latest designs bring the price down to $.002 per megabyte. Go back further in time and you find that the price of an IBM 5MB drive in 1956 was $50,000. Even at $10,000 per megabyte, savings were realized over the "old system". The huge savings comes in the time spent retrieving the data when needed and the electronic method would not have been adopted at all if it was not cheaper than the old paper and file cabinet system. So, the cost of data storage during my life has fallen from $10,000 to $.002, a factor of 5 million times! My friend will probably respond that he does not buy data storage and that he does not understand what data storage has to do with the cost of his food and gas. In reality, he does consume large amounts of data storage and he does benefit greatly from the decline in the price. When he goes to the hospital to get a heart operation to save his life, he will benefit from data storage. Neither the hear operation or the data storage even existed some years ago.

Perhaps this reader does an occasional "Internet Search"; since there will be 2.7 Billion Google Searches done this month and since 57% of all searches will be done on Google, lets assume the search is a "Google Search". Google did not exist 10 years ago. Before Google came along, how would my friend have gotten the information? Would he have driven to the public library, done a free search in a card catalog to discover the location of a source, visited the stacks to locate the source and then searched the table of contents to find the section, etc? Compare the cost of one data search and one can surely see that costs are going down not up. Inflation is really about productivity. What can we do today that will substitute a cheaper resource for a wasteful expenditure?

We are living in a time of accelerating innovation. We keep doing more and more while spending less and less. In the short term, care must be taken to not "jump ahead of ourselves". With massive numbers of citizens of the world just now able to afford the "good life", again due to the deflation of costs, we must try to maintain a reasonable speed limit. We cannot expect billions of more goods to be produced until infrastructures are in place to support the production and delivery of those goods.

Yesterday, the government of China made a few more tweaks to try to slow growth. The interest rate on second homes in China was raised to 10% higher than the rate for first homes. The projected slow down in growth from 11% to 7% in China would help the "capital markets catch up". Time is needed for resource capacity to be increased or diverted.

The markets are forcing resources that have been being devoted to building residential housing to business "housing". It would be inflationary to try to build homes at the pace of the past several years and to manufacture the 1,400 "small jets" and all the rest of the new capacity needs in our growing economy. So far, believe it or not, the switchover has been relatively smooth. New house sales figures have fallen sharply in America but the rate of sales is still in the area of 800,000 homes! We live the "good life" and find it hard to appreciate how good we have "it". We have plenty of houses available for a while. As the "business side" gathers speed, incomes will continue to rise and houses will become affordable for many more people but the emphasis of the market will remain on the "business side" for the next several years.

ONE MORE BRIEF ATTEMPT TO EXPLAIN OIL PRICES

Your answer to a question might help explain the current action in the oil futures market. If you were an institutional money manager and you found yourself holding billions of dollars worth of energy stocks and if you decided to reduce your holdings only to find that none of your fellow institutional investors had an appetite to buy shares, how would you go about making the reduction? Chances are you would negotiate a deal with one or more of the major retail brokerage houses. You would sell shares to the brokers "for distribution" to the public. With billions of dollars involved, the selling of these shares would take many months. To get the "job done", the brokerage houses would crank up their publicity machines. One of the ways to make news would be to bid up the price of oil futures.

In the long run, markets set prices, however, in the short run markets can be pushed around a little. The action in the coal yards and the natural gas caverns tells the story. It is an amazing story. Coal trains are having to suspend service because utilities are over stocked with coal. Natural gas production is being slowed or stopped because storage caverns are full. The prices of coal and gas have fallen. The BTU equivalent price of natural gas is in the neighborhood of $47 per barrel of oil. Because the coming decline in oil price is so obvious, people in the business of suppling oil are not purchasing supplies for inventory; they are waiting for prices to fall. Ironically, the publicity machines have been able to use the fall in inventories as a "fact in support" of higher prices. The overwhelming majority of individual investors do not buy futures contracts but they do buy oil stocks and mutual funds that own oil stocks. By losing a relatively small sum on futures contracts, the "big boys" are talking the public into holding and buying billions of dollars worth of oil stocks.

Yes, some would dismiss this theory as the "conspiracy theory of a kook". No matter. I am a patriot and I believe in free enterprise. This means I also believe in "buyer beware". I do not believe that the price of oil shares are going to suddenly drop. Large institutional investors have a hard time in beating the market because they are the market, like the Captain of a battle ship, they must turn slowly and they do not even try to dock the boat, or hit the exact peak in the market price. They must sell and sell and sell at an average high price, some shares way too early and some too late but few at the exact top.

Warren Buffet has said time and again that making above average returns becomes more and more difficult the greater the size of the investment. My favorite analogy is the story of "The Cincinnati Kid". The Kid was a fantastic poker player. He could beat the pants off all the local players. He even showed that he was good enough to play against the top professionals but he still went broke. The top player simply had the resources to out last him and the willingness to lose a lot of money on a bad play in order to set up a big win. It is a very old Steve McQueen movie that you should watch.

It is virtually impossible for the largest of the mutual funds to sell all their energy stocks if they wanted to do so. On the other hand it is easy for individuals to go to a zero weighting. The ability to make such bold moves gives the small investor a huge advantage but it also opens the door to the possibilities of making huge mistakes. Learn to make such moves with confidence based on sound knowledge and you will have Warren Buffets problem one day!

History tells us that it is DUMB, DUMB, DUMB, to run too long with the crowd. The crowd is convinced that energy prices still have momentum. The data tell a different story. The USA uses more coal than oil and the price of coal has fallen. Given time to convert and coal will be used to produce the electricity that will be used to fuel cars. Don't believe the "news" when the "facts" tell a totally different story! Big money is going to be spent on products that help us avoid wasting money on oil. BUY, BUY, BUY, GROWTH STOCKS; SELL, SELL, SELL OIL STOCKS!

SLOW, SLOW, SLOW, THEN GO, GO, GO

During my army days, I learned how to slow a race car into a curve while trying to come out of the curve with the maximum possible momentum. Understanding the concept and executing it correctly are two different things. One army buddy of mine could do it better than anyone else in the company. It was amazing that he did not have to be in the fastest car to win his race. He would make up the difference by maintaining maximum velocity in the curves and by hitting the gas hard a half a second before the next driver. His timing was so precise that he would be still be braking with one foot while applying gas with the other. Other drivers were fighting an "over-steering" problem that he solved by accelerating at just the right time. To me, his move was like the difference between a baseball bat swing and a golf club swing; the baseball bat swing is natural and instinctive whereas the proper golf swing must be learned. Hey, don't take me to task if my sports analogies are weak; the only individual championship I won in "sports" was shooting marbles in the 5th grade.

FAST MONEY!

I have written about the velocity of money before but not in the sense of knowing how to speed up after the economic turn. As we make this huge mid cycle turn, the velocity of money is a critical question. My confidence in Big Ben Bernanke continues to grow. It appears to me that he has hit the gas with a 50 basis point cut in the Fed Funds Rate at just the right time. Prior to doing so, he delayed moving too early by making the master stroke of cutting the Discount Window Rate. His work is not done. He will probably have to hit the accelerator at least one more time. Ben cannot decide his next move in advance because he must adjust to the national and international situation as the turn progresses.


MV = PQ

The good folk at GaveKal have written an excellent article about the above "Fisher" equation. This classical economic equation says that the money supplied times the velocity of that money must equal the quantity of goods times the price of those goods. All current yak, yak, yak we hear about inflation is coming from people who believe or who want to believe that Big Ben's move to boost the money supply will result in a sharp increase in the price of goods. These folk try to make the formula read, an increase in M = an increase in P. At the same time, the "poor" union folk, who have a firm hold on a number of members of congress, try to make the PQ increase by holding Q down while increase P; this is typically done by restricting where the Q can originate. Of course, all the citizens of the world are better off if they are free to buy goods from the low cost producer, no matter the location or nationality of the producer, but, as we expect, the unions try to "win" an extra slice of PQ for their members. In the same way, unionized businesses with contract negotiations pending, may be pleased to see a slow down in the product of PQ because a slow economy may help them keep their input costs low and thus increase their slice.

The formula has two inputs and two outputs and the emphasis on what the government can do to help our "free economy" achieve the most has changed over the years. In a press conference last week, President Bush stated that he is a "supply side president". Supply side economist believe that one of the best ways to keep the price of goods affordable is to make plenty of goods available. In other words, while Milton Friedman was absolutely correct that inflation is the monetary phenomenon of too much money chasing too few goods, one solution to inflation is to not change the amount of money but to change the quantity of goods. In the past, when inflation got out of control, the medicine of cutting the money supply was often bitter medicine. Had the goods available been increased, for example though free trade, the inflation problem could have been solved without causing the suffering inherent in an economic recession.

Of course, the FOMC does not control policy and can only work with the tools it has available. The good news for all consumers is that the union strangle hold reached a clearing price the day that Ronald Reagan fired the air traffic controllers. The unions have continued the fight but on balance workers have had to accept wages that are more and more in line with the value of the work done. Low and behold, GM workers just accepted this concept. GM workers will earn a contracted rate plus a bonus that is commensurate with the profits of the company. Such a plan is so powerful and right. It is absolutely a fair thing for workers to benefit if their productivity goes up and if they align their interest with the interest of the company.

The AMR contract is not up until May of 2008 but the company has proposed a similar plan. The pilots will get a raise by agreeing to fly more than 19 hours per week. Bonus money will be paid when appropriate.

"Sticky wages" have been "the big economic problem" for centuries. In the old days, when the sales of a company slowed, the only viable option was to lay off or fire workers. Laws designed to help workers, such as over time pay, resulted in the hiring of too many people in the good times and the firing of lots of people in the tough times. Schumpter helped us understand that we should not want or expect to go to work for one company and stay there all our lives. The old union plan that "locked" an employee into a job for life was viewed as a wonderful benefit but it often proved to be a curse. I personally am thankful to have worked in several different industries and to have done scores of different jobs during my life.

The point of the above discussion is that the system has changed. Today the formula MV = PQ is a much more dynamic formula than in the past and at the same time the product of PQ is much more stable than ever before. This is great news. Who wants live during times of uncertainty? Who wants to live in constant fear of an economic downturn? Who wants to fear losing their jobs?

Governments all over the world have come to realize that taxing the heck out of the producers of Q is the sure way to reduce the total supply of goods and to increase the price of those goods. Lower taxes have enabled consumers to purchase more goods and live better lives while avoiding many hassles created when governments try to provide services that should be provided by private enterprises. The recent irony has been that even control economies such as Russia and China have given more economic freedom to the people and the results have been substantial. Hundreds of millions of people are living better lives as a result of economic freedom. Russia has back tracked on the ownership of major businesses but their continues to be great strides toward economic freedom around the globe.

OOPS! WHAT HAPPENED TO V?

A relatively small portion of US mortgage debts are in default. Today's mortgage market place is very different than the one prior to the recession of 1973. Thousands of savings and loans went out of business during this recession and many more followed during the recession of 1990. These businesses bore the brunt of the inevitable downturns in the housing market. In recent years, the risk of these loans was split up into small pieces. The most secure of these loans ended up being owned by the billions of people who have money invested in money market accounts. The risk of these accounts is extremely small but, as a result of mistakes by rating agencies and of aggressive purchases of the high risk pools of mortgages, at extreme levels of leverage, several large companies will lose hundreds of millions of dollars and a few will lose a billion or two or three. A relatively mild down turn in housing has caused a bit of a panic. Savers stood in line for days to withdraw money from a bank in England that was caught with too much invested in these mortgages.

The above review of what just happened in the mortgage market was written to explain that the velocity of money slowed violently in recent weeks. People around the world have "hunkered down" to various degrees. The first response to the "news hype" about the "financial crises" was naturally to hoard ones cash. To stop the panic, Big Ben and other central bankers have pressed the accelerator hard. Money is routinely created when it is lent, deposited and relent again and again. High powered money is created when the central bankers hit the gas. In this race around the track, the big curve was entered, the brakes were applied to avoid going through the curve too fast and gas is already being supplied to shoot us out onto the home stretch.

HOW MUCH GAS IS ENOUGH?

The 50 point cut in the Fed Funds Rate receive the reaction of jubilation! The markets reacted more strongly than all but a few days in the history of the US markets. Up to down volume was 30 to 1 while the Dow soared 300 points. History tells us to expect average market gains of 20% or better over the next year.

However, it was not just stocks that went up in price. Gold, oil and the Euro Dollar all jumped. As stated earlier, many are looking at the actions of the FOMC to pump in money with the expectation that prices of goods will soar. This is a misreading of the situation.

WHALE HUNTING!

For the past couple of years, Ben and his fellow central bankers have been hunting "whales". You probably know about the country boy that fished by dropping sticks of dynamite in the lake. Each time a stick exploded, he would wait to see what floated up before dropping another. He did not bother collecting the little fish but kept on dropping dynamite until a "big whale of a fish" floated up.

For a long time, Ben and company have been well aware that there is a limit to how long the world economy can grow very fast. At some point in time, if there is too much growth the PQ side of Fisher's formula goes out of whack. When the supply of goods is limited because there is no spare capacity, the price of goods must rise or the growth in the product of PQ must cease. In the summer of 2004, Ben joined the hunt; he and Mr. Greenspan dropped the dynamite of 17 quarter point increases in the Fed Funds Rate. No whales showed up but other central bankers continued to hunt. You see, there are always small or medium sized businesses suffering or dying. The way the bankers know that they have dropped enough dynamite is to "float a whale". Recently, the run on a bank in England (North Rock Bank is the name that comes to mind), was the whale that stopped the dynamite. Now, part of what Ben has to do is watch the other hunters. Should, for example, the Bank of England, lower rates, Ben may be able to hold off the next move. Again, he does not want to lose any more momentum while rounding this curve than he absolutely must.

SUPPLY RESTRAINTS

I have written much about the supply of oil because this has been the most obvious area where capacity restraints have held down Q and of course forced up P. The good news is that the worst is already behind us. GaveKal Research reports that in 2008 there will be 1.4 million barrels per day of new refining capacity on line. Of this, the new 700,000 barrel per day refinery in China will process the sulfur heavy fuel oil that is in abundant supply. In other words, the oil is available now but just needs a place to be processed. With the rest of the world refineries running at only 92% and with conversions being made to other refineries, the sulfur heavy fuel is the equivalent of making a major oil discovery. Speaking of major discoveries, billions of barrels have been discovered time and again over the past few years. The process of developing those fields is in various stages at the various locations. By 2010, there will be ten million additional barrels of refining capacity available.

In any event, inflation need not "get out of control". No doubt, China needs to take action to avoid problems but Ben holds a lot of power in his hands and, besides, much work has already been done. Should you plot the Fed Funds Rate, the price of commodities and an inflation index on the same page, you would see that the three series follow closely together, with the Fed Funds Rate taking the lead from time to time. The current situation tells us that it is wise to expect inflation rates to moderate in the months ahead and since we know that the best time to own stocks is during periods of low to moderate inflation, BUY, BUY, BUY, BUY!

Again, how do the people who are bidding up gold and oil know that M is growing too fast? Do they know how fast V is falling? Is it possible that Ben will do a great job and increase M by just about the same amount of decline in V?

By the way, I do not believe it is total coincidence that there has been much saber rattling by Iran and the USA right here at the turning point. I believe $10 to $15 of the current oil price is an "insurance purchase". An exciting time lies ahead!

RESPONSE TO RESPONSES

Many thanks to those who respond to my emails. It is humbling to know that you took the time to read my words.

INFLATION:

I have used the example of newspapers and magazines to show that some prices are falling from something to zero; I could have used long distance phone calls, transferring money or maps instead. I personally read many articles from many magazines online without buying a subscription to those magazines. I use a map that plots where I am, calculates the distance and time to my destination and talks me through the turns. Using today's technology, the distribution costs of these services is almost zero. Therefore, the publisher can offer the services in exchange for goodwill or for advertising space.

At least one reader believes inflation is a lot worse than I. This reader still subscribes to his local paper and he notes that his cost of food has soared. One issue this raises is that we each have our own personal inflation rate; the national numbers are the average for all consumers. The consumer who is an early adopter may have inflated his costs when he waited in line all day to buy one of the first iPhones. He paid a high price in time and money. Another consumer can buy today for a substantially lower price. In very short order, the first iPhones are going to be relatively obsolete. They access the internet at a very slow speed relative to what is already available on other networks and extremely slow relative to networks that will be built over the next several years. The price of the next great innovation may be sold at a much higher price but that will not be an inflated price. The fact is that the price of new inventions start high and typically fall and fall some more. The first Xerox machines were leased because few businesses had $100,000 to spend.



Food is important to all of us. Very poor people spend the great majority of their income on food. The sharp run up in the price of food in recent months has caused many very poor people to go hungry. In America, the percentage of incomes spent on food has fallen for as long as charts can be found. I recall a chart from a year or so ago that compared spending on recreation to spending on food. The chart made a big X. The average American spends less than 6% of his income on food. He spends many times as much on recreation. Broad measures of inflation capture the price of all ski lift tickets purchased and the price of all hamburgers purchased.

The typical reaction to the preceding statement is to say, "Oh, so those who can afford a ski lift ticket are the ones who are not seeing inflation." In fact, for the great majority of people, this is exactly wrong. It has been the cost of services, most often purchased by the wealthy, that have gone up the most in price. The inflation rate for a college education, for a heart operation or indeed for a ski lift ticket, have all climbed many times more than the price of a hamburger. One of the wags at GAVEKAL Research quips that "it has never been so expensive to be rich."

Biased people can "mine the numbers" to always show that inflation is better or worse than it really is. We all know that one can prove anything with statistics. The all time best and most consistently correct inflation forecast has been supplied by the bond market. The FOMC likes to look at the implied 5 year and 10 year inflation estimates derived from the spreads on 5 year and 10 year TIPS bonds versus standard 5 and 10 year bonds. Old timers like to rely more on the structure of the treasury market. In other words the willingness of investors to buy 5 year treasuries paying 4.6% says a lot about the markets inflation expectations. Don Hayes uses the 10 year treasury rate chart, to plot inflation a few months into the future. The stats are that this method gives off an r square close to 90! In case you have not noticed, the ten year bond has stayed in a tight range for several years and is currently closer to the bottom of that range than to the top. The inflation risk in today's market is very moderate.

