Friday, February 22, 2008


It seems like a very long time ago when I wrote that energy stocks would pass the leadership torch to US big cap growth stocks. At the time, I encouraged readers to move their 401-K accounts out of small caps in favor of the S&P 500 index, which was the "good part" of the call. The S&P has outperformed the Russel 2000 for almost two years. The expectation that tech stocks would beat the energy stocks has been a mistake so far. Still, I had rather be early than late to the party and this party is just getting started.

The broad energy index was up 31% over the past 12 months whereas the technology index was flat. The last 5 weeks made up a significant part of that performance spread as oil prices bubbled up one more time. Those who have stayed with the energy sector have done well but the risk from here are high. Inventories in the US have been building for several weeks because the high price is destroying demand.

High inflation rates in China, India, Australia and many other countries are pushing government officials to consider tighter policies. The US is already on the "other side of the hump". US officials are providing both monetary and fiscal stimulus whereas many other countries are either holding the line or even making tightening moves. Tighter monetary and fiscal policies will slow the demand for oil and give producers time to bring the several new elephant fields on line.

China will remain the wild card as it continues in its hyper drive mode in preparation for the Olympics. No matter, the price of commodities always over and under shoots and huge investments are underway which will increase supply. Sooner or later the profits in the tech sector will lap the profits in the oil business.


In the US, the yield curve is very bullish. The talk about the extreme problem of mortgage resets in the US has died. With the Fed Funds Rate at 3%, the resets problem is no longer a big deal. Low short rates have given business and individuals lower payments on floating rate loans and the opportunity to make reasonable "borrow and spend" decisions.

The numbers show a steady increase in commercial and industrial loans, in consumer loans and even in real estate loans. Clearly there is a bit of schizophrenia in the air. Sentiment surveys show that people are very concerned about the economy but at the same time they are generally confident about their own situation. People are complaining about all the jobs that have left America but most have the best job they have ever had.


Which person is most likely to be happy? The person who consistently makes more than $100,000 per year, the person that consistently makes about $60,000 per year or the person that made $40,000 two years ago, $45,000 last year and $50,000 this year? The answer is the third person. People want to know that they are making progress. The average employee at American Airlines makes $84,500 per year but he is not a happy person. AMR employees gave up wages to help the company survive and now they want the wages back. The employees at CAL make an average of $66,000 per year but, the company did well this year and the average employee got a bonus check of $4,500. The CAL employees tend to be happy.


In Greg Mankiw's posts about income and happiness, he reports that surveys have consistently shown, since 1972, that Republicans are happy relative to Democrats. Indeed, 45% of republicans report being very happy compared to only 30 percent of democrats. I think the reason is that democrats tend to believe either the USA is going down hill or that the "little guy" in America is being "left out". Republicans tend to believe in the Horatio Alger story, even the poorest republicans believe they can pull themselves up by their individual efforts. Democrats are more likely to believe that they need help to survive. As a result, many democrats are "trapped" by reliance on the assistance of others.

The story is told of a single mother in Boston who found a better job. Her old job paid $25,000 per year and the new paid $35,000. Unfortunately, she could not make ends meet after accepting the new job. Her new income reduced her rent subsidy, eliminated her free child care vouchers and disqualified her for the Earned Income Tax Credit. She was financially better off in the old job.

The other problem democrats have is that they tend to believe the rhetoric of the politicians and the constant drone of bad news. John Edwards was one who campaigned on the premise that the poor in America are getting more poor by the minute. The reality is that Americans in the bottom 20% of income brackets in 1991 got an average increase in income of 91% between 1991 and 2005. To be fair, I am thankful not to be among the bottom 20%, but the bottom 20% often routinely receive non reported income of one sort or another. My church offers groceries to several hundred people at no charge. I am glad to contribute and thankful that I do not need the assistance but I do grow tired of hearing about how badly we have it here in America.

