FROM BUST TO BOOM

The "bust to boom" indicator made a sharp bottom at a very low ratio 4 days ago. This indicator has historically made sharp turns. It often makes a few pump fakes but once it turns it typically turns hard. At the last top, the indicator outdid itself. It did a few pump fakes in early 2006 and then dropped like a rock, only to do a 180 back to a final top in May of 2007. The fall from 57% in May 2007 to 26% last week was the largest move I can find. On October 10, 2002, the jumping off point for stocks after the last recession, the indicator had reached 30%. At that bottom, the indicator soared from 30 to 34 and then back to 29 in April of 2003 when the market successfully stayed will above the October 10 low. The jump of the last 4 days may be a pump fake but smart investors will not try to catch the exact bottom. Those who have bought when this indicator is below 34% have had very strong 3 and 4 year returns.

"BUY" IS THE SCREAM OF CONSUMER SPENDING

Yesterday, reported real consumer spending made the same move made November 1974, March 1980 and November 1990. Real spending is more the function of inflation reports than a function of actual spending. Inflation jumps at the tail end of the business cycle. While we all know that house prices, oil prices, wheat prices, corn prices, cattle prices, electronics prices, etc., etc. are falling, we see a report about real consumer spending, based on high inflation, making big news.


In case you are not familiar, stocks did very well in the months that followed the above dates.

The McCain Long Shot

A regular reader sent the following link to a political quiz.


http://www.theadvocates.org/quiz.html.


I score as a strong libertarian. In many ways, I am a classic liberal; I believe in freedom! I desire the least amount of government interference in my life as is reasonable.



I count the Rasmussen poll as reliable as polls can be, but a margin of error of 4% can be an 8 point swing. The race for President has tightened but McCain is still a 4 point underdog; he could squeak out a win or he could lose by more than 8. His hope lies with the electoral collage. Our founding fathers wisely set up a system whereby California (which did not exist) could not rule the land. The law of the land is that the electoral college vote is the one that counts, several million votes against McCain in New York and California will be of no consequence. McCain's best shot is to win all the "slightly leaning" states and to pull off upsets in Ohio, Colorado and Virgina; a tall order indeed. Virginia has traditionally voted republican but it leans heavily toward Obama. A number of other combinations would work but all are long shots.


Stranger things have happened and the turnout should break several long term records. A significant percentage of democratic voters are opposed to one party government, when push comes to shove, many a centrist democrat will "pull the lever" for McCain. Our country continues to struggle with the unintended consequences of one party rule under FDR and Lyndon Johnson. The one party rule from 1992 to 1994 resulted in no harm when republicans blocked the big government takeover of health care proposed by Hillary, but the potential harm of a Pelosi, Reid, Obama combination is great. My opinion is that the actual harm will be much smaller than the potential but we should avoid the risk if we can.

Employment Growth in the Travel Industry?

A few days ago, I mentioned that the travel industry has been one of the few areas (outside of government) where employment growth has been strong. I mentioned that the baby boom generation is traveling. There is more to the story.


The key other point is that package deals are being purchased. Instead of shopping for a vacation rental within a half day drive, the public is leaving the car at the airport. The reduction in total air miles flown has not been on the level of reduction in miles driven. Many travelers are buying package deals. Many destination resorts are doing much better than most individual rental properties. The employment growth is real, but, as always, the media emphasis comes after the trend has run along way. Yesterday, the New York Times published a front page article telling about how driving is making a come back.



The naive have used the article as the reason to "jump back into energy investments". Exxon just announced the biggest profits in history and the high profits make its PE multiple low. Exxon was the number one performing large cap investment over the past 35 years. It is a well run company. The left uses it and Wal-Mart as punching bags but this is mostly jealousy from those who wish they had invested. Still, the big energy boom that lasted from 1999 to 2007 has run its course.


I disagree with the many who believe we are in a commodities "super cycle". These folk see China as the largest economy in the world in just a few years and they see huge on-going demand growth for commodities. The reality is that Japan, a country that must import almost 100% of its raw materials, is on the other end of the China see-saw and the Yen, like the US dollar has turned. Shares in Japan were on fire for many years until about 20 years ago. Shares in Japan are now all the way back to the prices of 20 years ago, just as the cycle is turning. The upturn of growth in Japan will not suppress growth in China but one of the reasons that Japan will do well is its efficiency in using resources. China has the most progress to make in increasing the efficiency of its use. China, embarrassed by the smog at the Olympics, has built an assembly line to produce nuclear power plants. China is going to contribute to a dramatic reduction in the growth in digging and transporting coal.


Japan and a number of "old" EU countries and Russia combined are experiencing reductions in population. Population growth rates have fallen dramatically in many countries, including China. The worlds population growth would probably end by 2050, except for the longevity factor.


All the while, technological innovations are soaring ahead at break neck speed. Some of these innovations will dramatically prolong life, contributing to population growth, but many others will dramatically cut the per person use of the most valuable commodities. (The number one cause of death is heart disease and hearts are being "renewed" with outpatient injections. Just one example of innovations that will dramatically prolong life.)


The examples of reduced need for commodities is endless. For thousands of years, the real, inflation adjusted, price of commodities has been negative. The history of more efficient use is a several thousand years old. The stories about Joseph in Egypt are about learning how to use grow and preserve commodities. I have fussed about the foolishness of using corn oil in car engines but genetically improved elephant grass will produce 5 times the energy oils for a fraction of the costs. The next time the price of oil rises, elephant grass or some other cheap raw material will be ready to compete. We do not need an Obama boondoggle to talk the market into improving elephant grass or some other best alternative.


It is time for a backlash against big government. So far, the credit crisis has resulted in a backlash against big business. By the next, election (only 2 years away: :-)), there should be a backlash against the padded salaries of government workers.


The tide seems to be flowing in the big government direction right now but the government is broke and broken. The Bush tax cuts do not expire until 2010. To enact Obama's big spending programs, the government would have to take on even more debt. Democrats will hold significant majorities in the house and senate but they will not gut the military budget quickly and many are not in the mood to borrow and spend. The $500 tax rebate checks and the other $500 credits to be issued by the Obama plan will not do much. The decline in the household expenditures for inflated energy and food will be the much larger tax cut. The family household budget will be repaired faster than government budgets. Many state budgets are in horrible condition.


The baby boom generation will continue to travel. A significant portion of their energy savings will flow into their travel budget. The strengthening US dollar has made and will make international travel more affordable.

Don't Try to Trade Copper; Use it as an Economic Indicator

A regular reader wants to know how to make money off my projected continued decline in the price of copper. The following was my response.


The best way to trade commodities is with a futures account, however, this is a specialized business filled with professional snakes. The commodities trading pit is not the kind of place where a modest investor would want to hang out.



The main point about copper is that the price decline shows that the market turn is happening and that inflation rates will soon fall, as the significantly lower price of raw materials work their way through the production cycle.


As noted, 1) stocks have historically appreciated an average of 350% more during times of declining inflation; 2) during a time of declining inflation, bonds normally appreciate first and then there is an overlap, where financial stocks gradually take over before consumer spending explodes.


Manufacturing recessions play out a little different than real estate recessions but since I presented the numbers for the last real estate recession earlier, I will go over the numbers from the last recession. In 1999 the S&P 500 Bank Stock Index fell from .32 times the S&P 500 Index to .18 times the S&P 500 Index. The total return for the year was 22.7% but the bank index underperformed the S&P by 44%. At the bank stock bottom in March of 2000, the Bank Index got down to 15.5% of the S&P.


The S&P 500 in 2000, 2001 and 2002 returned -9.2, -11.9 and -22% respectively. In 2003, the first good year after 3 down years, the S&P was up 30.7%. From the March 2000 bottom at 15.5%, the bank index soared. The nominal bottom of the S&P was on October 10, 2002. In other words, the -22% return in 2002 included a plunge to the bottom in October and a strong rally to year end. The bank index was going almost straight up before the S&P joined the move. By April of 2003, the bank index had reached 37% of the S&P. Over the next two years, the bank index performed in line with the S&P, but by June of 2006 the bank index was trading at 32% of the S&P.


From the bottom in March 2000 to the peak in April of 2003, the bank index outperformed the S&P 500 238%. Unfortunately I don't have the bank index total returns handy. The weak substitute I can offer is that while the S&P was down 9.2% in 2000, the broad Financial Sector was up 26.9%.


One problem with the 2000 recession numbers is that the events of 9/11 distorted the outcome. I should also note that the top performing sector in 2001 and 2002 and the second performers in 2003 and 2004 was the real estate sector. These broad based returns, from 2000 through 2004 were 27.6%, 11.7%, 3.6%, 36.9%, and 31.2%. As you can see, the person who invested in the right place, early during the 2000 recession, did very well. Indeed, if one put up 20% of total value to buy real estate in early 2000, one made about 130% return in 2000, a tough year when the average big stock fell 9.2%.


As noted, real estate recessions play out differently than manufacturing recessions. The industrial metals index was about 62% of the Gold index in early 2000. The bottom of 39% was not reached until March of 2003, right at the take off of the big Dow Stocks. The ratio was at 76% in July of 2007 and it is already lower than the March 2003 bottom. It was trading around .35 a few days ago. The above illustrates that this recession, being a real estate recession will see even bigger swings than the average recession. By the way, real estate gets hammered in almost all recessions; the difference in a real estate recession is that real estate drags the rest of the market down, whereas in a manufacturing recession, high interest rates and the loss of jobs drags down real estate.


In nominal terms, the massive decline, in the price of copper from July 2007 to today, was from $4.11 to $1.66. After such a massive decline, a one to 6 month bounce would not be a surprise. The market sometimes takes time to digest a move before following through with the "second leg". I believe the price will go below 50 cents but that does not mean one will automatically make high returns by shorting copper futures, by nature, futures tend to be short term speculations. The main problem with futures is getting the timing right. When one looks into the future, one always looks through a cloudy crystal ball. It is easy to be off a few months, which can turn a wonderful trade into a major loss.


The clear immediate future is stuff that is already "in the works". The lower price of raw materials, the move that has already happened, will translate into lower prices of goods as those prices flow through the production cycle. Gasoline being sold at $1.48 wholesale in Texas and Louisiana will not reach North Carolina for a few weeks. My local Shell station was selling regular at $3.04 last week and is down to $2.69 this morning but it is a solid bet that it will be selling regular at $2.08 within three weeks (perhaps 4.5 weeks to get past the Thanksgiving Holiday).


The reason economist call copper, Dr. Copper, is because its price gives us an indication of our economic future. However, one should not try to use a decline in the price of copper to predict a further decline in copper. While it is obvious that the demand for copper will remain low until there is a rebound in the economy, we must remember that the stock market also leads the economy. As I have noted before, the prices of commodities are a lagging indicator, similar to unemployment. We do not see the worst of unemployment or declining copper prices until after the economy is well into a downward path. By the time these measures are indicating that we are in a recession, it is time for stocks and real estate to start their recovery.


In September, we had the largest reported monthly jump in existing home sales in 5 years. It was the first time in 30 months that existing home sales were up year over year. A bottom is being made in housing. The first bounce may prove to be only a test but it is a great sign. We are in the third phase of real estate, when sales are rising even though average price is still falling. In North Carolina the foreclosure ratio fell 27% last month. Nationwide about 35% of all homes sold last month were deeply discounted foreclosures. The other 65% of the homes probably were sold at higher prices (perhaps well below listing prices but still at higher year over year prices). Foreclosure sales tend to be concentrated, more neighborhoods are stable than are collapsing.


The key measure, as always, is supply and demand. The supply of homes for sale has fallen 5 months in a row from 11.3% months to 10 months of sales. The reason real estate did so well in 2000 to 2004 was the supply hit 2 months in early 2000 and was still only 4 months when the real estate fireworks really started in 2005. The time to sell real estate was in 2005 or early 2006, when supplies were just ready to exceed 6 months of sales. With only a modest pickup in home sales, the current 10 months supply could fall quite rapidly. A significant number of rental homes for sale will come off the market when their owners realize the market has turned. Many potential buyers have hesitated to buy while prices are falling. The sales rate will jump when these buyers realize that prices are rising. Because it takes time to locate the best properties, it is important to start looking and to make offers well before prices start moving up. The attitude of sellers will be very different once they hear that prices are rising.


Building permits are very low. There is pent up demand that is frozen while potential buyers wait until they know their job is secure or when their bank is more willing to offer great terms. Just in a few weeks, the 30 year mortgage rate dropped from 6.5% to 5.9%, rallied to 6.4% and is now back at 6%. In normal times, banks would only charge about 1.5% more than the 30 year bond. The 30 year traded at 4.04% yesterday. Home loans at 5.5% would make many more homes affordable to many more people.


Please note that with the exception of a few economist, Art Laffer being among the concerned, a turn in labor costs is not being forecast. In the late 60's and early 70's, the labor movement had a strangle hold on business. Obama will move policies toward the failed strong union policies of the past, but not nearly as far as his liberal friends in congress will attempt to pass. In the 60's and 70's, government policy ultimately resorted to hyper inflation of goods and services prices in order to counter the extraordinary salaries being collected by workers. Real interest rates were kept negative, at least up until deregulation hit and Ronald Reagan fired the air traffic controllers. The run up in commodities prices that occurred in the late 70's was accompanied by a run up in labor costs. Businesses had a difficult time making real profits and by 1982 PE ratios were down to 7 times. As usual, when the pendulum swung the other way, it went too far. In 2007, the average executive got a 38% raise. In 2008, the average executive will see a 15% cut in pay. The market correction in executive pay has started. Art Laffer's concern is that the pendulum will now swing to big increases in minimum wages and in union membership growth. Unions bankrupted the airlines, the rail roads and Chrysler, GM and Ford are on the brink. The best solution for GM would be to file Chapter 11 bankruptcy in order to get out from under outdated union contracts and dealership franchise laws. The more likely scenario is another government bailout.


This time is different! Dangerous words but labor in India, China and elsewhere is plentiful and technological innovations are reducing the cost of labor per unit of product even more. Obama's protectionist rhetoric was political rhetoric. He is not likely to push hard enough to end previous free trade deals.


Back at the start of the 80's, inflation rates fell dramatically as both the price of commodities and the price of labor came down. This time, inflation rates never got to extreme levels, even with the price if copper going more than 800% in a few years. This time, inflation rates will come to even lower lows. The unions who have spent billions of workers dues on support for Obama still face the new economy where robots do our manufacturing and where the low cost region is where the work gets done. By the way, Toyota will export trucks made in Tennessee to Latin America.


I say again, the average monthly return on stocks during times of declining inflation rates is 1.17% compared to .33% during times of rising inflation. Bonds will move first, financial stocks next and consumers will buy like crazy after they start seeing the price of things like Coke (corn syrup) fall dramatically. Just as the talk of GM bankruptcy gets the most play, there will be a massive shift of consumer spending from gasoline, energy and inflated food prices to consumer durable goods.

BUY REAL ESTATE!

From October 1973 to December 1974, real estate, as measured by an REIT index, declined 32%. Buyers in December 74 could not know the recession was over, indeed the declaration that there had been a recession occurred many months later. Buyers in December did know that the yield on real estate investment trusts had reached 12.9% at a time when 30 year treasury bonds yielded 9%. Buyers who bought in December 1974 and sold in August of 1979 made 245% cash on cash return on their investment in addition to very fat dividends.


The fall in real estate from August 1979 until July 1982 was even more dramatic. The total decline was 56%. Even so, at the market bottom, the yield had reached just 9.5% while 30 year treasury bonds were paying 15.5%. Buyers in July 1982, before the recession was official, made 113% in less than 5 years plus more fat dividends. Those who bought levered bonds did even better than real estate buyers.



The decline from 87 to 90 was 38% and once again, the adventurous who bought real estate during the recession did very well. From October 1990 to December 1997 they made 232% cash on cash plus fat dividends that started at 11.12% in October 1990.


The decline before the 2001 recession was 33% and the subsequent gain was 177% plus dividends that started at 8.8% in November of 1999. In this case, the time to buy was even before the recession started!


The average peak to trough over the past 35 years has been 39.5%. The biggest decline was 56% from 1979 to 1982.


BUYING TIME IS HERE


VNQ, the Vanguard REIT, went down 56% from March 2007 to yesterday. During the same period the S&P 500 went down 35%. Real estate is cheap relative to Stocks. The yield on the VNQ has shot up to 8.34% while the yield on stocks is about 3%. You earn 278% more in dividends on the REIT. The 30 year treasury bond yields 4.1%, less than half the REIT yield.


In the early 1980's the FOMC was eager to kill out of control inflation. Short term interest rates were raised to 19% in 1981. The great majority of people thought rates were going even higher. The US Government had to offer 15.5% to sell its thirty year guaranteed rate of return. It was very difficult to see that it was time to buy real estate during the summer of 1982 when 30 year mortgages required the payment of 17% interest and while short rates were still around 15%. Those who bought had no way of knowing that short rates would be down to 9% within a couple of months.


Yesterday, the FOMC cut short rates to 1%. The 30 year mortgage has been bouncing between 5.9% and 6.4% but this rate needs to fall to 5.5% to be in line with treasury rates. Those who buy real estate now should get a low cost variable rate loan, like the ones being offered at credit unions at 4.5%. One can earn 8% on 4.5% borrowed money, in addition to making capital gains on the entire asset value.


Please note, all of the above returns except the previous sentence were cash on cash returns. The person who bought real estate with leverage most likely made many times the cash on cash returns.


COMMON SENSE


Our common sense tells us to buy when prices are low. The decline of 56% over the past 19 months is as large as the biggest decline in the past 35 years. Our government has boosted the monetary base by 48% in just a few weeks. While I and others have complained about the negative precedent set for the future, we do not deny that the investment of 700 Billion Dollars by the Federal Government will provide a tremendous boost to our economy.


Those who keep trying to declare this crunch to be a repeat of the great depression do not know their history. The response of the government after the market crash of 1929 was to shrink the monetary base by half, this fed has increased it by almost half. Obama , Pelosi, Frank and Reid are anxious to move forward with the same New Deal style programs that caused the Great Depression to take years to end but the dramatic pump priming already done by the treasury and FOMC is going to work by the time the congress can make too many mistakes. Ben Bernanke wrote his thesis on the great depression. He is well aware of the mistakes made by the Fed. He is not inclined to repeat them.


BUY REAL ESTATE!

OBAMA SAYS "DON'T CONFUSE ME WITH FACTS"

A regular reader emailed a chart showing how our soldiers in Iraq will vote heavily for McCain. As we all know, Obama would have pulled out of Iraq in defeat 19 months ago, terrorism would be on the loose again. Now that the Iraq phase has been all but won, Obama refuses to admit that this phase of the war on terror has been won. He learned from Bill Clinton that the best political strategy is to repeat certain words until the storm passes, words similar to "I did not have sex with that woman". The war on terror is one of those areas where Obama found a politically popular point and stuck to it no matter the facts. He continues to win brownie points with many Americas by saying that he will end the war in Iraq. McCain gets little credit for helping win the war in Iraq.