SLOW DOWN OR ECONOMIC RECESSION?

Many a coincidental indicator shows that the world economy is slowing down. Weak economies are most often accompanied by declines in inflation rates. As I noted yesterday, even the decline in interest rates that occurs during slow downs or recessions is by definition a lowering of inflation rates. The USA holds the trump card! Many pundits have "talked-up" their international portfolios. The common theme has been that the world economies have been stronger than the US economy and the stock markets have out performed. The key words in the prior sentence are "have been". Smart investors do not invest in what has been but in what is likely to be. What is likely is that the economy that has the strongest currency is actually "set-up" to suffer the worst during the slow down.

2000 EXAMPLE

In the year 2000, the US dollar was very strong. In 2000 and 2001 the USA was the only major country to suffer through a recession. Yes, 9/11 influenced the US economy but the economic down turn was well before September of 2001. Right now, numbers are starting to flow showing a slow down in Europe. The weak US dollar is a wonderful blessing in these circumstances. US businesses can easily compete with others because the exchange rates with many other nations gives us a strong boost. The great news is that the slow down will lower short interest rates more. We might easily see another 50 basis point cut by the FOMC before year end and with new great prospects for strong growth in the USA we could see the dollar climb out the roof. The big money is made by buying near a currency bottom, just like buying a stock near the bottom.

WHICH STOCKS?

This morning I read a story about a German oil drilling company that has hit another oil gusher in Libya. The company, RWE, has moved from $19 to $88 over the past 5 years. Late last year, it briefly traded above $90 per share. The price had settled back down to about $80 before the gusher was hit. I hope you can how the fact that the price is lower now than it was last year is a signal. The time to buy this stock was 5 years ago. The exact best time to sell the stock was last year when it was trading above $90. The momentum is gone. Those who moved from energy to technology when this stock was at $90 have done well.

The total investment process required to "catch up to the new price of oil" still has many years to play-out. We know many things about the way this process will be completed. For example, we know that Shell and the Saudi will spend $7 billion to more than double the capacity of the Port Arthur, Texas refinery and we know that Kuwait has increased its budget on its new refinery to over $14 billion. We expect that the Port Arthur upgrade to be completed in 2010 and we expect the Kuwait refinery to start-up in 2012. Others refineries will start-up before and after each of the above. While it takes a lot of faith to spend $14 billion on a refinery that will not start until after scores of others have been completed, it does not require faith that the price of oil will stay above $50 per barrel.

The existing Port Arthur refinery has paid for itself many times over at much lower after inflation adjusted prices. It was started way back in the Spindle Top days. It has refined billions of gallons of oil and it is being expanded so that it can refine even billions more over the next many, many years. The investment is being made because the investors expect to make better than a 15% gross return on their investment. They can do that even including a forecast of oil falling back below $50 per barrel. Long term investors can certainly buy oil drilling stocks, hold for decades and make solid returns. However, with the crowd pushing oil stocks hard, you should expect to see these stocks under-perform the market for the next 5 to 10 years. Innovative companies, the ones that are generally finding ways to do things while using only small amounts of energy will do well. Transportation companies that consume large quantities of fuel will also do well.

BANKRUPTCY AT AMERICAN AIRLINES?

After I wrote that AMR faces tough union negotiations in the weeks and months ahead, one reader mentioned that a pilot friend believes AMR is about to be forced into bankruptcy. I strongly disagree. AMR made it though a very difficult time, after 9/11 without filing bankruptcy. Since that time, the company has dramatically reduced its costs and dramatically improved its balance sheet. It has even survived the spike in fuel prices and it will earn at least 65 cents per share this quarter after paying an average of $2.11 per gallon of jet fuel. A few pennies decline in the price of fuel, not due to a recession but due to growing supplies and demand destruction, would boost earnings by perhaps dollars per share.

The big argument being made by the pilots union is that they gave up 30 percent of their pay when it was necessary to save the company from bankruptcy and they now expect to get this pay back. There are at least a couple of big ugly flies in the soup! After AMR pilots "volunteered" to cut their pay, other pilots at other carriers gave up an even higher percentage of pay. In several cases, such as DAL and NWA, the negotiations to reduce costs were held while the companies were in bankruptcy. In the case of CAL, the total give-backs of all union employees were more than a billion dollars per year. The other big fly is that even after the give backs, the AMR pilots are very well paid. So, what you have is a situation where the pilots want 30% raises that cannot be supported by the current market.

It so happens that just this morning the GM -- UAW deal was completed. Thirty years ago, it would have been incredulous to suggest that one day GM workers would give up their company paid health benefits or to accept a contract with no annual cost of living increases. American consumers can rejoice. We have been paying an average of $1,500 in healthcare benefits each time we have bought and American car. Many who can not afford health insurance have paid for it for others.

It is a totally new, global, world in which we live. AMR pilots face the same problem as the GM workers. The fastest growing airlines, which are not based in the USA, expect to dramatically increase their flights to and from the USA. Without doing the searching to prove the point, I am confident in saying that the senior pilots in China do not earn $170,000 per year for 30 hours of work per week. $5,500 per hour plus benefits is not a bad gig but only a very small percentage of the worlds pilots get that rate. Ironically, if the public were willing to trust highly reliable electronic systems, which are much more dependable than the average pilot, the pilots would be not needed at all. Ouch! Believe it or not, in the not too distant future, the competition for travel will include 100% auto pilot crafts. Of course, the politicians would have to stand aside for this to happen and when it does happen it will start with small planes at remote locations.

THE NEAR FUTURE

The new satellite based air traffic control system will be a blessing. It will cost a lot of money but the investment will cut the operating cost of the carriers while, most importantly, reducing the time in the air for tens of thousands of flights daily. Millions of people will save hours daily after the plan is fully implemented. As usual, when the government is the provider of a service, politics get involved and one result is a huge amount of waste. It is only common sense for a 10 passenger jet to have a financial incentive to give up a prime landing spot at a major airport for the benefit of a 300 passenger jet. Giving up this slot should be based on the micro-economics of the situation. In other words, the price of the landing spot should be determined by the market, so that some operators would voluntarily choose smaller airports. Only the individuals involved can determine how important it is to land at the major airport. The government imposed system is the equivalent of Soviet Union system of deciding how many pairs of blue jeans the country should make.

THE IMPORTANT POINT FOR INVESTORS

Investors need to avoid taking one small data point and drawing harmful general conclusions. The core facts are that airlines are operating at record capacity and making money at the start of the prosperity phase of the business cycle. The solid growth in the revenues of these highly levered companies is leading to spectacular growth in earnings. Here in the middle of the mid cycle correction, it was "big news", a couple of days ago, when AMR announced that revenues for the quarter would grow at only 3 to 4%! When a business with very high operating leverage grows revenues by 3%, profits might rise 20%!

What will be the story a year from now? Will the unions still be fighting for a 30% raise that is not going to happen? Are these employees frustrated? Certainly! Do they really expect to make 30% more than their friends at other carriers? Most do not.

BAD NEWS IS GOOD NEWS

The "news" this morning was "bad." Orders of durable goods declined. Duh! Housing starts are way down so there are not as many furnaces or hot water heaters being purchased. The down tick is the "bad news" needed to push interest rates lower and inflation down more. Yes, this is circular logic but that is why they call it a business cycle.

Just remember that interest rates and commodity prices tend to move together. Right on cue, oil supplies recovered a bit this morning and oil prices slipped. The process is slow but sure.

HANG IN, HOLD ON, BUY ALL YOU CAN!

Thanks again for the feedback.

WHAT HAPPENED TO THE AIRLINES YESTERDAY?

Yesterday, I received a fair question. What happened to the airlines? One fellow was kind enough to note that his Google and Garmin are at record highs but he is in the hole on more than half of his airline shares. I took a look and his QLD has done quite well also but then I have to admit that I have been aggressive on CAL, aggressive for good long term reasons.

The casual observer thinks that airline shares were down hard because of a modest tweaking of guidance at AMR. AMR reports that non fuel costs will be slightly higher this quarter and that revenue growth will be slightly slower. Sure enough, some analysts cut AMR's estimates from as much as $1.04 per share to $.66 per share. This was a bit much, especially considering that the company corrected the figures a bit later in the day to say that cost per mile would come in at $11.98 versus the $12.06 that the analysts were using. Even so, the cost figures were up and the spread between AMR's cost and the costs at CAL, NWA and DAL has grown.


WHAT IS THE REAL DEAL?

It has become clear that Congress is going to practice a game of "rope-a-dope", also called Chinese Water Torture. As we all know, it is difficult for congress to complete a budget on time. The US fiscal year begins on October 1 and none of the 12 budget bills have been passed. There is little budget discipline to be seen anywhere in the process. For example, the Senate is just about through hammering out the defense appropriations bill and it is loaded with about 300 amendments that do not relate to defense in any real way.

The old "Christmas Tree" game is being played. In this game, one member agrees to support the goodies wanted by another member and another and another until they can cobble together a voting block and attach what has traditionally been called "pork" or "pork barrel spending" to bills that "must" pass. Today Congress calls pork barrel spending "ear marks". Politicians from both sides of the aisle work very hard at "winning these goodies" for their home states or districts. Get a large enough group together and a real government boondoggle will be passed.

A good example of a boondoggle is the corn ethanol subsidies. By agreeing to build 200 small refineries in 200 different counties across the country, enough votes were added to the farm belt votes and to the "environment-at-all-costs crowd" to pass the very wasteful ethanol fuel program.

The way the "rope-a-dope" strategy is going to work is that Congress will drag out the budget process until the November 16 adjournment date and perhaps even into a "recall" session in December. Congress will send Bush bills for him to veto. Then they will send him a continuation bill. Even the continuation bill will not be "clean". If the government gets closed down for a day or night, they will act again but try to blame Bush for the closure. All the while, horse trading will continue; a vote for this will be traded for a vote against that. Of course, subsidized "health care for the children" and attempts to cut off funding for the troops will be trotted out again and again.

In case you are too young to remember, "rope-a-dope" was the strategy used in a famous boxing match 30 or so years ago. The one fighter covered up and allowed the other to hit at his arms and gloves. The blows were largely reflected by arms and gloves and eventually the hitter wore himself out. Congress is going to try to wear Bush out. Bush will have to veto spending deals that include "goodies" for all the districts before the budget is finally passed. The Democrats hope that they can gradually offer the right combination of "goodies" so that they can peel away enough votes to over turn a Bush veto.

The "heath care for poor children bill" has lots of supporters even though it extends Medicaid to families making $85,000 per year and even though it adds to the mess of Medicare and Medicaid. The strategy of the Democrats is like a sacrifice pawn move in chess - by loading the health care system up with inefficiencies it is believed that the whole system can be scrapped in exchange for a comprehensive government plan.

Hillary's latest plan is far better than the one she attempted to pass more than 10 years ago but it is still a "take-from-some-to-give-to-others government confiscation". In her plan, those who are young and those who take care of themselves are forced to over pay in order to subsidize those who are slothful.

The analogy is constantly drawn to the area of auto insurance. It is said that just like all drivers are required to carry auto insurance, we must all be forced to buy a certain kind of health insurance. I agree that a lot of folks drive up the cost of medical care by not carrying insurance and then going to the "free" emergency rooms to get very expensive care for non-emergencies.

However, the analogy to auto insurance only works to a point. Individuals can choose to carry only liability auto insurance and even then only a base level is required by law. More importantly, those who drive carefully pay much less than those who are repeatedly caught speeding or violating other traffic laws. In the Hillary plan, the young guy who eats properly and exercises pays far more than his fair price while obesity is subsidized.

HOW DOES THIS DRIP, DRIP, DRIP CONGRESS EFFECT THE AIRLINE BUSINESS?

Both the house and the senate passed bills to fund an important upgrade to the air traffic control system. Of course, as usual, the Democrat majority passed a bill that would increase taxes and one that would continue to force the major airlines to pay for an extra large share of the system. Like the subsidized heath care for the obese, they would give the corporate jet fleets a major break; small jets now pay only 3% of the cost of running air traffic control systems but they consume 16% of the services provided. In one way this is no big deal but when day after day thousands of passengers are delayed, routinely by 30 minutes or more and sometimes by several hours or even days, as a result of waiting on small jets to clear, the problem is real. As always, when the government sets the price, great harm is done to some while others are given great gifts. The Soviet Union fell apart for the very reason that central planning is wasteful; markets are the most efficient means to set price.

Charging set rates for FAA services is similar to what has happened in NC to the highway system. In the old days, all the gasoline tax dollars were used to build roads. In order to have great roads, NC citizens went along with one of the highest gasoline tax rates in the country. Many years ago, Governor Hunt, who had preschool education as a priority, started finding ways to take money from the highway trust fund. The annual "withdrawal" is now around $175 million per year. Not a huge amount in terms of state government but enough to service the debt to build about $3.5 billion worth of roads.

Over the years, NC roads have suffered and the current governor is pushing to build toll roads. Of course one idea behind toll roads is that of a user fee. Another idea is that politicians tend to want to raise revenues (taxes) and they can because the government knows how to spend money better than the market place.

COLLECTIVE WISDOM IS GREAT, WHEN APPLIED CORRECTLY

The old saw that a camel is a horse designed by a committee contains truth about collective wisdom; folly follies when "group think" wins. On the other hand, the wisdom of the crowd has been proven time and time again in markets all around the world. Markets are not perfect but they are far more perfect than are "group think" asset allocations.

The following is an example to show the wisdom of the crowd. If a large number of people are asked a question about which they know little they will tend to offer an average answer that is better than the one derived at by a committee. Specifically, if 10 to 1000 city folk at the fair are asked to guess the weight of an large animal, it does not matter if it is an elephant or a jersey cow, the average guess will be very close to the right answer. The more people that guess, on average, the closer the average guess to the actual weight. However, ask a group of 10, 20, 30, or more to get together to choose one best guess and the wisdom of the crowd goes away. The dominate members of the group pull the group toward their guess rather than toward an average estimate.

THE BOTTOM LINE

Congress has passed continuation funding for the current air traffic control system. Three months worth! The huge sums of money spent lobbying Congress for the past several months is simply not enough! Give the passengers sitting on the tarmac three more months to soften them up! In the mean time, AMR and its unions will have their own little slug fest. AMR is the only major line to have made it through 9/11 without filing bankruptcy. The AMR pilots took big cuts in pay to "save the airline". After bankruptcy, DAL, NWA and even UAUA have lower cost structures in place. The pilots are in the unenviable position of asking for their wages back even though they are already earning more than most other pilots. They are asking for wage increases of more than 30%. I doubt they will get more than 10 or 12% but the fight is on. The lowering of guidance by AMR yesterday was probably related to the negotiations ahead. This is one of those times when the airlines are accounting for every expense they can find.

CAL just put an extra $50,000,000 into its pension plan. As I recall, the accounting on pension deposits is a complicated mess but all in all I suspect that CAL was able to lower its current earnings by some portion of this addition and the prior ones made.

LOOK AT THE CASH

The cash hordes being built by the major carriers tells my story. Until sentiment turns and the "feel good factor" boosts these stock prices, the "accounting game" can hide a lot of stuff but the billions in unrestricted cash says a lot. One might guess that these cash hordes will be used to fend off a hostile takeover but we all know that financing the purchase of a company is much easier if the company to be acquired holds lots of cash. One might argue that the cash will be used to buy new planes but in reality planes are usually leased or acquired with long term financing.

A couple of weeks back, Alaska Air announced a share buy back. It seems that the wisdom of the stock buy back might finally be spreading to the airline business. The pay negotiated at AMR will effect all the other carriers but once a deal is done, a share buy back announcement by any major carrier could be the catalysts to sentiment change. CAL is currently selling at around 7 times trailing earnings and 5.7 times forward earnings; boost these numbers to the market average and you get a jump in share price from $30 to $80 lickity split.

Of course, the change in sentiment is not the whole story. A buy back of shares will increase the earnings per share. The normal roll over that will take place in the oil market over the next few years will also result in higher earnings per share.

NEW CAPACITY

CAL has quickly added a lot of flights to its new hub. Many of these flights are on "feeder sized" planes. The big jets will still be used to leave the hub for profitable long haul flights.

If you do not appreciate just how much growth there is in international business, take a look at the recent action by Google. Google will partner to put a new communications cable beneath the Pacific Ocean. Google will gain access at cost rather than the current extra high Pacific rates. These rates have been pushed up because demand is great relative to available space. A fellow on one of the business shows said it well last night. He notes that just because the world has been blessed to be able to bring a few hundred million Chinese out of poverty over the past 20 years it does not mean that we should forget about the 2 billion others. He says the globalization story is still in the early stages. There is no doubt that air traffic is growing most rapidly within the borders of China and India but US International Carriers will get a fair share of the traffic that spills out to the rest of the world.

PATIENCE, PATIENCE, PATIENCE

Being of virtue is tough. Patience was never my strong suit. However, in regard to market moves, I have had to learn to wait, wait, wait, wait, wait and wait some more. The current situation takes my memory all the way back to the summers of 1982 and 1974. In each case, waiting for the market to make its big move was like waiting for paint to dry. The 1974 time was more exciting than the summer of 1982 but not in a good way. In 1982, most of the shares I purchased just sat there. They did not keep going down much but it seemed that the start of the "big bull" would never come.

This time we have had a number of fits and starts. For example, it was late July of 2006 when value lost its momentum to growth and when small lost its momentum to large. Even so, value stocks and small stocks keep making surges. Our QLD has made us happy but the last dip was large and the recent very strong run has just now put us back close to a new high. An upside break out from here would probably run-up another 15% pretty quick but who can time the market? We are left with the charge to be patient. Congress will eventually get its work done and the odds are good that no major new taxes will be passed. The drain to the markets will not be great enough to kill this bull.

BAD NEWS IS GOOD NEWS!

One thing that will help you be patient is to recognize that right now, bad economic news is actually good news! With T-Bills trading at 3.75%, it seems that the FOMC will need to cut the Fed Funds Rate by another 50 basis points pretty soon. Big Ben and company many feel the need for cover. Bad economic news would do the trick. If personal spending slows or if there is an increase in unemployment claims, the FOMC may have all the ammunition it needs to give the patient another high powered electrical jolt.

INFLATION PHOOEY!