The really sad thing is that the poor are routinely mislead in exchange for their vote. One of the common ploys is to suggest that middle class taxes will be lowered by raising the taxes on corporations. The reality is that the poorest of Americans pay no direct income taxes but they pay indirectly when they buy products. Companies are routinely demonized for making profits but we all know that without profits those businesses would not exist and the jobs they provide would not exist. The very large company, such as Exxon, has to earn a lot of money to pay the owners a fair return. As such, it makes a lot of profit and it pays a lot of taxes. Indeed, in each of the last 4 years Exxon has paid more income taxes than the combined total paid by 50% of all families in America. When the politician says that he will not raise taxes on the middle class but only on the wealthy, he surely understands that it will be the middle class that will be hurt the worst when they go to buy gasoline.


Sentiment surveys show an up-tick. Lots of little things are ready to add up to extra spendable income for the average person. The $600 checks will be in the mail soon. The new payment rates will go into effect on student loans in a few months. Floating rate loan payments have started to fall. Car companies are cranking up to offer rebates, low interest rate loans and zero interest rate loans. The elections are more than 8 months away so there is time for a lot of good things to happen.

One of the things I expect to happen is a breakout in the price of US stocks. Those people who are adding money to their accounts every month have been seeing a "lucky hit" every now and then. In some cases they have increased shares in a stock they already own and have brought their average purchase price down. In other cases, they have bought new stocks that have bounced off very low prices.


John McCain has pledged to cut the corporate tax rate from 35% to 25%. The Chairman of the House Ways and Means Committee has also pledged to cut the corporate income tax. A few months ago, the likelihood of tax decreases seemed slim. The case for lower corporate taxes is strong. The story of the miracle of Ireland is compelling. The economy of Ireland had suffered for a very long time before taxes were reformed. The rate was cut from 50% to 12.5%. Books have been written about the economic boom that followed. Today, Ireland is among the most wealthy of all nations and tax revenues are higher than they have ever been. Indeed, tax revenues have increased from 1.6% of GDP to 3.6% of GDP. The dramatic improvements in standards of living has made rich and poor alike very happy.

Ireland is one of 24 countries that has cut tax rates in the past 20 years or so. As a result, US corporate rates are the highest to be found. McCain understands that lower tax rates are needed in America in order to create the new jobs in America.


The primary reason the USA has benefited so greatly by the Technology Revolution is because our individual tax rates have attracted the best and the brightest. The smartest people are drawn to work in the USA. The USA has low individual tax rates and a steady influx of "brain power". Britain, which levies significantly higher taxes on high income people, has been suffering from a "brain drain". It only takes one word to tell the remarkable story of what it means to a country to encourage the best and the brightest to live and work in America: GOOGLE! All Americans are better off to have this profit making machine head quartered in our country.

Google is currently using the 100 million cell phone users in Japan as a test lab. So far, the most interesting discovery is that Internet mobile phone use will not be nearly as "location oriented" as once thought. The Japanese search for anything and everything on their phones just like we do on our lap tops. Once a person gets used to connecting to the Internet by phone, he is just as likely to connect while sitting on his home sofa as anywhere else.

The Japanese use emoji to speed up their cell phone conversations. Emoji are animated cartoons. There are over 600 "standards" so far. One can send the message to "please take the dog for a walk" by selecting the correct emoji with just a few key strokes.

Google is certainly not the only profitable high tech company. Wii and others have produced several more neat interfaces for computers. As you might expect, the Wii interfaces include things like skis, dance floors and snow boards.


Innovations are coming hard and fast. In the area of stem cells, cells have been adapted to produce insulin. The cure for diabetes is a matter of time. Heart surgeries are being done by thin robotic rods that require small entrance holes. Damaged hearts are being injected with stem cells and new muscle and veins are being grown. AE Biofuels, symbol AEBF, is preparing to build commercial ethanol plants where "cocktails of enzymes" will convert grass and cornstalks to fuel.


It was about 100 years between the kite flying days of Ben Franklin and the invention days of Thomas Edison. In other words, electricity was around for a long time before the right genius came along to put it to use. A nice little bit of trivia is that Edison's first invention, at the age of 21, was an electronic voting machine. Deja vu!

The voting machine was invented in 1869 but electric lights in New York City were not common until around 1910 (if memory serves). It took a long time for electricity to reach the average man. It took the telephone 100 years to reach 90 percent of the market. Right now, 87% of the people in America have a cell phone. In just a few years, 90% of Americans will carry pocket sized super computer terminals.

Buy the chip makers, the software providers, the infrastructure companies and the service providers!