As regular readers know, I hate the fact that the US Government spends 33 billion dollars per year to subsidize ethanol. I hate even more the fact that the government forces its "free citizens" to "spread our wealth" to the "poor" farmers. I hate that we are forced to spend trillions of dollars on a fuel that causes children in poor countries to go hungry. I hate that the production of that fuel harms the environment greatly. And, I hate the hypocrisy. The situation is like that of Ananias and Sapphira, the lies are one thing but the hypocrisy gives off the putrid smell of death. Obama does not care, provided he is the elected one. In the face of growing evidence that ethanol and wind mills are not up to snuff, Obama continues to extol their value.


Obama continues to support annual subsides to wealthy farmers to the tune of 33 billion dollars. At the same time, he attacks McCain for the oil company subsidies that Obama helped pass. Obama voted for oil subsides in a trade off to win ethanol subsidies. McCain voted against both oil and ethanol subsidies. McCain and Obama disagree with the economic policies of Bush, McCain objects to the reckless spending and Obama objects to the lower taxes on capital gains, inheritance and income.


It is understandable how the public was easily duped when the price of oil was rising. Bush joined the democrats in making it look like the government could solve an economic problem; when will politicians learn? Democrats went much further than Bush when they repeated, at least a few thousand times, that "we cannot drill our way out of this crisis". The reason the price of gasoline is about to drop to $2 is because a huge amount of drilling was done over the past 6 years. Marginal new supplies have finally topped marginal new demand. Yes, I know, demand is down because of world wide recession but supplies of 60 million barrels per day in the late 90's were boosted to 87 million barrels per day now. If supplies were still at 60 million barrels per day, we would not see prices falling. In addition to the producing supplies, the discovery of 70 billion barrels of oil off the coast of Brazil, not more than a drop of which has been produced, puts OPEC in the position of continuing to sell all they can at $67 because the price will be lower in a few years. US offshore drilling will help us by the time demand growth resumes.


Obama likes to claim that he will create 5 million new jobs in the alternative energy business. I have a couple of news flashes for him, 1) the millions of subsidized jobs created in Europe to build wind mills and solar panels are at risk, 2) the private sector will create the jobs in the most productive area, if wind mills is one of the winners, that will be just as good if nuclear power is one of the winners. However, the rational for investing huge sums into wind mills was marginal at $147 per barrel but really stupid at $67 per barrel. Sixty percent of the investors in T. Boone Pickens energy fund have asked for their money back. The Pickens plan relied on government subsidy to work. The likelihood of massive government subsidy for wind mills has fallen now that the price of oil is down 60%. Obama's campaign slogan is Change, yet he has handcuffed himself to a winning political story even though he knows the economical story is false. Or is he so naive to think that we can or should beat the Europeans at government subsidy and ownership of businesses?


Areva, the nuclear plant builder in France, just made a deal with Northrup Grumman to build a nuclear parts plant in Virginia and the Department of Energy just signed off on the wisdom of reprocessing nuclear waste into new fuel. For a very long time, our nuclear power plants have burned 4% of the fuel and left 96% as waste. Even at such low utilization rates, nuclear plants have been economically competitive with other means of energy production, including dirty coal. It takes 10 nuclear regular nuclear plants to produce the fuel for one fast burner plant. The fast burners will turn tonnes of nuclear waste into trillions of dollars worth of fuel.


A couple of days ago, I had a conversation about nuclear power with a friend from Canada and a friend from Switzerland. The thought that nuclear power might be the answer was almost repulsive to each of them. However, when the Canadian learned that China has built a nuclear power assembly line, which will make possible the production of electricity for 1.3 to 2 cents per kilowatt, he acknowledged that nuclear power makes economic sense. The friend from Switzerland was unwilling to dwell on the economic question but repeatedly went back to the dangers of nuclear power. The events at Chernobyl are ingrained in his thoughts. However, he was willing to accept my point that at least 10s of millions of people have died producing coal power or by breathing dirty coal air. When asked what the world would be like if we did not consume coal or nuclear energy, he had no answer. If memory serves, there were 14 people who died immediately at Chernobyl and the expert estimates of those who died because of radiation range from 40 people to 2 million people. I believe the low number is in the ball park and my friend believes the high number is. We ultimately had to agree to disagree. Thus far, my friend has delayed the installation of roof top solar panels: he is waiting for the relative total price per kilowatt to come down. He will have a long wait. Jimmy Carter put roof top solar panels on the White House, Ronald Reagan took them down.


Obama and my Swiss friend continue to support wasteful spending, but: 1) Thunder Horse, in the US Gulf of Mexico, just brought another 100,000 barrels per day online, 2) Mexico just voted to allow drilling in the Gulf of Mexico by companies that know how to find and economically produce oil, 3) natural gas production growth in the US has grown dramatically over the past couple of years and it should grow for 50 more years, 4) China has broken ground on two new refineries, one in Nigeria, 5) Russia is adding a Chinese spur line to its pipeline from Siberia to Japan, 6) Kazakhstan is moving forward with the development of the huge Kashagan oil and gas field, 7) the net growth of the worlds population was down in the 90's down more each year of the 2000's and it should reach zero in about 50 years, 8) every day trillions of energy saving substitutions are being made.


The stock market in resource rich Russia is down 70%. Bulk supply shipping rates are down 87%. The mortgage interest rate bottomed in 1977 three years after the end of the real estate recession. The mortgage interest rate bottomed in 1993 almost three years after the end of the real estate recession. Smart investors will buy real estate today, using variable rate financing, and they will lock in fixed rate financing in a couple of years. As evidenced by the shipping rates, the demand for iron oil and other goods required to build big factories or big office buildings or big bridges will be slow for a number of years.


On the other hand, the US economy continues to be amazing. With the exception of autos, retail sales continue to be extremely strong. Total loan growth in America continues at double digit rates, down from the peaks, but still strong. Americans are apparently taking the money they would normally put into a new car and spending and spending part of it elsewhere. The strongest area of employment growth is in the hotel and leisure goods business. Apparently, retired baby boomers are traveling. Based on research done by the Cleveland Federal Reserve Bank, inflation expectations are from 1 to 1.6% and GDP growth for 2009 will be in the 3% range! The guys and gals on TV are talking about a bust but the market bust shows a major decline in capital goods, energy and materials and a surge in other areas.


How can it be that housing, banking and autos are in a major recession but the US economy is still so relatively strong?


I always circle back to the innovations taking place. Yesterday, I wrote about the progress being made toward "print manufacturing". In a few years, if a company needs a certain part, it will download the specs and hit the "print" button. Supper strong, super tiny materials will be arranged according to the specs. The savings will be huge.


Yesterday, Google settled the law suit between them and book publishers. Google, perhaps through Amazon, Sony and others, will soon make millions of out of print books available on line. Google will keep 36% of the sales revenue and 100% of the advertising revenue. Google will win but so will the rest of the world. Shared knowledge is extremely powerful. The invention of the printing press was one of the greatest inventions ever. Even so, it took a major shift in attitudes to make the printing press feasible and another major shift in attitude to make its products useful. Think about how life would be today if only priest were allowed to read. China was once the greatest nation on earth but it lost its way when those in power decided knowledge should be sequestered.


The savings that will be realized by the movement of paper books to electronic readers will be enormous. The number of trees saved will be in the trillions. The easy access to great stores of knowledge will trump the benefit of saved trees many times over. Sales of the "Kindle Two" will be huge relative to the Kindle. Amazon might win big but the people will win more.


Mountains of new royalty income will flow to those who have written "good stuff" in the past. Those who write "good stuff" in the future will find an audience. Under the "laws of the long tails", we know that the distribution curve will be flattened. The most popular stuff will not necessarily lose readership, but billions of people will find millions of books on the subjects they enjoy. The costs of any one book may vary greatly but the net cost of reading good books will fall dramatically.


Thousands of book stores and thousands of video rental stores will close or convert to coffee shop book and movie preview locations, kind of like sports bars for books, videos and magazines. Floor space at many other stores, including Wal-Mart, will be reallocated. Paper newspapers will go the way of answering machines, fax machines, analog TV, hand written letters, dial up Internet, cameras that use film and yellow pages (for a longer list go to WalletPop.com).


The "gales of creative destruction" are nothing more than the biblical teaching that there is no joy without suffering. When Obama, McCain and others, push to eliminate pain, they also push to eliminate the resulting benefits. The push to eliminate pain is the equivalent of taking heroin or drinking excessively. While Obama has done a masterful job of running as a liberal democrat during the primaries and as a centrist democrat during the general election, he has not changed his fundamental positions. He is still a big spending, "spread the wealth", liberal. He is still willing to shrink the economic pie, provided he and his "friends" get a much larger piece of the smaller pie.


The good news is that multiple new economic pies are in the oven. The market will spread the benefits around the world. For example, the decline in the cost of books is going to be of greatest benefit to the poorest of people. Can you imagine how the availability of cheap books and videos will change the lives of billions of poor children in Africa, China and India?


The bad news is that we are a long way from one of the attitude shifts we need in America. Unfortunately, the old rhymes that compare school houses to jail houses have come true. Most of our children are locked into holding cells for a few hours each day. I taught a few classes at local middle and high schools last month. I learned more than I wanted to know. Our teachers need the authority to expel children from class. Children who are not motivated to learn should not be allowed to disrupt the educations of those who are. Indeed, classrooms are "old school". Each child should have his own "study office" with the freedom to come and go to the gym or playground or education conference, provided he works hard enough to "keep his job". Political brainwashing should cease. The Google book project grants free library access to millions of volumes. Motivated children should be given free access to these millions of volumes. Children and adults should have access to the facts. Obama is not the one at fault for his willingness to ignore the facts, he is simply a reflection of a society that has been brainwashed.

REAL INTEREST RATES -- DOLLAR GAINS STRENGTH

Stocks do 350% better during times of declining inflation; such an important concept for investors to appreciate. Many investors think bonds are the investment to own during times of low inflation but the irony is that bonds should be bought when inflation is high but about to go down. Stocks and bonds are first cousins. Unlike gold, stocks and bonds earn a stream of cash; most bonds give off a fixed, limited and guaranteed stream and stocks give off a variable stream. The stock variable stream grows best during times of low to moderate inflation. Real estate is an even more distant bond cousin. Utilized real estate also usually throws off a growing stream of cash. Real estate is more closely related to stocks than to bonds. The rough times are when the net returns produced by stocks or real estate are negative.


The US dollar has recently skyrocketing against many currencies. One of the sharpest runs has been against the Aussie Dollar. By the same token, the Japanese Yen has risen even faster than the dollar. Marvin Appel writes about foreign investing in "Investing with Exchange Traded Funds". He notes how volatile emerging growth stocks can be and how one one can lose money for very long periods of time in foreign stocks. If you are not enjoying this market, say a word of thanks that you are not heavily invested in Russia.



Back in 1967, democrats were in control of our three "houses" of government (the make up of the supreme court is always important but never truly "in control of a party"). Under one party rule, a lot of mistakes in the same direction were made. The presidents of the 70's were all forced to fight hyper inflation. Nixon, Ford and Jimmy Carter still get blamed for tough times that were the result of the inflationary policies of the Johnson years. By the Carter years, wage inflation was so bad that the only way to keep the economy together was to allow the hyper inflation of other stuff. The FOMC went along with the hyper inflation "cure". Interest rates adjusted for inflation were negative from 1973 to 1981. Indeed, by late in the Carter years, real interest rates reached minus 6%! while the price of gold soared and the US dollar collapsed.


We just got a small taste of what it was like during the 70's; real interest rates were negative by a percent or two from late 2002 until early 2005. Negative real interest rates hyped the value of houses just as the congress pushed banks to lend 100% to non qualified buyers. We are all paying the price for "forced charity". We are paying a great price yet due to our lack of understanding we are about to continue in the direction of forced charity.


The good news, so far, is that there is no wage-price spiral, like the one of the 70's. Real interest rates were positive during 2006 and 2007 and only went negative, again, at the end of the oil-commodity price spike. Real rates went negative by about 2% last summer and the stock market has been pounded almost as bad as it was in the late 70's. The difference this time is that inflation expectations have already collapsed, as noted in the price of every thing from copper to oil. Some talking heads continue to worry that large increases in money supply will cause hyper inflation but the truth is that the tendency of most businesses and consumers will be to pay down debts over the next several years.


Back in the 70's and early 80's, wages went up rapidly regardless of the price of raw materials. Starting by 1966, union members got big wages, the minimum wage was raised rapidly and even the very tough recession of 1973-74 did not take away the inflation caused by mandated wage increases. Without the intervention in the markets by government and unions, the invisible hand of Adam Smith would have solved the problem quickly. As it was, the invisible hand eventually won but it had to battle the fact that the starting wage of a bag boy at the local grocery went from $1.00 per hour in late 1965 to $1.80 per hour by 1968; an 80% increase in about 2 years! Bag boys earned $2.50 by 1970, an increase of 250% in slightly over 4 years. And, they all made about the same, the hard working ones and the goof offs. The real price was much higher as everyone paid extra to cover the waste perpetrated by the goof offs.


This time around, amazingly, we continue to experience deflation in durable goods prices. We were on the edge of seeing significant price increases in manufactured goods about the time oil hit $147 per barrel but the turn has been made. The number of people working in manufacturing jobs continues to fall. Around the world, manufacturing jobs are being reduced as are the prices of everything from computer phones to car batteries.


There are two things going on here: 1) "Ricardo style" processes where one manufacturing set up after another is reviewed to find more efficient ways to produce goods while using fewer materials, and 2) The more important process going on is the Schumterian "gales of creative destruction". In other words, inventions are totally changing the way things are done. For example, scientist have invented carbon fibers that weigh less than steel but are many times stronger than steel. More importantly, they are learning how to "print" these fibers into any shape they want. The day is near when a manufacturer or maintenance company will need no parts inventory; it will "print" the part it needs just as the part is needed. Can you imagine the savings of capital and transportation? Can you imagine a world where steel is no more valuable than flint arrowheads?


BOOO OBAMA!


The sad thing is that politicians who do not appreciate what drives Schumterian creativity are about to win control of government. As part of the backlash against the ridiculous executive bonuses that have been paid and as a result of a news media that has been willing to fight the war on terror with a war of words, these politicians propose that we throw the baby out with the bath water. They want to increase already high taxes on innovation. The economic rule is simple, tax innovation more and the less of it you get.


The additional taxes to be applied to capital gains is a terrible economic idea and sending "refund" checks to those who do not pay taxes could be the start of yet another gigantic and harmful government program.


Thomas Jefferson would be appalled. In the 1780's Jefferson was very concerned because there were too many parasites living off the industry of others. Can you imagine Jefferson's heartache if he saw his and our constitution being shredded?


Obama says it is a matter of fairness, to confiscate from some and give to others. Of course, tax policy will never be exactly fair and there will always be those who pay too much and those who pay too little, but forced "charity" is a disservice to the provider and the recipient. It takes away the incentive to work from both parties. It is the stuff of the Lyndon Johnson years. At the time of Johnson, one could argue about the need for government largess as the way to solve the major civil rights problems of the day. As usual the government did things the hard way and made matters worse before they could get better. Millions of children have been raised by single Moms as a result of the mistakes made by Johnson (perhaps even Obama himself).


Obama's missing ingredient is that the hardest working people are the ones who make life better for the rest of us. The fellow who just invented the process for "weaving" cloth at 10,000 times the old speed will become rich but he will save the people of the world trillions of dollars. Obama says this man should be taxed heavily; I say that this man is likely to spend millions to save us more trillions, if we give him a fair shake. How about the thousands of inventors who only occasionally hit a single or a double, compared with this mans home run. Inventors normally strike out many times more often than they even make it to first base. The inventor who makes $200,000 in one year and is taxed heavily may not want to risk his balance on another high risk, high potential project.


Again, the economic truth is simple, when the government taxes rich people and subsidizes poor people, the result will be fewer rich people and more poor people. The law of supply and demand is more powerful than all laws made by man. The laws of man can be changed but only God can repeal the law of supply and demand.


In the mean time, real interest rates are set to rise in the USA and in Japan. The market is waiting with baited breath for the FOMC and the Japanese central bank to decide about lowering the nominal short rate. The prices of many things are falling, including the price of money. The strength of the US dollar and the Japanese Yen shows the relative projected strength of our economies. Countries like Canada, Australia and Russia are seeing a collapse in their currencies (and thus higher inflation rates) as a result of the lower demand for the raw materials produced in these resource rich countries.


Ironically, the best news would be for the FOMC to not need to lower short rates. The yield curve is very steep. Both monetary policy and fiscal policies are pushing the US economic locomotive forward. To further bring down the price of gold and other commodities, real interest rates need to go up. The strongest move would be for short rates to hold or rebound while the price of abundant supplies of coal, copper, oil, Tupperware and other durable goods falls. As low cost nuclear energy comes on line in China, the cost of durable goods will fall another notch.


(By the way, Intel expects to make 7 trillion digital radios over the next several years; more than 1,000 radios for each man woman and child on the planet. Your computer telephone is going to know the amount of milk that is left in the jug inside your refrigerator.)

HOW DO YOU SPELL RELIEF?

The Calvary bugles can be heard in the distance, relief is on the way. In recent days, consumers have been pleased to spend $20 less on a tank of gas, but the gas that will sell for $2 per gallon is just entering the far end of the pipeline. A few weeks from now, consumers will be pleased to save $40 per tank (20 gallon tank). The sound of other bugles, telling the story of relief can be heard. It is not just the price of gasoline that is coming down.


Saturday a friend in the plastics business mentioned that his company posted a huge price increase in July. At the time, oil was trading around $145 per barrel. My friend admits that his company will hold up prices for as long as they can. The company needs to rebuild its balance sheet before adjusting to the current price. The decline from $145 to $62 is a 57% decrease in his companies prime raw material. Inflation is on the way down!



The 5 year EU Bund has dropped from 4.75% to 3.25% since June! The cost of 5 year EU money is down 32% in 4 months. South Korea just lowered its short rate by the largest move ever. Rates just went from 5% to 4.25%, a 15% decline in one day. The news media is talking about how this recession might last three years but the big drag on the economy, housing, just saw its first year over year sales increase in 30 months. Home sales were up 5.5% in September and up 1.4% year over year. The percentage of homes in foreclosure is falling fast because the foreclosed homes are being dumped on the market rapidly. The banks want these properties off their books. The short term effect is the final drop in average home prices even while prices rise in most communities.


It is worth repeating that based on price moves that have already happened, the average household is going to reduce its spending on fuel, including transportation fuel, by $4,800 per year. Include the savings to the consumer from price decreases of other raw materials and the average household will spend $12,000 less in the next 12 months. This $12,000 increase in the family budget will not be taxable income, it is more like found money.


This cycle was unusual in that the economy stayed very strong even as consumers were pounded mercilessly by higher prices. Now that the higher prices are dissolving, the consumer is going to see times like the 90's, after the last real estate recession. I remind you that after the bottom was made, Best Buy went up 1,400% in less than 3 years.