One of the funny things is how short sighted prognosticators can jump to the long term view at just the wrong time. We all understand that those who want to be negative can always find a reason to do so. In the case of lower interest rates, the negative always jump on the risk of higher future inflation. While it is true that if interest rates are too low for too long, the economy is likely to overheat and there is likely to be inflation, but that process does not happen in days, weeks or even months. The immediate effect of lower interest rates IS LOWER INFLATION!

The decline in the cost of money from 5.25% to 3.75% is a tremendous price reduction. For many a business, it is like a 28% cut in the cost of raw materials. TV pundits seem to love to talk about the decline in home prices and inflation in the same breath. Again, those who are looking for "bad numbers" can find them or they can make them up. When the price of gasoline was rising, inflation was terrible. Now, with the price of gasoline back down to $2.62, it is the price of oil that is the problem.

The facts of life today include that each and every day a large number of people stop paying for certain magazines and newspapers. These folks have found that the Internet provides all the news they need. The marginal cost of this Internet news source is ZERO! The price of the newspaper falls from 50 cents to ZERO! The law of substitution lives and breathes. The bottom line is that publishing a newspaper online is far more economic that physically printing a newspaper. My old boss, the President of Legg Mason Wood Walker was fond of saying, "In the long run, economics wins!"

GRANDMA and GRANDKIDS

Put all of Grandma's CD's into just a few big stocks such as GE, MSFT and WB and she will do well. She will no longer be on a fixed income as her profits will grow over time.

Be sure that the grandkids own Google in what I call an ABC portfolio. My only grand child owns APPL, BIOGEN, CAL, Dell, Etrade, Google and Sprint. We plan for her to own the rest of the alphabet before too long. We pay no mutual fund fees and no commissions except for the initial purchase. The educational value for her to own small quantities of so many companies is worth more than the millions she will eventually earn. We live in freedom! We are blessed beyond measure! Praise the Lord!

HISTORY SAYS BUY, BUY, BUY

The following is yet another snippet of history to show that now is a good time to BUY, BUY, BUY.

A decline or near decline in the price of the average house is a rare phenomenon. Right now, it is interesting to notice that the cost of new construction, including a lot in a good location continues to rise, even while folks belly ache about a fall in the value of homes. One of the tenets of economics is that "clearing prices" are reached. Yes, the supply of unsold homes on the market is large, especially when looked at in terms of months needed to clear the inventory at the current sales pace. The problem with this popular measure (especially popular with those making the bear case) is the "double leverage" involved. Other numbers show that building permits and starts have fallen dramatically. On the demand side, the numbers show that mortgage applications are already on the rise. In just the past two or three weeks, the bears have said again and again that mortgages are not available.

I am trying to make two points here: 1) that the housing "debacle" is not as bad as it is perceived to be, and 2) the housing debacle has not killed the bull market in stocks.


The following are the 5 times during my life that housing prices were flat or negative over a full year and the increase in the S&P 500 over the next year.

September 1982 44%
November 1990 33%
July 1992 15%
February 1993 8%
April 1995 39%

ON AVERAGE, LARGE CAP STOCKS INCREASED 27.8% IN VALUE IN THE YEAR AFTER HOUSING PRICES WERE FLAT. WOW!

I like the last entry the best because April of 1995 was right at our previous mid cycle turn. The most recent pattern is in my opinion the one that will be most closely followed in this cycle.

STRONG DOLLAR RESULTS

The financial news media is always in search of the next headline. The recent one has been the fall in the US Dollar. Here again, I like the pattern set in April of 1995, when the dollar bottomed just as the pundits were saying that housing was killing the economy.

There are logical reasons why the bottom in the housing market coincides with the bottom in the dollar. Canadians are currently in a state of euphoria over the value of the Loonie. For the first time in 31 years, Canadians can trade a Loonie for a dollar and get back change. For a number of years, Americans could trade a US Dollar for a Loonie and get a quarter or more in change. This is big news for Myrtle Beach and many other coastal communities. When I was a kid, Myrtle Beach had Canadian Day Parades. These celebrations were held during the early spring, when it was still too cold for Americans to consider Myrtle Beach as a vacation destination. Florida resorts are also celebrating the return of the Loons!

The Euro Dollar has also appreciated substantially. The European can trade for a dollar and get more than 40 cents change. Just a few years ago, Americans could trade for a Euro Dollar and get about 20 cents change.

In April of 1995, the winds of change were blowing as they are now. Many a European and Canadian will make out very well by purchasing a US home now. The European might use one million Euros to buy a $1.4 million luxury home in the states. The price of this home will appreciate substantially as soon as the market clears. Even if it were to only hold its value, the return would be 40% to the European if he held the home until the US Dollar and the Euro Dollar reach parity again. While there is no guarantee that parity will ever be reached again, the history of the move after the mid cycle correction of 1994 says that it will.

OIL PRICE TO RISE IN EUROPE!

Should the US dollar strengthen, the price of oil in terms of Euro Dollars will soar. The law of substitution, which is already going 90 miles per hour in 3rd gear, will hit overdrive. No one knows where new supply smashes into new demand but it is clear that that there is going to be a collision between millions of small cars and scores of super large oil refineries. In Port Arthur, Texas, Shell and Saudi Arabia will more than double output about a year after the first of the Vietnamese super refineries comes on line.

Just in recent weeks, wholesale traders in the US have been reluctant to hold inventories of oil as the amount of natural gas in storage is near record levels, gas producers are being forced to slow down or shut down production and the price of natural gas is down to 47% of the price of oil in BTU terms. Of course, natural gas storage capacity is not enough to supply all our winter time needs with natural gas but a mild winter could see a steady decline in the price of heating oil. Any facility set up to burn gas or oil will go with the less expensive gas until supplies are diminished.

GLOBAL WARMING IN THE NEWS

Ken Fisher notes that when the financial press cannot find negative economic statistics to whine about, they write about global warming or Paris Hilton. Ken avoids making this a political point but in truth it is. The steady push in most media outlets is anti-Bush, anti-business, anti-war and pro-government "solutions". Of course, the exceptions to the rule, such as talk radio outlets and Fox News, prove the rule. Pretty soon, the stock markets should benefit from a change in sentiment. A "Feel Good Factor" is going to emerge. We have moved into the prosperity phase of the business cycle. During this phase, real wages and incomes of the average citizen will rise to the point that the constantly negative "news" will not sell well. As Andy Warhol taught us many years ago, the "news" is a reflection of the feelings of the people. During a time when the "bad news" does not sell, "good news" will be more prominent. Of course, the market top will come after the public has received a steady diet of "good news".

My "good news" for you today is that the process of building a market top is just getting started. Keep a close watch and you will notice a very gradual shift in the news. Also keep in mind that the kinds of advertising that you will see will also change. You will see lots of ads for companies like Boeing that are making all the planes they can make. Of course, the right time to buy shares in this company was several years ago. It will not go down in price for many years to come but its upward price momentum has already peaked. It takes a long time for the "big boys" to distribute their holdings to the public. Of course, the media outlets that sell these large corporate ads will be the outlets that survive. Do you think it coincidence that positive "news" articles and corporate ads will accompany one another, or soon before or after?

Yes, be a skeptic but be a wealthy skeptic. A fun market is headed our way.

POLITICS IMPORTANT

No one knows the ultimate outcome of the current fight for budget and campaign dollars. Funds are flowing in all directions. Powerful "special" interests are playing hard ball. In this crazy but necessary game of horse trading, many in power are willing to vote to spend billions annually for years to come on all sorts of wasteful schemes, provided they "win" the goodies they want for themselves. Senator Grassley, a Republican from Iowa, is one of the current key power players. I do not believe Grassley is for a $35 Billion add on to a disruptive health care plan, but he is willing to vote for it to establish a strong bargaining chip. Almost everyone in the House and Senate would agree that health care reform is needed but none of them would honestly say that the $35 billion dollar would be their personal first step.

Again, I have good news. So far, Congress has been unable to pass much of anything. This is good news for America and good news for the markets. As we have seen time and again, lots of bad legislation passes when one party is in control. Bush will veto the worst of the spending. Unfortunately, to get a dose of his own sugar, he will swallow some bitter medicine. Still, all in all, the compromises reached will not harm the economy badly. As a general rule, the economy will do very well for as long as the government stays out of the way.

BUY, BUY, BUY the fight will be over in a few weeks and members of congress will go home to take credit their "wins". That is one of the good things about a good compromise, all can claim to have won. These wins will become part of the "FELL GOOD" cycle discussed above. When corporations, the news media and the congress combines to tell the "good story", it will be natural for the masses to "FEEL GOOD". BUY, BUY, BUY!

ANOTHER STRONG BUY

Jaywalk reports that another analyst has moved from a hold on CAL to a strong buy recommendation. The Jaywalk numbers are now, 1 strong sell, 0 sell, 9 hold, 10 buy and 4 strong buy. The Thompson numbers are 0 sell, 1 under-perform, 4 hold, 5 buy and 3 strong buy. The consensus estimate for 2007 is now at $4.27 and the estimate for 2008 is now $5.19. The $4.67 has been increased about 10% over the past several weeks.

The house has passed a bill to pay for the new air traffic control system by raising taxes on jet fuel. The bill will also allow airports to increase the ticket tax from $4.25 to $7. President Bush has pledged to veto the bill. Last night after the bill was passed, the President said in a press conference that he got a B in economics but an A in holding down taxes.


All the strong buy ratings in the world will not push the price of CAL up. However, the stock has become an obvious value. What analyst is willing to put a sell on a company that is growing earnings dramatically even while enduring very high input prices?

DON'T FORGET ABOUT GOOGLE!

I have struggled to keep a few accounts on board in regard to the airlines. I get few complaints about my other stock selections. Google is still the most fun stock to watch. Google makes dramatic moves week after week. The Google presentation package is similar to prior products designed to take market share from Microsoft. The package is a good basic package that is free to use. It does not have all the bells and whistles as PowerPoint but it is more useful to those who enjoy the free and easy collaboration across the Internet. Google has the money to move in any direction that it wants but it has clearly chosen to allocate a lot of resources to mobile communications. The world is changing as we speak. Millions of people are taking their home phones mobile. One day, the internet is going to be everywhere! Google is on the way to $100,000 per share!

BUY, BUY, BUY!

DOLLAR BOTTOM, BOOM AHEAD

When US Fed Funds Rates hit a peak on February 1, 1995, the dollar began a blow off plunge. Record lows were made in March and April. Suddenly, on July 6, 1995 the FOMC had to change directions. The FOMC cut rates by .25. Each cycle is a little different. The second .25 cut did not come until December 19, 1995. For the next 5 years, the dollar index and the stock market climbed while real estate agents searched for a bottom in housing. Does this sound somewhat familiar?

The market climbed, inflation stayed tame and commodity prices rolled over. New production of commodities overwhelmed new demand.


Part of the reason many investors stay in a confused state around major turns is the J curve effect. The J curve is one of the "normal" paths that numbers take. For example, the relationship of blood pressure to the incidence of cardiovascular disease follows a J curve. There is a good chart of British Pound Sterling posted on the internet that shows the J curve that took place at the mid cycle turn in 1995. A good way to understand this phenomenon is to think through the process when there is a turn in a trade balance. When a currency is devalued, the higher cost of imports hits hard. Take gasoline as an example. When the price jumps, everyone does not go out and buy a new fuel efficient car the next week. Indeed, even though they may cut back on total miles driven, their total gas bill goes up. However, if the price stays high, more and more cars are traded and eventually the total fuel bill goes down because the reduction in the volume used eventually is bigger than the increase in price. We all know this to be true. We all understand that the laws of supply and demand dictate that the higher the relative price of a good, the less of it is used. Economists talk about the process in terms of elasticity of demand. Their point is that it may take more or less time to adjust to price swings for certain goods but the law of supply and demand still holds.

The accumulated effect of the decline in the dollar has put US exports growth on a solid growth J curve. Indeed, because the Yuan is linked to the dollar, the growth of Chinese imports has been spectacular. Indeed, a clearing price is near. The "blow off rally" has hit in several markets, including the Euro Dollar, the Canadian Dollar and Crude Oil. We are talking about a "capitulation rally." What's happening is the investors, including any hedge funds, that were on the wrong side of this market have gotten so tired of losing money that they are closing out positions. Specifically, those who were short oil future contracts are buying oil at all time record levels.

Congress has the responsibility of passing the 12 massive spending bills by September 30. One of these bills includes big tax increases on the oil industry. Of course, those who put the tax increases in the bills like to talk about how they are closing loop holes granted to the oil industry (by many of these same politicians). One of the ways the Democrats want to increase spending is by adding middle class children to the government health insurance plan. Bush says he will veto this "Trojan Horse" which is designed to build a European style government health plan.

Bush has said he is prepared to veto 5 of the 12 spending bills as they are currently written. He and Congress will grin and pretend to enjoy the signing ceremonies on the other seven as both sides will be holding their breath to avoid the stink of compromise. The Dems will probably go all out to force Bush to veto the children's health bill. As we all know, the jockeying for the best position in the 2008 elections is the point of this health bill. We all know that major healthcare reform is needed. In the mean time, points will be scored by two sides. Solving an issue is often not the best path to being elected to office. Politicians need an issue to run against to be successful.

The markets are to some extent hostage to this political process. Investors cannot be sure about what congress will do about the "BIG BILL". The BIG BILL is in regard to AMT (alternative minimum tax). Something must be done! Neither Congress nor the President would want to be responsible for 23 million middle class families to pay extra taxes this year.

The bottom line is that the deadline is due in 9 days. A continuing resolution could drag the deadline out another week or two but the pressure is continuing to mount. While I do not believe that the oil industry has manipulated prices at the pump, the timing of the blow off rally in oil seems to be about perfect for the industries political purposes. Of course, it makes all the common sense in the world for the industry to reduce investments when under the gun of a Congress bent on taxing the one industry in order to subsidize others. As usual, whenever politicians try to "drive the markets" they make very expensive wrong turns. The American people need an education in economics. They all should understand that the invisible hand of Adam Smith will lead to efficiency whereas the heavy hand of government will lead to excessive costs.

Once the bills are passed, a lot of uncertainty will have been washed away. Conditions are ripe for a continuation of this great bull market. Since the market bottom in October of 2002, big returns have been realized. Even in this seemingly tough year, the average stock is up about 10%. There has been a J curve dip in a number of areas but the staff of the J is going to be climbed over the next several years. Hold onto the bucking bronco and ride like the wind! BUY, BUY, BUY STOCKS, SELL, SELL, SELL LONG BONDS.

UP and UP and Up

CAL earnings forecasts keep going up and up and up. The increases are only pennies at a time but the pennies are adding up in the face of record oil prices. The forward PE is now at 6.38%. What would this number be if a savings of $2 per share were to materialize?

OTHER BLACK SWANS ARE SWIMMING IN THE AREA

The key point of the "black swan concept" is that a surprise can happen at any time from most any direction. The thing is that one can often see the potential for spotting a black swan in areas where the great majority see no possibility. So far, no one has been able to reasonably explain the "air attack" of Syria by Israel on September 6. Did Israel drop a bomb on nuclear supplies bond for Iran, explosive supplies bond for Iraq or was it just a reconnaissance plane that mysteriously dropped extra fuel tanks on the Turkey -Syria border?


In any event, rumblings continue about a potential deal in regard to Palestine and Israel. Don't hold your breath but don't be shocked if this is the "surprise" that ignites the next big move in the market. The odds of a particular event may be very small but the accumulated odds for one of many possible events is great. How many times have you heard someone say that such and such could not happen again in a million years?

My favorite once in a life time story is my golf story. I had a clear shot at the green except for one problem, a very small dogwood tree was directly in my way. It was at least 30 feet away and my partners told me to aim for the tree because I couldn't hit it in a million tries. My ball hit the tree dead center looped upward and landing exactly in the spot I had just hit it from. After a good laugh my partners said that that the shot was truly one in a million. They said to aim for the tree again. Yes, I did. I hit the tree the second time in a row. You had to be there to know how unlikely the shot was. I honestly believe that I could go to the spot and try a million times to hit that small sapling again and never succeed.

BIG SURPRISE!

Even after the cut in the Fed Funds Rate, the psychology of the market place is still one of disbelief. Yes, there were huge inflows of funds to mutual funds but a large amount of this money flowed into "old news stocks." Money is flowing into international, energy, basic materials, gold and other inflation plays. WHY? Because people are doing what the "big boys" suggest. Goldman Sachs just announce an earnings jump of 70%! They make most of their money trading against the crowd. They are saying that oil is headed much higher. Believe them at your own peril.

JUST THE FACTS

The facts are that the CPI was up 2% year over year and down .1% in August. At the same time, the real, inflation adjusted earnings of the public, were up 4.4% year over year. Over my 57 years of life, there have seldom been better numbers. Even the price of gas has not gone up for close to two years. During the same time, the price of a very useful electronic map has fallen by thousands of percent.

BUY, BUY, BUY, BUY, BUY, BUY, BUY

HOLD YOUR NOSE, I SMELL A STINKING COMPROMISE AND A VERY BIG BULL

Congress has failed to pass 12 of the 13 budget bills. The deadline of October 1st is also the date the debt ceiling runs out. Is there going to be a replay of the 1995 government shutdown? I don't think so. A very smelly compromise or two may be in the works.

One bill likely to pass will be the "Airline Passenger Bill of Rights and FAA Satellite Air Traffic Control and Airline Flight Path Correction Bill." No, Congress will come up with a shorter name but to "get the votes" the bill will include provisions to soothe the wounds of the unhappy. This bill will regulate payments and benefits granted to those who are stuck on the tarmac for hours on end. Of course, once the airlines get a bill passed to fund a new high tech satellite navigation system, the problem of being stuck on the tarmac will miraculously be solved. CAL has already spent at least $50,000,000 building a new hub in Cleveland to relieve the congestion at Newark. There is no question that the big carriers have been paying more than a fair share of the cost of FAA services. After the bill has passed, smaller planes will save a lot of money by avoiding taking a prime landing spot from one of the big carriers. Smaller airports will be utilized more by these smaller planes.


The airline industry and the traveling public will all be big winners when a compromise is reached. Among the losers will be the owners of homes that are in the direct flight path to the major airports. Part of the huge cost savings will be more direct flight paths near these airports. The savings will be in terms of money and time. Many a flight will cut 20 minutes off its landing time. Connecting flights will see improved scheduling. The cost of the system will be upwards of $50 billion but it will be well worth it. A compromise should be reached very soon.

