Thursday, June 12, 2008


Over the past 18 months, a recurring theme offered here is that emerging markets will suffer and the money will flow into US stocks. In some ways, it has been a slow turn but in others it has been very fast.

The Shanghai Stock Market illustrates how much of a bubble developed in emerging markets. The index has hit the following points along the way:

June 2005, 1,000

June 2006, 1,700

June 2007, 4,000

Oct. 2007, 6,300

June 2008, 2,950

Which way do you want to look at this? Has the market fallen 50% in 9 months or has it risen 295% in three years? Both are true. The turn is pretty obvious.

The turn is less obvious in US markets but still there. US markets made an intra-day low in January, tested the low in March and are coming close to retesting the lows in June. The US dollar turned versus various currencies as far back as last October and against others between January and March of 2008. Kudlow and Company has obsessed about talking the US dollar up but the reality is that the dollar will seek its correct level and that intervention will only cause short term but unsustainable swings. The Kudlow sentiment is correct that a strong dollar will lead to strong profits and strong stock market rallies.

After a very long time of import growth and a weaker dollar, the decline is finally having an effect. The turn in the dollar has been giving foreign investors in US assets a boost in their profits. Large businesses do not move a factory to America on a whim. They have to see that there will be sustainable profits to justify the investment. Over the last 18 months or so, exports from the USA have been growing at a dramatic pace as US companies are producing products that are not made anywhere else. The easy example is the Petra Flop Computer that IBM just manufactured. Only a few years ago, when the fastest computer could perform 200 trillion transactions in a cycle, it was thought that at least a temporary plateau had been reached. The machine now being installed does 1,000 trillion transactions per cycle!

Productivity continues to soar. Somewhere, yesterday, I saw a chart, perhaps it was on the Carpe Diem web site, that showed an increase in industrial production of 600% over a number of years and during that same time the number of workers engaged in manufacturing dropped by almost as much. It is hard for many to see productivity as a good thing because it eliminates the need for workers. The good news is that when more goods are made with fewer workers, consumers can buy goods for lower prices and then afford other services with their savings. Thus, millions of people are working in jobs that never existed before. My daughter is a professional counselor at an elementary school. When I was in elementary school, I had one teacher each year and the school staff was composed of the principal, the janitor and a few ladies who ran the cafeteria. I am thankful that my daughter helps kids. I am also thankful that she does not hold a rivet gun 8 hours a day on a factory line. All work is honorable but smart people learn how to do things the easy way.


Over the past few months, Defense Secretary Gates has put a lot of pressure on Air Force Commanders. Gates has needed more UAVs, drones, in the Middle Eastern theater. What is not to like about these drones? Many can be operated by specialist trained in only a few months. They can be operated from an air base located in the US or anywhere else. They can stay aloft for hours with no pilot fatigue, when one guys shift is over, he passes control to the next in line and he goes to his home in a US city.

How did the USA and Israel know that Syria had three nuclear sites? One theory that fits a number of facts is that drones "followed the trail from Iraq" and have been collecting more info ever since. The US Senate Intelligence Committee has confirmed once again that Saddam Hussein had weapons of mass destruction. It is known that he destroyed some of these weapons under UN supervision but that he refused to give a full accounting to the UN for other weapons. It has long been suspected that some of these weapons were moved to Syria. Israel bombed one of the locations and UN inspectors have asked to visit another two suspected locations. An amateur detective acts as soon as he discovers a lead, the professional takes the time to build his case before he makes his arrest.

North Korea and Iran have each worked on guided missile programs and each have tried to build nuclear warheads. The USA has obviously been following these developments closely. These programs put the world at risk of nuclear war. They need to be monitored closely and drones have played an important role in the process.

The good folk at have noted that if the time comes when nuclear facilities need to be attacked, cruise missiles and other non manned air craft should be the weapons of choice. There is no need to put pilots at risk when a drone aircraft can do the job. The combination of missiles, surveillance drones and unmanned aircraft that can deliver ordinance and return to base is a powerful combination. The evasive action available by the drone aircraft is superior to that of a manned aircraft as a man cannot survive the G forces that machines can.

Knowing that nations such as Iran are working on guided missiles is fuel for "an arms race". Rational people who love peace know that the route to peace is paved by military strength. A bully will not attack you if he suspects you have a close friend who has a black belt in Karate. Iran will not attack Israel if it suspects that Israel and the US have the capability of putting a cruise missile in Ahmadinejad's bedroom. The risk is that Ahmadinejad will acquire the expertise to put a cruise missile into George Bush's bedroom. I am sure there are terrorist who dream of steering a cruise missile into the Freedom Tower being built at the World Trade Center.

US companies benefit from their advanced electronic skills. Drones must be able to electronically listen and see through fog and "noise". It takes very powerful computers to monitor chatter. The reason there has not been another 9/11 style attack on the US is largely because communications from terrorist have been well monitored. Week after week, leaders of terrorist cells have been captured or killed. Last month, 500 terrorist turned themselves in to US forces in Iraq.

Insurance costs on everything from oil ships, to New York buildings to elementary schools are going to come down over the next several years. As insurance and other costs come down, the US market is going to do extremely well. The US is set up a bit like California during the gold rush days, one did not have to own a gold mine to make money in those fun times.

The second half of the business cycle is upon us. Big computers and expensive US provided services will be purchased. World commerce will flourish. After a small cap surge coming off the slowdown, the market will move more toward the "big business good times". IBM and GE will likely be among the big winners. The emerging markets have collected piles of US dollars, now they will buy software from MSFT, turbines from GE and computers from IBM.