For some time I have recounting the events that occur during an economic slowdown. Three of the key things expected: 1) a drop in commodity prices, 2) a decline in bond rates 3) a sharp turn around in bank stocks. So far, we have seen 1) a steep drop in commodity prices followed by a minor bounce which lasted for a couple of weeks and then a resumption of the decline, 2) a significant decline in bond rates in the US followed by a minor bounce during which stubbornly high EU Bund rates finally rolled with passion, and 3) we saw a significant V bottom in bank stocks followed by a "correction". Pretty soon, the pace of bank consolidation will pick up and prices will rise.


This morning in London, the financial sector is off 5.8% while the Energy sector is off 6.1% and the Basic Materials sector is off 8.5%. Keep in mind that the EU will not benefit as much from lower fuel prices as will Americans. In the EU, there is much more use of mass transit, but in both countries the sharp decline in fuel prices is just beginning to make its way to consumers. RELIEF is on the way.


POLITICAL NOTE


While McCain has been accused of using the race card, Obama is set to enjoy the most lopsided and largest turn out of black voters in our history. Obama will likely receive 98% of the black vote. Only in recent days has McCain found the way to get the message out that Obama's policies would push the country back toward the welfare state. More than 200 years ago, Thomas Jefferson lamented that there were too many parasites feeding off the efforts of the industrious. TJ would not be fond of many of McCain's ideas but he would deplore the policies proposed by Obama. Government has gotten control of too much. The recent mistakes made in the housing-banking arena demonstrate again that individuals and small businesses make mistakes but when big business and big government make mistakes the costs are enormous.


The good news is that Obama continues to moderate his positions. When he ran against Hillary, he was a flaming socialist. His most recent proposals reduce the level of pain he would cause the economy because he has reduced the size of the income re-distributions that he would force upon the "rich". The interesting thing is that Obama appears to be headed for a box that is upside down from the box where Bill and Hillary found themselves. Obama might actually be forced to fight proposals pushed by the most liberal of democrats.


In the know republicans are unlikely to admit that an Obama administration will not be as "socialist" as it is being painted during the heat of the election. The danger is the direction because the number of parasites has grown to well beyond majority proportions. Eisenhower warned of the feeding at the trough by the industrial-military complex, however, the over kill of defense spending did not do the kind of harm that will be done if we move back to the policies of the 70's. In his campaign against Hillary, Obama railed against free trade, he supported the union check off system that would take the secret ballot out of the system and he supported the fairness doctrine. I suspect that Obama will not destroy the benefits brought to consumers through free trade; his rhetoric of the past was for the purpose of staying to the left of Hillary during a critical time in the primary. Unfortunately, he will go along with too much support for oppressive labor policies but I doubt that the check off system will be instituted, it is just too anti-democratic to pass or to stand a supreme court review. The fairness doctrine was very harmful and, again, so anti-democratic that I doubt it will be re-instituted. Thoughtful liberals and conservatives hold tight to our rights of free speech.


While Americans have learned that the media is biased, we constantly get taken in by the media. In the old days, there was a stark difference between op-ed pieces and the news. Today, most news is op-ed in disguise. Opposing stories are ignored. The "old media", newspapers, magazines and network TV is dominated by liberals. As always, the market finds its way around impediments. The market place and free speech are like water flowing down a mountain, it will ultimately find its way to the atmosphere, most likely making it into the ocean along the way. Today we have talk radio, cable TV and the Internet serving to counter balance the "old media". And, once again, restrictions on contributing to political campaigns has become a joke. McCain has been hoisted on his own petard while it was Obama who committed to accepting limits before he rejected limits.


Right at this moment, polls suggest that democrats will sweep all three houses and may gain a filibuster proof majority in the Senate, a dangerous combination. I would not bet that McCain pulls out a victory but I would bet that the race tightens greatly. For perhaps the first time ever, polls show that the majority of Americans believe rule by one party is best. I disagree strongly, but the more important point is that a significant number of those who believe one party rule is best are far right republicans. Many independents and moderate democrats are likely to flinch before voting for a democratic house, senate and white house. In North Carolina, Obama has a slight lead in the polls but NC has traditionally (for 25 plus years) voted for a democratic state government and a republican national government. Liddy Dole is running behind as is McCain but I would bet that they pull out narrow victories in NC.


The investment reason to discuss the elections is that the fear of one party, extreme left rule, is over done. In the final days of the campaign, the irrational anxiety will calm down. Just having the election over will be a relief.


At the bottom of the market, there is fear of everything. I chuckle at the fears expressed of hyper inflation that might come come as a result of the surge in money supply. We are seeing record declines in prices for all sorts of goods and yet during a time of panic some folks raise the fear of hyper inflation. Right now, the fear of socialism is more reasonable than the fear of hyper inflation. A good measure of how much money is being printed is the total loans being made. So far, the pattern is very consistent with past cycles, the growth in lending prior to the recession was quite high, growing at better than 14%, but the growth in lending has slowed substantially in recent weeks. The rate fell and then bounced but loan growth should remain slow for a year, two or three after the recession is over.


When I report that the average household will spend $12,000 less on inflated prices, over the next year, I do not mean to suggest that the entire $12,000 will be spent in other ways. The pain suffered by those who paid too much for houses, stocks and SUV's will not go away immediately. Most consumers will use a significant portion of their savings to repair their balance sheets. Many loans will be paid off or at least paid down. The growth in the money supply will be stronger than the past few years but not so strong as to cause great inflation.


The fear of hyper inflation is from those who have noted that the FOMC is suddenly growing the monetary base at a 14% annualized rate. We must remember that the banks are more responsible for printing money than is the FOMC. When banks have tighter lending standards, less money is printed. This is where we are now, the FOMC is actually having to increase the monetary base rapidly because the banks are reluctant to lend, except to top score credits. Indeed, it is clear that the FOMC did not lean hard enough against the banks during the boom times of a few years ago. Now, it is appropriate for the FOMC to lean against the banks by making more money available.


Other doom and gloom projections about the coming great depression are the result of fears that the banks have stopped lending. I say again, existing home sales jumped by 5.5% in September, to 5.18 million units. The average price of those homes was around $200,000. The total value of US housing loans made in September approached the 1 trillion dollar mark. During times of fear, there are boogie men around every corner but the US is the most solid country ever. We make mistakes but we recover from them. The quality of the loans made in September was a far cry from the quality of the loans made in September of 2005 when the congress said bankers would go to jail if they did not loan to the unqualified.


The current problem developed over a long period of time. It will not be solved overnight but our country began taking its medicine three or more years ago. We sent a rider out to Fort Laramie a long time ago. Now we can hear the sound of bugles. Relief is on the way.

Oh No! A Democrat at Halloween

THINK ABOUT IT!

This morning the US Dollar has appreciated 7% versus the Australian Dollar and the Japanese Yen has appreciated 4% against the US Dollar. What a turn? The price of raw materials being mined in Australia, assuming no change in local prices, just dropped by 11% to Japanese buyers. Stocks do well during times of declining inflation rates. As lower priced raw materials work their way into products, the initial event will be an increase in manufacturing profit margins but the lower costs will later show up in lower priced products. Inflation rates are going to fall in the USA and even more in Japan, which imports a very high percentage of its raw materials.


Many an international mutual fund is charted to exclude Japanese investments. The rational is that Asian emerging growth nations are at the other end of the Japan see-saw. If you hold international funds, in 401-K accounts or elsewhere, you should focus on Japanese stocks. Over the long term, China, India and other nations will grow faster than Japan but Japan will be a strong performer for the next many years. Japan under performed from 1989 until 2003. It's relative performance has been strong since 2003 but the recent sharp declines have brought shares close to the 2003 bottom. EWJ is an exchange traded Japanese Fund.

HOW LOW IS LOW?

The cheapness of the US stock market has reached 1982 levels by a growing list of measures. Stocks were very cheap in 1982. Overnight, stocks in Japan, Korea and London were down again. How low can they go?


Bond investors have always included the smartest of investors. While bond investors must ultimately guess, just like the rest of us, their business has much more straight forward math involved. In recent weeks, bond buyers, by nature a conservative bunch, have been willing to buy long fixed rate bonds instead of buying TIPS (variable rate inflation protected securities). Many of these buyers are 100% bond buyers; the charters they hold forbid them from buying anything other than fixed income securities. These buyers are currently willing to lock funds into 3.6% for ten years rather than earn a variable rate starting at 2.5% for 10-years. The implication is that inflation rates will stay low for 10 years. The difference between 3.6% and 2.5%, with relatively minor adjustments (as can be seen on the Cleveland Fed Web Site) is the markets inflation forecast. Inflation expectations are at 1.1%!


Sock investors should be elated. Stocks do very well when inflation rates decline. Investors often times miss an important distinction here. Investors frequently assume that stocks do well when inflation rates are low. Stocks do best during the move from high inflation to low inflation. Victor Canto has frequently made this point. In "Understanding Asset Allocation" he included a table that shows: average monthly returns during times of decreasing inflation rates. From 1948 to 2004, the average monthly return on stocks was 1.17% during times of decreasing inflation and .33% during times of increasing inflation. Bonds and stocks are distant cousins. Bonds and real estate are more like the Hatfields and the McCoys. From 1948 to 2004, the average monthly return on treasury bonds was .3% during times of decreasing inflation and negative .44% during times of increasing inflation. I don't have the numbers from real estate handy but real estate returns are almost inversely related to bond returns. Please note that the risk of loss is much higher in bonds than it is in stocks.


OPEC just met and lowered production quotas by 1.5 million barrels per day. The people of the world are drowning in oil that is 10 feet deep and OPEC just lowered the level to 8.5 feet. The wholesale price of gasoline is down another 11 cents this morning. Retail gasoline should sell for $2.04 within 2 to 4 weeks. By the way, it is true that a wholesale price increase would have been reflected in the retail price quicker, but so what? If you were in the gasoline business, you too would be slower to lower prices than to raise them. Do your part by shopping for the lowest price. You can check prices on line and avoid going out of the way to save a few dollars per fill up. The station that is slow to lower prices will get the message quickly.


While we obsess over the price of gasoline, we miss the big movers. From 2005 to 2007 the shipping rate index for bulk commodities went from 1,000 to 11,500. It has taken less than a year for the rates to fall all the way back to 1,000. The number of supertanker sized ship loads going from Chile to China has fallen rapidly.


In 2000, the supply of palladium, a metal used in automobile catalytic converters, were tight. Prices soared. By 2001, Ford Motor felt forced to buy stockpiles to prevent having to shut production lines. That decision ultimately cost Ford a Billion Dollars. The invisible hand of Adam Smith is always at work. The world finds always finds substitutes when necessary.


It is the folly of man to believe that he can force substitutes on the market. In recent weeks, the prices of numerous metals have fallen 50% or more. Palladium is an interesting metal. Because it can absorb 900 times its volume of hydrogen, it is seen as a "metal of the future". The problem is that the push to build hydrogen fuel cells (and wind mills and ethanol plants) loses its economic reason to be when supplies of oil are abundant. The reason the price of oil has fallen from $147 to $63, 57%, is because supplies are abundant. Cuba just raised its estimate to 20 Billion Barrels for a field that is common to the USA. When Nancy Pelosi was blocking off shore drilling, she and her friends used very old USGA estimates. The old survey estimated total recoverable off shore USA oil of 18 Billion Barrels. If the one field next to Cuba has 20 Billion Barrels, how much oil do you think there might be in more than 10,000 miles of coastline? Back when the survey was done, the 70 Billion Barrels off the coast of Brazil had not been discovered. Do you think that the estimates might have been higher had it been known that Brazil found 70 Billion Barrels under two of 13 known formations off their coasts? Do you think similar formations off the coast of the US will be explored in the future?


It is unfair but fun to compare the current situation to that of WWII. Back in those days, inflation rates were negative. Around the world, much time and effort were spent recycling everything. Can you imagine a soccer mom driving a dually truck to haul a couple of school kids during those days? Consumers would have used more of many things had they been available but supplies were rationed. It is the height of hypocrisy for politicians to ride in massive SUV's while recommending tax increases on the pension funds of Exxon owners. The experience of WWII shows that the price changes of goods can be negative for a very long time and interest rates can go very low. The stock, bond and commodity markets are all suggesting that inflation is going to virtually disappear.


WHERE ARE WE?


The "book" says that consumer staples reach their relative price peak right at the end of the expansion phase. This is part of the natural flight to safety. The book also says that commodity prices start coming down hard during the early contraction phase. Many commodity prices have now been falling for a year but even the stragglers have been falling for at least 4 months. The book says that bond values go up during the late contraction phase. Bonds peaked by some measures in June of 2006 and by many other measures by July of 2007. According to the bond market, we have been in the late stages of contraction for 15 months. Finally, still in the late contraction phase, the book says we will see a V bottom in financial stocks. Since the July 11 "bottom", the S&P 500 Index has fallen 27.5%, the KBE S&P Banking Index has fallen 3.9%, the TLT 20 year treasury index has gained 4.6% and the KRE Regional Bank Index has gained 12.9%!


The "book" goes on to say that the market bottom will be made before the economic recovery starts. The market bottom will happen soon after the turn in financial stocks and consumer cyclical stocks will be the first stocks to jump after the bottom has been made. The official declaration of a recession will not be made until well after stocks have risen sharply.


The ROW (rest of the world) gets hit harder during real estate recessions than does the USA. This morning, the US Dollar has once again soared. The US economy is relatively strong. It is other countries which need to cut their interest rates and they are obliging. The brakes are gradually being let up in one country after another. As the dollar soars, the price of gold and oil falls, but there is more to the price of gold and oil than the strength of the dollar. In the last few months, the dollars needed to buy one Euro has fallen from $1.58 to $1.26. After this big move, the price changes of oil in terms of Euro Dollars are getting close to the levels seen in terms of the US Dollar. The point is that the price of oil, money and other commodities went up around the world and now these prices are coming down around the world.


Japan has been in an economic funk for 18 years. Japan, as a major importer of raw materials, will benefit greatly from the decline in commodity prices. Even so, it appears that Japan will be forced to lower interest rates. Sony, a major consumer cyclical products company, just took a big hit on lower earnings and a weak forecast. Once again, the market keeps telling us that we are in the late contraction phase, where bonds are increasing in value and where financial stocks are showing relative strength and in many cases real gains, but where we have not quite reached the market bottom. We have not quite reached the point where consumers find 100's of billions of unspent gasoline and heating oil dollars in their pockets.


It does not take a rocket scientist to see that wholesale gasoline priced at $1.44 is going to flow through pipelines and reach consumers at around $2.04 in 2 to four weeks (retail prices have already hit $2 in Texas and Oklahoma). One can use simple arithmetic to estimate the savings Americans will see over the next year. A year of oil at $147 would have cost Americans more than 1 Trillion Dollars. A year of oil at $63 per barrel would cost Americans 460 Billion. The difference in a year of each price works out to 613 Billion Dollars. The savings from lower prices of everything from money to corn chips will be substantially more than the savings from energy. Politicians are anxious to do a 150 Billion Dollar stimulus package so that they can take credit for the turn; a turn that will result from annual savings to US consumers of more than 1.4 Trillion Dollars. A savings of about $12,000 per household! As we saw last time, a stimulus package where the government borrows 100 Billion to give out $600 checks does not stimulate the economy. Forcing consumers to borrow $600 does not make them want to spend money. A fall in the price of gasoline from $4.11 per gallon to $2.04 per gallon has nothing to do with borrowed money. The owners of oil reserves are hurt and the consumers of oil benefit, but those hurt did not have their property confiscated by the government. The person who finds an extra $40 in his pocket after filling up his tank does not have extra debt hanging over his head.


A few months ago, consumers, businesses and countries around the world were playing the same game Ford played in 2000. There was a rush to buy up all the supplies of raw materials possible; before the prices went higher. Now that the world wide recession has hit, it will take many years for stockpiles to be worked off. Capital intensive mines run during good times and bad. At the height of the craze, investments were made in new production facilities. Many of these projects will be completed. For example, the Willow Creek Mine in Nevada will spend the next several years finishing the development of a 6 million acre project while knowing that supplies will be more than adequate when the project finally goes into production. Mines will continue to produce as long as all marginal costs are covered. The huge capital cost will have to be recovered during the strong times of the next cycle.


The price of raw materials is substantially higher today than they were in 2002. The price of copper went from below 50 cents in 2002 to above $4 in 2007. It is now around $1.80. I don't want to guess when but it will probably make it back to 50 cents. As raw materials prices fall, the inflation rate as measured by the CPI will fall. Interest rates will fall but real interest rates will rise. As US real interest rates rise, the value of the US Dollar will continue to rise and the price of Gold will continue to fall. If gold prices fall, the owners of DZZ will make as much as 200% of the decline in prices. This is one way to "win" while the market makes it's way to the bottom.

THE SOARING US DOLLAR

The US dollar is soaring because the growth prospects in the USA are better than in the rest of the world. This week, EU central bankers will cut rates to improve the prospects for future growth. Canada cut rates last week, Australia cut rates last month and there are more cuts on the way. Long term mortgage rates in the USA have once again fallen to 6%. Credit spreads are narrowing. The surge in the US dollar is consistent with strong relative US stock market performance. After real estate recessions, US stocks tend to do better than international stocks. Good times are around the corner.

APPLE I-PHONE LEADING THE CONSUMER SPENDING SURGE

Right in the middle of a recession is the time to have a consumer spending surge. This is not the time for gloom and doom. AT&T just reported lower than expected earnings because it sold a surprising number of subsidized Apple I-Phones.


The consumer spending surge, where thousands of dollars of food, fuel, money and other commodity savings are transferred into consumer goods, has started. Keep in mind that those paying $2.87 today for gasoline will pay $2.20 in a few weeks. The stimulus of lower prices will be in the range of 500 Billion to 1 Trillion Dollars, far more than the $100 Billion of government refund checks sent a few months ago.

How Low Will Interest Rates Go?

During the real estate recession of 1990, the 30-year treasury bond traded at 9% in mid 1990 and at 5% in late 1993, a decline of 44%! Will housing construction snap back faster this time than last? There are too many houses in countries from Iceland to Bulgaria. If the thirty year rate were to follow the prior pattern, it would be down to 3.4% in a couple of years and banks would be making huge profits.


There is demand for long term construction money, for nuclear power plants, around the world. For example, Italy has decided to build 8-10 nuclear power plants, having declared the closing down of nuclear plants a 50 Billion Euro mistake. Should a new US congress decide to rebuild bridges across the USA, the demands for long term funding would be significant.



However, for the past several years, China has built interstate highways on a scale never seen before. The point is that demand for long term financing is not the key to interest rates. There are three factors that have been keeping the lid on interest rates; they all have to do with keeping inflation low. 1) In our new global economy, there are ample supplies of labor. 2) There is better understanding and use of fiscal and monetary policies. 3) Innovations continue to boost productivity.


In our global economy, supplies do not get wasted by inefficient users, nearly as much. The age of chopping down trees to burn in out door fire pits is largely over. While it is true that Americans and others drive extra large and wasteful cars, businesses do a good job of finding the low cost producer. Furthermore, the run up in commodity prices has made the citizens of the world aware of the tremendous waste committed. For the next many years, consumers will look for ways to conserve.


We all know that Greenspan let interest rates stay too low for too long during the real estate bubble, but even the current down turn is mild compared to those of the past. Thousands of savings and loans and banks went busted during the last real estate recession. The many countries that built up sovereign funds during the boom times are cushioning the down turn. Petro dollars are being recycled. Substitutions, that result in lower consumption of resources, are being made by the second.