ALTERNATIVE MINIMUM TAX

Senator Grassley of Iowa is trying to steer Congress toward the elimination of the AMT along with making the 15% rate on capital gains taxes permanent. Grassley argues that Congress does not need to offset or score the loss of revenue from the AMT tax because the government has never expected or budgeted this income. Of course, Charlie Rangle and the rest of the Democrats are pushing other ideas. The idea that the democrats will fight the hardest for is the closing of the "loop holes" in regard to "carried interest." They know they have a "winner" in regard to attacking the taxes paid by hedge fund managers. The fact that a change in the law will not cause even a twitch in the tax revenue collected gauge does not matter. Many a business will have to be restructured to avoid the extra tax but, again, the amount of new taxes collected will be minuscule. Indeed, the normal, reasonable and rational decision of many an investor will be to avoid realizing the gain on investments once the tax rates go up. The free flow of capital is one of the things that makes the US economy dynamic and prosperous. The passage of extra taxes also includes a hidden "tax surcharge."

Senator Grassley needs 60 votes to get a bill through the Senate. The Democrats need the 60 votes to get a bill to the President but it needs 67 to over ride a veto. Congress currently "enjoys" a favorable rating of 27% of the citizens and the disapproval of 64%! I don't recall lower numbers. Do the Democrats really have the stomach for closing down the government? When the Republicans tried in 1995, they caught too much heat to handle.

BIG BULL MARKET!

Twenty five long years ago, when I was an investment broker with Merrill Lynch, an event happened two times that has not happened again until the day before yesterday. The up to down volume on the New York Stock Exchange was greater than 25 to 1. Such an event, according to The Sentiment Trader, has happened only seven times. In addition to the two times in August of 1982, it happened in 1950, 1951, 1957, and 1978. In most cases, the market jumped, then stumbled around for a week or two and then jumped again. In all seven cases the market was up strongly within three months and the average increase of the average big stock was 9.4%. If you appreciate how "heavy" is the S&P 500 or the Dow Jones Averages, they you appreciate that serious money was made during these historic moves.

The up to down volume this past Tuesday was better than 30 to 1!

One possible scenario is that the market will struggle for the next couple of weeks and then have another huge up day when Congress passes a reasonable compromise. Of course, when Congress lumps 12 massive appropriation bills into one grand package, all sorts of extra billion dollar earmarks get funded. Yes, I can already smell the stink of the compromises coming but the process of "muddling though" is as good as government gets. Government is a necessary evil, generally the less the better.

GOOGLE ADVERTISING REVENUES TO SOAR!

Google continues to charge ahead with innovative "solutions." The coming advertisement revenues from "rich media sources" is going to make the revenues from the current text ads look very small. Google is ready to patch together its innovative "gadget" ads with its current operations and with the DoubleClick system as soon as the closing of the purchase is complete.

Mobile ads are also ready to explode. INTC, TXN and others are making dramatic strides in reducing the battery power needed to operate sophisticated hand held, wireless computers. Those children born this year are going to live in a very different world than the one that you and I know.

STRONG DOLLAR AHEAD!

After falling hard for 4 years, the value of the US Dollar is about to turn. As a general rule, the turn will mean that the performance of international investments will weaken and the performance of US investments will improve. Part of the reason that China has been growing at unprecedented rates has to do with the value of the US dollar. As the dollar and the yuan (which is pegged to the dollar) have fallen, the price of Chinese goods sold in Europe has fallen. The ECB is still in need of an increase in Euroland short term rates to slow the European economies. Job losses are going to be very large in Euroland unless they can reverse the growing advantage of the Chinese manufacturers. ECB rates are at 4% and the US Fed Funds rate was just reduced to 4.75%. Under the circumstances, one cannot expect the dollar to climb until the market is confident that either the spread is going to switch from a -.75% to a plus something.

Yes, I am saying the opposite of what the TV pundits repeat at least a few dozen times each day but history and common sense are on my side. The price of oil and gold is being pushed by fear of an "Iranian Event", by the falling dollar and by the belief that lower short term rates will stimulate the economy and thus the consumption of oil. Since 1978, Iran has been isolated from the rest of the world. Over the past couple of years, hundreds of deals have been made that will bring Iran out of isolation. The current situation is much like the negotiations to buy a business. Outsiders can often discover that negotiations for a takeover are in progress but only the insiders can make an highly accurate, educated guess as to weather the final deal can be closed. It would be a silly move for insiders to openly state their educated guess. If one suggests that a deal is close only to see it fall through, then the party has embarrassed himself with no potential gain. If sabers are rattled putting the prospects of a deal into great doubt, then a successful conclusion provides relief to all parties.

Iran has fastidiously maintained its right to develop the peaceful use of nuclear power. I believe Iran will develop said nuclear power after a deal is made that will reduce the threat to the rest of the world. Obviously, almost everyone would prefer that all nuclear weapons were destroyed. It has never been a comfort to know that Russia or India or Pakistan or others have the capacity to start a nuclear war. The deterrence of self destruction just does not seem very powerful when dealing with people who are willing to commit suicide to insure a trip to heaven. Still, I suspect that the final deal will give Iran the "supervised" right to develop nuclear energy.

Our French Friends have added a bit of pressure. I smell a compromise in the works but it has been more than a year since I first caught a slight scent in the air. Only time will tell but the combination of a few deals in Congress and a couple of deals in Iraq and Iran could make for a huge stock market rally before the November elections.

DO NOT TAKE THE RISK OF BEING OUT OF THIS MARKET! A SMALL SPARK COULD CAUSE A MARKET EXPLOSION!

LOVE IT, LOVE IT, LOVE IT

The rest of the world followed the USA lead over night; markets around the world soared! The part I love the most is that at least half the talk is about the boom in oil and gold. A lot of money is pouring into the "tired end" of the market while the "jump" in the "other end" is just getting under way. Part of the reason is that many investors falsely believe that inflation is about to soar.

Yesterday a reader sent an article that suggested investors should hide out in bonds until the "worst" is over. My SELL, SELL, SELL on bonds is looking pretty good right now; bonds have fallen while stocks have soared. Economics professor, James Hamilton, issued a follow up study yesterday that suggests that the whole curve shifts down when the Fed Funds Rate is cut. Oops! Not this time! My belief is that even the good professor tends to get the cart before the horse. In the past, central bankers waited too long to cut short rates; the economy has often reached "free fall" before the start of the rate cuts. The first move in rates is never enough to float a falling lead hot air balloon, it is only enough to slow the fall. After the second cut or two, it is only common sense for long rates to go up, stimulating an economy is positive for future real growth and for future inflation.


The great news is that inflation continues to be very well behaved. The massive purchases of raw materials in Asia continues to be converted into lower priced goods around the world. The dramatic fall in the US dollar continues to "put the wood" to the seat of the pants of all the other industrialized nations. Exports from the USA and from China (which pegs its currency to the US Dollar) are soaring. You won't read this hardly any where else but, Bush has made some great chess moves in recent months. He has sacrificed a pawn or two in order to set up the democrats. If you were a democrat senator right now, what bill would you propose and expect to get signed into law?

The big push by democrats to "bring the troops home now" has failed in its purpose while pushing the democratic presidential candidates to take left wing positions that will not help them in the general election. The American people want to be safe from terror. Bringing the troops home in the middle of the war is not the winning position. The latest attempt to disrupt the war, forcing the troops to spend a lot of "down time" is unraveling.

On the energy front, the "big oil" man, Bush, has forced the environmentalist to admit that ethanol is not the answer. Bush caved into the democratic game of "paying off corn farmers." By doing so, he helped start the back lash to wasteful subsidies for bio-fuels. Many folk on both sides of the isle have started to understand that it would consume far too many food resources to replace even a small portion of our energy needs. Even the carbon sequestering schemes are starting to be seen as just more government boondoggle. The fact of the matter is that the most effective scheme for sequestering carbon is managed forest growth. New growth sequesters carbon much faster than old growth. China is now moving hard in the direction the USA headed over 100 years ago. The USA has reforested millions of hectares. The fear of environmental activist, those who want to leave the forest alone even if it means the occasional fire burns a few billion acres, has impeded the process but common sense prevails over the long haul.

The wealthy are always attacked by the left but, of course, wealth allows the "right thing" to be done. The poorest of the poor continue to use up the forest. Countries like Bangladesh are down to 7% forest coverage. A country like China, which moved rapidly from the poorest of the poor to a developing nation, can now afford to join the USA in its reforestation program. Of course, much more could have been done in the USA. The USA continues to pay farmers not to grow crops on land that could be growing trees. Like I have said before, an acre of forest sequesters more carbon annually than what can be saved through the growth of ethanol in 50 years. As usual, people (particularly democrat people) tend to try to do for nature what nature will do for itself. It is hard to do better than God!

With the price of oil at all time highs, as a democrat senator, would you fight for carbon taxes when the science continues to show that many of the schemes to cut carbon dioxide are proving to be inefficient boondoggles? Would you push for tax increases in the middle of a housing recession and credit crunch?

The tide is turning. Senator Obama just proposed a tax cut for the middle class. No doubt, he would pay for it by eliminating slapping shackles on the rest of the economy but at least it is a mention by a democrat that taxes need to be kept low. One of the economic things least understood by the democrats is corporate taxation. The bulk of the taxes paid by corporations are passed directly through to consumers. The big company is easy for democrats to attack but the attacks hurt the "little people" the most. Today, corporate taxes in the USA are high relative to the rest of the world. The same politicians who complain about jobs being lost to competitors overseas are willing to make the situation worse. Countries in Western Europe, Eastern Europe, Asia, Africa and South America have lowered corporate taxes. The manufacturing boom in Eastern Europe, for example, is not an accident. Tax policies do matter and the general principal holds that individuals make better decisions than the government in regard to how to spend the peoples money. There is waste all around; waste committed by individuals, governments and businesses. Schumpter won the "battle" with Galbraith long ago. Even totalitarian regimes do well when they allow the people economic freedom; the Chinese do not have a bill of rights but they are buying homes and buying and selling goods.

WHERE DO WE GO FROM HERE?

Ben Bernanke has demonstrated his understanding that the price of oil will ultimately take care of itself. The economic train does not need to be slowed to a crawl in order to halt inflation. Inflation is always a problem in the balance of goods and money, but given the opportunity the market will find substitution goods if the money is available. The big oil energy projects are still under construction but price does cure price. Much of the current run up is a continuation of speculation. It has always been true that market tops are much harder to see than market bottoms. The topping process is one where momentum is lost and where relative declines occur long before there are actual nominal declines. From 2005 to 2006, the price of oil clearly went up. From the peak in 2006 to the peak in 2007 there has been no real increase. The momentum is gone even though the dollar has fallen to record lows. The dollar is about to turn and go up for the next 5 years or so. All the while, new energy supplies will come on line. Let me put it this way, who would have ever guessed that Russia would sign contracts to supply China and Korea with electricity?

The invisible hand of Adam Smith has been at work and it will continue to work its magic. Is it not just wonderful how the slack in the housing market comes just as construction of refineries, power plants and industrial facilities is gathering steam? Is it not neat that the build out of WiMax net works will occur just as Intel and many others are ready to supply the world with incredibly cheap chips that will dramatically change the way we communicate?

Once again, the price of a computer chip, this time made incredibly small by nano-technology, will drop by thousands of percent. Those who focus on oil to say that inflation is terrible have simply not considered the growth in computer chip sales relative to oil sales. Over the past 30 years, the people of the USA have used less and less oil per person. Sure the nominal price has gone up but the total increase in dollars spent on oil lost its momentum long ago. At the same time, the number of silicon chips purchased has gone up many thousands if not millions of times. The price of these chips has fallen and fallen and fallen some more and are ready to fall once again.

Huge quantities of chips will be sold in coming years. All the ways these chips will be used to boost productivity are not known and not knowable. One known and easy example is the huge savings from avoiding the wrong turn. When GPS is everywhere, a few trillion wrong turns will be avoided each year. Yes, GPS will serve as a substitute for trillions of gallons of fuel.

BUY CONSUMER CYCLICALS, BUY TECHNOLOGY, BUY TRADITIONAL BANKS, BUY INDUSTRIALS, BUY TRANSPORTATION!

MAKE MONEY ALONG WITH THE REST OF THE WORLD!

SELL LONG BONDS, AVOID GOLD, SELL COMMODITIES, AVOID OIL STOCKS, AVOID MATERIALS, AVOID UTILITIES.

NO SURPRISE COMING FROM THE FOMC TODAY

Markets make their big moves when a black swan shows up. Not when everyone is waiting with baited breath for an FOMC announcement. Today's announcement, whether a .25% move or a .50% move, will not be as big an event as is anticipated by many. The history of the last recession serves to tell part of the story. The FOMC cut rates and the market continued to struggle.

The long history is that the S&P is up an average of 12% 6 months after the first rate cut and up 19% within the first year. These averages hide a lot of stuff. One is that after the turn, certain sectors did much better than 19% during the next year and a lot of other sectors struggled. The other thing hidden is the take off point. The history is that the market begins to go up about a month before the first rate cut and that has already happened. As I recall, the market bottom was on August 16th. The market is anticipating a lot of volatility, which means option spreads have widened. Thus, high returns can be "locked-in" with various collar type strategies. These strategies are for those with super sized accounts and with automated computer driven trading platforms. The point for the small investor is to not get caught up in the short term.


In case you do not know the story of the black swan, a couple of hundred years or so ago, it was decided by scholars that although other white birds had black cousins and although there is the occasional black sheep, the black swan does not exist. They said it could not be proven but one had never been seen and one did not exist.

SELL, SELL, SELL!

Greenspan talks from both sides of his mouth but he is probably right about long term interest rates. LONG BONDS SHOULD BE SOLD!

Some of you own long term bonds hidden inside of various mutual funds. Some of these funds automatically buy more bonds the older you get. SELL, SELL, SELL.


Look at in terms of the US Dollar versus the Euro. Back in 2000, a great time to sell stocks and to buy bonds, the US Dollar would buy the same as $1.17 Euros. Today, a dollar will buy the same as $.72 Euros. It is not time to take a vacation in Europe! The relative costs has gone up better than 60%! Of course, with the value added and carbon taxes added, it costs about 23% more to travel to Europe than it first appears. If you want to conserve wealth and energy, stay home.

I do not believe the pattern we are about to follow is like prior times when inflation was out of control and long rates went up and up and up. On the other hand, it is not wise to own long bonds while thousands of billion dollar industrial projects are underway around the world. The demand for money is real. Some of these projects are close to the time when they will reverse their current effects. For example, the cracking unit was just installed on the first of the new super refineries in Vietnam. For the next 18 months, a lot of resources will be devoted to finishing the construction. Then, when it cranks up early in 2009, it will supply two thirds of all the fuel used in the whole country. When the second unit is finished, a couple of more years out, Vietnam will be a finished oil product exporter.

Investors must always keep in mind that inflation is a result of too much money relative to the amount of goods available. In the 1970's, it was assumed that the "oil shock" had to cause inflation. As we have just experienced over the past 5 years, oil can go up and up and up without causing the overall inflation rate to go crazy. For years, the demand for oil has increased dramatically in Asia but the prices of the products flowing from Asia has gone down. Have you noticed the price of a GPS mapping device lately? Pretty soon, owning an electronic map will be affordable by almost every one in the entire world. Now don't tell me how awful the inflation rate is. The iPhone has dropped 25% in price only a few months after its introduction.

So, long bond rates are not going to go out the roof, as implied by Greenspan. However, there will be pressure on interest rates while the infrastructure is built to "catch up to the demand". My friend and former colleague at Merrill Lynch made a forecast in the early 1980's. He said that the business cycle was going to be tamed. I believe Ben Bernanke will not take the Fed Funds rates up and down the ladder as was done by Greenspan. Shortly after Greenspan was made Chairman of the FOMC, he took short rates up sharply and the crash of 1987 hit. The Dow Jones Average went down and down some more, then on October 19, it went down 23% in one day. The little 10% dip we had last month was not enough to cry over.

The problem in the short run is that the market may be initially disappointed with tomorrow's rate cut. It took a number of years after the 1995 rate cuts for the dollar to recover against the Euro. The ECB is still holding rates at 4% so Ben will not likely match that rate any time soon. We also have Congress to worry about. The leaders of congress want so badly to install a carbon tax system that will raise the level of lobbying to new all time levels. Already, billions have been spent trying to influence the outcome. Of course, those companies that have room to reduce carbon emissions would love to be subsidized for providing the service. Just like corn farmers, who would turn down the payments from the "government of the people."

As usual, good intentions have hurt us all with unintended consequences. Had the environmentalists not fought the management of the forest and had the government not paid land owners to not grow crops, many more acres of forest would exist and the world would be a cooler place. The democrats in congress have a "mandate" from the misinformed to raise taxes in order to "improve" health care and the environment and to end the war in Iraq. Bush has the upper hand except in regard to the expiration of the tax cuts passed in 2001 and 2003. Economically, raising taxes and spending inefficiently will keep the US from achieving its potential. Our country is so strong that we can take a tax hit and keep on ticking. As we are moving into the prosperity phase of the business cycle, we can afford a lot. Still, we should not waste what we have.

The ECB is under great pressure to "normalize" their interest rates, which is another way of saying that they need to bring them in line with US rates. The export growth from the US is adding to our total GDP but Euroland will suffer a huge trade deficit if they do not adjust. As is evidenced by the bank collapse this past weekend, Euroland is also suffering from the sub prime mess.

Until the adjustments are made, the dollar will fall, oil in US dollar terms will go up and gold in dollar terms will go up. Even so, inflation rates are falling so it is possible for the ECB to hold rates and for the US rates to fall more than I expect they will. Like I have said, I believe the swings are going to be less violent than in the past. Therefore, I expect Ben to make a cut but for the ECB to increase rates. Growth will slow for a quarter or two, as the consumer who has listened to the news has been frightened. Those who pay little attention to the news are as happy as can be. Their paychecks are rising, they are buying stuff they could never afford before and enjoying the good life. Their retirement accounts have risen in value year after year for 5 years in a row and the value of their homes has doubled in a relatively short period of time.

BUY, BUY, BUY, STOCKS, STOCKS, STOCKS

SELL, SELL, SELL, BONDS, BONDS, BONDS.

