Tuesday, January 22, 2008


Having talked about the coming mid cycle turn for almost 2 years, I am suddenly surprised by the ferocity of the turn. Australia, one of the "kings of commodities" has seen its market go into free fall. This market is down 12 days in a row. As you know, I have written and written again that once the turn comes, that emerging growth, small stocks and commodities will take a hit and money will move out of these markets and gradually into big cap US growth stocks.

The turn was delayed for a long time because world wide economic growth was so strong. It is a violent turn as a result of the policies of the Bush administration. Jim Sinclair has posted the perfect cartoon to depict what has happened. The cartoon shows the heads of the Federal Reserve Banks as puppets of the Bush administration. As a long term supporter of Bush, I must say that I am very disappointed in his recent policies. Of course, his defenders would say that the FOMC is independent but I really do not believe that Bernanke is stupid enough to hold the fed funds at 4.25% during a market collapse in the 3 year note to 1.9%. In my opinion, Ben is holding up rates at the direction of the President. The President is playing politics as usual. On the one hand, he is forcing those who are running for office to be supportive of tax cuts, not tax increases. On the other hand, by supporting the "old system" he is protecting the fees earned by the big brokerages. On the third hand, he is cooperating with "the big boys", including the Sheiks of the Middle East, in buying up assets on the cheap while driving fear into the hearts of the average investor. The public is selling stocks at the cheapest prices on years and the "big boys" are buying.

Worst of all is that the "little guys" are buying what has gone up 200% or more over the past 5 years but has fallen 30 percent in recent weeks. Many of the stocks being bought by the "little guys" will do little for several years to come.


There is lots of good news.

1) The public is scrambling to buy bonds at the highest prices in about 70 years. Bond prices did spike to this level just a few months in 2003, just about the time stocks took off. By running scared, bond buyers are making stocks all the more attractive. Time to zig while the others zag.

2) The recovery is over, now the prosperity phase is here. As the chart M.J. Perry posted at Carpe Diem, it took 6 years for commercial and industrial loan volume to reach the old peak after the crunch in 1990. The old peak was passed in 1996 and the stock market soared. Of course, loan volume made a new all time record in early 2000, just before the next crunch. Last month, the recovery was finally complete. During the recovery, businesses have had such wonderful cash flow that C&I loans just now passed the old peak. For the rest of the cycle, businesses will be the strong borrowers. On the other hand, housing loans have hit such a crunch, I expect they will bounce back. Homes are more affordable today than they have been for several years. Demand will continue to pile up until interest rates start rising up again. Of course, the rise in mortgage rates is being delayed by the political games being played by Bush. Holding short rates high is bring long rates down and down some more as the economy slows. Giving $600 tax rebates is a political ploy that only drags the slow down out longer. Cutting short term interest rates would provide many times the stimulus to the economy but "the good people need the good politicians to give us some money in this election year". Still the market will take off long before the slow down is over. The stock market leads the economy by an average of about 9 months.

3) Big interest rate cuts are near. Ben has held off about as long as he possibly can. Inflation statistics are lagging indicators but even when looking in the rear view mirror we can see that prices are falling. Even the headline making stuff like oil and corn have fallen dropped hard in recent weeks. After the collapse in Asia and Europe over the past two trading days, the US market is primed for a big fall but a cut by the FOMC could turn the market on a dime.

4) The end of the jihadist war is drawing near. George Freeman of Stratfor.com notes that al Qaeda is being ground down. The Bush strategy has worked. The US presence in and in between the key countries of Pakistan, Afghanistan, Syria, Iraq and Iran has done the job. Car bombs are still going off but infrequently and the people of the area are ready for peace. Even the people of Iran seem ready to dump their president if a deal is not made. Another meeting is being held to impose more sanctions. Ali Khamenei has had to step in to resolve conflict between the president and other leaders in Iran. The main point here is that the Iranians are no longer sending bombs into Iraq. It is too early to say that all is well but George is right about the grinding down. The remnants of al Qaeda have lost the bulk of their financial support and relative peace is taking hold in the area.

5) Jupiter is a big oil field. The oil discovery in Brazil continues to grow. In the oil business there is a saying that you find lots of oil near where it has already been found. Brazil has hit natural gas deposits near its 8 billion barrel discovery of a few months ago. This deposit appears to be the largest found in 30 years. Lots of oil while the news from Japan is that refinery runs are being reduced due to slowing demand for oil. High prices have caused the Japanese to find ways to conserve. America will increase auto mileage by 40% over the next 14 years. This time will be a little different but the last time America increased gasoline mileage by 40%, the price of a barrel of oil dropped all the way to $10.

6) Progress on renewable fuels continues. An acre of soybeans produces 50 gallons of fuel per year. An acre of switch grass produces 1,050 gallons of fuel. An acre of algae produces 4,000 gallons of fuel per year. Switch grass is ready for development. Switch grass produces 7 times the energy required to grow it. The microbes being used to "digest" switch grass and algae are the most voracious little buggers yet discovered or invented. As I have said before, we will never run out of oil. At some point it will simply not be worth the trouble to drill for it.


The Dow might be down a few hundred points on the opening Tuesday morning. Again, the good news is that the FOMC is going to be forced to do what it should have done months ago. Once short rates have been cut and stocks start rising, buyers will jump on houses and the current crisis will be over in just a few months. Stocks will go up while the news seems to get worse!