Innovations are spewing out of laboratories across the country and around the world. The most exciting innovations are nano sized. Last week, a fellow at NC State announced a way to "weave" nano super strong fabrics at about 10,000 times the normal rate. Before long, we will need very few people working in manufacturing plants. We can all spend our time inventing something neat or at least offering some service or another to our fellow citizens.


Productivity is better than found money. For one to find a wad of money, someone else must have lost a wad of money. Productivity produces new money out of thin air. At first, the bulk of this money goes to the people who use the new idea to lower cost and increase profits. Before long, productivity shows up in lower prices. Lower prices show up in lower interest rates.


I don't know where interest rates are headed, but I know that interest rates and commodity rates trade together. I also know that, for the first time in many years, China's steel mills are not running flat out. The world wide demand for highly elastic goods has fallen. The price declines are as large as those seen at the end of the inflationary 70's; back when treasury bonds offered 14% returns. Long term treasury bonds paid 2.5% during the 1940's. Stranger things have happened!

BAD NEWS--GOOD NEWS 1989 TO 1998

When the real estate recession began to bite in 1989, international stocks began to suffer in relative terms. 1989 was a good year for investments with the average investment up 18.24%, but the average REIT was up only 8.6% and the average international stock was up 10.5%. The next three years, international stocks were at the bottom of the list of performers. In 1990 the average investment was down 4.8% while the average international stock was down 23.4%. From 1989 through 1997, international stocks were the worst or second worst performers 7 out of 9 years. The 1990's were great years to be an investor, an American investor. A similar story can be told about the years following the 1973-74 real estate recession. US stocks do very well in the years that follow real estate recessions.


This morning the EU has fallen relative to both the US Dollar and the Japanese Yen, again. The big turn is still happening. The price of a barrel of oil is trading below $70, the China market is down again, the 10-year treasury bond rate is down, the wholesale price of gasoline is down to $1.63 (implies the retail price will soon fall to $2.23), gold is down another $11and the list continues. Silver, platinum, Korean stocks, Thai stocks, European stocks, Hong Kong stocks are all trading down. Over the next 12 months, assuming energy prices stay at current levels, the average household will save $4,800 on energy costs. The savings in other areas are more difficult to determine but they will be even greater. With the price of copper, steel, zinc, palladium, down 50% or more, the price of your next new car will be considerably lower than it would have been. Loan rates will soon be at lows not seen in 70 years.



This morning, the big movers, in England, are once again basic materials, capital goods and energy. Commodities of all stripes have gone from tight supply to excess supply. In the mean time, Paulson has asked banks to apply for bail out money by November 14. Paulson's push to get congress to act was once like a man whose house was on fire. After he got control, the government bail out is moving as fast as molasses. At the same time, the FOMC is supplying all sorts of funds to the banking system. Bankers are being given plenty of liquidity with which to remain in business while they wait to find out their fate. Will they be forced to sell shares to the government or not? Many banks will be forced to merge with others. Those who do not need the government money are making plans to buy banks that do not "qualify". The treasury department has been given extraordinary power to pick winners and losers. It is clear that the Bush administration cared more about making big money for the super fat fat cats than about winning republican votes. The action of throwing McCain and the rest of republicans under the bus, has caused billions if not trillions of dollars to run from the market just when money should be running to the market. The super fat cats have purchased billions of shares, including shares from former fat cats. A number of billionaires who were not close buddies of the super cats are now millionaires.


Yesterday, a sophisticated reader, one who is in the investment business, worried that the huge amounts of money being printed by the FOMC are going to cause hyper inflation. I reminded this fellow of the fact that private banks actually control the printing of money. Yes, the FOMC has injected high powered reserves but the money pipeline flows through the banks. The FOMC cannot fill the swimming pool as fast as the banks can collectively drain it. To put it another way, the job of the FOMC is to lean against the banks. The FOMC did not do its job a few years ago when the banks were "printing tonnes of money", but it is currently trying to fill the pool that is being drained rapidly by banks. The monetary base has recently grown by more than 15%! The FOMC is supplying money; stocks and money growth trade together; the new supply of money is increasing the demand for stocks.


Banks print money by loose lending. There are always willing borrowers. The way congress set up the mortgage rules, banks were being paid fees to lend money and there was no end to the lines at the door. The banks that sold the loans seemed to have avoided all risks; most got burnt by buying the AAA rated securities packaged by investment bankers such as Paulson. The current situation is that many banks are on the hook for bad loans made in the past. The average bank has raised the qualifications for getting loans. The FOMC is printing money but banks are soaking up old loans.


To put the above in mathematical terms M*V = P*Q = GNP. The FOMC is printing money but the velocity of money has fallen dramatically and thus the product of P*Q probably fell from second quarter levels. In the energy, basic materials and capital goods areas, we know that it is P that is falling rapidly. Quantity sold in a some areas has been falling but there is a see-saw effect going on. The further the declines in P, the greater the Q that will be sold. In the past quarter, GNP was probably lower than the previous quarter but the quantity sold is going to soar over the next couple of quarters.


The other thing to remember is that money is nothing but another commodity; the rapid fall in the price of commodities, including the falling price of money, is anti inflationary. Copper went up from 50 cents to $4.25 while the retail price of gasoline went from $1.25 to $4.11. The price of copper is now close to $2 and, based on the wholesale price that is working its way to market, the retail price of gasoline is down to $2.23. The price of copper went up 850% while the price of gasoline went up 320%. Gasoline gets noticed, with big signs posted on every corner, while the price of copper is hidden in the price of other goods. The price the FOMC charges for money has fallen from 5.25% last year to 1.5% this year. The decline in the price of money has been bigger than the decline in the price of copper which was bigger than the decline in the price of gasoline. The average fellow spends far more on money and other commodities than he does on gasoline.


One of the ways to play the current situation is to own commodity short funds. For example, there is a double short gold fund and a double short oil fund. These funds have been soaring for the past few months. If the price of gold and oil continue to go down, these funds will continue to do well. I am most confident about the continued decline in the price of gold. The current price includes a "flight to quality" premium. People have purchased gold because they believe the wheels are coming off the economic wagon.


One fundamental reason to buy gold is to protect against negative real interest rates (inflation). The thing is that declining commodity prices are going to raise real interest rates. As soon as the economy starts to move, the FOMC is going to reduce the stimulus of new money, short rates will rise and gold will face high real rates. The past several years were remarkable in that inflation remained relatively tame even as the price of corn, copper and oil exploded. China gets all the blame for the high price of corn, copper and oil, but it also should get the credit for supplying labor at cheap rates. The average American has been blessed by the lower cost of goods and by the creation of high paying jobs in America, jobs that in one way or another are connected to the strong economic growth in China.


In regard to the international situation, Iran's economy is being crushed by the decline in oil prices. The risk of war with Iran keeps going down. Iran is now talking to western nations about nuclear power plants. Russia is about to finish Iran's first nuclear power plant. Volume refiners can supply Iran with nuclear fuel for these plants at a small fraction of Iran's cost of refined ore. The Israelis now believe it will take 5 more years for Iran to make a nuclear bomb. It is in Iran's best interest to sue for peace, especially if they do not have the expertise to build a bomb. The country is hurting and Amadenijhad is at risk of losing power next June. The point for investors is that gold is partly over priced due to exaggerated fears of war. Said another way, it is the price of industrial metals that pull the price of gold up or down; deflation in industrial metals means the rational for holding gold has been reduced.


THE BAD NEWS -- the world wide slow down in economic growth combined with increases in production of commodities over the past 7 years has resulted in a steady decline in the price of goods -- THE GOOD NEWS


Add the savings from oil, corn, copper, money and all other commodities and the average house hold will save $12,000 to $15,000 per year for the next many years. Can you see why companies such as Best Buy will sell a lot of goods over the next several years? Can you see why auto sales are finally going to turn up? Can you see why mortgages are going to get paid?


A sophisticated friend, one who makes his living in the investment arena, made a great point yesterday when he noted that he knows of no one who has lost their job as a result of the current economic recession. One can argue that lay offs are coming and that there are people out of work and there are people hurting, but, the other side of the coin is that the cure is already on the way. Last night, I paid $2.87 for gasoline. The highest I paid this summer was $4.11. Within two months, I expect to pay less than $2.11. On the way up, the extra $2 per gallon hurt, but it will help on the way down. My tank is a 22+ gallon tank. I normally buy about 21 gallons. $42 savings per fill-up will be welcomed relief. Two to five years from now, there will be much talk about just how low prices will go. With anti oil democrats about to take control of government, the US will spend too much money subsidizing wind mills and solar panels. Taxpayers will foot the bill for extra energy supplied. This will mean lower fuel prices and it will mean that we continue to buy a lot of foreign oil. We will pay a lower price by the time the fields in Cuba and Brazil are fully developed.


Buying at a low price from foreign suppliers is not a bad thing. We get fair value for our money when we trade. I frequently buy Washington state apples and grapes from Chili. Still, we should allow drilling while reducing subsidies. We can bring the price of gasoline down to $1 per gallon. Yes, we should convert our tax system from an income tax to a consumption tax, we should be taxing the use of energy rather than subsidizing the production of it, but that is another story. For now, investors should deal with the good news. Make enough money in stocks over the next several years and the relative importance of the price of gasoline will collapse.

THE KING IS DEAD! LONG LIVE THE KING!

Stock prices turn up just as the great majority of people come to know that there is a recession. For more than a year, some have argued that the US is in a recession. The housing business was in a recession way back when the total economy was growing by better than 3%. The auto business was in recession way back when US exports were soaring. The last quarter of 2007 contracted by a tiny amount but the next quarter saw rapid growth. By the classical definition, the US is in recession only if it experiences two negative quarters in a row. After the swoon in September, it is highly likely that the current quarter will be a negative quarter, however, recessions tend to be over by the time most people believe we are in one. The public believes.


Looking back, we see that the real estate recessions of 1973-74 and 1990-91 ended just when housing starts hit rock bottom, just when real retail sales fell rapidly and just as industrial production hit the skids. Over lay the numbers and this recession is just where the 73-74 and the 90-91 recessions were when the markets began to soar.



Stocks were up big in November and December of 1974, but they were down for the full year. In 1975 the average small stock appreciated 52.8% in value, the average large cap value stock appreciated 43.4% in value, the average conglomerate appreciated 37.2% in value, the average growth stock appreciated 31.7% in value and the average non US stock appreciated 26.9% in value. In November of 1974, at the jump off point, new housing starts hit a low not seen in many prior years. The words being used by the news media were about how bad the recession would be and was another great depression upon us?


Google the headlines in early 1975 and you would come to the conclusion that the consumer was unemployed and broke. Many Americans were very confused. Why were stocks going up during the worst of times? Most people decided to wait before "jumping back in". Many waited for a "pull back" buying opportunity. In 1976, the respective gains for the classes of stocks mentioned above were 57.4%, 34.9%, 23.8%, 13.8% and -.6%. (Notice that international stocks do not do nearly as well as US stocks in the years just after a real estate recession). Those who bought a non levered $1,000 worth of small stock shares on January 2, 1975 saw the value climb to $1,520 in a year and to $2,392 in two years. Those who used maximum leverage turned $1,000 into more than $10,000 ($10,000 into $100,000) in two years.


The story of the next and only other real estate recession since 1973-74 is the same. The market "released" around February of 1991, right when everyone was well aware that a recession had hit. The returns on small US stocks (large companies but small relative to S&P 500 companies) over the next several years were: 1991, 44.6%; 1992, 23.4%; 1993, 21%; 1994, 3.1%; 1995, 34.5%; 1996, 17.6%; 1997, 22.8%; 1998, -7.3%; 1999, 29.8%. It was easy to miss the 44.6% return in 1991 because "the wheels were falling off the economic wagon". Even the 23.4% returns of 1992 were not easy to grab because the world looked to be in such great trouble, after all Hillary was about to force the takeover of the private health care system. The average person found the way to start adding money to the markets by the mid to late 1990's. Today, they still wonder what hit them when stocks went down from 2000 to October 2002. The returns of -3.6%, 2.5% and -15.3% of 2000 through 2002 hurt badly if one did not catch the 44.6% return of 1991.


Yesterday, the story went around that OPEC will slash production this week. How silly the concern! At $70 per barrel, windmills and other expensive alternative energy projects make economic sense. OPEC can encourage the building of windmills if it likes. Once the huge capital per kilowatt is spent to build a windmill, it will not be shut down even if oil drops to $5 per barrel. The windmill that does not make economic sense to build makes economic sense to operate. Each member of OPEC certainly wants to keep their oil revenues high. Total revenues are a function of both price and quantity. The current price is well above the cost of exploration and development of new supplies.

Cuba just discovered 20 Billion Barrels; it will make huge profits at $30 per barrel, any oil not sold by OPEC today for $70 will be competing against Cuban oil in a few years. Within 10 years, the USA will be extracting oil from fields adjacent to the Cuban fields.


A few months ago, resources were the King of the Hill. Resources were in tight supply. China, for one, was seeking supply deals from all around the world. Today, resource after resource is being stock piled. Aluminum, steel, copper, zinc, silver and other industrial metals are being stock piled; the amount being consumed is lower than the amount being produced. Gold is being horded because people fear that the wheels are falling off the economic wagon, but, the fact that home sales in England are down 53% from a year ago shows just how much the demand for zinc plumbing facets has collapsed. Palladium has never (as far back as I can find) been so cheap relative to gold! The CRB Index divided by spot Gold prices has not been so low since the fall of 1982, the jumping off point for one of the greatest bull markets of all time. Most of 1982 was a recession year but stocks took off by September. Small stocks gained 28% on the year and were up another 39.7% in 1983.


A few months ago, resources were the King of the Hill, but the King has taken a fall. Many want to help this King back up the hill. Yesterday, energy and materials stocks lead the charge. All the while, the new King is gaining strength. Last night, during a meeting on other matters, I learned that our church pumpkin sale is $4,000 ahead of last year. I noted that people have money to spend and I mentioned that the average family will spend about $4,800 less on fuel over the next 12 months versus the last 12 months. The chorus of gloom and doom from the other committee members was amazing. One believed the drop in the price of gasoline was temporary, another said that those who still have jobs have money and the third said 401-K accounts had been devastated. All points made were true but they all were looking backward. Markets do well during times of falling inflation rates. Inflation rates cannot fall unless they are high in the first place. Getting to the high inflation rate was fun for the owners of resources; the fall will be fun for the consumers of resources.


In a couple of weeks, when retail gasoline hits $2.30 per gallon, these attitudes of gloom and doom will begin to fade. The new king of the hill is not resources but consumers. While Ben Bernanke talks about another economic stimulus package, Americans are starting to receive their first "energy rebate checks". The total value of the energy rebate checks is at least three times the size of the prior government rebate program and the energy rebate checks will just keep on giving. Just like Alan Greenspan, Ben is talking gloom just when boom is approaching.


Perhaps one more set of numbers is worth posting. From November 23, 1990 (during the middle of the real estate recession) to October 1993, Rex Stores (RSC) went up 643% in value. Over the same time frame, Best Buy (BBY) went up 1,472%!


Yesterday, the word on the street was that Circuit City will close hundreds of stores to avoid bankruptcy. CC cannot afford to stock and man these stores during the Thanksgiving through New Years selling season! The consumer appears to be totally tapped out. On the other hand, we know that millions of people will sign up for cable and buy new TV's between now and the analog signal cut off in February. Can you believe that the second generation of the Android mobile computer is close to production? before the first generation has gone on sale! The mad rush is on! Consumers are about to be flush with cash. Retailers will have a surprisingly good season. King Oil is dead, long live King Consumer!

THE ECONOMIC RECOVERY TRADE

The markets are involved in an "economic recovery bounce". In other words, it does not matter if the economic recession is over or not, the things that were hit hard in recent months are enjoying a bounce. Sectors such as basic materials and energy are participating in the bounce, it is going to take a long time for traders to come to realize just how abundant the worlds supply of materials.


Prior to the 1990-91 real estate recession, copper stockpiles were virtually non existent. Stockpiles were listed at 500,000 tonnes but those were spread out at various sites, making it almost impossible to load up a full train without further production. The recession hit but the mines did not close down. Supplies were re-built. By 1994, copper stockpiles reached 6,000,000 tonnes; just in time, because a necessary ingredient of the 1990's economic boom was abundant industrial metals. By 1997, stockpiles were back down to 1,000,000 tonnes, but toward the end of the boom new mines opened and, wouldn't you know, during the economic slowdown of 2000, stockpiles reached 8,000,000 tonnes. When the events of 9-11-2001 caused further economic heartburn, stockpiles reached 10,000,000 tonnes. The swing in copper inventories from bottom to top was 20 fold.



Last year, there were almost no stockpiles of aluminum, zinc etc., but, during the economic cycle of the 1990's, zinc stockpiles rose from 500,000 tonnes to 12,500,000 tonnes and aluminum went from 100,000 tonnes to 2,600,000 tonnes. The swing in aluminum stockpiles was 26 times. so far. It will take years for auto makers to totally retool.


With the disappearance in the demand for copper, zinc, aluminum and other metals upon us, is the economic trade going to last? Not likely. The tea leaves that tell the future are always vague, but it is easy to understand that the demand for copper and other metals is highly cyclical. Copper traded for 50 cents per pound just a few years ago, during a time when more was being put into stockpiles than was being sold. Copper traded for $4 per pound last year. Copper traded last week for a little over $2 per pound. One set of copper users, car manufacturers, are selling cars at the lowest pace seen in 30 years. Car manufacturers are no longer outbidding one another for scarce copper. The price of copper is on its way to 50 cents or less.


Believers in peak oil, tend to believe that all resources are in short supply. They "buy" the theory that China and India will consume all the worlds resources. They believe in the impossible.


The stock market in China has fallen from 6,000 to 2,000 in less than a year! The Chinese market traded below 200 in 1991. I am not suggesting that the Chinese market is about to fall all the way back to 200. What I am saying is that the drop from 6,000 to 2,000 is a forecast of economic slowdown in China. So far, the rate of growth in China has fallen from 11.5% last year to 9.3% in the most recent quarter. If the EU is in recession, which it appears to be, then exports from China to the EU will slow.


I can't remember the ratios but one tonne of uranium replaces many tonnes of coal and one tonne of carbon nano-fibers replaces many tonnes of steel, the same way that one tonne of two by fours replace many tonnes of logs in a home. No one knows how many people our world can support but, so far, the number is many times larger than the forecasts of Mr. Gloom and Mr. Doom of ages past. China's policy of one child per family has been a tough pill for the Chinese people to swallow, but domestic population growth is negative in Japan and most of Europe. The age when children provided an economic benefit to the family are no more. In any event, our world history is of using resources more and more efficiently. The cost to produce and spend a copper penny is at least 1,000 times the costs to electronically produce and spend a penny.