NORTHERN ROCK BANK LOOKS BUSTED

The run on Northern Rock Bank in England continues and is making "news". At the same time, former FOMC Chair, Greenspan, is blasting Bush while apparently trying to talk the market down as much as he can. He talks about inflation on the one hand and deflation on the other. He seems to have forgotten his part in this whole cycle. It is a matter of record that he took the Fed Funds Rate down to 1% in June of 2003, well after the stock market had turned up and after home mortgage lending was already hot. Big money is made when the market swings wildly. Most investors should stay in the market 95% of the time and avoid "playing the other man's game". To some extent it at least appears that the FOMC is running a crap table and the "big boy bankers" have the house odds in their favor.

While I believe in supply side economics, I cannot throw out classical and Keynesian truths. The control of money by the FOMC does play a major roll in the sharp fluctuations of the business cycle.


The good news is that in about two months, this will all be behind us. Unless "Big Ben" executes a water torture drip, the turn should be relatively fast. The wild card is still Congress. It remains to be seen just how hard the congress will push for tax and spend social programs while trying to cut off the support to the troops. Chances are that a continuing resolution will be passed at the end of September. Over the next few weeks, trillions of dollars of spending will be pushed into a hectic schedule of horse trading. Dr. Ken Wertz at Chapel Hill was fond of the muddling trough budget process. He, unlike most of us, enjoyed watching the sausage being made. Boy, do we need to reduce the wasteful spending. To not pass the 13 budget bills and then roll all of government into a massive last minute lump that no one knows all that has been stuck in and pulled out at the last minute is no way to run a railroad.

The savers at Northern Rock will not lose money but most are taking the precaution of withdrawing from one bank and redepositing with another down the street. Our fractional banking system works and the evidence shows that the level of skill of the central bankers keeps improving. I do not believe there will be a recession. I am counting on the central bankers to provide liquidity as is necessary to avoid a "real credit crunch". So far, as has been demonstrated by stock markets that are down only 5% or so from the top, this "turn" is being handled well.

The next few weeks will probably be volatile weeks in the market. You should avoid trying to jump in and out on the bounces because one of them is going to soar. The short term swings will look small when viewed in hindsight a couple of years from now. Get on this bucking bronco and hold on because a fun ride is under way!

ANOTHER BUY BUY BUY SIGNAL

Folks, I just returned from the library where I was surprised to find the bull market indicator of indicators. The front cover of the September 10 Business Week is a black and white image of flying planes reminiscent of an MC Escher wood cut of flying swans. Are the swans black or white? Are they flying east or west?

The front cover headlines were:

OVER BOOKED PLANES CANCELED FLIGHTS RECORD LUGGAGE CLAIMS

FEAR & LOATHING AT THE AIRPORT

HOW A FAILURE OF LEADERSHIP LED TO THE SUMMER FROM HELL!

In case you have never heard of the front cover indicator, I used it to my advantage in 1982 and bought John Deere heavily in 1982 when right at the bottom of the market the Business Week front cover was all about the death of the American farm, another one of the famous front covers was called the Death of Equities, also published right at the market bottom. Of course, the farmer on the cover was driving a John Deere and he was headed for bankruptcy. I will leave it to you to search the Internet for more details but this indicator has worked well. This is my third email today because I want to make myself clear: the signs of a dramatic turn in the market are here.

Today, Marion Blakey resigned as the head of the FAA to take a new job as the president and CEO of the Aerospace Industry Association. As the Administrator of the FAA she earned in the neighborhood of $168,000 per year. At the AIA she will earn more than $500,000 per year. In her parting interview she talked at length about how the new satellite based air traffic control system will dramatically improve on time performance of the airlines. It will cut costs and improve safety. She goes on to say that a President Bush has committed to veto the bill if it includes the provision in the house bill that reopens the bargaining table for the unionized FAA employees. The house is willing to negate an agreement to "earn" more campaign contributions from the unions. Of course, the other continuous part of the bill is how to fund the new system. Currently, big planes pay as much as $7,000 per landing while small planes pay as little as $600. Of course, it takes just as much time and effort for the controllers to land a small plane as it does to land a large plane. When several hundred passengers are delayed while a few employees of a company are given a prime landing spot the repercussions can be huge. Many other connecting flights are sometimes delayed as well. In other words, thousands of passengers are routinely given a bad deal while a few wealthy companies or individuals land where they need not land. Many times these smaller planes would land at smaller less congested airports if they were not allowed the "free lunch".

In the Business Week article, it was made clear that the congress will not pass the bill to fund the FAA on time. They will invite President Bush to close down the airlines temporarily. They hope to create as much havoc as possible. The first contract for the new system has already been let. ITT won its $1.8 billion bid to get the ball rolling. Ironically, many of the smaller planes will not wish to spend the money for the sophisticated electronics needed per airplane. The total cost of the new system will be more than $40 billion.

Do you see how the second half economy is going to be a very different economy that the consumer lead first half? Fewer homes will be built but total investment will be much larger. Sophisticated electronics, designed by American engineers will be the products of the next 3 or 4 years.

The Bush veto pen is a powerful weapon. You may recall that when the Republican Congress tried to make Clinton shut down the government, the public took out its rage against the congress. It is the congress that will be under pressure to pass a total package of legislation that Bush will be willing to sign.

Again, the next several weeks could be choppy at best. A 50 basis point cut in the Fed Funds Rate may be met with initial but fading joy. The big discounted housing sale this weekend will put all the more pressure on congress to avoid raising taxes. The Democrats have their hearts set on starting lots of new programs. They want to give relatively wealthy children free health insurance at public expense because they believe they can "win the argument" that all children should be covered by health insurance. One irony is that the Canadian System that was the model for Hillary's plan is falling apart. A judge has ruled that having the right to stand in line for health care is not free access to health care. Law suits are being won by those who are being denied treatment in Canada.

As we all know, the news media shows us graphic pictures of injured soldiers daily. More than 100 US citizens die each day in auto accidents. Something should be done to save the many children who are lost because of reckless behavior, poorly designed roads and scandalous engineering. If we got a steady diet of death on the highway each night, our politicians would be forced to stop diverting highway construction money to other "social needs". North Carolina is one of the worst of the worst. At least 175 million dollars have been diverted from the highway trust fund annually. Now the Governor is pushing to build toll roads. The gasoline taxes are not enough. Government needs more money to give to corporations rather than safer roads.

If the technology were not available, perhaps I could understand the apathy toward the safety of our families but ask congress to fund a system that will save lives and a hold is put in place until the unions can negotiate some more.

An inventor is working on an airplane that will fly itself. This is not new as there are many unmanned drones flying around the world. What is new is that his plane will be an inexpensive but very safe five passenger plane. The unions are not happy that legacy pilots pay has been cut from $250,000 to $170,000. This for work that can be done better by machine. I am not advocating that planes be unmanned. I am simply saying that our priorities are based on political considerations rather than on what is right.

Millions and millions have already been spent lobbying Congress. Ms. Blakey has completed her job and, yes, it looks like she is being rewarded for steering the system toward one that will improve the experience of the great majority of passengers. The congress will balk like a stubborn mule for a while but in the end, they will do what the vast majority of Americans want them to do. That is to modernize the air traffic control system. The investment required by the industry will be huge but the payoff will be rapid. At the current cost of fuel, a 15 minute savings per flight adds up quickly. The time savings for 100's of thousands of passengers daily will add up to millions of hours saved per year. The safety record of the airline industry is incredibly good but it cannot be maintained with over crowded flight paths and antiquated control systems. The new system will ultimately save hundreds of lives.

A RARE EVENT JUST OCCURRED

The Business Week indicator comes along once in a blue moon. When it happens, you should take advantage. It was such a pleasant surprise to see the cover tonight. I had noticed a significant change in the attitudes about airlines. Firm after firm has been raising their estimates. I knew something was up but could not put my finger on it. Yes, many indicators are screaming BUY, BUY, BUY. The front cover indicator confirms the others! BUY, BUY, BUY!

THE POWER, POWER, POWER OF LEVERAGE

A few moments ago, CAL was up 46 cents or 1.42%. In margin accounts, the equity was up 2.84%. The January '09 $35 call option was up 8.82%. The December '07 $35 call option was up 12.73%.

The risk of losing money is difficult to quantify but it is safe to say that the risk of a 100% loss of principle is very high for the December '07 call option but very low for the non-margined stock.

The higher the risk, the greater the potential reward. This basic economic reality must be faced by each individual. The major problem concerning acceptable levels of risk is that individual attitudes about risk change dramatically at just the exact wrong time. When stocks are going wild, the perceived risk tends to fall dramatically when the real risk is in fact rising rapidly. Modern portfolio theory includes the concept that money managers should "take money off the table" each time relative prices of holding rise. If you study the actions of "professional mutual fund managers", "professional hedge fund managers", brokers and especially individuals, you find that people follow crowds and not logic. The higher the prices go, the more inclined people are to take risks. Right now, the "psychology of the market" is very negative. It has been at worse levels before but not at such negative levels with stocks so near the all time highs. This tells me that stocks are likely to go much higher. Fundamentally, stocks are cheap. It is indeed an unusual time for stocks to offer earnings yields much higher than yields on bonds. Finally, we have monetary policy turning very positive toward stocks. The above three, psychology, fundamentals and monetary conditions are the three legs to the Don Hayes investment stool. Don has been pounding the table, telling his readers to get into the market, 100%. He is a tough old buzzard who has followed the market for better than 40 years. He does not try to out guess the market in regard to short term moves but he climbs aboard and holds on for dear life when these indicators are all screaming BUY, BUY, BUY!

Again, I would not be at all surprised if Congress were to fail to pass the budget before October 1. I would not be at all surprised if the auto unions do not reach a settlement for a couple of weeks beyond today's contract expiration. I would not be at all surprised if congress must pass a continuing resolution to keep the government running. I would not be at all surprised if a big fight is fought over every thing from troops in Iraq to eliminating the alternative minimum tax while raising the tax on stock market gains. All of these things are a part of the WOW! (Wall of Worry). The market must have a WOW to climb. We have one in place. It is evident by the sentiment figures. Congress and the president both get very low readings in opinion polls. They need to do something! The President's ratings have bounced a little. Congress is down at a rock bottom level of 29% approval rating. I even believe the odds are good that an immigration compromise will once again be voted upon. A court has put a stay on booting millions of hard working emigrants out of the country. These folk are paying social security taxes but their social security numbers do not clearly match with their identities. The country will be hurt if these people are forced to leave. The pressure is once again on Congress to do the right thing. The next couple of weeks could be very choppy. The move by the FOMC on September 18, no matter what it is, will not solve all these political questions. The Democrats will push hard for a cap and trade carbon tax. They will not call it a tax but the effect of it will raise the cost of fuel to all American individuals and most businesses and it will increase the revenues of the government.

The next few weeks will be full of political rhetoric. When it is all said and done, I believe the power of the Bush veto will force reasonable compromise. Congress cannot over power the president without 60 votes in the Senate. A number of Republicans are tired of the war in Iraq but most will continue to support the president.

The next couple of weeks could be a roller coaster ride but as soon as the market sniffs that Bush will hold firm, the market could take off before the final deals are complete. Those who are speculating on China stocks might want to consider trading for US growth stocks.

Have a great weekend and be sure to tell your friends that the big mid cycle turn is upon us!

SHARE BUY BACKS AND GROWTH!

For the first time I can remember in a long while, an airline announced a share buy back today. Alaska Air will buy back $100 million worth of stock and will use cash on hand to make the purchase. A lot of pundits rail against share buy backs. One thought is that companies should pay dividends instead. The counter argument is that the effect for the company is the same but the buy backs give the share owners the option of collecting taxable income now or deferring the gains to a later time. The frustration about buy backs is in regard to employee stock options. Company managements are tempted to "spend" stock options like drunken sailors. As we all know, a few company CEOs now make millions of dollars per year off of company issued stock options.

Another major positive thing about company buy backs is that they show the wisdom of "holding back on capital spending". The age old problem that has created the boom and bust of the business cycle has been excessive expansion during the "good times". If the individual companies in an industry are disciplined enough to avoid cut-throat expansions, all the companies earn higher profits and the "bust phase" is muted.

The airline industry has been showing much restraint in recent years. The biggest carriers, including UAUA, AMR, DAL and NWA have all reduced capacity. Old fuel guzzling planes have been sold to fuel rich countries such as Russia.

CAL has gotten into this act and recently sold 5 planes to Russia and has reportedly been negotiating the sale of at least 10 more. CAL was the first domestic carrier to order the new, fuel efficient 787. It has also lead the way in taking other steps to reduce fuel consumption, such as installing winglets on the tips of their fleet. These winglets are similar to the air foils installed on trucks some years ago to reduce wind drag. CAL has bucked the growth trend to some extent. It has reduced its US presence but it has been expanding rapidly in the international market. The strategy of adding direct flights from US hubs to international locations has provided CAL with niche flights with no direct competition. Many a passenger would rather fly direct rather than land in a hub to connect for the second leg. The cost to CAL is lower and yet margins are higher.

With the New York area saturated with as much traffic as it can stand, CAL has added another major hub at Cincinnati, OH. The city agreed to pay $16,000,000 of the cost to upgrade facilities. CAL will grow this hub by 40% over the next several years. With new plane deliveries to begin next year and with steady world wide demand growth, CAL will add several more direct international flights. The second CAL direct flight to India will commence in October and the company is lobbying hard to start another direct flight to China.

CASH, CASH AND MORE CASH

Because CAL's earnings have been sheltered by depreciating assets and by Net Loss Carry Forwards, the company has been collecting cash, cash and more cash. To "dispose" of some of the extra cash, the company has made extra large contributions to its employee pension plan. The company just announced yet another $50,000,000 deposit. The good news for the company is that if it gets into a pinch, it will be able to stop making contributions because it is well ahead of the level of contributions required by law. Even so, the company has announce that it expects to end the quarter with over $3 billion of unrestricted cash.

With $9 billion of new planes on order, $3 billion does not seem like a lot of money but airlines often lease planes with little or no money down. It is entirely possible that Alaska Airlines has started a new trend; the share buy back may be the first of many to be announced in the industry.

Merger Mania

Time and again, merging two carriers has proven to be a difficult and unproductive task. Midwest Air was recently successful in fending off its determined suitors. NWA will own a minority stake but Midwest will remain an independent carrier. The merger of US Airways and US West is still a work in progress. Each of these carriers know how to "do things right"; it takes a lot of effort to over come the cultural biases built up over the years. Airline mergers are tough. Still, many believe consolidation is needed; perhaps not. By buying back shares with excess cash, all carriers might enjoy higher profit margins, stronger balance sheets and niche markets. It is pointless to continuously do battle to try to take over another carriers prime market. CAL is one of the carriers that defends its hubs at all cost. No matter how low a discount carrier goes, CAL is willing to match prices and still offer bonus amenities such as bonus frequent flier miles through out its extensive net work. In addition, frequent fliers can visit CAL lounges and those of its partners.

It took a few years for the "big boys" to learn how to compete with the low cost carriers. Now a days, the big boys fund small companies which can go toe to toe with the discounters. A company like Republic gets the fuel buying power of CAL, discounted costs to buy planes and yet it hires lower cost employees to operate the lines. The company signs contracts to fill the feeder flights that land just in time for connections to the major hub flights. As a result of this well planned and executed competitive strategy, companies like LUV are left to admit that they cannot grow at the same rate as they have in the past and they continue to offer employee buyouts.

TIE UPS, LINK UPS, NETWORKS

Companies like LUV need the same type of "link ups" that have been made by CAL. CAL has over 250 "partnerships" with other carriers. Russians can buy one ticket all the way from the depths of Siberia through Moscow, New York (Liberty New Jersey), and to whatever final destination in the US they might choose. The various carriers share the revenues. CAL has the most sophisticated ticketing system. The most recent change permits customers to go online to make changes from one flight to the next. Depending on the circumstance, there may be an extra charge for making the change. Customers can even select seats online.

1995 ALL OVER AGAIN

In 1995, the dollar was hitting all time record lows against other currencies. The airlines were having a tough time. Indeed the entire US economy was under pressure from a Fed Funds Rate that had been pushed to high levels. Then the FOMC cut rates. The dollar turned and climbed for the next 5 years. The airlines saw dramatic traffic growth while their fuel costs fell.

The recent free fall of the dollar combined with hints that Iran will be embargoed have sent oil prices out the roof at the same time that supplies are more than adequate to meet our needs. We are in the "shoulder season" when less and less gasoline is demanded and when refineries must make the switch to produce double the amount of heating fuel and half the amount of gasoline. The reason refineries are not buying as much raw fuel right now is because they perceive that pending slower economic growth is going to reduce demand for oil. China, which has seen its industrial production soar partly due to the rapid fall in the dollar, is about to begin a steady slow down. Substitution effects are starting to take hold. New supplies are coming on line. OPEC did not increase production out of the kindness of their hearts. Saudi Arabia spent $6 billion over the past 4 years developing a new field. Having spent the money, it made sense to sell the oil.

Ironically, both of the leading Democratic candidates for the Presidency have supported liquid coal fuel for most of their careers. John Edwards has tried to use the issue to gain support. He says that CTL technology should not be used because liquid coal throws off more hydrocarbons than does other fuels. I am starting to have fun observing the gyrations of the environmentalists. They have come to realize that bio-fuels are not nearly as environmentally friendly as they first believed and they have come to realize that sugar cane grown in Brazil is a much better source of fuel than is corn, rape seed, palm oil, soy or other northern hemisphere crops. Their actions to support bio-fuels has lead to the destruction of ever more hectares of rain forest. Clear cutting in Brazil is producing bamboo and sugar cane plantations which indeed do absorb about twice as much carbon as do rain forest but this is not "worth the price".

Eventually, CTL technology will be improved to the point that liquid coal will become a growth industry. Probably not in this cycle because the price per barrel is about to fall and because the Democratic Congress has put fear in the hearts of anyone who would consider such production. Should the Democrats pass one of their tax and spend schemes (both a carbon tax and a cap and trade system are "tax one to give to another programs", congressmen can raise lots of campaign contributions by being for or against either one of these systems), the added cost of the tax could sink otherwise profitable ventures. Ironically the drive to reach energy independence is being held back by those who express the desire to achieve this goal.

