Wednesday, January 09, 2008


While it is obvious that my BUY, BUY, BUY recommendations have been early, it is long term investors who strain to buy when prices are down who make the serious money. Indicator after indicator show that the public is running scared. The richest stock investor in the world is famous for buying when the public is fearful.


I will not list all of the indicators that are screaming BUY, BUY, BUY. Instead, I will list a few that are at the most extreme position.

Number 1 on this list is the market value relative to the 10 year treasury bond. We are currently sitting on the all time record spread between the yields offered by the 10 year bond and the earnings yield projected by adding up the projected earnings of each stock in the S&P 500. Stocks are now undervalued by 48% on this measure. Obviously, earnings will be adjusted downward if the economy slows and all sorts of comments can be made about this indicator but no matter what the comment, one cannot get around the fact that the indicator is at a record. Buying stocks when this indicator has been at 30% or higher has been a very profitable long term strategy in the past. The past does not predict the future but the past does typically at least rhyme with the past.

Number 2 on my list this morning is the two year treasury price momentum. This indicator hit the extreme value of .51 around October 10, 2002. I went all in on my family accounts. The "all in bet" looked smart for a couple of months, then looked questionable in March of 2003, then looked very smart over the next couple of years. Last week, this measure was at .58, the lowest reading since 2002. It was the high beta stocks that soared after the bottom was made. Airline stocks are high beta stocks, they "ride a huge roller coaster".

Number 3 on my list is an indicator that my good friend Lamar Jones asked me about last week. When Lamar and I worked at Merrill in the 1980's, we watched the ratio of the t-bill to the Fed Funds rate. The problem with this indicator has been that buy signals are few and far between and buy signals tend to be early. For example, the t-bill/fed funds ratio dropped below 200% in August of 1990, again on September of 2001 and again on July of 2007. The big move in the market has tended to follow 4 to 12 months after the decline. So we currently sit on a rare, strong buy signal that screamed buy 6 months ago.

Number 4 on my list is the rule of 20. This is basically the same as indicator number 1 but I mention it because the last time the spread widened even close to the current level was in the summer of 1982, prior to the start of the BIG BULL!

Number 5 on my list is the economic recession calls being issued by the "big buyers" such as Goldman Sachs. The big investment bankers buy for their own account and sell for their own account. Theoretically there is a "Chinese Firewall" between the analyst at Goldman who make economic and market calls and the Goldman traders. I do not accuse Goldman of doing anything illegal but it has been my experience that when I hear Goldman economic calls on the news, it is time to react the opposite of the way the call would suggest.


In 1991 I gave a lecture series title Crisis or Opportunity. The title came from the idea that the Chinese symbol for Crisis and Opportunity are the same. When Goldman, Merrill and other "big boys" suggest a recession is here or near, the public tends to take these words to heart. They sell stocks and put the money in the bond market. As related above, bonds have never been so over priced relative to stocks in the history of the market that is available to me. Bonds are very expensive, stocks are very cheap.

Yes, earnings projections are likely to fall in the weeks ahead. The big cap winners of the first half of the economic cycle, which include the big investment banks and the big oil companies are facing a margin squeeze. You can see this for yourself, a barrel of oil sold for around $70 in May of 2007 and a gallon of gas sold for $3.19. Yesterday, a barrel of oil sold for $97 and I found gas for $2.78. Yes, the $2.78 was an anomaly but $70 to $97 is the same as $3.19 to $4.42. If the price of gas had gone up as much as the price of oil, a gallon of gas would cost you $4.42 today. What can be happening?


Take a look at the big oil project being put together at the Wiki Encyclopedia. What you will find on this site is that oil demand growth has slowed to a crawl. World wide demand grew by about 2.5 million barrels per day in 2005, by about 1.4 million in 2006 and by about 1.1 million in 2007 (I quote these figures from memory which means they are close enough to make the point without being precise). The real focus of the web site is the amount of new oil coming to market. Over each of the next several years, there will be more new oil coming to market than the growth in oil demand.

Yes, it was more than a year ago when I noted this the first time and the price of oil is higher now than it was back then. The reason is because there is still fear that a war with or a boycott of Iran will occur. All the while, steady progress has been made toward resolving the Iranian crisis. The Iranians have dramatically reduced their support of the insurgency in Iraq and they have gradually shared more and more information with the UN Nuclear Inspectors. Several avenues of negotiations are now open and moving forward two steps and back one as these negotiations are apt to do.

Bush is on his way to the Middle East and while there is no reason for the administration to raise expectations, progress in negotiations are often followed by meetings of the top leaders. With plentiful oil, the price should drop by at least $20 per barrel as soon as there is a tentative agreement. Some believe that a deal will never get done and they may be right but many parties have an interest in successful negotiations. Economic deals between Iran and a number of countries are pending. These deals include everyone from Japan and India to Turkey, China and Russia. The "moderate" Arabian states, including Egypt, Kuwait and Saudi Arabia desire for a deal to be struck whereby US military might will remain in the area to help maintain peace. Americans do not complain about having troops at bases in Germany, South Korea and many other places where the purpose is to maintain peace. I believe we will have troops in Iraq for many years to come but, again, as a peace keeping force.


While I continue to monitor the markets, I am not getting a lot of "desk time" right now. Jules (Julianna Tucker) will get her test results this morning. Please keep my family in your prayers.