The ""economic rebound trade" is part of our ongoing "see-saw trade". The weight of the energy, basic materials and capital goods can be held off for a short time but it will prove to be more than enough to push up the value of the consumer side of the see-saw. Please note that while consumer staples have been one of the beneficiaries of the confusion, consumer staples are not on the receiving end of this see saw. Consumer staples have held up very well as a part of the flight to quality (people have gotten off the see-saw to avoid the gyrations). The flight quality has included the flight to gold and t-bills. T-bills are being purchased to yield half a percent safe interest and gold is being purchased at $800 per ounce. The irony is that people are willing to accept almost "guaranteed" losses to avoid what they see as greater risk. They are avoiding risk at a time when the probabilities of upside risk are very high.


Back in the days of hard money, dollars were gold or silver or they were backed by gold or silver. The US Government was forced to constantly suffer runs on the bank. During strong economic times, there would be runs on silver. During strong economic times, as the value of industrial metals, such as silver, copper, zinc and aluminum sky rocketed, smart investors would bring gold to the bank and trade it for silver. No matter what the ratio set, the government soon found itself having to accept too much gold in exchange for all its silver or during hard times, the government ran out of gold when tonnes of silver were exchanged. In the late 1500's, Sir Thomas Gresham wrote down the rules about bad money driving out the good. This rule has become known as Gresham's law. In the past year, the value of industrial metals has collapsed. In particular, the price of industrial metals has collapsed relative to the price of gold.


Gold and industrial metals are now in a long downtrend. The decline in the value of industrial metals is part and parcel to a decline in inflation rates. Lower inflation rates produce higher real interest rates. The rational to hoard gold disappears during times when interest rates are higher than inflation rates. Thus, contrary to common beliefs, it is often the price of industrial metals that drags the price of gold up and down, not the other way around.


The above statements are not meant to be an affront to Gibson's Paradox. The price of gold actually moves inversely to the real interest rate on the long term bond. This is perhaps the most important fundamental understanding that one needs to do well as an investor. The key point that is so frequently ignored is that rising short term rates are tools used by central bankers to ultimately lower long term rates. Commodities trade with short interest rates and inflation but a rise in short interest rates, inflation and commodities tends to ultimately push long rates down. It is counter intuitive but true that rising inflation proves to be a powerful force that ultimately drives bond rates down.


All of the above explains why the ratio chart of silver to gold provides better forecasts than the average economist. At the start of one of the worst bear markets of all time, from 1970 to 1982, silver was valued at 5.7% of the value of gold. By the time the market was ready to soar, in the fall of 1982, the price of silver was valued at only 1.75% of the value of gold. The ratio still had a long way to fall. By 1991, the ratio hit 1%. It was time to buy real assets, every thing from semiconductors to real estate. Prior to the big 2000 peak in tech stocks, the ratio had bounced all the way to 2.4% in 1998. It got back to the 1.2% range when it was time to buy stocks and real estate in 2002 and 2003. In 2006 and 2007, the ratio rose to 2.2% and 2.3%. It was time to avoid real estate in particular. Today, this ratio is back to 1.2%. Those who suggest that we are at the start of another great bear market are not paying attention to relative values.


Looking at the numbers from a different angle, we find that by 2002 it took 810 ounces of gold to buy the average house. Since then, the price of houses increased but the price of gold soared. Today, it only takes 300 ounces of gold to buy the average house. Which is cheap, houses or gold? The numbers for silver tell a similar story; it took 53,000 ounces of silver to buy the average house in 2004 but it takes only 15,000 ounces today. The relative cost of a house has fallen 72%! Today, the smart investor sells his gold and silver to buy real estate or stocks on the other end of the see-saw from capital goods, basic materials, energy and consumer staples.


Hank Paulson is taking plenty of time to let the Sword of Damocles hang over the heads of bankers. Bankers do not know their capital positions until after the government buys mortgage backed securities. This period of uncertainty is giving weak kneed investors ample opportunity to sell at low prices, and, how! The public has sold and sold stock mutual funds and bought gold and t-bills. Last year, there was 7 trillion dollars in US money market accounts, this year, with the Dow Jones down 40%, the public continues to sock away money in these funds. The buying opportunity of an age is upon us but the people are afraid.


The public continues to hold energy, capital goods and basic materials in their 401-K accounts. Thus, in the place where they continue to invest, on a regular monthly basis, they continue to buy the "wrong stuff". Again, the economic recovery trade in these sectors is only a bounce. These sectors had great runs, the prices are down enough to find support but not enough to make these sectors the place to invest for major profits. Industrial metal mines will continue to pump out ore at steady rates. For a few years, much of it will be added to stockpiles. Sales of existing homes picked up a bit last month, this does not mean that builders will rush out to build millions of new homes in 2009 or 2010; not in the USA, England, Australia or China. The car story is similar, customers are not going to rush out to buy the big SUV's sitting on lots all around the world. Lower gasoline prices will cause a rebound in the number of miles driven but for many years to come there will be a relative increase in miles driven in more fuel efficient cars and a relative decrease in miles driven to miles not driven. For example, those who own two cars will drive the more efficient one the most and more trips will be made by scooter.


Lower interest rates, lower fuel prices and lower commodity prices will put more money in the hands of consumers. The real price of manufactured goods is going to continue to fall. Retailers are going to enjoy a surge in consumer spending. There is an economic recovery in the works, but the current bounce in "old" sectors is only a bounce. The real value of homes is rising. Banks will soon begin to recognize a bounce in the value of mortgage backed paper. Bank stocks down 50% over two years are set to recover. The rotation to bank stocks is underway. Soon, there will be a nice surge in retailers and technology stocks will follow. For now, the best values are in the banking sector.


Oil supplies work differently than metal stockpiles in that much oil is left in storage under-ground. During the 1990's when oil was in abundant supply, drillers continued to operate their equipment, they continued to drill for oil. They spent most of their efforts finding new oil rather than developing fields where oil was known to exist. This is the reason that when demand soared by 20 million barrels per day, there were no shortages. The oil companies did a great job of developing existing wells. The price went from $1 per gallon to $4 but the free market pricing system maintained order. Eventually, the congress was forced to release restrictions on drilling. Over the next several years, drillers will once again drill when new oil is not immediately needed.


Cuba has reported the recent discovery of 20 Billion Barrels of Oil, in the Gulf of Mexico, adjacent to US waters! During the debate about allowing US off shore drilling, old US Geological numbers were often quoted. Tell me the truth, do you really believe there are only 18 Billion Barrels of Oil off the entire coast of the USA when Brazil has found 70 Billion Barrels, so far, and when Cuba has found 20 Billion Barrels, so far? We know that millions of barrels annually leak into the waters off the coast of California. Eventually, stupidity gets trumped by economics. We will eventually extract the oil from California waters rather than let it pollute our planet.


No matter if Obama or McCain is our next President, either will have to contend with a liberal congress. One that, so far, has been too stupid to collect oil that is ours. A congress that would rather pay friends to pollute than to allow resources to be used. The price that will be paid again will be pork money given to the friendliest of campaign donors. We are not about to run out of resources, we are about to run out of ways for government officials to pay off their friends.

HOW BIG? REALLY BIG!

Few people realize how big this turn will ultimately be. No matter how many times I say that commodities fall in price over time, the feedback always seems to be the question of how low oil will go before it turns up again. I am reminded of Dr. Efird, professor at Duke Divinity School, who often says that you don't normally find the right answer if you are asking the wrong question.


In a couple of recent postings, I have written about how the price of copper has fallen dramatically. The move has just started. Copper sold for 20 cents a pound in the late 1990's and in the early 2000s. In 2006, the price soared to $3.75 per pound. The price went up more than 1,800% in 5 years. The recent drop from $3.75 to the $2.00 range was big but not in the grand scheme of things. The recent drop is a start to lower inflation rates. But, before this move is over, copper will once again sell for 20 cents per pound (in 2001 dollars).


The copper story is about the same as the aluminum story, the steel story and most importantly the same as the corn and the wheat story. The real price of commodities goes down, down and down. People still think that inflation is ready to soar. They don't take into account the possibility that copper and other commodities could fall 90% in price from current levels.


Billions of people in the world do not own microwave ovens. Billions still burn wood, peat or coal for heat. Much can be done to reduce the consumption of natural resources. Much will be done. Supplies of goods are abundant. Prices will fall. Consumers will benefit.


Conservatives elected George Bush and expected change. Liberals are about to elect Obama on the expectation of change. The change in government policy will not be great, but the next 20 years will be a time of great change. The biggest changes will be the fields of genetics. Life expectancy is going to increase beyond most expectations. You are likely to live to see an economic boom like none that has been before. In the near term, the economic turn will be bigger than you think.

INTERESTING SPREADS

The Obama -- McCain spread is closing. McCain needs a minor miracle but his 8 point deficit is down to 4.


The 10-year -- 5-year spread has widened. The yield curve is pushing an economic recovery.


Oil use in the US down 6.2%! Jet fuel use up .1%. Fewer miles being driven. More plane trips being taken.

OIL $70 CAL $31

The last time oil was at $70, CAL was at $31. The economy was better. The economy will get better. The write downs being taken by banks are from real estate price declines that occurred over the past several years. Crying over these prior losses is crying over spilt milk.


Analyst suggest that China is only going to slow to an 8.5% growth rate. If that is true, air travel demand to China will pick up and the decline in oil prices will slow. The trend in oil prices will remain down. The 36 nuclear power plants under construction will be built regardless of the price of oil. Indeed, the world is quickly approaching proposed plants that would double the amount of nuclear electricity. In London, car purchases were down 8.5% year over year. Train stations all over England are being lengthened to accommodate loading and unloading. Once the stations are built, the public will not be quick to go back to car travel. Fly to London and then take the train or the underground

THE TURN CONTINUES

Over the past two years, the S&P 500 index came down 33% and the bank index came down 50%. In the past 3 months the S&P came down 27% and the bank index went up 2%. The turn is being hidden by the talk.


The basic materials sector is down 36.6% in one month! A mother in a crystal shop has given her two year old a hammer. The broad financial sector, which includes mortgage brokers and lenders such as Fannie Mae and Freddie Mac, came down 17.3% in the past month. The KRE bank index came down 15.7%. Down sharply in a month but making the turn represents a buying opportunity.


History remains the best guide. Numbers from the last real estate recession, as made available by Bespoke Investment Group show the following:


In 1990, Financial stocks were 7.5% of the total market value. By 1992 this number had jumped to 10.6% and by 1996 to 15%. The relative bank over performance was 41% in two years and 100% over 6 years; great numbers because the average stock went up during these years.


In 1990, Technology was 6.3% of the total market value. By 1992 this number had fallen to 5.1%. By 1996, it had soared to 12.4%. Right at the turn, financial stocks beat the pants off technology. While financial stocks over performed average by 41%, tech stocks under performed average by 19%. However, after the turn was made, tech stocks over performed average from 1992 to 1996 by 143%!


Energy and basic materials both suffered at the turn and in the years that followed. In 6 years, energy under performed average by 31% and materials under performed average by 19%.


The absolute peaks were as follows: Tech went all the way from 5.1% in 1990 to 29.2% in 1999. In a very strong market, Tech beat the rest of the market by 472%! Of course, the energy bottom and top were opposite of the tech bottom and top. Energy went from 13.4 in 1990 to 5.6% in 1999 and back to 15.3 in July of 2008. The relative performance of the energy sector is partially hidden by the fact that these stocks tend to pay dividends that are many times the average tech dividend.


Consumer staples stocks follow closely behind energy stocks. They peaked one year after energy, in 1991, at 14.5%. Staples bottomed in 1999 at 7.2%. They currently are valued at 12.4% of the total market. Can you see how it is time to be out of the Proctor and Gamble's?


Big gains will soon show up in consumer discretionary stocks, which follow banks. Consumer discretionary stocks hit 13.4% in 2002. In other words, they exploded up just as the manufacturing recession ended. Today, they are down to 8% of the market.


$4,871


The average household will spend $4,871 less per year as a result of declines in the price of oil! It ain't over yet! People who "cannot afford a new car" will be able to pay for one with their "energy income tax cut".


$4,871 supports loans of $58,000. Incredibly, some folks believe that it will be many years before the public borrows money again. The history of America has been that we get over tough times quickly (all the social programs passed during the great depression delayed that turn). 93% of Americans who want to work are working. Another 2% are drawing pay for not working (not counting retirees). Throw an extra $4,871 into the average family budget and a lot of buying will occur.


Despite the low price of stocks, consumers are not hunkering down in order to buy more stocks. The rational for saving and investing seems to have been lost. Consumers will pay off some credit card debt for a month or two but pockets filled with gasoline savings will be hot pockets by Christmas. The turn continues.

TRUTH IN VIDEO -- DON'T CONFUSE DEMOCRATS WITH THE FACTS

A regular reader sent the following link:


http://www.youtube.com/watch?v=cMnSp4qEXNM&feature=related



It is amazing that democrats, with a straight face, say that Bush deregulation caused the current economic crisis. My mind is made up, don't confuse me with the facts!

MIRACLES PENDING

Pakistani clerics have issued rulings declaring suicide bombings to be "un Islamic". The UN says that more than 190,000 Pakistanis have fled from battle areas in Pakistan. The Taliban in Afghanistan is reportedly asking for peace negotiations. We must remain skeptical because we have heard these rumblings before, but hope is eternal.


The ruling in regard to suicide bombings is a rejection of al Qaeda. The US has said it will not negotiate with any group that maintains ties with al Qaeda. Hope is eternal. Bush still has three months to negotiate the peace.

EXPECT NO MIRACLES BUT

It is not time to wilt in despair. Neither is it time to expect miracles. I do not think Obama qualifies to be President but he is likely to be elected. The good and bad news is that Obama is the classic puppet on the string. The "Chicago Political Mob" is responsible for his past elections, his past policies and his future policies. His administration will not be vastly different from a McCain Presidency. My major concern being the potential changes in the war on terror.


Having said the above, there is still a chance a rabbit will be pulled out of the Iranian hat. Now that North Korea is no longer on the state sponsor of terror list, the country is already being courted by nuclear energy suppliers. India, which came off the nuclear sanction list last week, is rapidly developing plans to grow its nuclear power generation by 700%. Iran is jealous.


There are calls from within Iran, begging the 5+1 to come back to the bargaining table. The Iranian leadership bluffed one time too many. They were offered all they could say grace over to make a deal but they held out for more. A major concession from Iran is needed to make the deal worthwhile to the west.


In the mean time, Venezuela and Iran are two of the nations being hit the hardest by the fall in oil prices. Venezuela, in particular, got used to living off high priced oil. It spent its new found money and then some. Stories abound that both Venezuela and Iran need $95 crude to balance their budgets. Today, crude has dropped to $75 and the slow down in China has just begun.


One of the things I do not understand is the huge jump in bond rates over the past few days. The unwinding of the Yen carry trade always gets the blame for big up moves, but it looks like the flood of money into the banking system might be more than enough to re-flate the system. Perhaps this is no big deal as it took until 1993 for bond rates to hit bottom after the 1990-91 real estate recession.


In recent days, there has been push back from the liberal blogging community. The negative side of the nuclear power story has been told again and again. All the while, country after country is gearing up to build nuclear power. Economics wins. The capital cost per kilowatt hour to build windmills is more than double and the windmills run reliably only a third of the time. The Greenies can talk about windmills until they are green in the face but the cost of nuclear power keeps going down relative to the cost of wind energy. The United Arab Emirates is the latest of the oil rich middle eastern countries to go nuclear.


Iran wants desperately to be a leader. It's current policy, which has not changed much in 30 years, is taking the country in the wrong direction. I am sure the Bush administration has said the best deal is on the table now. Does Iran want to depend on favorable terms from an Obama administration that will continue to fight nuclear power in the US?

THE BOOM -- BUST CYCLE IS TURNING

The smoothed real estate cycle is 18.3 years. Turning points hit in 1954-55, 1973-74, 1991 and in 2008. There is also a boom bust cycle that takes 3 to 5 years to play out. We are at that turning point too.


Some people call the boom-bust cycle the copper-gold cycle. During a boom, businesses must buy copper, during a bust, the fearful hoard gold. Watching the interplay of industrial metals with precious metals is the best way to get a quick picture of the boom bust cycle.



For some weeks, I have been writing about how basic material stocks have been getting slammed. Yesterday, the one US sector up was the financial sector. The KRE bank index was one of the big winners. Take a look at its components and you will see stocks such as CVBF making good chart patterns. CVBF made its bottom in July at $7.6 per share. Last week, it tested the bottom by dropping down to $9.51 per share. It bounced off the test and traded at $11.60 yesterday.


Basic materials have not seen the bottom. This morning, on the London Exchange, KAZ, a big copper mining company, is down 15%! The one day fall in the basic materials sector is almost 10%!


LEADING INDICATORS -- THE ECONOMY -- LAGGING INDICATORS


A cycle is nothing but the never ending turning of a wheel. Thus, while most people think of leading indicators as coming first, investors should look for lagging indicators that lead the leading indicators. Lagging indicators tell us when it is time for leading indicators to lead; when it is time for stocks to move up.


Commodities, interest rates and inflation are three lagging indicators. A good way to draw a picture of commodities is to plot industrial metals as a ratio to gold. In early 2000, this ratio reached 62%. The market boom was at its peak; it was time to sell stocks and to buy bonds. By October 2002, the GYX ratio to Gold had fallen to 40% and it was time to sell bonds and to buy stocks. The next peak was strange. The ratio hit 62% in 2006 but the boom was not over. It was not until July of 2007 that yield curves flattened in Europe. I lost my focus and failed to sell stocks and to buy bonds in June of 2007, when the ratio hit 77%. However, the ratio has once again fallen to the 40% area. It was at 42% yesterday but the slamming of copper this AM makes 40% probable by tomorrow. It is time to sell bonds and to buy stocks.


The 40% figure is not magic but it is a strong number. The key point to remember is that stocks turn up while commodities are still on the way down. Commodities, interest rates and inflation rates trade together. The fall of these three set up both the stock market and the economy for a nice run. Yesterday, INTC, a major user of industrial metals, issued a stronger than expected profit report. This, during a quarter when the decline in metals had just gotten started.


What trades with the stock market? The money supply, the yield curve and the Dollar. The money supply has taken off to the moon, the yield curve is as positive as it has been in ages and the dollar turned up several months ago. After financial stocks lead the way, consumers will buy anything that moves. They will take their new found petro dollars to the store.


Looking backward can give a nice glimpse of the way forward. Using Alcoa Aluminum for an industrial metals proxy and Wachovia Bank as a financial stock proxy, we discover the truth about real estate recessions. From the start of 1990 until April of 1993, the US suffered through a real estate recession and a slow recovery. Alcoa Aluminum shares fell 15%. The S&P 500 did much better; it gained 25%. Wachovia Bank gained 123%. None of the above numbers include dividends. Those who held the average stock from before to after the recession made money. Those who held financial stocks more than doubled their money.


THE OBAMA ADMINISTRATION


The Obama administration will not result in great changes to our laws. The annual payments of $1,000 to those who do not pay taxes will not wreck the economy. The payments will not do us any good but the end of the world is not coming. Put another way, the big difference between the Rubin - Clinton Administration and the Paulson - Bush Administration was the timing relative to the business cycle and the willingness of Bush to go after terrorists. The Clinton Administration actually was the more conservative.