I am not fond of tax increases, but if we want to tax "pollution externalities" a straight forward carbon tax would be the best solution to the energy problem. Under this method, the fuels that pollute the most would pay the highest tax and the market would quickly figure out which fuel works the best.

Windmills, which are very resource expensive (requiring tons of concrete and steel per unit of production) might make a little more sense if they were deemed to be a low source of pollution. Of course, the problem is that some agency would have to rate them as a pollution source and the citizens of North Carolina have declared that we do not want windmills sticking up from our mountain tops. Location, location, location would be a key determinant of a windmill's pollution rating. You can see that a carbon tax would put a lot of power in the hands of some agency but again, this would be better than seeing billions spent to lobby congress.

If the tax on CTL were fixed in the law the lobbying would not surface except before the next expiration date of the "fix". In any event, the USA has enough coal to supply our energy needs for 200 years. We also have enough natural gas off our coast to supply our needs for the next 200 years. We also have enough shale oil in Colorado, Wyoming and Utah to supply our needs for the next 200 years. Canada has enough tar sand oil to supply our needs for the next 200 years. There is no shortage of energy. There is an unwillingness of Congress to legislate!

The purpose of reviewing the energy situation is to provide support for my market stance. Those who understand that the price of oil will not go up and up and up can have faith in the idea that the price of airline stocks will go up and up and up. The turn is near!

BUY, BUY, BUY!

PROBABILITY GOING UP, UP, UP

The probability of a 50 basis point rate cut rose this morning. Slow retail sales and a further decline in the dollar shows that the US economy needs to be stimulated. Keep in mind that the world economy is not like a smooth lake on a clear day but more like an ocean with many storms raging. A swell in one part of the ocean means there must be a dip in another area.

China has announced its 5th interest rate increase. The base lending rate in China is now at 7.92%. The deep decline in the value of the dollar has been the major dip that has helped cause the huge swell in China. Because the Yuan is pegged to the dollar, the lower the dollar goes the more other nations buy from China. China's manufacturing growth has been phenomenal. The increases in rates in China will have a marginal effect on economic growth in China but the turn in the dollar will be far more important. Once the dollar starts to appreciate, just as it did after the turn in 1995, the price of goods purchased from China by other nations will rise. Because oil is priced in dollars, the price of oil will also rise in terms of other currencies. Demand destruction will accelerate in Euroland and else where as their cost of oil rises.

The Kurds have made a deal with key players in Iraq. The Kurds are to get 17% of the oil revenues produced in this very oil rich region. Iraq is the 15th largest oil producer in the world but it is the 3rd largest in terms of reserves. The potential for steady production increases is there. The final resolution of the oil sharing agreement still has hurdles to jump. The central government has still failed to pass a compromise bill. The people of Iraq are getting tired of waiting for the compromise to develop. The Kurds have signed additional development deals. The latest is with the Hunt family of Texas. There are many other development projects under way. The investors range from the Japanese and Chinese to the Canadians and Norwegians.

The new strategy of arming militias in the various provinces has worked well in the Anbar province and the model is being followed elsewhere. Should the various armed factions go to war with each other, the civil war could be big, but giving power to the providence's is, so far, working against al Quaeda.

SLOW DOWN IN US ECONOMY IS CONCENTRATED IN SECTORS

The slowdown in the US economy is concentrated mostly in housing. Even the auto industry appears ready to surge forward. A drop in US interest rates would begin to heal a lot of wounds in a hurry. Those people sweating a reset of their home mortgage rate will be relieved by the drop in short term rates. Unfortunately, many will have been scared into refinancing at relatively high fixed rates. It is not the time to lock in to a 30 year loan, but, again, the financial industry is doing a good job, in cooperation with the news media and the democratic congress, of taking advantage of the unknowing. The impression has been given that mortgages are hard to find. This impression makes the high fees being charged for refinancing easier to swallow.

THE STRONG WILL GET STRONGER

While the "non bank banks" have gotten pounded; the strong have gotten stronger. The cost of money has already fallen sharply. A cut by the FOMC will lower the cost of money more. Those who borrow huge sums (airlines being my favorite example), will benefit greatly from the lower cost of funds.

Each time a set of weak numbers is announced, the probability of a 50 basis point rate cut increases. It remains to be seen if 50 basis points will be the move and if the one move is enough to cause the free fall in the dollar to stop. Of course, should the free fall in the dollar turn into a sharp climb in value, the price of oil will fall along with the climb. What a wonderful environment to make serious money! BUY BUY BUY

ALL IN, ALL IN, ALL IN

It may be too soon to go "all in" but I am virtually all in right now. The numbers show that I could be off by weeks or even months but it's not likely. In prior times of financial stress, such as 1974, 1980, 1982 and 1987, when the short term t-bill dropped like a rock even though the LIBOR rate stayed high, it was time to BUY, BUY, BUY! (A hat tip to Mark Dodson for the historical perspective.)

Insiders are buying. They too can be early. Indeed, the first reduction in the Fed Funds rate has sometimes been early (2001 for example), but it does not pay to try to time the market precisely. It will be hard to climb on board after the first surge in prices because there is still a lot of bad news to come from Congress, from Iran and from the credit markets.

CAL EARNINGS ESTIMATE

Two or three days ago, I wrote about how the consensus earnings estimates for CAL had been increased from $4.24 to $4.38 to $4.45 and about how the 2008 estimate was raised to $4.96. Guess what? Others have climbed on board. Tuesday the consensus moved to $4.51 and today it moved to $4.57. The 2008 estimate is now up to $5.11. The forward PE is 6 times!

The number of buy ratings is now up to 11 and the number of strong buy ratings is up to 3.

My palms are sweaty and I am trying to keep a solid poker face while I wait for the "river card". The good news is that I still have time on my side. If the FOMC decision next Tuesday does not spark the fire, I can wait for Congress to end its budget fight in October. Sooner or later, with the dollar at all time lows, the FOMC must do what ever it takes to goose the economy. GO FED GO!

NOT THIS WAY BUT THAT WAY

Ben Bernanke, the leader of the US Central Bank, suddenly finds himself running in the opposite direction of his team mate, Jean-Claude Trichet, leader of the European Central Bank. Perhaps the blame is Bernanke's for getting to the 5.25% level too quickly or perhaps it is Trichet's for taking forever to get to the 4% level, but the large spread is pounding on the currency markets. Three months ago, the ECB had made it clear that short rates would be increased last month above 4%. When the sub prime mess hit, the ECB held rates at 4% only to spew out hawkish statements since that time. In other words, the ECB is ready to raise its interest rates.

This is a good thing as the dollar has fallen to all time lows against the EURO. TV pundits often talk upside down about the strength of the dollar. A discussion about the relative strength of a currency can be and often is just as complicated as you want to make it. The pundits tend to focus on the attraction created by high relative interest rates. This focus fails to accept that currencies are much like stocks in that the price is based on potential real growth. A country that keeps its tax burden low and that constantly works to improve its productivity will enjoy a rising currency. With 4% rates, Euroland businesses currently have a cost advantage over US businesses. US businesses must currently fight off base rates of 5.25% which is a significant burden over and above the 4% rate. As a result, the US economy is weaker than much of Euroland.

What if Trichet were to follow though on his talk and raise rates to 4.25% and what if the FOMC gradually lowered to 4%? Can you see what a relative boost that would be for US businesses and consumers?

China just reported the highest inflation rates in 10 years. The Yuan is closely pegged to the US dollar. When the dollar falls, the Yuan falls relative to other currencies. As a result, the cost of imported goods goes up. Now that the turn is upon us, the dollar will appreciate, the Yuan will appreciate, inflation rates will fall in the US and in China and the second half boom will be under way.


WHEN, WHEN, WHEN?

The $64,000 question is when? Unfortunately, the exact timing is never clear. Will it take two cuts by the FOMC or two increases by the ECB to turn the tide?

STAGE 1 AND STAGE 2

In stage one of a perfect cycle, bonds soar in value while stocks and commodities suffer. The real price of industrial commodities peaked several months ago, so even though oil and gold are hitting new highs, I believe we are well into stage one. In stage two, stocks climb on board with bonds. After all, the way stocks are priced is to capitalize earnings at the discount rate that is available in the bond market. The lower the current yield of bonds, the more attractive stocks become.

Since August 16, stocks have been in a hurky jurky uptrend. Bonds have soared in value. A cut in the Fed Funds Rate and an increase in the ECB rate should both serve to support the dollar (I know, John Brown and many other TV pundits disagree, but the evidence is clear). Strength in the dollar will cause low inflation rates to fall out of bed. By the time all of this happens, the selected stocks will be off and running.

DO THE MID CYCLE TURN STRETCH AND DEPOSIT ALL THE EXTRA CASH YOU CAN SPARE. BIG MONEY WILL BE MADE OVER THE NEXT THREE YEARS!

BIG TURN IN SIGHT

The dollar hit a new record low and the news flash was: Dollar Hits Record Low vs Euro on Expectations For US Rate Cut. The article goes on to tell that the debate is between a .25% rate cut and a .50% rate cut.

Gold and oil is denominated in US Dollars. When the value of the dollar declines, it is automatic that the value of gold and oil rises relative to US Dollars. The premise of the news flash is totally wrong, go the opposite direction to make BIG MONEY!


The dollar is falling because the US economy is slowing. The US economy is slowing because real short interest rates are too high. The dollar will stop falling when rates are lowered because the prospects for growth will immediately improve. Large investment flows will reverse to the US after the growth prospects have improved.

One can see that I speak the truth by noting the action at the mid cycle turn in 1995. The dollar was hitting all time record lows right before interest rates were cut. Over the next few years, the dollar climbed and climbed and climbed some more. History does not exactly repeat but it does rhyme again and again. What is about to happen is that interest rates are going to be cut, prospects for growth will be improved, stocks and profits will begin to rise and the price of oil and gold will suffer.

Of course, more than one cut may be required and indeed the futures market suggest that short rates will fall from 5.25 to 4% over the next 6 months. The profits of every little bank in the country will be enhanced by the lower cost of money. The number of businesses that will benefit from the lower rates will be all businesses that borrow money and all businesses that sell to businesses that borrow money. In other words, almost all businesses will see significant benefits from lower rates. Many of the home mortgages that are facing the threat of much higher reset rates will see much lower resets than is currently believed. The housing market will be in full recovery by next spring.

The price of gold and oil will automatically fall as the value of the dollar rises.

TWO OR THREE EMAILS PER DAY

I am sending two or three emails to you each day because the turn is upon us. I will tell you and tell you again because big money will be made by those who "believe". Many will not bother to read the emails, many will read but take no action and a few will make a ton of money. I hope you will be one of the ones to participate in the gains. Do your friends and family a favor and send them a copy of this email. It will not cost you anything to say, "Take a look at what this guy is pounding the table about! "

Best Regards.

BUMP, BUMP, ???

Yesterday, I wrote about the three cycle humps. Today, I want to note the two bumps in CAL earnings estimates. Just a couple of weeks ago, the consensus earnings estimate for CAL was $4.24 and then it was raised to $4.38. Today, the consensus took another bump up to $4.45, the 2008 estimate has been raised to $4.96.

Thirty-one divided by 4.96 produces a forward PE ratio of 6.25. The inverse of 6.5 gives an earnings yield of 16%. I don't know of many investments that offer a 16% yield. Even better, I am confident that the $4.96 estimate will be increased several times between now and next year.


6.25 is a value stock PE ratio but half of CAL's business, the international half, is growing at 17%. The other half is growing at 6%. At the very least, CAL should trade at its earnings times its average growth rate of 11.5%, or 4.45 times 11.5 or $51. My guess is that the stock will reach $51 within 6 months of today's date. I'll put $51 on my calendar on March 11 just to see how my guess works out.

BUY BUY BUY!

GOLD IS A "SPECIAL" COMMODITY

The CRB is composed of energy, agricultural and industrial commodities. The price of precious metals is a whole 'nother story. The recent "flight" to quality saw the price of treasury securities jump and the price of gold jump. Any "flight to quality" is a "fear response" to an event or events. The "meltdown" of the sub prime paper market had people around the world running for safe havens. Even the price of gold is getting lower and lower in inflation adjusted terms. Those who bought gold more than a year ago at $700 cannot sell it now at a real, after inflation adjustment, profit. Seven hundred dollars in a good money market account for a year is now better than $730.

Gold is special but it pays no dividend; it earns no interest; it is what it is, but never more or never less. Yes, gold is an industrial metal, but we use substitutes whenever we can. As an industrial metal, gold is used up but most of the gold in the world is held as a "safe" store of value. Holding gold is very much like insurance. There is a significant cost to owning an insurance policy but we do it to reduce the extremes of our personal risk-reward. In other words, I cannot fault anyone for keeping a few thousand dollars in gold, provided they understand this is an emergency reserve and that there is a steady long term loss of value. The after inflation value of gold drops at about the same speed as the value of a printed dollar. It makes no sense to keep a lot of cash or gold hidden in a mattress.


ABUNDANT SUPPLIES

The false reasoning that I constantly see is the idea that "we are running out of resources". The idea was common for centuries because lots of people were always at risk of running out of food. The supply of gold available is more than we will ever need. Just as the supply of oil available is much more than we will ever need.

Over the next 10 years, more industrial metals will be used in the production of electronic gadgets than ever before. The boom in gadgets is nowhere near the end. However, each of these gadgets is more powerful and smaller than the gadgets they replace while using less resources per gadget. The real "win" is that these gadgets often replace the need to spend many times more resources.

A lot of gold will be used in the production of electronic connectors over the next 10 years but one gaudy gold chain is enough to produce 10's of thousands if not 100's of thousands of connectors. There is still more gold in the ground than all that we have ever dug. Indeed, there is more gold on the ocean floor than we have ever used. There is a cost to go get it and depending on the next invention, the relative value of gold to titanium might change dramatically. However, in the long run, the relative value of gold goes lower and lower and lower to our standards of living. In the old days, a fellow who owned a bar of gold was a very wealthy man. Today, millions of people live in houses that would make that wealthy man's house look like a chicken coop.

OIL, OIL and More OIL

Today, OPEC will decide to hold production levels or not. Saudi Arabia has an extra 500,000 barrels of supply available. In two more years, a huge project will give Saudi Arabia another 1.2 million extra barrels. With Iran and Venezuela pumping at 100% of capacity, they have little desire to increase quotas. From a fairness point of view, it makes sense for all the OPEC producers to produce at a set percentage of capacity. The current excess capacity of about 3 million barrels per day is largely available from Saudi Arabia. Does it make sense that Saudi Arabia would spend $6 Billion to develop a 500,000 barrel field only to sequester 100% of its production?

In the old days, OPEC routinely increased production quotas in the winter time in order to supply the heating demands of the Northern Hemisphere. However, substitutions have been easy for winter time heating needs relative to summer time transportation needs. It is simply much easier to burn extra coal for heating purposes than it is to somehow convert coal into fuel for automobiles. Even Toyota has struggle when trying to make their hybrid vehicles "more electric and less gasoline". Much work is being done to figure out the best way to "refine coal" into liquid fuel.

The political left continues to beat their drums about "renewable" energy. They are willing to fight the use of more coal at every juncture. It does not matter if coal can burn clean to them. They score no political points for finding a solution to the "energy crisis" but they win big as long as they are able to convince a gullible public that we must develop renewable energy because we are going to "run out" of the good old stuff. Of course, the battle is tangled up with the "environmental cause". We plow 90 million hectares of rich top soil annually to grow pesticide laden corn in order to "save the environment". What a shame and what a waste!

The good news is that the "energy crisis" is on its last cyclical leg. Over the next two to five years, the investments already made and being made in energy production will start to bear fruit, just as the investment in production of more efficient autos and other uses will bear fruit. Keep in mind that the extra money now being spent on gasoline is going to flow into "electronic gadgetry" and the software required to operate these gadgets. This software will include music and videos. The hand held "Dick Tracy" watch is just around the corner. The use of these gadgets will save a lot of gold.

BUY, BUY, BUY!

ROCKS IN THE ROAD, SO WHAT?!

When I wrote that Big Ben is about ready to fire the starters pistol, a reader asked how I can believe the "race is ready to start" when there are so many problems. He mentioned the union negotiations, the failure of congress to pass the budget and of course, the housing "collapse".

My reply is: What is new about financial stress at market turns?


Indeed, one of the most positive indicators I have that the market is ready to turn is the fact that there is financial stress.

As I have said many times, the ideal environment for stocks includes a low inflation rate. When does the inflation rate fall? During times of economic stress.

We must remember that one man's pain is another man's gain. The slow down in the housing market is largely the result of the 17 increases in the Fed Funds Rate starting in June of 2004. The increases were brought on by the strong world wide economy. If one area of the economy is super strong, another area needs to be weak in order to avoid over heating and high inflation rates.

INFLATION RATES ARE FALLING AND ARE PROJECTED TO FALL SOME MORE!

China just hit a 10 year inflation peak; inflation in the rest of the world has started rolling over. Please remember that listening to the talking heads in regard to inflation is only confusing. You have people on the TV such as Barry Ritholz who has been whining about inflation for several years. When gas prices were going up, he had a point, but after two years of flat or moderating gas prices, he still yaks about how the FOMC is between a rock and a hard place. The best inflation forecast is available in the blink of an eye. All one has to do is observe the 10 year treasury bond rate. The rate on the treasury bond is always a combination of projected real economic growth and inflation. Don Hayes moves the bond plot forward 2 months and gets an inflation forecast that has an r square of 88! Did you notice the huge drop in 10 year rates over the past several weeks? INFLATION RATES ARE READY TO FALL SOME MORE!

My friend Lamar, who was a broker at Merrill Lynch in the early 1980's, will remember our old 1.9 indicator. We plotted the t-bill over the dividend rate of the S&P. In the summer of 1982, in October of 1984 and in September of 1990 this indicator gave a BUY signal, just as it did two weeks ago. Again, this is nothing but a fall in short term interest rates.

Fed Funds have been trading day after day well below the target rate of 5.25%. In other words, the FOMC has been keeping enough reserves in the banking system to hold rates well below their own published target. The rate has bounced around the 4.7%. The FOMC has already cut rates but is waiting for the "appropriate" time to make the announcement.

YES, I DID SAY...

