Tuesday, January 22, 2008


As I wrote last night, the action in the world markets has forced the hand of the FOMC. This morning, while facing futures contracts that suggested the Dow would open 500 points lower, the FOMC has cut the fed funds rate by the unusual amount of 75 basis points. On the way up, Greenspan raised fed funds 25 basis points 17 times. A half here and three quarters there and the FOMC is catching up to the market quickly. The two year note is trading at 1.9% which suggest the FOMC should be at 2.2 to 2.5%. The 75 basis point cuts puts them at 3.5%. In other words, rates are likely to be cut again. Still, the huge drop is the stuff that turns markets quickly.

When the market crashed in 1987, Greenspan cut rates hard and fast and opened up the discount window to businesses. The public saw the big fall and continued the flight to quality they had been on for the previous several weeks (many people do not remember that the market fell in September and October before the crash that occurred on October 19). While the public bought bonds, defensive stocks and money market accounts, new leadership stocks started to chug higher. My clients were all encouraged to buy while stocks were cheap.

The reason this market has been hammered so much more than was necessary was because of politics. The democrats won the house and senate a year ago and came in ready to raise taxes. Bush has held them off with the veto and by holding short interest rates too high. Under the pressure of short rates, the economy is seeing an ugly mid cycle turn. As a result, all three democratic nominees for president, and the top 5 republican nominees, are running on how much they would cut taxes. Of course the democrats are still saying they would raise the tax on the rich to give to the "middle class" but they are willing to bust the budget to give back several hundred dollars per person in income taxes paid.

The democratic congress that has tried to be the fiscally conservative group by promising to rule budget by "pay as you go rules" broke their rules when passing the 2008 budget and they will be forced to break there rules again very soon while passing a stimulus package. Again, another cut by the FOMC would make the stimulus package unnecessary but don't try to tell a politician not to hand out a few goodies during an election year.


This is the kind of situation where successful investors dig deep. The fearful crowd has piled up a Mt. Everest of cash and short term notes. A much smaller mountain of cash, in the money markets a couple of months ago, was earning very high real rates of return. Of course, there are many of us who wish we had had the perfect vision to be there. However the rates being paid on this cash have fallen like a rock. The move by the FOMC from 5.25% to 3.5% was slower than it needed to be but the fall is still real. With inflation on the run, 3.5% is still a high real rate of return but the lower rates will stimulate investment and will lead to economic recovery which will lead to a bull market stampede in the stock market. The huge mountain of cash will come back to the market only after the first big run is past. Of course, I cannot guarantee the future but I am confident that much of the big drop will continue to be in the sectors where I have little invested. During this fall, the Australian market has been down 12 days in a row and the over bought China and India markets have fallen very hard. In other words, what was hot is no longer hot. All the money that flows out of these formerly hot areas will find a home somewhere else. In the short run, the public has flown to the "safety" of the bond market. We have never seen US bonds so over valued! It will not take long for some of this money to start to move into "new leadership".

It is time to dig deep to invest. It is hard to do so in the face of what looks like Armageddon to us but what is in reality a man made "crisis". The books have been cooked! Phony write downs have forced the liquidation of the weak players. Those holding dramatically under-priced mortgage backed securities are holding mostly money good notes.

The Chinese symbol for crisis and opportunity is the same. Some believe this is because the correct word is easily determined by the context in which it is used. However, there was great wisdom in China many centuries ago. The fact is that the greatest of opportunities arises during the greatest of crisis. It is not the crisis that determines your fate but how you respond to the crisis.

You have been given a gift. The market has been clobbered for "cooked up" reasons. With this knowledge in hand, you can dig deep and add to your account and have the fortitude to hang in there while "little Effie loses her head". No need to panic with "little Effie". The world is not coming to an end. Indeed, we live in an era of prosperity and on top of that we have entered the prosperity phase of the shorter term business cycle.

Last week, Japan announced cut backs in oil refinery utilization and reduced oil exploration. Oil stocks fell like a rock. If you own no oil stocks, this is not bad news for you. Oil stocks can fall as far as they might without hurting a portfolio that owns other stuff. On the other hand, the reason the oil exploration was reduced was because projects will be completed in 2008 and again in 2009 that will add 7 million barrels of new oil per year. The fact that Brazil has found a monster oil field has nothing to do with this new production in 2008 and 2009. The monster field in Brazil will not start yielding oil for another 4 years and it will not be producing a lot until 5 years have passed. The fact is that the turn is here. Billions and billions of excess dollars have flowed into high priced oil. Consumers around the world are about to get a "tax cut". The price of fuel has turned the corner. Trillions of dollars will be available for "other stuff".

As usual, the economic stimulus package is late and it will produce little tangible results for the economy. However, of course, it has been timed such that it will have been passed by the time the reports show a big turn in the economy. The cuts in the FOMC that started too slowly back in August, will have produced results by the time the "rebate checks are in the mail". The markets will be up, the public will have cash in their pockets all well before the big election. The big and the powerful need to hold the congress or the Presidency to maintain the status quo. Protecting the big fees "earned" by the investment bankers and protecting the big salaries "earned" by the top brass is the key for the old money. The way to win in the markets is to invest with the big money. The statistics show that insiders have been buying and buying and buying stocks. As indicated by the money flows into mutual funds, the public is selling and selling and selling stocks and buying and buying and buying bonds and money market accounts like the world is coming to an end. DIG DEEP and BUY, BUY, BUY!