Nancy and Harry have suggested they might call a lame duck congressional session in order to pass yet another stimulus package. Blue dog democrats and conservative republicans will form the loyal opposition. Such a bill will not pass without tax increases to pay for the largess. Dead on arrival!


"Conservative republicans" went along with Bush to pass huge spending bills. No child was left behind and seniors got discounted drugs. With liberal spenders in the majority, it will be the conservatives who will keep the brakes smoking. Yes, we will gradually move in the wrong direction but a strong cyclical recovery will provide the funds for growth in the economy and growth in government. The next train wreck will be many years down the road. The boom cycle is here.

LIFE GOES ON

INTC just announced excellent financial results. Apple just announce lower priced computers. Earlier today, BEA Systems announced a major new order for aircraft components, which may be built in Winston-Salem. Life is good and life goes on.


The people of Iceland fell into the trap of 100% home financing. The value of homes soared and late buyers were like snipe hunters left holding the bag. Many a citizen has lost two or three years pay by over paying for real estate. This is sad but it is old news. It will take a number of years for homeowners to rebuild equity and many will choose to rent, but life will go on.



The decline in real estate prices started 4 years ago. Many people hardly cared until a few weeks ago. Now everyone is aware that real estate prices "are falling". But they are not. Some are and some are not but the replacement cost of the average home has been going up while the carrying costs have been going down. Homes in good locations are appreciating in value. This will become very clear as banks thaw. Credit Unions are offering 4% home loans! 5.9% fixed for 30 years!


The demand for long term money has fallen. People want to get out of debt and to stay out of debt. Capacity restraints that were pushing new construction have faded. As spreads between safe rates and risk rates recede, money is going to be cheap. As is always the case, investors who go against the grain will do better than those who do not. Homes in good locations are for sale at prices where the rents will more than make the payments. Now is a good time to buy real estate and the bank companies that finance real estate. There is going to be consolidation and there will be losers and winners but the average bank stock will do well.

Financial Stocks Up

The market broke out and then flamed out. Financial shares are up 3% but the NASDAQ is down. The short term is uncertain but, historically, bank shares lead the way out of recessions.


The price of gasoline is dropping quickly but it has a long way to go before making people happy. A year ago, the average price was around $2.75 and 6 years ago it was around $1.25. This morning, the average price is down to $3.12 and it is headed to $2.60 in a couple of weeks. The decline from the peak to the current price represents a savings of $4.33 per day for each man, woman and child in the USA. This $1,600 per person per year is much bigger than the $1,000 welfare checks proposed by Obama.



It is impossible to predict the future but it is reasonable to expect lower fuel prices, already coming down the pipe, to have a positive effect on consumer spending. The recession will put 2% of the people out of work temporarily but these people will draw unemployment insurance. The savings of the masses will be larger than the losses of the few.

TWO UP DAYS IN A ROW!

How desperate can one be for a major rally? The Volatility Index has been seeing levels seldom seen before. There has seldom been so much pessimism. Conditions are ripe for a major rally. Two strong up days in a row are worth talking about. These trades are "economic recovery trades".


Cyclical stocks, including energy and basic materials, are bouncing high in London again this morning. Economically sensitive stocks, such as airlines, that once traded inversely to oil are now trading with projections for economic growth. Gloom and doom have turned around to see that the world is not ending. Lest we forget, financial stocks are among the most cyclical of all stocks. Plot a ratio chart of the S&P Bank Index divided by the S&P 500 and you will see what I mean. Bank stocks dive into recessions but soar back out of them. For example, by the time the stock market took off on October 10, 2002, bank stocks had been beating the broad index for two years. If you don't believe that financial stocks have been beating cyclical stocks for the past three months, you should take a look at the resource based market in Russia. One day last week, it was down 19% in one day. The market was closed a couple of other days.



Today, in London, the financial index is up another 5%. Energy and basic materials, after being pounded over the past three months, are up around 9%. Yesterday, US energy stocks were up 18% while the average stock was up only 11%! The 11% move was bigger than all but 5 days in history.


For some weeks, I have said that if Paulson wanted to inject money directly into the banking system, he could do so with the stroke of a pen. Actually, Ben Bernanke has the authority to lower required capital ratios. Paulson went through a long drawn out vote as a stalling tactic, making it look like the government was doing something, before doing essentially the same thing. Today, he will announce investments of $250 Billion directly into banks. It sounds better to say that he is investing, even though the borrowed money being invested was invented by the stroke of a pen and is not really different than adding lending authority by lowering capital ratios. The main difference is in the timing and distribution of monies. The danger is that the government camel has poked its nose under the side of the bankers tents. Once a camel smells something tasty, it is almost impossible to keep it out. Had the distribution been made by a small reduction in capital requirements, all banks would have been treated the same and all banks could have seen relief weeks ago.


The big thing that happened between the big drawn out public vote and today was the market bottom that caused huge margin calls. The market was allowed to go down enough to force a lot of wealthy people to sell out at low prices. Of course, the closest friends of the most powerful got the wink to avoid margin, until the bottom was made. Did you ever wonder who did all the buying last week when some very wealthy players were forced to sell? Now that the bottom has been made and now that banks are being flooded with money, those burned by margin trading will be slow to take advantage.


While there are still a few trillion dollars of sub-prime paper stashed away by banks around the world, new accounting rules allow that paper to be valued based on cash flow. As these loans are gradually paid off, refinanced or brought current, the true value of the paper will become known. It should be considerably more than the lowest price reached at the bottom of the turn. Bank stocks fell sharply for more than a year (the KWE index of regional banks fell by more than half between February of 2007 and July of 2008). Again, these stocks are highly cyclical, they tend to make V bottoms early during recessions. They tend to have recovered most of the prior losses by the time the recession is over. They will continue to go up during the recovery years, after the recession, but at a slower pace than other stocks. Looking only at the bank index, we do not see the spikes in relative performance. Again, ratio charts show that bank stocks get killed going into recessions but they lead the way back out.


After an 11% surge, a day of rest would be in order. However, it sure does look like we are going to see TWO BIG UP DAYS IN A ROW!

5% Becomes 10% in a Hurry

This morning, before the US market opened, based on the 5% bounce in London, a 5% bounce in America seemed probable. Over time, it seemed reasonable that the 5% bounce could turn into a 500% bounce. Today the bounce went right on past 5%, past 10% and it settled on a one day 11% bounce!


This has to be one of the biggest "melt ups" in history. The bounce included the beaten down energy and basic materials sectors. The energy sector was up 17%! Don't be fooled. The economic clock is not going to go backwards. The turn from capital goods, energy and basic materials is still upon us. The turn is to financial stocks, consumer cyclical stocks and then technology stocks.



We all understand that as the relative price of something comes down, the more of it we use and vice versus. The price to visit electronically continues to fall dramatically relative to the price of a physical visit. The price of a physical visit is coming down in terms of the price of the fuel required but time is our most precious commodity. The time it takes to visit with someone by phone, email or video feed is a tiny fraction of the time needed for a physical visit. One of the "forever trends" has been our desire to save time. Today, people have more "free" time than ever before but many feel more hurried than ever before. People are looking for more ways to save time.


Yesterday, a quick scan of the Parade of Homes showed that the great majority of fine new homes in the Winston-Salem area are being built far to the west of town in Lewisville. Leave Winston at 5 PM and one discovers a traffic jam all the way from in town to the most distant Lewisville exit. Meanwhile, sales of new downtown condos have stalled. Has the time saving trend already been broken?


A good friend travels some 40 miles 4 days a week to his job. The fifth day he telecommutes. When will his telecommute turn into two out of 5?


While forecasting the future is a fools game, there are some safe bets. For example, it is safe to bet that the long term non levered return on stocks will be higher than the non levered return on real estate which will be higher than the non levered return on bonds. It is also a safe bet that returns from recession lows will be substantially higher than average. It is time for the conservative investor to pull money from his bank CD and to invest it for higher returns.


Another safe bet is that we will use less energy per dollar of GDP in five years than we use today. Old trends continue until they are broken, the longer the trend the more likely it is to continue and energy use has declined for thousands of years. A hot bath was once a very expensive luxury. If we are going to use less energy, then we are going to stop driving to and from the Lewisvilles of the world. The jobs, schools and churches will move to Lewisville in one way or another.


A good friend has gone full circle. He worked in a downtown job before he was "encouraged" to become an independent contractor for his firm. As an independent contractor he worked from the home. After about 5 years, the contract work disappeared. He is now back at work at a downtown job. One that is done at a major medical center. His work involves a lot of time looking at a computer screen. I suspect that the work could be done from his home. Is the work being done at a central location because the medical center is largely supported by US government grants? In the long run, will it not be found that it is more efficient to do this work from home?


Working from home reduces transportation costs, but, again, it is the travel time that is precious. The gasoline consumed in a daily commute of an hour (counting parking time and time to and from ones vehicle) might be valued at $4, but the hour of non productive work might be valued at $40. Working from a computer changes the dynamics of "relationships". Computer connections are getting better. At some point, the worker at a terminal will be more connected than the office worker. Collaboration via computer networks is still in its infancy. We are perhaps a long way from deciding to hold a Wednesday night bible study via teleconference, but the day is coming.


Exxon Mobile is going to be around for many years to come. Oil is going to be a part of our energy mix for many years to come. The bounce back today of energy prices is only a bounce on a new trend line. Energy stocks showed strong relative performance from 1999 until 2008. For the past 3 months, in the middle of great noise about a financial crisis, bank stocks have out performed energy stocks. This new trend will gradually gather steam and it will last several years. There will be consolidation of banks and the relative number of physical visits to banks will decline, but bank stocks will do well. The Secretary of the Treasury is the "king of the day" in America, but most of his work is done. A system is in place to re-capitalize the banks that are in trouble. The decline in energy costs, including the pending drop in the price of gasoline to $2.50 per gallon, will give consumers the money they need to pay mortgage payments. The unfreezing of capital will release pent up demand for home purchases. The troubles caused by the housing bubble, the one that reached its zenith in 2005, are mostly behind us.


The FASB has softened its crazy mark to market accounting rules. The SEC refused to act to suspend these rules but the Accounting Board has fuzzied them up enough to give banks wiggle room. Under the new rules banks will be able to price their holdings based on a cash flow model. Last week, banks were holding tight to securities that last traded at fifty cents on the dollar. The bid for the securities was at 20 cents while the banks argued that they were worth 70 cents. Should any bank sell at 20 cents, the other banks would have to recognize the "loss" on their holdings of 30 cents, from 50 cents to 20 cents. The bid of 20 cents was based on the vulture price. Again, the situation was similar to the beach home purchased for $100,000. With gasoline at $4 the home produced cash flow to support only $50,000. The vultures were willing to buy for $20,000 the owner knows that a small drop in the price of gasoline would push the price back to $70,000. Having a government rule that says the homeowner must sell at $20,000 would be a dis-service. Under the new rule, banks can value the "beach condo" at the $50,000 and it can increase its holding value to $70,000 if the "rents" come in strong.


The market is not going to go straight up but investors should remember that 40% of the recovery occurs in only 10 days of market moves. Today was one of those days.

FREE LAPTOP COMPUTERS SOLD OUT!

T-Mobil has been offering a "free" cheap Acer Laptop Computer to those willing to sign up for a $55 per month communication plan. They sold out quickly.


As I wrote the other day, there will come a time when the most sophisticated mobile computers will be available "free" to those who pay for a WiFi plan. Or, and more likely, the day will come when the WiFi plan is "free" in exchange for advertising dollars. The "production cost" of those $55 monthly plans is probably less than $5. Most of the cost is acquiring customers.


Earlier today, I mentioned that a letter sent by Pony Express from St. Louis to Sacramento cost $5. The equivalent information is routinely sent around the world and back for "free".


We live in exciting times. Make sure your children and grand children get every opportunity to learn about computing. Let them play games with kids from all over the world and in what ever language they choose. The big old world continues to grow smaller every day.

DEALS STILL COOKING

It is probably too late for any international deal to help McCain become president, but international deals are still simmering. Indeed, the deal just made with North Korea is an important one. North Korea is no longer listed as a sponsor of terrorism and it is dismantling its nuclear bomb making facilities. North Korea had been a supplier to Syria and Iran.


Iran: the economy is suffering like few others. Shop keepers have closed doors in protest of new taxes. There are shortages of necessities. With each drop in the price of oil, the outlook gets worse. The government has lost its bargaining chips but it still wants to make a deal. In recent weeks the Iranian government has been in the position of the young fellow trying to buy a $30,000 new car for $15,000. He has heard that there are huge mark ups on new cars and he wants the best deal he can get, but no matter how many times he tries, he will not buy that new car for $15,000. He might have success at $22,000 or he might not but it does him no good to stick with his $15,000 offer. Iran has to make a move or it must continue to suffer.



In another sign that deals are simmering, Russia has backed away from selling sophisticated defense systems to Syria and Iran. Russia has no interest in seeing Iran or Syria become strong, nuclear armed, world powers. In the meantime, yet another of Iran's neighbors has struck deals for the peaceful development of nuclear power. Iran is spinning small quantities of nuclear fuel while its neighbors are buying many tons.


Iran and Iraq sat still for about 30 years. Iraq is now moving forward rapidly; it is about to let 20-year contracts for the development of several massive fields. Iran is going the same direction as Venezuela. Iran and Venezuela produce fewer barrels of oil each year because they do not have the expertise to develop rich resources. Unless there is a deal, the revenues or Iraq are going to soar past the revenues of Iran within a few years.


The world wide recession is hitting oil producers particularly hard. Countries that saw nirvana when oil was at $147 will be hit very hard by $60 prices. The effect is similar to the fellow who lost his $150 a day job and replaced it with a $60 a day job. His family has a lot of cutting back to do.


The difference is that Iran has incredible resources. It can make the deal to develop these resources if it wants. In the short run, it appears that the Iranian leadership is holding out to help prevent a republican "victory", but the pressure continues to build.


Iran's partners in crime are gradually going away. The deal with North Korea is one more deal that isolates Iran. There is even talk of peace negotiations between the Taliban and Afghanistan Government. The US is skeptical about the supposed break between the Taliban and Al Qaeda, but anything is possible in the Middle East. The Taliban has switched its allegiance many times before. The key change in Iraq was when Sunnis switched their allegiance from Al Qaeda. Al Qaeda's leaders are being pounded in Pakistan daily.


It would not take much for a couple of great victories in the war on terror. While we still cannot declare victory in Iraq, the battles with Iran, Lebanon, Syria, Afghanistan and Pakistan are all at least close to tipping points. There are 157 terrorist camps in Pakistan, but they are being hit from both directions and there are indications that some leaders are ready to sue for peace.


Deals are cooking. Ethanol plants are closing.


What if the Pony Express had been a government corporation? During its short life, the Pony Express reached the level of having 60 riders in the saddle at all times. They road day and night, through Indian territories. They rode without guns because each letter, written on very thin paper, collected a huge $5 fee (10 days pay). As telegraph wires were strung, the Pony Express quickly closed down routes. Had it been sponsored by the government, we would still have the Pony Express today.


Even with government subsidies and even with the average gallon of gas at $3.25, ethanol plants are going broke. Many are shutting down. Our government mandates the use of certain quantities so the stuff will be around for a long time. Same with windmills and solar panels. They will be around due to government subsidy and mandate. The good news is that the nonsense of government mandate has been at least crippled. For the first time in many years, nuclear power plants are being permitted. The invention of the telegraph continues to change the world (it is now wireless throughout Baltimore). The change to the world from the innovation of nuclear power is just underway. In 10 years, North Korea will be enjoying abundant supplies of low cost electricity and the price of a gallon of gas will be less than $1.50 (in today's dollars).

No Quick Fix

No, I did not mean to say that there will be a quick fix to our financial problems. If that were true, the problem would have been fixed long ago.


We are now in the 12th year of "excessive home ownership". This is not a problem that developed over night. The Community Reinvestment Act was passed in 1977. Peak home ownership reached 69% in 2004, peak prices were reached in 2005. We are in our 12th year of above average home ownership but we have had declining home ownership 4 years in a row.



Historically low interest rates support high levels of home ownership. It is not necessary for housing ownership to fall all the way back to 1994 levels. Even today, Fannie Mae buys loans in which little or no down payments were made. Fannie Mae has been instructed to buy at least 40 billion dollars worth of troubled mortgages each year. Fannie was not put out of business but only had its knee caps broken.


Those who cry out in gloom and doom continue to use statistics as blunt instruments. It is commonly reported that household income has been flat for a number of years. This reporting ignores the decline in the size of households. In recent years, young people have purchased their own houses. The young, single, school teacher who owns her own home pulls down the average household income, but the average net disposable income of individuals has gone up, at least until this "crisis" hit.


There is no quick fix but the invisible hand of Adam Smith has been working on this problem for 4 years. Many a young home owner will "tough it out". In the old days, the young apartment renter might run home to Mama during tough times. The young home owner is more likely to find the way to stay put.


Keep in mind that only a few of the gas and heating oil "refund checks" have been cashed. These checks are not like the one time $1,000 Obama checks. These checks will come week after week and their sum will be many times more than $1,000. These checks come with an automatic attitude adjustment too.


To put it another way, many times more people in the world will be helped by lower fuel prices than the number of people hurt by 401-K balance declines. Furthermore, the fuel rebates go in the pock whereas the gains and losses in 401-K accounts is of little short term consequence. Put one more way, the biggest decline in the value of housing has been a paper entry decline. The great bulk of the prior gains or the recent losses has been of no cash flow significance. My house payment is the same this month as it was 10 years ago.


There will be no quick fix but at what point does the fix take hold? Huge amounts of liquidity has been supplied. Paulson has not spent one dime of the $700 Billion Bail Out money but the FOMC has increased the money supply by more. Central bankers around the world have responded in recent days. The fix is in.

Trillions of Capital Freed UP

India reduced its capital reserve ratio from 9% to 7.5%. With the stroke of a pen, India did, in percentage terms, far more than the Paulson Circus bail out. India did not allow a central administrator to pick and chose winners. All banks, the healthiest and the weakest, got capital relief. The healthy now have room to maneuver while the weak have room to survive.


Ironically, the danger involved her is in "teaching" banks that they can take excessive risk and still survive. But, it was government policies that were the root cause of this crisis and thus it required the action of government to "solve" the crisis.


The "sophisticated" governments of Europe have, like the US, found more dramatic ways to inject capital to the banks. Again, India used the method that helped all banks at once.


The markets are off and running. There will be many more bumps in the road but capital is flowing again.

THE 5% BOUNCE

In London markets, there has been a bounce of 4 to 6% this morning, let's call it a 5% bounce. Every day, while this crisis plays out, assets are being sold by the weak and gathered in by the strong. The good news is that the number one asset class has been making a bottom. Real estate construction has died and the excess of prior inventory is being absorbed.


The recession has caused even more real estate to come onto the markets, but it too is being absorbed. Bring mortgage rates back in line with government securities rates and a mini housing boom will develop. Houses are more affordable today than they have been in a number of years.


The world economy continues to grow. Even growth in the US economy is going to surprise many. Our export-import growth continues. With China and India still above 7% growth rates, US export and import growth is adding a couple of percent to our economy. Housing construction is no longer a big factor. Housing construction has been low for more than a year; the slowdown in housing construction is over.