I said that stocks would take off after commodity prices have moved down the "third hump". I also said that the stock market discounts or moves 6 to 12 months ahead of the economy. Each cycle is a little different. In 1996, the CPI adjusted CRB index peaked in February of 1996, the big gains were made by those who "got in" to the new market leaders even before the peak. The CPI adjusted CRB peaked in January of 2007. The NASDAQ 100 is already busting out. The DOW JONES is making headlines by jumping up and down by 200 points or more but all the while the NASDAQ is performing well. Yes, it jumps up and down but it jumps three steps and only retreats a couple.

ROCKS IN THE ROAD

The auto unions and the congress are holding out as long as they can. They would love to see a big turn in the economy. The unions want auto sales to take off. The car companies have produced enough "extra" such that they might even enjoy reducing inventories during a strike. The congress wants to spend a lot of money. To spend the money they need to raise a lot of taxes. They would love for the economy to be strong. Unfortunately for them, the economic weakness will continue until well after the budget needs to be passed. The idea of raising taxes, while the economy is in the tank, cuts against the wisdom of all the major economic theories. Keynes nor Friedman would have advocated raising taxes during a "slowdown".

Because the stock market leads the economy by 6 to 12 months, there are always "rocks in the road" before it takes off. Sure, the battle between Bush and the Democratic Congressional Leaders will likely drag on for several more weeks. By law, the 13 budget bills are to be passed and signed by October 1 but continuing resolutions are not uncommon. Bush is likely to veto some spending and the congress is not likely to "close the government down". The state of the housing market is going to encourage Democrats to advocate all the more spending. They will want quasi government agencies such as Fannie Mae to "bail out" the mortgage market. The argument will be made that this will be done to protect the poor homeowner, who never had equity to start with, but the effect would be to bail out the lenders who stretched to make an extra buck.

Bush has asked for reformation of FHA. The odds are that some of the reforms he wants will be passed along with a few additions that he will not like. My guess is that by mid October compromise budgets will be passed. The actual speed will depend on the perceived advantage or disadvantage in regard to the coming elections. With many primaries just around the corner, the candidates will want to be back on the campaign road as soon as they can.

WILL THEY CUT AND IF SO BY HOW MUCH?

Keeping the market guessing serves a purpose. The longer the FOMC can keep the question in doubt, the more inflation they can squeeze out of the sponge. As noted, their strategy has worked. TIP spreads and regular 10 year bond rates show that inflation is dead. China will be the last to feel the slowdown but some big economic waves are already headed across the ocean. The weakness of the Yen and of the dollar are each having the expected effects. Industrial machine orders in Japan just jumped by 17%! The super efficient Japanese are ready to go head to head with the Chinese who have low cost labor as their comparative advantage.

I continue to believe that the odds of a recession are less than 50/50 even though the highly accurate TradeSports betting site now has the odds at around 55%.

YES, RATES WILL MAKE A DIFFERENCE

It has been fun to listen to various pundits suggest that it is "too late" for lower rates to make a difference. OH COME ON! Have the pundits forgotten the law of supply and demand? If the price of money is cut, the demand for it will go up. A cut in one of the cost of doing business will mean there will be more business done. It is true that the effect of lower rates is a process for the economy the effect will be much more immediate for the stock market. EACH CYCLE IS A LITTLE DIFFERENT. WE DO NOT KNOW IF THIS ONE WILL JUMP EARLY OR LATE. THE BEST STRATEGY IS TO JUMP ON THIS BUCKING BRONCO AND HOLD ON FOR DEAR LIFE. ADD ALL THE FUNDS YOU CAN BECAUSE ONCE THE STAMPEDE STARTS THE TEMPTATION WILL BE TO WAIT FOR A "PULL BACK" TO JUMP. IT IS SIMPLY HARD TO GET ON A MOVING TRAIN. GET ON NOW AND SIT FOR A WHILE! YOU MAY BE SCARED BUT NOT TRYING TO JUMP ON BOARD AFTER THE TRAIN IS MOVING IS EVEN MORE SCARY. BUY BUY BUY!

HUMP 1, HUMP 2, HUMP 3, HIKE

The business cycle is composed of three humps. Hump one is a sine wave of the stock market. The stock market leads the second hum, the economy sine wave, typically by 6 months to a year. Therefore, stocks typically take off to the upside right in the middle of a period of economic weakness. While The economy lags the stock market it leads the third hump, which is the commodity sine wave.

Many stock market investors pay little attention to commodities as an indicator. They listen to the news about oil futures contracts without appreciating that futures contracts lead spot prices of commodities and often accept rumors of $1,000 gold or $100 oil as gospel.


KEEP YOUR EYE ON SHORT TERM INTEREST RATES!

Short term interest rates rise and fall in step with the commodity wave. Thus, the best way to get a good idea of where we are in the business cycle is to follow short term interest rate moves. Take a look at a chart of gold and you will see what I am talking about. Back in 2003, the price of gold was low. As I recall, in the low three hundred dollar range. By the time the FOMC had raised short interest rates 17 times, the price had risen to the $700 range. Please do not assume cause and effect; did the FOMC raise rates to try to hold down inflation? or did inflation cause the FOMC to raise rates?

Current futures contracts, this is where real money is being bet on the level of interest rates over then next many months, show that short rates are expected to decline several times between now and next March. The futures market expects short rates to be down to 4% by March.

STEPS 1 THOUGH 6!

Another way to look as the business cycle is the six stages presented by Martin Pring. I often disagree with the way Mr. Pring uses short term, intermediate term and two year indicators as a method of following a business cycle that is typically close to 9 years in length but his six stages are worth following closely. As you well know by now, I believe the typically business cycle is actually composed of two halves with the middle being divided by a mid-cycle rotation rather than a full blown recession. Harvard History Professor Alvin Hansen uses the term minor cycle and major cycle but lets not let terminology get in the way.

In Pring's six stages, the first stage is when bonds do well while stocks and commodities are doing poorly. Did you see happen to notice the huge rally in the bond market Friday, while the stock market fell out of bed? This is not a new event. Bonds bottom in July of 2006, tested the bottom a this summer and have rallied steadily since. Months ago, I wrote that the mid cycle turn is near because the last "event" of an old cycle is the sharp rally in the bond market.

With the BOOM, BOOM, BOOM in China, it was difficult to believe that the world economy would slow enough this cycle to allow for a massive rally in the bond market. In July of 2006, I wrote that I leveraged family accounts to purchase long term treasury bonds. I don't believe that I mentioned taking a nice profit, albeit too soon. In hind sight, I should have held the bonds at least until today.

Still, the bond market is giving strong evidence that we have entered Pring's stage one of the business cycle. Again, in stage one, the bond market soars while the broad stock market averages suffer and while short interest rates and commodities decline.

The current fly in the ointment is that the price of gold, oil and other commodities appear to be holding onto stage 5 for dear life. Here again, if you look at the broad commodity index (CRB), you can see that commodities are rolling over. The tricky part is that it is expensive to hold commodities when real interest rates are high. There is still a large group of traders who believe inflation is out of control and that real interest rates are still low. As is show by the spread between the 10 year bond and the 10 year tips bond, inflation rates have fallen, even while oil has tested the old highs. When the "inflation hawk" speculators finally capitulate, the price of oil will decline by at least $20 per barrel. As noted in other postings, there are numerous new supplies coming to market with the really big projects arriving in 2009 and beyond.

The bottom line is that real interest rates are high enough to drag down the price of commodities. Those that follow real interest rates closely, come to understand that real interest rates is where the "rubber meets the road". Real interest rates fluctuate wildly because when inflation rates are high, short rates must be raised by an even greater increase than the increase in inflation. When the economy slows down below trend growth (which it is likely to do over the next couple of quarters), short rates must be lowered to well below the inflation rate, in order to stimulate the economy. Thus, the series of 17 short rate increases that started in June of 2004, have worked their magic and the current 5.25% Fed Funds rate is MORE THAN 3% ABOVE THE INFLATION RATE! REAL RATES ARE VERY HIGH! THE COMING DECLINE IN REAL RATES WILL STIMULATE THE ECONOMY AND THE STOCK MARKET LEADS THE ECONOMY BY 6 TO 12 MONTHS!

HUT 1, HUT 2, HUT 3, HIKE

Big Ben is at the quarterback position and play is about to begin. We have already heard the count of hut 1, hut 2, hut 3, but Ben has not uttered the word hike. Ben is a smart fellow. He is also a highly educated fellow. His most recent use of the discount window to provide liquidity while continuing to squeeze out inflation was from a 150 year old play book found in England. Ben understands that making a move between meetings adds an emotional element to FOMC moves. Ben is playing a cool game. He is deflecting a lot of criticism. No matter what he does, many will blame him for all sorts of problems that are not within his control. The FOMC only controls monetary policy, it is the congress of the United States that consistently votes to handcuff the great US economic machine. The congress waste so much money that it is incredible for the economy to remain as strong as it does.

We should all be thankful for our "fractional banking system". Gold bugs are constantly on a rampage about our "fiat" currency. This means that they want a dollar in gold in the vault for each dollar printed by the US government. Americans live better lives because we are willing to "share the wealth". I am thankful for our wonderful free enterprise system and I am painfully aware of how much better we could all be if our government were not so wasteful. Our solace must come in knowing that "democracy is a very ugly form of government except when compared to all others".

GOLD, GOLD AND MORE GOLD

In the old days, the wealth took their gold to the "bank" and the banker earned a fee for keeping it safe. In other words, in the early days, banks were basically a collection of safety deposit boxes. If the citizens of a community had 1 million dollars of gold on deposit at a bank, that bank had one million dollars worth of gold in its vault. The history of the move to the "fractional" system of banking is a wonderful story of joy and horror and one you should take the time to explore.

The purpose here is to show where we are now and what that means for the immediate future.

The total output of our economy is composed of three components. We have government spending, consumer spending and investment. The formula is G + I + C = GNP. The TV pundits like to focus on C. They get in a tizzy about how much debt consumers have. There are three truths about the debts of Americans: 1) the total debts owed by Americans is a large number, one that is easily railed against 2) the total debt owed is a small amount relative to the total assets owned 3) our wonderful fractional banking system allows all of us who save and all of us who borrow to "share in the great wealth of America".

An important fact often over looked is that C is actually the most stable of all the components of GNP. Indeed, you can generally count on Americans to spend the money they get. Personal income in America is growing by leaps and bounds. During the past 12 months, personal income rose by 6.5%! We do not really have to worry about consumer spending. The employment numbers last week were a very late joke. They showed that government employment dropped by 29,000 jobs, ha, ha, ha. Employment numbers are lagging numbers and they are always revised time and time again. The "slowdown in jobs" relates to the slower economy of the first quarter of the year and not to the strong 4% growth of the second quarter. Jobs are plentiful and the reason we call this component consumers is because this word defines what Americans are know to be.

Government Spending is much more volatile than Consumer Spending and Investment Spending is the most volatile of the three. Ironically, the big problem comes when government waste becomes so pervasive that the votes are available to do something about it. In other words, when the government builds a bridge to no where, the economy grows! In our fractional system, we must remember that one dollar spent is "shared" or spent again by more than 5 other spenders. Like the economist Paul Samuelson did in my Econ 101 text, I will use a high fraction of 20% just to make the math simple. When the government builds a bridge to nowhere, each $1,000 spent is deposited by someone, somewhere. When one of the flagmen on the project deposits $1,000 to his bank, the bank must keep 20% (actually much less) but it can lend the other $800 to others. This $800 is ultimately deposited to other banks which also keep a total of less than 20% and they lend the other $640. The $1,000 deposit typically grows to more than $5,000 worth of deposits plus $4,000 worth of loans. The 500 million dollar bridge becomes a 2.5 Billion Dollar "surge" in the economy.

WE ARE SPENDING TO FIGHT A WAR!

Those who believe the economy is going deep into the tank might have forgotten that a recession is not likely during the middle of a war. After a war, governments must go to extremes to keep money circulating. They could give it back to citizens through tax cuts but, as we know, politicians generally like to control more not less. Chances are your government will find a way to spend all it has available plus another 3% that is borrowed. The good news is that the 3% borrowed never has to be paid back because the economy grows as fast as the debt. During a war, extra government spending stimulates the economy. The "big deficit" that is railed against is solid evidence that the government spending portion of GDP is strong. If you believe the war is Iraq is going to suddenly end if Hillary is elected, I have a bridge to no where I would like to offer for a very reasonable price.

THE BIG DOLLARS

The big dollars are the investment dollars. If all the needs of all the people were being met, there would not need to be any new investment. On the other hand, as the population grows, sooner or later another factory, hospital or fast food joint will need to be built. When you or I buy a stock, we only trade assets with other people. When a factory is built, an investment is made. When a factory is built, it is like a stone has been thrown into a pond, the ripples are felt all the way to the other side.

During the first half of an economic cycle, workers who were laid off in past recessions find new jobs and old machines are cranked up. During the typical four year rebound, some new "stuff" is added but gigantic new power plants are not needed to support the addition of a little bit of "new stuff". By the time the second half rolls around, the "big stuff" is running scarce. This weekend, Boeing announce the sale of still more big planes and Siemens signed a multi-billion dollar deal to build high speed trains throughout Russia. Only a few years ago, the Russian economy was on life support. Now, largely because the country is resource rich, they are spending billions to provide transportation.

SHORT RUN OR LONG RUN

In the short run, we have to get over the housing slump. In the short run, the announcement of one major capital project after another shows that a "big boom" is on the way. The big projects are all over. They range from Intel semiconductor factories to hundreds of refineries (both new and additions to old) to nuclear power plants, to WiMax installations. Some of these projects will be much more profitable than others but few will be as silly as bridges to nowhere. Even the dumb ones, will serve to stimulate yet other projects. In China, a very long list of projects have been delayed pending construction of electrical power generation facilities.

MID CYCLE TURN

The reason that we do not have to have a recession at the mid cycle turn is because there has not been "over investment", with the exception of residential housing, during the first half of the cycle. During the second half, when the big projects are going full steam ahead, we will eventually need a "serious cooling off time".

GO, GO, GO

Right now, we do not need a "serious cooling off". Big Ben can "afford" to lower interest rates because there are plenty of goods available which means prices are falling in many categories. China continues to export deflation. Japan cannot get up off the floor because its economy is a manufacturing economy in direct competition with China.

This six stage space rocket is ready to roar. Stage one is here. Aggressive investors will do well by going against the psychology of the masses and BUY, BUY, BUY!


This posting will be used in an investment class at the Winston-Salem Library. Your feedback is much appreciated. Are the ideas presented clearly? Where could improvements be made?

Please forward this to your friends and family. Should your 14 year old "catch the economic bug" he may become the next "Big Ben".

KNOCK KNOCK KNOCK

They say opportunity only knocks twice but the market is giving you a chance to make serious money. Some goofy jobs numbers were reported this morning. The government says that the government lost 29,000 jobs. YUK, YUK, YUK! I suspect that the overall loss of 4,000 jobs will be revised upward by at least 100,000. Of course, this revision will be long after this democratic congress that is eager to raise taxes has had to pass the 2008 budget bills.

Karl Rove has left the White House but he has set the table for the 2008 elections. Between now and next fall, a lot of good news is going to flow. One way to make numbers look really good is to report low ball numbers and then revise them when it counts. No, I have no proof that there is manipulation and I am not big on conspiracy theories but the presidency is at stake. The temptation for playing games is certainly present.

INTEREST RATE CUT

The probability of an interest rate cut improves after each "bad" set of data is released. Since my new home is under construction, it will not hurt my feelings if rates are much lower next spring. I will not count on lower rates because the construction of 100's of refineries and power plants around the world will cause crowding out; interest rates will come down a little because of the current consumer loan problem, but literally trillions of dollars will be spent on major capital goods projects over the next 10 years.

Those who are building private windmills may eventually get their money back from energy savings but they sure will shell out the big bucks in the short run. Of course, those who got started early look smart right now but when the price of oil falls by about 33%, the wisdom of even these projects is in doubt.

History tells us that the market goes up an average of 19% within six months of a cut in the Fed Funds Rate. If I am correct, basic materials and energy sectors will not go up nearly as much as 19%. Thus, those who hit the right sectors will do much better than 19%. Ben may still have a creative move up his sleeve. Since the congress will not have acted by the 18th and since gold and other commodities have bounced as if inflation were out of control, Ben may delay the cut for a few more weeks.

Don't try to out guess him. When the market dips down, like today, then find a way to add to your accounts. The BIG MONEY IS MADE WHEN ONE STEPS UP DURING THE TOUGH TIMES! BUY BUY BUY!

SHOPPING WILL NEVER BE THE SAME

The rapid adoption of wifi enabled devices, such as the new Apple iPod, is about to change the "shopping experience". In the near future, when you go into the grocery store, your hand held computer will lead you to the location of the items on your list. It might also mention that P&G is running a buy $10 worth, get a $1 off sale. It might notice that you purchased nutmeg and mention that frozen pie crust are on sale. The utility of a good includes your consciousness that of it. Out of sight, out of mind, but just a gentle nudge will save you a return trip for hot dog buns after you scan in the hot dogs.

Apple has come up with a neat use of the new digital radio frequencies. When you enter a Starbucks, your iPod will pick up the music being played. The service will be free. Of course, should you decide that you like the song you might choose to down load it for a fee. The combination of digital radio and computer is one of the "convergent" technologies. The difference in advertising to a couch potato or to a person who is in the store buying is powerful. Scan in any item and it will give the competitor the opportunity to suggest a deal to try his product--only one freebie per iPod!


Sprint, Nokia, Cisco and many others are gearing up for omnipresent wifi which is a chicken and an egg proposition. Earthlink has back off on offering to install free municipal wifi. Earthlink has started asking cities to become "anchor tenants". After all, city governments can certainly save a lot of money by using this technology. They might read meters, report building inspections, coordinate traffic, communicate in regard to public safety and, of course, libraries and schools would be prime beneficiaries. The savings from wiring government offices for phone and Internet service should be substantial.

Sprint and others will offer a plethora of wifi devices, every thing from digital cameras, to gameboys, to email devices, to laptops and to phones will we live 24/7. Cisco is charging ahead with 802.11 N products. Once these networks are more common, it will make a lot of sense for billions of people to upgrade equipment to this super fast and super strength service.

