Wednesday, April 23, 2008


The market move,about 8% off the March lows, has caused some of the short term stock market indicators to back away from screaming the word BUY. However, stocks have become an even cheaper asset class.

It has been a few years since stocks first became very cheap relative to real estate and to bonds but they keep getting cheaper still. Stocks became very cheap relative to gold over the past 5 years. The crazy market in commodities has now made stocks unusually cheap relative to every thing from rice to oil. Stocks are very cheap. Rice is now priced at many times the cost of production and production can and will be increased. Millions of acres of good land lies fallow because we no longer need to use all available land to produce all the food we need. With prices out the roof, more food will be grown this year than in any other year in the history of the planet. Those who are speculating on the price of rice and other grains have sold stocks short. The common play of short term traders is to buy one thing and to sell another. This is a form of hedging, even though it is an imperfect hedge. The point is to buy the thing that goes up the most. If they are wrong and all prices fall, they figure to recoup some or all of their losses on the short sale.

The see saw is tilted to the extreme. The end to the speculation in rice will be when the rice is sold and the money is used to cover the short. It may seem weird but the price of many stocks will go up when the price of commodities comes down. Commodities and interest rates are normally strongly correlated. Right now there is a huge divergence. Either a slowing economy is going to cause commodity prices to fall or a booming economy is going to cause interest rates to rise. Perhaps, there will be a simultaneous move of commodities down and interest rates up, but that would certainly be unusual. Little by little, one can see leaks in the commodity price spiral. For example, South Korea suddenly has more LNG than it needs. At the same time, US refiners are meeting product needs with run rates hovering around 80%! It appears likely that the commodities bubble is about to bust.

The last run up in stocks has even slowed down the insider buying trend. Insider buying of recent months has been extremely heavy, at the same time that the public has sold and sold out. Huge numbers of small investors are now largely out of the market and they feel relieved; no more worries for them. Of course, as history has shown us time and again, these same small investors will come into more and more money as time moves forward. Some of it will come from work earnings, some from inheritance, some from the savings achieved as the real cost of goods and services declines over time. At some point, with stocks having soared and with all the news and pundits suggesting that the good times will last for a long, long time, these small investors will steadily add funds to the market at much higher prices.

Professor of Economics, Don Boudreaux, likes to tell about the prosperity pool. I like to think of prosperity as a light misty rain. It is so light that you do not think you need an umbrella but if you stay outside very long, you cannot avoid getting wet. Prosperity drips down upon us just a little bit at a time. We hardly even notice the drops coming down. Some of the drops hit us directly, others indirectly and others hit only other people but, we all get wet. At first, we expect the wealthy to be our guinea pigs. They must dole out the high dollars to buy the first cars that park themselves. Once the technology is perfected, the price will fall and the new "toy" will be available on many more models. Then, to our surprise, the technology will become very useful and even productive. At some point in the future, we will look back and laugh about the time when we had to park 10 blocks down the street and to walk to work from there.

Visitors to Wal-Mart get wet faster than those who frequent other stores. At every visit to Wal-Mart, people buy things for less than the time before. It might be an MP-3 player that cost the same as last years model but this one holds 100 times as much. You might buy a digital camera and save thousands of pictures for free, as opposed to the old guy who continues to send off for prints at more than 50 cents each. His cost for a hard print is infinitely more than the cost of a digital image and his annual expenditure on film is extremely high relative to the number of good shots he gets. The digital user might make a thousand shots before deciding to pay for one print.

I can go on line, view my daughter's and my wife's photo albums and view several thousand snap shots of my grand daughter and scores of short videos. The daily life of my grand daughter is being documented for only a fraction of the money Marilyn and I spent on the relatively few pictures we have of our daughter. Prosperity just keeps on landing on me, Thank You Lord!

Day after day, new and better stuff is available to us all at lower real prices. In the Don Boudreaux post I borrowed from yesterday, Don included the following:

Frances and Joseph Gies, in Life in a Medieval Village, of the roofs of pre-industrial cottages:
Roofs were thatched, as from ancient times, with straw, broom or heather, or in marsh country reeds or rushes. . . . Thatched roofs had formidable drawbacks; they rotted from alternations of wet and dry, and harbored a menagerie of mice, rats, hornets, wasps, spiders, and birds; and above all they caught fire. Yet even in London they prevailed.

We have a hard time imagining what it would be like to have to deal with rats, hornets, wasp, spiders and birds in our roofs. With no screens in windows, fresh air in the summer was fresh with flies. Can you imagine the smell of the air around the people and animals of the old times? The rate of death from fires has gone down and down and down!


A major reason for the angst of the public is the thought that their homes are falling in value. Even the fall from the peak, if any, has been a small number compared to the prior years of appreciation, still the news media implies that all houses are falling dramatically, so it must be true. Yesterday, the official government statistics showed that houses fell in all regions of the country with the biggest decline of 9.2% being in the Pacific region. The North East "escaped" the "slaughter" with a decline of 1.3%. Houses in the Pacific region went up a few hundred percent over the prior 5 years so what is the big stink about? The non-weighted average decline of 6 regions was 3.4%. So, did the average house fall 3.4% in value over the last year? No, according to this same government report, the average price of the average home sold increased in value by .6%. Now I grant you that a .6% increase is not much but include this figure in the average of the past 5 years and the average house has gone up an average of something like 6% per year compounded!

To feel all down and out about house prices right now is like being upset halfway through a sports season when your team record falls from 14 and 1 to 14 and 2. Sure the loss hurts emotionally but, would it be any fun if everyones team won every game every year? There is no joy without sorrow!