US GDP is likely to have been negative last quarter but the decline in the price of gasoline to the $2.40 range in a few weeks will give a powerful boost to the economy before the holiday buying season. The average family is going to have much higher free spendable cash next month than what they had last year.


The 5% bounce of one day is going to turn into a 500% bounce.

NOT ARMAGEDDON

The world has taken an economic hit. The hit is nothing compared to WWII. It is nothing compared to the Great Depression. It is no fun but it is not the end of times. Armageddon it is not. The worlds assets have been written down by somewhere in the neighborhood of 15 Trillion Dollars. A lot of money indeed, but still only a small fraction of total assets.


World wide, times were too good for too long. During these good times, the policies of government were designed to inflate the number one asset held by most people. In America, the percentage of homeowners averaged 64% for 40 years. In the late 1990's, US leaders decided to dramatically lower traditional home buying standards. It was a grand experiment that did some good. A large number of families who purchased homes under these programs continue to own those homes today. We reached the level of 69% home ownership before we began the retreat. The cost of government social engineering, combined with greed has resulted in a major correction. That is all! A huge correction, on the order of recession, not on the order of depression or World War. Something to be lived through.



Our top leadership has made a lot of noise while giving our economy ineffective doses of Castor Oil. Democrats and republicans have joined in votes to give $600 to each person in the country and to one day "invest $700 Billion" to "bail out" the banks. The patient feels no better because the medicine offered was designed to give the "doctors" cover for having done something, not to effect a cure. The actual system used to cure "credit drunkenness" has been to allow the biggest binge possible and then to make a lot of noise while millions of people suffer through their hangovers. The pain has been felt by the drunk and by their neighbors, but the neighbors must not be sanctimonious because almost all got at least a little bit drunk along the way. There has been a tremendous amount of talk about all the little band aids being applied but no real influx of core capital has taken place.


It has been weeks since our Treasury Secretary proposed legislation under which the government would "bail out" the banking system. We have been through the long public "trial", but none of this money has been spent. Back when Wachovia was being plundered, the government, without a special vote from congress, was able to grant Citibank 12 Billion Dollars at the stroke of a pen. Now, day after day, banks hoard money in anticipation of the day when the government will establish a new price for securities held by the banks. The "bail out" has been turned into a "Sword of Damocles"; as always, the waiting around in the hospital is as bad as the illness.


Had Paulson wanted this problem solved in a hurry, he could have used existing tools months ago. To make the influx of capital "make sense" to those out to get the "greedy bankers", it could have been done like the Citibank deal, where the government picked up 10% of the bank at a diluted price, in exchange for the accounting entry needed to re-capitalize the bank. As an alternative, all banks could have been given an equal dose of help by temporarily lowering capital requirements.


While living though the real estate recessions of 1973-74 and 1990-91, it became obvious that much of the pain and suffering could have been avoided. In each of these prior recessions, the powers in control of the purse, on the democrat and republican sides of the isle made matters worse than they had to be. Yes, I have seen this movie before. I know how it turns out. After months of being "frozen up", a number of ocean front condos recently sold. The owners finally gave up. They were holding on for dear life, before the public bail out circus came to town. Most of these sellers have lost all or most of their entire investment in the condos. These big chunks of assets are changing hands at prices not seen since a similar game was played in 1991. Like Mr. Buffet has said, the markets are controlled by fear and greed. What Mr. Buffet has not mentioned is that fear is a tool often used by the greedy.


Over the past few years, trillions of dollars of assets changed hands at high prices. Those in control of governments have worked together to bring the value of trillions of dollars of assets down dramatically and once again trillions of dollars worth are changing hands. There are two reasons why It is difficult to be among those buying while the prices are down. One must have money and one must have attitude. Of the two, attitude is the key factor. Money can be found.


Those who buy while prices are low will be well rewarded. This situation is not Armageddon, it is a man made game being played. Yes, people are hurting. But, it is still a game being played by the powerful. Those in power see their actions in a different light. They are "saving the world from itself". Only a very few at the very top knew how much control they had. When this started, the rating agencies and everyone else believed that sub prime securities had been sufficiently isolated. A relatively small problem has been turned into a financial crisis.


One of the many ironies is that the transfer of wealth to the most powerful has been enabled by those who have cried about the distribution of wealth. An a relative basis, the poor did extremely well during the past 15 years. Today, the poor are getting hit the hardest. The healing has already begun, the government will pass a number of more bills to aid the poor. There will be more stimulus plans, more unemployment insurance and $1,000 checks will replace the $600 checks. While these side shows are played out, the center circus ring will move along. No, not Armageddon, not even a great circus.

CONDONING TERROR IN THE WHITE HOUSE?

Matthew 10: 16 "I,m sending you out like sheep among wolves; so be as cunning as snakes and as innocent as doves".


Jesus did not ask us to be stupid. He expects us to understand the "ways of the world". When we pray, "Keep me from evil", we pray in two directions. We want to avoid doing evil and we want to avoid being near unrepentant evil.



McCain and Palin are trying to make Obama acknowledge at least a few of his blunders. Unfortunately, in the world of politics, as well demonstrated by Bill Clinton, one can get away with a lot if one avoids admitting mistakes.


For many years, Obama has been supported by unrepentant terrorists. William Ayers has been allowed to be a University Professor. His story is amazing. He avoided being tried because of technicalities in the law. He admits to being a former terrorist and he wishes he had been a more successful one.


Obama has been less than truthful in regard to his relationship with Ayers. In America, we remember the Boston Tea Party as an "illegal protest". We do not honor those who would kill innocents to make a political point. Obama has known Ayers for many years and has been supported by him. He should have refused to have any association with him. The man should be shunned.


Today, most Americans have little concern about terror. It seems so far away. Daily there are terrorist strikes somewhere in the world. If not checked, the situation will get very bad before it gets better. Electing to the Presidency a man who has been friends of terrorist for many years is not the solution. On the surface, the difference between a McCain Presidency and an Obama Presidency will be similar. The underlying attitudes are very different.

DOLLARS FOR SALE, 86 CENTS EACH!

The average closed end equity fund is now available for at a discount of 14% to its calculated value. These are the times that value investors such as Warren Buffet love. While I must admit that Warren still has powder dry, he has been making some incredibly good deals.


12 OUT OF 12 MONTHS ARE UP!


There are many ways to try to determine when this crunch is over. We know that history does not really repeat itself, but we know it does rhyme with itself. The following is an interesting rhyme. The information was gleaned from Mark Perry of Carpe Diem fame.



There have now been three times in recorded history when the number of miles driven by Americans took significant down turns. The first was an 11 month downturn from December 1973 until October of 1974. This was in the middle of a market meltdown greater than the present one. More than 25,000 savings and loans went bankrupt during this real estate recession. By October of 74, the average number of miles driving per month had fallen by 2.12%. In November of 74, the market shot up like a July 4th firework.


The second occasion was from May 1979 to May 1980. In this case, inflation rates were out of control. Nominal stock prices went up significantly during the driving slowdown. The driving down turn lasted 12 months. The stock market was a good place to be in 1980 but the high inflation rates caught up to the market in 1981 and a very tough market lasted all the way until September of 1982.


The third case is the current one. Miles driven in the 9 months through July fell at about the same annual rate as in 1973. As in 73, there is a real estate recession in progress. This time, the decline in miles driven seems to have accelerated in the past three months. We are now in our 12th consecutive month of declines but prices are falling rapidly. The relief of $2.50 gas is going to cause a number of people to take at least a joy ride or two.


With history as our guide, driving reductions have not lasted more than a year. The sharp decline in prices (gas is selling for $2.68 in much of Oklahoma) is going to provided a long awaited psychological relief. Plus, it will offer real pocketbook relief. The first $30 savings may feel good but the second and the third will see an accumulation of money in consumers pockets.


Beach houses are on sale, many at 65% discounts to 2005 prices. It has been 18.3 years since better deals were available at the beach. Assets available for 35 cents on the dollar. The average real estate cycle is 18.3 years. The bottom is here.

THE NEW WIRELESS WORLD IS IN PROGRESS

All of Baltimore is now a hot spot. The new Sprint-Nextle-Clearwire system is up and running. High speed Internet is available throughout the Baltimore Metropolitan area. The new wireless world is now a work in progress.


For years we have heard that one day dishwashers, refrigerators and thermostats would be Internet available. It now makes sense for manufacturers to manufacture such devices. Houses will not have to be rewired to add smart appliances. For these and many other reasons, the pace of productivity growth is going to gradually speed up in Baltimore; and, in another dozen cities as other roll outs follow. One of the things that will be great about Internet appliances is not that we will go online to start the dishwasher but that we will routinely set it to run at convenient times. We will set digital thermostats to come on an hour before we arrive home. The ease of changing the settings at a computer console will make these features have considerable value. The ability to check the contents of a refrigerator for items such as milk or eggs will save trips to grocery stores.



The futuristic talk about appliances is all for the purpose of presenting pictures of what can be. The daily routine use will be for a sundry of reasons and regular use will make the cost of service fall dramatically. It is realistic to believe that wireless Internet service will ultimately be offered free of charge, to the user. Visa, among others, is already working with Google and others to develop hand/computer payment systems. Again, the beauty will be the free delivery of valuable services. Google and Visa might sponsor the free connection to the home refrigerator and supermarkets. Enter a supermarket and one's hand computer might display ones pantry and refrigerator contents along with a suggested shopping list over-laid on a layout of the store. No more hunting for the brown rice.


In the short run, the world has to get through the stress of the financial crisis. However, progress toward extremely low cost and very available computing is not slowing down. Innovations are bringing down the future cost of computing electricity and dramatically reducing the amount of computing electricity used.


In one of the quirks of history, Western Union, at the time the most powerful company in the world, was offered the rights to the Telephone. WE turned the offer down because it seemed silly to suggest that a person would come to a telegraph office to speak to someone when the telegraph office was willing to deliver a message directly to the party in question. We ain't seen nothing yet!


At a minimum, our "smart phones" will soon know which questions it is allowed to answer, unassisted. For example, my "smart phone" might be willing to tell my wife's smart phone my GPS location. At a minimum, our new smart phones will know when to interrupt our activities and when to take a message. As sophistication is added, our smart phones will become electronic administrative assistants. Nuance or some other company will add the ability for our "smart administrative assistants" to listen to us and to respond in voice.


There are competing hardware, software and service platforms. There will be winners and losers along the way. The cost to build out systems will delay positive cash flow for many years, but this next wave of innovation is going to be huge. Inflation expectations are extremely low largely because easy communications have opened the market place to great competition. Expanded markets benefit low cost producers and consumers.


In the near term, the banks that can hold onto and realize the profits that will be realized by the "mark up" of deeply discounted securities will make billions. Banks that have purchased massive "extra pools" of deeply discounted assets, companies such as BAC, have later paid through the nose to raise the capital needed to support the ownership. Having raised the capital to support the deeply discounted securities, these banks will be in great condition to expand rapidly as soon as the values of the securities increase. If the Paulson Group pays a fair price next week, the values will start to rise next week. A brave new world is just around the corner. (Dow down 600 plus today, so the short run pain continues.)

Selling Fruit Cake to Fruit Cakes!

In the absence of a miracle, Obama is going to be the next President of the US. I am amazed that the media keeps allowing him to sell fruit cakes to fruit cakes.


Obama continues the line that tax breaks have benefited only the wealthy. The IRS reports that in 1980 the bottom 95% of all income tax payers paid 63% of all US taxes. In 2006, the IRS reports that the bottom 95% of all taxpayers paid 40% of all income taxes. The bottom 95% of taxpayers have seen, on average, a 36% reduction in their actual taxes paid. This trend has been steadily going in the favor of the bottom 95% in most of the days since the Reagan cuts.



The number of hours worked by the average person fell dramatically during almost all of these years. My father and I worked 70 hour weeks during the days when we had a family to support. Today, the average US employee works less than 35 hours per week (mostly by choice). People tend to believe they work more hours than they do. Many work a 40 hour week but they take a lot of personal days and vacation days that were not nearly as available years ago. Prior to this recession, the average person has been living much better. Cooking with microwaves or eating out frequently.


It never seems that "times are good". Times always seem tough. Our children all think they grew up in very tough times and our parents got a good laugh when we talked about how much tougher our growing up years were. We must constantly remind ourselves of the words of John Adams. "We are all entitled to our own opinion, but we are not entitled to our own set of facts". Saying it ain't so enough convinces ourselves but it does not change the facts.


More than 4,100 Americans have given the ultimate sacrificial gift in the past 5 years. Pray with me for their families, but without hard individual evidence, please don't allow accusations that they have indiscriminately killed civilians and children. Never before in the history of war has human life been so protected and honored. Ask the families of the 56,000 dead in Vietnam if such great care was taken to prevent the loss of life. The reason the surge worked was because we targeted leaders and convinced the other side to rebel against the indiscriminate killing they conducted.


It is time for the public to protest the selling of fruit cake, by Obama, NBC, the Winston-Salem Journal and any number of "news outlets". How many blind, deaf, apathetic or gullible fruit cakes are there in this great country?

Re: WHAT'S DIFFERENT THIS TIME?

No need to split hairs here. The congress passed Sarbanes Oxley. Not the accounting board or the SEC. It is the responsibility of the board and the SEC put the laws of congress into practice; they "make the rules" but they do not "make the law".


Sarbanes Oxley was passed in response to the Enron fraud. Enron officers were prosecuted and convicted under prior law. Sarbanes Oxley has done us no good what so ever. For example, it did not prevent the fraudulent accounting performed at Fannie Mae or Freddie Mac. What it has done has been to dramatically increase the cost of doing business. This law in combination with others has made it impossible to comply with any one regulators interpretation of the law. Corporation officers are frequently in the position of damned if they do or damned if they don't. Even corporate salaries were largely driving up to extremes by the actions of congress.



The situation is the exact opposite of what Obama claims. He says that the deregulation of Ronald Reagan continued all the way through the Bush term and caused the current problems. There is no doubt that the capital rules or the mark to market rules need flexibility. Tight regulation is a major reason that Wachovia, a firm worth 78 billion last year, was sold for 2 billion a couple of week ago. No doubt greed was a contributing factor but the greed would not have had the path to take had government regulations not forced the actions of lenders.


As one who has suffered greatly at the expense of those willing to change and enforce rules at their whim, I am very sensitive to how incredible heavy the hand of government can be. I am a falsely convicted felon because my wife was almost at the point of death due to the heavy hand of a government run amok. My point remains that our constitution correctly limited the size and powers of our federal government and that we have allowed this government to grow too large.


I repeat the quote made from Lord Acton yesterday. "Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men."


Lord Acton lived after the constitution was written but his words reflect what has happened. Our members no longer go to Washington for the benefit of the people but to gain power over a national purse.

On Thu, Oct 9, 2008 at 11:04 AM, Al wrote:

FASB (Financial Accounting Standards Board) is the designated private sector organization in the US that establishes accounting and reporting standards.The Financial Accounting Foundation (FAF), organized in 1972, is the independent, private-sector organization with responsibility for the oversight, administration, and finances of the Financial Accounting Standards Board (FASB). The FAF selects the members of the standard-setting Board.

Since 1973, the Financial Accounting Standards Board (FASB) has been the designated organization in the private sector for establishing standards of financial accounting and reporting. Those standards govern the preparation of financial reports. They are officially recognized as authoritative by the Securities and Exchange Commission

The Securities and Exchange Commission (SEC) has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934. Throughout its history, however, the Commission's policy has been to rely on the private sector for this function to the extent that the private sector demonstrates ability to fulfill the responsibility in the public interest.
The Mission of the Financial Accounting Standards Board
The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.
Accounting standards are essential to the efficient functioning of the economy because decisions about the allocation of resources rely heavily on credible, concise, transparent, and understandable financial information. Financial information about the operations and financial position of individual entities also is used by the public in making various other kinds of decisions.
Go to www.fasb.org for more information

The correct terminology is FASB Statement 157, as FASB can only issue statements on how to apply GAAP (Generally Accepted Accounting Principles). Statement 157's is in its title "Fair Value Measurements". It establishes that fair value is an exit price in the principal (or most advantageous) market from the prospective of the reporting entity.

(1) Congress did not have anything to do with this statement issued by FASB.

(2) The SEC determined how this statement applied to financial transactions through its authority to enact regulations, as given to them by congress in 1934.

(3) The intent of Statement 157 in full compliance with GAAP, and the devaluations that occurred in property need to be properly accounted for in company statements.

Currently blame is aimed at a congress that allowed for easier home ownership. Why was this a priority to congress? Maybe it was an easy way to avoid dealing with illegal immigration? Make those who were here more upwardly mobile, making room for illegals at the bottom?

What really caused the current crisis in liquidity will be debated for years, but until it plays out, only the people who point fingers and yell the loudest will be noticed. Who did what to create the climate that allowed this situation? Did a congress pass laws that created or contributed to it? Did the FED act inappropriately? What about the Treasury's actions? How about individual greed by bankers and Wall Street?

Yields Chart

The following link shows how tight the euro bund market was in June of 2007. In hind sight, it is very easy to see that one should have sold all stocks in July of 2007 and put all the money into long term bonds.


http://www.kshitij.com/graphgallery/eurosin00_files/Euro%20Yields_31620_image001.gif

OLD FACTS -- NEW ATTITUDES

The facts in regard to the way our world economy works have not fundamentally changed. The attitudes of many people have.


DEBT IS NOT EVIL. Right now, large numbers of people believe that debt is evil. A foolish thought. It is the same idea that knives are evil. A good chef can put a good kitchen knife to great use and kitchen knives help billions feed families daily. The amount of help people have received through the use of debt is about a trillion times greater than is commonly perceived. In the same way that a lot of children have benefited from kitchen knives while never having used one, people who avoid debt, receive benefits from it daily. Without debt our world would be a poor place. Debt is a valuable tool and not one that is going to be thrown away.


Over the past three years, we have been through a tightening phase. The use of debt by the inexperienced was encouraged. The problem is that when the inexperienced cut themselves, they cut the rest of us. Drowning men have threatened the lives of good swimmers. The retired owner of Wachovia Bank shares, one who has no debt outstanding, has been a great beneficiary of the system of debt but this person did nothing wrong and is currently suffering greatly.


Banks in the USA still operate off the same system today as the one of last week or last year. Basically, a bank with $8 on deposit is allowed to borrow another $92 and to lend the entire $100. Since $100 lent ultimately shows up as new deposits in banks, an initial deposit of $8 is "multiplied" many times. The leverage built into the worlds banking system has not gone away, but a few rule changes caused this de-leveraging of assets to be very violent and indeed very painful. Those who have cash to invest are making out like bandits. In times of economic crisis, "cash is king" but even so one must have the fortitude to put cash to work during tough times if one expects to benefit greatly from it.