MOVING UP THE ACCELERATION CURVE

Hundreds of millions of people are rapidly moving up the acceleration curve. The acceleration curve is the sigmoid curve that traces out the first half of the bell curve. As people earn a little more, they are suddenly able to afford new things. A good example is airline traffic in India. Traffic is growing at about a 30% annual rate as Indians discover they can afford to go places. Because airline fuel is taxed heavily in India, the airlines hope to expand their international routes where fuel cost are lower and where competition is reduced. India has executed an open skies agreement with the USA. Under the deal, Indian airlines and American airlines can add equal numbers of flights. In October, CAL and one of the Indian carriers will each start daily direct flights to and from the USA. This will be the second direct flight for CAL.

The USA continues to benefit from world wide economic growth. Our exports are growing at the phenomenal rate of better than 10% and our service exports are growing at about 13.5%! The huge growth rates are keeping the pressure on interest rates, commodities and inflation. Some central banks continue to raise short interest rates. Developing nations are starting to be pinched. Oh My, Lions and Tigers and Bears, the growth rate in China is likely to drop to to 8 or 9%. Still, the slower growth will help reduce the over heated nature of the commodities market.

Right now, the "big boys" appear to have the speculators caught in an oil short squeeze. The wholesale price of gasoline has remained around $2 per gallon while crude oil prices have soared. They are soaring because the "big boys" are holding back, waiting for the speculators who must cover to come to them to buy. It is really hard to deliver oil if you don't own the wells that produce it.

While the news media continues to report that prices are "skyrocketing", crude is testing the highs made well over a year ago. Even after this latest run up, oil is selling for less than it did at last year's peak. In the mean time, Saudi Arabia will boost capacity by 500,000 barrels this year and its Khurais field will crank up at 1.2 million barrels per year by mid 2009. Qatar is adding about 250,000 barrels, Libya about 300,000, and Iraq is now pumping 400,000 more barrels. Angola is whole 'nother story; it has gone from 750,000 barrels per day in 2001 to 1.75 million per day this year, a million barrel per day increase, and it will add another 200,000 soon. Many other fields, from Uganda to Newfoundland will not come on line for at least another year.

TERRORIST CHATTER

As we draw near to September 11, there is once again chatter about Terrorist plots. Yesterday, Fred Thompson made his opening presidential campaign stump speech. He got one thing exactly right, which is that the American people need to come together with a sense of purpose and show our resolve to end terrorism. Many a war has been prevented or was ended quickly as a result of intimidation and over whelming strength. Alexander concurred the bulk of the civilized world in a few short years by demonstrating massive power. Most of his men were foot soldiers with shields and spears but he knew how to go after an opposing force.

Sanctions were first imposed on Iran in 1979. The heat needs to be turned up two more notches. The recent election of moderates shows that the pressure is having an effect. The Berlin Wall was taken down as a result of unified pressure. Americans need to get behind the war effort and stop giving aid and comfort to the enemy. Stopping the terrorist now will save thousands of lives over the next many years.

BOOM, BOOM, BOOM

In the past, a drop in housing of such great magnitude would have throw the US into recession. Indeed, the steep climb in the price of oil were part and parcel to the big recessions of 1973, 1982 and 1991. The housing market is dragging the US economy down between one half and three quarters of one percent. The GNP is likely to slow this quarter from 4% to around 2.5%. Investors should remember that stocks are the leading indicator. The correction in stock prices in July shows that the economy will slow over the next 6 months or so but the rebound in August shows that the decline in the economy will be modest. Indeed, with the coming build out of wifi services heating up, and with billions of construction projects underway to increase energy capacity, next year we will be talking about the booming economy. Wow, what a surprise, the economy is going to be pretty strong right before the presidential election!

BUY, BUY, BUY!

THE TAIL WAGS THE DOG--AGAIN

Paul Samuelson, the MIT Professor who wrote Econ 101 text, tells the story of spending an hour explaining the concept of marginal utility of value. At the end of the lecture he saw the look of confusion on a number of faces but one student was relaxed. The Professor asked this student if the lecture was clear and he said sure, "the tail wags the dog".

The short term tail is currently wagging the dog, again. The total amount of money lost or gained in the short run on futures contracts will be small in relation to the total long term money made or lost. It is a mistake to focus on the wagging tail of this dog and to conclude that this is a risk free dog. The wagging tail is a distraction from what is real.


THE HISTORY OF A MID CYCLE CORRECTION

Leading up to the last mid cycle correction, stocks and bonds fought with commodities for leadership from mid 1994 to mid 1995. On balance, commodities beat out bonds as the FOMC raised rates to try to slow down inflation. The increase in rates (short rates and commodity rates trade tend to rise and fall together) finally started to bite toward the end of 1995 which only sucked the momentum out of the commodity rally. Prices did not fall much but they did stop going up. The final bounce took prices to peaks in 1996. Futures contracts peaked first, during the second quarter of 1996 and spot prices peaked during the third quarter. Commodity prices did not fall hard until the 4th quarter of 1997, long after the stock market had taken flight.

At the turn, the stock market was only down a little over a month starting in September of 1995. By late October of 1995, stock prices were off and running for a five year jaunt. Do you see that history is in the process of rhyming with the past. History does not repeat but it often comes close. The swoon in July and early August was similar to the swoon in September of 1995. The run up in futures contracts is making news but there is little oil trading at these prices.

The price of big oil stocks reflects the markets longer term projection that oil is going to average less than $55 per barrel over the next 10 years or so. The current price of $76 is the tail wagging the dog.

The tail has grabbed hold of China. China bankers have upped their reserve requirements again. The increase is a restriction of credit done for the purpose of slowing an over heated economy. The inflation rate in China just hit a 10 year high. The restriction of credit is in concert with the other central banks of the world. The ECB and the Bank of England have each decided to hold rates at current levels but their prior moves in coordination with many others including the USA, Australia, South Korea and Canada have done enough to slow the pace of expansion in the "rest of the world". China still has work to do but as its policies begin to bite, the marginal demand for resources will be reduced.

WHAT IS AN INVESTOR TO DO?

BUY, BUY, BUY!

Over the next several years, consumers will spend their gasoline "savings". BUY RETAIL!

Jim Kramer gets a lot of stories right but he often is fickle in his execution. He jumps on an idea one day and is quick to move onto another idea the next. He is currently on a "buy retail" kick and I believe he is "on the money".

This does not mean investors should sale other sectors to buy retail. As a general rule, investors want to avoid trading as much as possible. However, with new money in accounts, it makes sense to buy retail.

As I wrote a couple of weeks ago, Art Laffer gave two thumbs up to the "buy retail idea". He is also a bull on technology and industrial stocks which typically do well right after an economic slowdown.

The numbers this morning show once again the resilience of the US economy. Inflation is low and growth is strong. BUY BUY BUY!

WORRY, WORRY, WORRY

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.

WORRY WORRY WORRY

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.

MARGIN, MARGIN, MARGIN

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.

COAL, COAL AND MORE COAL

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.

OIL, OIL, and MORE OIL

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.

DON'T WORRY BE HAPPY!

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!

MID-CYCLE COMPARISON

This cycle continues to be stretched. Each is different. The following numbers show what has happened in the past. The past tells us what is possible not what is to be.

PRICE OF CAL ON CERTAIN DATES

Jan 1995 $4.60
Jun 1996 $31.00
Sep 1996 $21.60
Jun 1998 $61.60
Sep 2004 $8.8
Jan 2007 $52.40
Aug 2007 $27.0?????



In 1995, the stock went up better than 6 times in 18 months.
In 2004, the stock went up slightly less than 6 times in 28 months.
In 1996, the stock lost 30% of its value during the mid cycle correction.
In 2007, the stock lost 48% of its value during the mid cycle correction.
Over the next 21 months, the stock went up 285% after the mid-cycle correction in 1996. 2.85 times $27 is $76.95.

I believe the international nature of this business cycle could make the climb last a longer time and ultimately be significantly larger, however, I will not cry if the stock only goes to $76. A fully margined gain of 285% could net 1,400%.

Now don't tell me that 14 times your money would make you sad. Of course, most accounts are not fully levered nor will they stay fully levered. It takes a thrill seeker to ride the biggest of the roller coasters. I hope we can all find and maintain a comfortable and appropriate level of "thrill seeking" for our own circumstances.

HOT, HOT, HOT

CAL is HOT! Congratulations to those of you who added money to your account while the stock was below 30. There may still be a few bumps along the way but I expect a double in value within a year or so.

This morning, LUV raised fares up to $10 each way. LUV is the key for higher prices. The legacy carriers have been quick to follow the increase. JP Morgan has once again upgraded its estimates. The firm expects yields to rise. Duh, if all the seats are full and you raise prices, the yield is likely to go up.


We are in a time like 1996. After the 90's mid cycle turn, total passenger miles flown grew by better than 10% for three years and better than 6% for 5 years. Business people fly during the prosperity phase of the business cycle. When a deal hangs in the balance, only a foolish executive is willing to rely on electronic communications. The old rule in sales is to get the signature on the dotted line and take it with you.

In response to the questions about my price target, I should point out the obvious. I am not an analyst and I do not sit around calculating to the penny what a company is likely to make. My view is clearly a top down view. I can tell you that airlines have done very well during prior prosperity cycles but each cycle will be somewhat different. The big difference about this one is that international growth has never been so strong and the advanced stage of our communications abilities increases the odds that international deals will be made. If millions and millions of dollars can be saved by making a product in developing nations, then the companies saving those millions are more than willing to buy a few airline tickets.

APPLE IS PERHAPS TOO HOT!

Apple is set to announce its latest version of the iPod. Indications are that it will have a digital radio receiver built in, allowing one to download songs directly (for a small fee of course). My concern about APPL is that the company has once again tried to lock up a market with proprietary software. I know that Sony and many others will make a strong push with competitive products. I continue to believe that a wifi enabled Google "phone" could open the doors to many other services. It seems to me that a lot of iPod customers would find an open source Google phone attractive relative to the 99 cents per song model.

The stock has done well and most of my accounts hold it individually or as a part of a QQQ fund. The stock is about 7% of the value of the QQQ fund holdings. CREE and Magellan are also almost too hot to handle. I will continue to hold current positions but am not likely to add shares at current prices.

KEEP IN MIND

The market may be in for a huge disappointment if BIG BEN does not cut rates by the September 18 meeting. Be prepared and don't let additional volatility buck you off this bull market bronco!

MULTIPLY, MULTIPLY, MULTIPLY

The power of dollars invested in capital goods is not to be underestimated. These dollars multiply, multiply and multiply again. Take advantage and you will see your investment account multiply, multiply and multiply again.

It is interesting that the understanding of the business cycle was developed so long ago and yet is only recently being tamed. Smart people have been trying to corral this bucking bronco for at least 150 years. It was a French Doctor by the name of Clement Juglar who got took the first serious whack at taming the bronco. In 1862, when Clement was 43 years old, he wrote Des Crisis Commercials et leur periodique en France, en Anleterre, et Aux Etats-Unis. While the US was in the middle of civil war, Clement was studying the business cycle.


Clement observed that the business cycle lasted 7 to 11 years. Years later, in 1923, Kitchin stressed the 3 to 4 year inventory cycle that most people focus on to this day. Schumpter observed the 40 month cycle. Van Duijn was the "long wave" proponent who saw three Jular cycles of about 9 years each from 1948 to 1957, 1957 to 1966 and from 1966 to 1973. Since that time, I have observed three more Jular's from 1973 to 1982, 1982 to 1991 and from 1991 to 2001. It appears that we are currently in a Juglar that will last from 2001 to about 2011. The "official story" is that there were many more cycles, from 1945 to now and that only one of the first 6 lasted more than 39 months. The "official story" is that the peace time record was set from 1975 to 1979 and then broken wide open by the record cycle from 1991 to 2001.

Why is the official record wrong?

The reason is in the definition of the cycle. If the mid-cycle correction is large, then the "official records" will show that one cycle ended and another began but the two are really one Juglar cycle.

The numbers reported by the government this morning tell the story. The talking TV Heads reported with glee or with sadness on their face, depending on if these numbers support their prior biased reporting, that construction spending slowed .4% last month. This decline was not a great number for the bulls or for the bears. The bears wanted blood. Since they believe the US economy is headed for recession, then surely the decline in construction spending was greater than four tenths of one percent! The bulls wanted a positive number so they could say, "I told you so".

The numbers hide the whole story. The reality is that the .4% decline was a decline from all time record levels! In the US, in the last year, 1.7 Trillion Dollars were spent on construction!!!

The big thing to know is that these 1.7 Trillion Dollars are the multiplying kind. The four guys holding shovels and the two holding flags at the construction sites are making the most money they have made in their lives. The machine operators might be making 5 times as much!

Old man Says was the economist who realized that supply creates its own demand. This is counter intuitive like so many economic and stock market rules. Follow through the process and it makes all the sense in the world. If a government or a company says it is time to build something, it will spend big dollars. One example that is highly leveraged is road construction. It takes very little personnel to "operate" an interstate highway but it takes a lot of money to build one. In business, a common situation is to hire 3,000 people to expand an oil refinery, spend $6> Billion dollars on the process to create 45 new permanent jobs when the> project is complete.

Knut Wicksell, a brokers son from Stockholm, 1951-1926, refined Says law. He noted that Says placed limits on the process by requiring savings to occur before the investment could take place. As we have all learned well over the past 60 years or so, one does not have to have savings to spend money. Knut noted a "cumulative process". The borrowing and spending by one party might influence the next to borrow and spend.

During an economic recovery, like the one we just went through, there is relatively little need for capital spending because old facilities can produce enough to fill the needs up until the past peak of production was reached. Once old peak levels are reached, more capacity must be built. Because the building of new capacity is largely done with high powered leveraged dollars which are spent again and again and again, there is a serious risk of a "stampede". Like the sand piles put along the sides of mountain roads so that run away trucks have a way to stop, the current economy has gradually made it to the top of the mountain and if "Big Ben" is not careful, he knows this truck is going to burn through his brakes and "run away".

If you appreciate that an uneducated flagman will make and spend big money during these times of expansion and if you appreciate that the money he spends is spent again and again as it makes its way to the grocery store clerk, the bar maid, the bank teller and all the many others who will benefit from this "extra money in the local economy" then you can appreciate what the numbers show.

I feel it is worthwhile to give the number again, construction spending in the USA is running at the annual rate of 1.7 Trillion Dollars. What you hear on the news day after day is that the housing market rolled over in the summer of 2005 and construction is dropping like a rock. This is another one of those "true reports" that is misleading the average American investor, who is negative on the economy and the market right now. Housing construction accounts for about 4.8% of the US GDP. Housing construction will fall by about 9% this year, a big drop no doubt. 9% of 4.8% is only .04% (a that tip to Brian Wesbury). So, the economy that just grew by better than 4% and which is projected to grow 3% in the next quarter would be even stronger if it were not for the housing slowdown. In the grand scheme of life, the difference in a quarterly growth rate of 3% instead of 3.4% is not a big deal. The more important point is that total construction is still very strong.

YES, we live in a service economy. The numbers are amazing. Health Care construction is up 18% year over year! Amusements and recreation up 12%! Public Safety up 12%! Education up 10%! Religious buildings up 10%! The common belief is that all the factories are being moved to China but even that is not true. Manufacturing construction is up 6% year over year! If the other numbers were not so huge, we would be very pleased to have manufacturing growing at 6%! Besides, the huge sums being spent to build in China also have a multiplier effect for us all. The unsophisticated and selfish response of many is to be jealous of the growth in China (of of immigrants getting wealthy in America) but the reality is that this is a plus, plus, plus game. The more wealth created in China, the more money available to be spent buying from Americans. Export growth from America is growing at an annual rate of 11% and personal income is growing at around 6.5%! Do you see a recession around the corner when the income of the> average American is growing by 6.5% per year???

We all know that the 18% growth Health Care construction is not sustainable. People come from all around the world to the US to get the best of health care but the nominal growth in China GNP is ONLY 15%! We all know that the Fed must keep leaning against the wind to help tame this 18% growth in construction. We all know that if the economic train gets to moving too fast, the risk of a wreck up ahead is great.

Again, it was Knut Wicksell who arrived at the "where the rubber meets the road argument". He said that as long as the money rate is less than the natural rate of interest then the rational company will borrow and spend and borrow and spend some more. Like Grandpa said, "you have to make hay while the sun is shining".

Yes, I still put make the odds slightly in favor of an interest rate cut buy "Big Ben" but I certainly would not be totally surprised if he continued to resist the urge. Who amount us wants the operator of a roller coaster to keep his foot on the brake? Those who enjoy the big dips and turns want all the speed they can get. The problem is that more and more big heavy weight companies will jump aboard this train if Ben does not provide Wicksellian restraint.

Australia's central bank and the ECB both seem prepared to delay planned increases in short rates. Europe has been directly effected by the collapse of the sub prime paper market. Australia has not been hit. Australian rates are higher than US rates already. This resource rich country has been a direct beneficiary of the growth explosion in China.

FORGET ABOUT THE SHORT TERM INTEREST RATE QUESTION!

I go through the current mania in order to show that it is only that. The correct posture is to not worry about weather the FOMC will cut rates or not. Your doctor is not the key person when it comes to your health. If you have good genes, eating habits and exercise habits, you will be healthy no matter what the doctor says. If you commit 100% of your investment dollars to stocks right now, you will look back a year or two or three from now and be thankful. What happens at the September 18 FOMC meeting will not> be a big event in your life.

BUY, BUY, BUY, BUY, BUY, BUY!

The money being invested in every thing from interstate highways all across China to heath care facilities all across America is "HOT MONEY". IT MULTIPLIES! IT IS CREATED OUT OF THIN AIR WHEN BANKS LEND FOR CONSTRUCTION AND IT IS SPENT TIME AND TIME AGAIN. THE FIRST HALF OF THE BUSINESS CYCLE IS OVER! HOME BUILDING WILL BE SLOW FOR A FEW YEARS BUT CONSTRUCTION SPENDING WILL REMAIN STRONG! CAPACITY CONSTRUCTION IS UNDERWAY. 40 NUCLEAR POWER PLANTS IN CHINA, 9 IN AMERICA AND MANY MORE AROUND THE GLOBE! BIG MONEY THAT WILL FIND ITS WAY TO CONSUMERS WHO WILL ENJOY THE BOOM TIMES!