By the way, the above government figures are fascinating. And, it is also fascinating to note how the press jumps on the most biased numbers. The Shilling numbers include several of the previously hot, hot, hot markets to show that the housing market is much worse than indicated by the above government numbers. How can it be that the average sales price is up across the nation but down in all regions?

There is migration out of the most expensive markets. The most expensive markets are the least healthy. Not a lot of sales are taking place there. However, in growing areas, such as North Carolina, homes are selling relatively better and at increasing prices. For example, in the Winston-Salem market, prices were up 2.4% over the past year. There are many more markets like Winston-Salem than there are markets like Las Vegas.


The decline in houses in the previously "hot markets" is the cure not the disease. It was emotional buying that drove the prices of the houses in the hot markets to irrational levels. This emotional buying caused the construction of more units than were needed. The correction is bringing common sense back to these markets. Yes, the prices will over shoot on the way back down but the rental values and projected future values will build a price floor. Keep in mind that the are lots of people who need to buy a house at a good price, furthermore, with mortgage loans near all time lows, houses are very affordable. The decline in price is a loss for the seller but a win for the buyer. Another major indication that the housing market is much better than we have been lead to believe is that a third of all homes purchased in the past month were second homes. People across the country are rich enough to afford a second home and they are confident enough in the long term to buy a second home today. Prosperity is raining down like "Manna from Heaven"!


In the same way that rice and oil are loved beyond all reason, airline stocks are hated beyond all reason. What will the catalyst be that will turn this situation around?

Under the stress of extremely high and unsustainable fuel prices, CAL lost 80 million dollars last quarter but raised ticket prices by substantially more than that for the coming quarter. During the same quarter, UAUA which operates an old, fuel guzzling fleet, lost $537 million which was the result of an increase in fuel costs of $516 million during the quarter. Unlike CAL, UAUA was not able to make up half of its higher fuel bills with other savings and revenues. As a result, UAUA announced that it will lay off 1,000 workers and ground 30 of 450 planes. It will reduce capacity by 9% by the end of the year, which is on top of a 5% or so reduction last year. I am reminded of the old joke where the patient bends his arm and says, doc, "it hurts when I do that" and the doc says, "then don't do that". The good news is that UAUA is not willing to keep on flying just to "keep market share". The UAUA average ticket price has gone up by $150 round trip in 9 increases done over the past 3 months. The reduction in capacity will allow all the airlines to increase ticket prices once again. The management of DAL has suggested that the industry still needs increases of 10 to 15% to break even.

The loss of 80 million dollars at CAL has resulted in a loss of market value of about 500 million dollars; total insanity! Today, the entire value of all the shares works out to 1.69 billion dollars. The firm currently holds about 3 billion dollars in cash and the 80 million dollars was a "paper loss", the companies cash balance grew by a couple of hundred million last quarter.

UAUA is the much larger airline. Without looking up the exact numbers, I can tell you that UAUA has about double the revenues of CAL. Yet, the market value of the company has fallen like a rock. The value of all shares is now 1.61 billion dollars. The management of UAUA has been ready to sell for a couple of years. With the DAL - NWA deal moving forward, CAL suddenly finds itself in the "cat bird seat". In addition to being the higher capitalized company, CAL now has more to offer the employees of UAUA. The UAUA employees are surely concerned about the possibility of UAUA bankruptcy. Here again, UAUA has tons of cash on hand. It is a solvent enterprise. The earnings will recover as ticket prices begin to catch up with fuel prices. Still, the environment is ripe for consolidation and UAUA would hate to see CAL and AMR team up. UAUA does not want to be the "last girl at the dance".


I have noted that some of the short term oscillators are not currently screaming BUY, BUY, BUY. I have also noted that stocks keep getting cheaper relative to other asset classes. I want to be clear that longer term indicators suggest the market is still a screaming BUY. One of the things we can all easily do is check the sentiment. I am certain that if you poll your friends about the market, most of them will not even want to talk much about it. During the good times, you will note that everyone loves to talk about stocks. The old front cover of Business Week Indicator is alive and well. Last month, right at the bottom of the market, the front cover was, in bold red, the word RECESSION.


While I rail against the silly extremes of the environmentalist, I believe we should be good stewards of this old planet. The prophet Ezekiel in chapter 34 verse 18 asks us, "Is it not enough for you to feed on the green pasture? Must you trample the rest with your feet? Is it not enough for you to drink pure water? Must you also muddy the rest with your feet?"

My thinking is that the environmentalist need to spend some time on a farm. They need to learn that the good earth must be managed. The good earth does not supply us with a bountiful harvest. We must put forth the effort to use the good earth to produce the bountiful harvest. An abundant supply of fertilizer was put on this planet but it was not put to good use for most of the planets existence. It would be silly to not dig up potash in order to "save the environment". Our common sense tells us to dig up the potash so that we can feed ourselves. Our politicians should stop playing games with the lives of hungry people. We should drill for oil and put our corn back on the food market. Yes, as demanded by the market, we will substitute other energy for oil. We need not abandon rich supplies in order to do in a few years what can be done over decades. The market drips prosperity upon us, we do not need a benevolent government to force us to go the long way around.


I can only hope that I will rise to the occasion and do my share to stop the insanity. I hope you will forward these words to others. We need our politicians to get the message. They need to turn away from the government intervention that is causing wide spread hunger. With trillions of barrels of oil available for the drilling, it is immoral to use our food supply as fuel.