SAME ATTITUDE


As a college student in 1974, I reached the conclusion that the real estate recession was much worse than it had to be. It was clear that government officials purposely made a tough recession very tough. In 1991, I reached the same conclusion. It was clear that the US economy could have been guided to a "soft landing" but the politically powerful turned a de-leveraging process into a crash. Those who knew in advance how forceful the government would be, made a killing by buying what others were forced to sell. The current "crash" is no different. Those few who knew that new government rules would be used to force banks such as Wachovia to sell, are collecting assets for as little as a penny or two on the equity they invest.


More could have easily been done to cut back on wild speculation when the market was going up, eliminating the need for a super crash, and even after the excesses of the past many years, this crash could have been softened. My attitude about debt has not changed but the importance of using debt at the right time is all the more evident. Those who have the resources and willingness to make levered purchases now are likely to experience extraordinary profits over the next several years.


SUFFERING AND JOY


An age old question has risen to the top. Must we suffer, to experience joy? Without having the deep recession, millions of people who paid far too much for their home, would never know the error committed. They would gradually be bailed out by the long term growth in real estate values. They would live in a fine home while never having saved a nickel toward the initial purchase and while experiencing monthly payments less than their prior rental rates. With no pain in this round, the next bubble might be much greater.


I believe we are all called to give sacrificially. We should all love our neighbors enough to live frugally. One friend of mine tries to "live simply so that others can simply live". However, the investor who invests wisely helps his neighbors too. Jobs are created by the smart use of assets. Where is the proper balance? In any event, it is important to use our funds wisely. We should not spend excessively. Not an easy trick given that we live lives of great wealth relative to 99% of the people in the world. It does not matter if the funds we use are borrowed or not, we and our government should use our money wisely. It is not the federal debt that is creating this problem, not in any way. It was the misuse of government money that was the root cause. Had Fannie Mae and Freddie Mac not had about 5 trillion each with which to buy over priced loans, this event would not have happened.


THE CHANGE IN ATTITUDE AND ENVIRONMENT


Market mavens are talking about the "final capitulation" as if someone is going to ring a bell to say that the end of the down draft is over. All the while the sense of capitulation is in the air. Last night, I listened while men who have been hurt severely by this "crisis" expressed their concern for the retirees who might not have the opportunity to "make it back". The words of concern for others was touching but they also were words of acceptance. Acceptance that times will be tough for many a family for a long while. People will once again save, just at the right time to be aggressive investors.


There has already been a change in attitude but there has also been very real changes in the financial environment. In only 5 or 6 days, the rates on the 30 year Euro Bund has fallen from 4.85% to 4.16%. This means that trillions of euros of cash flows have suddenly increased in "real value" by about 15%! It means the payment needed to support the trillions of euros of debt have fallen by 15%! Yes, a lot of sales and refinancing must occur to realize this 15% of Trillions but it will filter into the worlds economy in the months ahead. In less than 4 months, the rate on the 5-year guilt has fallen from 5.4% to 3.9%. The "safe money 5-year return" in England has fallen 27% in less than 4 months! Capitulation has been going on for weeks.


The average price of a gallon of gas is about to fall to about $2.60 in America. Having predicted these lower prices for a long time, it is painful that they come partly as a result of a tough recession. However, we must not be fooled into believing that prices will "go right back up" when the recession is over. Yesterday, several articles suggested that OPEC is about to have an emergency meeting. One theory is that OPEC will attempt to support an $80 price target. Pundits need to put themselves in OPEC's shoes so they can get a taste of reality. OPEC knows that $80 per barrel is still well above the marginal cost of finding and producing new oil and even the marginal cost of producing energy through a large number of alternatives. They therefore know that if they defend the $80 price, they will simply encourage expenditures to produce energy via other means. No matter what they do, the price is going to settle down to the level where the marginal cost of the last barrel produced is equal to the market price of oil. My current best guess is that this number will be below $50 within three years. It is my belief that the "new nuclear power equivalent price" is lower than $40 per barrel but it will take 5 years before nuclear start ups pick up the pace.


Under the circumstances, OPEC, after making a little noise, will continue to sell as much oil as they can, until the price is at least close to the cost of production in marginal fields. In other words, new tar sand fields in places like Canada may not be developed as soon but they will not stop selling oil from Canada that only cost $35 to $45 to produce. Certainly Saudi Arabia will not stop selling oil that only cost $5 to $18 to produce.


LENDING IS TAKING PLACE


An oft repeated myth is that lending has dried up. In truth, banks, credit unions and others are making loans daily. Highly leveraged companies are desperately conserving cash, in order to hold onto assets that will produce enormous returns on equity over the next couple of years, but most banks and credit unions are not involved in the highly levered transactions.


The returns on extremely levered assets of just a few percent are compounded into massive returns by the leverage. This morning there are clear indications that the large sums of money being pumped into the banking system are starting to relieve pressures on the highly levered. This all before even the first purchase of mortgage backed securities by the TARP (or whatever name the $700 Billion bail out fund now has). It will take months to run the bail out program but the price of the average bank stock will not fall during the bail out.


Even the person who is not inclined to speculate should not use this "crisis" as the reason to procrastinate. For example, homes have seldom been so affordable as they are today. Low prices, low mortgage rates and deals to be had. Now is a great time to buy a home or a second home.


Again, in 1991, under very similar circumstances, my wife and I purchased $200,000 beach condos by agreeing to take over payments. If we were young, we would go to Myrtle Beach now and buy a couple of hundred million dollars worth of property. Coming lower oil prices will release pent up vacation demand. Rents at the beach will increase as will the the value of beach homes. OLD FACTS -- NEW ATTITUDES?

WHAT'S DIFFERENT THIS TIME?

Democrats say that this time is different. They say it is different because of deregulation, started in the Reagan years and continued in the George Bush years. The truth is that a horrible regulation, passed by democrats and enforced by Hank Paulson, is causing a great transfer of assets from "little boys" to the "big boys".


Throughout history, cash flow has been the key to success in business. Businesses can suffer catastrophic loses, lose tons of money, but stay in business and recover as a result of positive cash flow. Many a consumer, who paid too much for a car, has experienced this phenomenon. Car "owners" frequently go "under water" because a car depreciates in value dramatically, the moment it is driven off the lot. Consumers often owe more money than their cars are worth. However, we do not add insult to injury and take the car away at the worst of times if they are making the payments. If they make regular payments, over time, they climb back into the black.



In the condo rental business, condos that I purchased in 1996 were worth less than my loan balance after 9/11/2001. I was deeply underwater, but I made the mortgage payments and the values soared by 2005. Had Hank Paulson been in charge, after 9/11 he would have required me to sell my property in 2001 and realize huge loses which would have never been recovered.


Since Reagan's time, a number of new regulations have been passed. Regulations were passed that forced banks to make mortgage loans in the highest risk communities to the highest risk borrowers. The combination of low interest rates and unrestricted credit caused housing prices to soar. It became easy to pay too much and millions of people borrowed too much. November 2007, yet another new regulation took effect, FASB Rule 157. This accounting rule basically says that it does not matter what was paid for a house or if one intends to sell it soon, it must be valued it as if it must be sold tomorrow. Because banks, by design, work off highly leveraged capital, Rule 157 forces banks to sell assets when they go down in value. If you had to sell your house tomorrow? How much do you think you could get? Should the government be allowed to force you to sell tomorrow even if you are making timely payments?


While democrats and republicans are all to blame for this mess, it is painful to know that far more than a fair share of the blame is being heaped on republicans. One of my beefs is with gullible Americans who allow Obama to get away with blaming the crisis on deregulation. During times of stress, people want someone to blame; Obama knows he can divert the blame onto "big business" and the free market, because the complete story, including the major role of Fannie Mae and Freddie Mac, is a complicated story. Since Bush is a very unpopular President, it is easy to divert the finger pointing to him and in effect toward McCain, even though both men proposed reforms that were rejected by democrats.


It is not unusual for a significant number of businesses and households to be underwater during tough economic times. What is unusual is that Hank Paulson is insisting on "his solution" while businesses and families are being harmed. As Bob Tierman? said on CNBC this morning, the President has the right to suspend habeas corpus and the bill of rights during a national emergency but apparently FASB Rule 157 is sacrosanct.


With a stroke of a pen, rule 157 could be suspended. Even better, it could be modified. Only those very close to Hank Paulson could have known that he would be willing to use the stupid rules passed by democrats to rape and pillage. The mistakes made by democrats and then the support from them to pass the "Paulson solution" has given him all the cover he needs to cause a massive consolidation in the banking business (big losers and big winners being picked by Paulson and cronies).


As made evident during the Wachovia circus, CitiBank was to receive an investment from the government of 12 Billion Dollars in order to buy a bank recently valued at $78 Billion. WFC was willing to buy WB for about 12 Billion Dollars more than CitiBank would pay and without the 12 Billion Dollars of assistance from the government! Change the ridiculous mark to market accounting rules and WB could easily survive on its own. The shareholders would not be getting raped.


As Lord Acton said, "Power tends to corrupt: absolute power corrupts absolutely. Great men are almost always bad men." Our government has gained much more power than was authorized by our constitution. Tom Osborn voted for the Paulson Bailout Plan even after declaring the unconstitutionality of it. The machine has gotten too big. A mistake by the powers that be could bring an end to civilization as we know it. The size of government needs to be gut. The Acton Institute Power Blog is worth reading.


Any company that has the cash flow to pay its bills should not be forced out of business by powerful special interests. That has always been the rule. It is different this time.


GOING THOUGH THE MOTIONS


The ECB and BE are finally bringing European interest rates down. These are powerful moves but until the Paulson wheel lock is removed, this train is not going to go anywhere fast. Paulson refuses to remove the wheel lock with a stroke of a pen, but by next week his program of buying up assets cheap will begin.


A friend wants to know why the government is not doing another RTC, the method used during the 1990-1991 recession. In that program (and in the HOLC program during the great depression), the government bought troubled real estate, not just the mortgage secured by the real estate. In many cases, legal title involved a court battle. In some cases, the RTC actually had to pay to unload unfinished buildings. The demolition costs were more than the value of the land. The Paulson system is far more efficient than the purchase, maintenance and reselling of real estate.


My memory is that that it took 25,000 government employees to administer the depression era program. Paulson will sub contract a lot of work and have only 25 or so government employees. The program will be efficient and successful in terms of making a profit for the public. The public will be fooled into the belief that Paulson saved the country from collapse. Stories will be written about how JP Morgan made out like bandits but they will keep the profits made and play the same game some years from now. So far, this process has already caused the changing of hands of billions (if not trillions) of dollars of assets at very deeply discounted prices.

FIGHTING THE BLUES

For three days I have been fighting a flue bug. No fun. This must be the third one for me in less than two years.


Watching this market has made the aches and pains all the worse. The stress caused by the market meltdown has been visible in the faces, voices and emails of family and friends.



Last week, a regular reader and good friend wrote about a nerve condition that has made one side of his tongue go numb. I mentioned his condition to friends Friday night and was reminded of another friend who once had Bell's Palsy. The left side of his face temporarily went numb. I am not trying to give a medical diagnose, but I am keeping my friend in my thoughts and prayers. It is comforting to recall that the friend with Bell's Palsy was self healed in a few weeks.


THE MARKET CURE IS BEING DELIVERED


Central bankers are delivering the goods and gearing up to deliver more goods. Furthermore, without the aid of the central bankers, the market is delivering its own cure.


In three days, the 10-year Euro Yield has fallen from 4.85 to 4.2%. The US 30 year bond is at the historic low of 4%. Mortgage rates have once again started to fall. In the UK, the 5-year note has fallen from 5.8% in June of 2007 to 3.9% yesterday. Back in June of 2007, it was hard to see that 5.8% was a high interest rate; a very expensive miss. Short rates were just cut in Australia (a full 1% cut), Israel and India. The drop in Euro yields is going to force the ECB to join the club very soon and the US has already instituted a De facto cut of 1%.


With my head feeling like it weighs 100 pounds, it is time to stop. I leave you with the thought that the "investor class" which is republican dominated cannot get slammed much harder. It looks like we are headed for financial Armageddon just before a democratic three house sweep. Are we at the depths of despair? Indicators such as the VIX show levels not seen since October 2002. Is there hope?

MORE GREAT NEWS!

Non farm payrolls fell at the fastest rate since March 2003. The stock market made a bottom in October of 2002 and then tested the bottom in March of 2003. It was smooth sailing for the next couple of years.


Employment is a lagging indicator. Once unemployment rates jump by 1.2% or more, history tells us that the turn in stocks is upon us. Inflation pressures simply go away by the time unemployment rates jump. Interest rates around the world can be lowered once it is clear that economic stimulus is needed, just as some central bankers finally let off the brakes a little, others step on the accelerator.

WOW! GOOD NEWS COMES IN THREES

1) This morning an Iranian official hinted that Iran might suspend its production of uranium if it got "cast iron guarantees" on the delivery of supplies from international sources. IS THIS JUST ONE MORE TEASE? It is nothing but rumor now, but it is the kind of news I have been hoping and praying about for a long time. Stay tuned!


2) Wachovia has negotiated the sell of the company to Wells Fargo. President Steele has praised the management of WFC and he offers the encouraging note that the deal will allow Wachovia to remain intact. Shareholders will receive about $7.


3) Palin did a fine job in the debate and Biden once again stretched the facts enough to provide fodder for campaign ads. Plagerist never learn?


Because middle class voters in key swing states tend to be anti big business and pro union, both candidates blamed greed on wall street for the mortgage meltdown. Little was said about the complicity of congress. The record is that McCain introduced a bill in 2005 to reign in the abuses of Fannie Mae; this bill was shot down by democrats who said that there was no problem and that lending should continue. For the most part, the story of how we got into this mess will be left up to individual congressional races as some republicans voted with democrats when banks were pressured to make risky, nothing down, no documentation loans to one and all. It will be up to the great numbers of honest bank employees to make the case that banks, wishing to make any mortgage loans, were required to make considerable numbers of risky loans or to face prosecution. Companies like BBT avoided the meltdown by focusing on loans to builders. They got burned a little when construction died but the loans to builders were of a commercial category where the pressure to lend to the unqualified was not so great.


Last night, whenever either candidate blamed greedy wall street, the focus group approval dials went up. When either mentioned government blame, the dials of men went up but the dials of women went down. Women were much more supportive of government intervention. They are willing to break contract laws, forcing banks to suffer at the expense of individual borrowers, without any determination of bad faith on the part of banks. Women have always been more supportive of government mandated health care.


The comparison of the heavy government involvement in the mortgage market and Obama's plan to mandate health care should be helpful. Anyone who even thinks about support for massive government health care should stop to think about the governments intervention to make mortgages affordable. Government mandated, affordable health care, will ultimately be extremely expensive. It is ironic that Russia is no longer a super power because socialism tends to fail, while America continues to move in that direction.


IRAN


BOY! If the table were ever set for a deal in Iran, it is now. Last night, when Biden was asked which was the most dangerous situation, Pakistan or Iran, he focused on Pakistan. Pakistan has nuclear weapons but they are on our side. Would it be better that they not have nuclear weapons? Certainly! However, which country has expressed its desire to use nuclear weapons? Iran!


Obama has implied that US forces have recklessly killed innocent civilians in Afghanistan. There has been collateral damage, as there is in all wars, however, this has been the first war in history in which targets have been precisely selected. Instead of throwing hundreds of relatively inexpensive bombs into enemy territory, where there are women, children and other non combatants, the USA has sent $70,000 precision guided missiles and bombs directly to the vehicles and headquarters of known leaders. The enemy has often hid behind the skirt-tails of women and the diapers of children, but one of the reasons millions of Sunnis in Iraq joined the fight against al Qaeda is for the very reason that al Qaeda has killed indiscriminately and the US has done an excellent job of preserving life.


Most importantly, there are rumblings in both Afghanistan and Pakistan about potential peace for peace negotiations between the remaining Taliban leaders and the governments of Afghanistan and Pakistani. Negotiations are not likely to begin before the US election, but US precision ordinance is making the leaders of our enemy cower in caves.


The words of Obama have been extremely hurtful. He has repeatedly given encouragement to the enemy in Iraq, Afghanistan and in Pakistan. He has been adept at converting some of his hurtful words into rational positions, but the man is dangerous. His plan to invade Pakistan in order to take out Osama bin Laden has been modified to the position that we will take him out if we get actionable intelligence. For many months, the Pakistani government has allowed the USA to take out enemy leaders in Pakistan, provided we did not acknowledge that we have the governments permission. Obama has made it difficult for the Pakistani government to work with America without catching political heat. Obama has demonstrated his naivete or he has purposely tried to win the election by causing more pain to America, you decide which. When an American Presidential candidate says that US troops are killing innocents, the statement races like wild fire through the enemy camps. When he says that the US should invade Pakistan, the US becomes the feared enemy rather than the friendly ally.


RUSSIA INTERNATIONAL POWER


Russia, in exchange for military aid to Somalia, has influenced yet another nation to recognize the break away states of Georgia as independent countries. Now in addition to Russia, there are two who recognizes these small territories as nations, Nicaragua and Somalia. Both very influential countries on the world stage (yuk-yuk). Russia is losing this battle. If it wants to continue this ruse, it will continue to do so at great economic costs. The way to resolve the issue while allowing Russia to save face is through a multi-party peace accord with Iran.


Obama has shown little knowledge about the role of nuclear power in world wide diplomatic struggles. However, his position continues to evolve. He is slightly more aware of the need for nuclear power than he has been in the past. It is absolutely amazing that China is in the process of building 100 nuclear power plants, designed by Westinghouse, while Obama continues to push for 30 cent on the dollar subsidies for expensive and unreliable wind mills. Subsidize nuclear at the same level and the price of gasoline will be below 70 cents per gallon in 7 years.

A GOOD DAY IN THE MARKET?

My guess is that the market will do well Friday. The bail out will pass and investors will have new hope that McCain will win the Presidency. The tax increases proposed by Obama would not be good for the country. Tonight, CNN focus groups were mixed while Fox focus were impressed by Palin, several decided to vote for McCain tonight. Frank Lutz declared that the polls will move in McCain's direction over the next 48 hours. McCain has a lot of ground to make up and only a 30 days to do it. On NBC, Tom Brokaw said that after tonight, democrats are thankful that there is only one vice-presidential debate.

VICTORY! VICTORY! and VICTORY!

VICTORY NUMBER 1


My guess is that the house will vote for the bail out bill tomorrow and declare VICTORY! The bill was improved from the prior bill by the increase in FDIC insurance and by the moves by the SEC to lighten up on the mark to market rules. Furthermore, republicans will be delighted to pass the AMT tax cuts. A significant amount of the increased spending has been explained away as renewals of previous laws. Those who are friends of T. Boone and other investors in solar panel and wind mill companies will also be pleased to vote yes. The ones, who voted no the first time, now have cover to declare that they made a horrible bill much better. The markets should reward the positive vote.


VICTORY NUMBER 2


Gasoline prices will fall by more than $1 per gallon between now and election day. The wholesale price hit $2.25 today, making the expected retail $2.85. Republican members will reap benefits from now until election day, each time the price of gasoline is reported lower. The average price retail price was $2.33 the day that Nancy Pelosi promised the American people that democrats had a plan that would bring the price down. The moratorium on drilling was in effect during the entire run up to more than $4 per gallon. We will see Nancy's nationally televised promise replayed many times between now and the election, along with her promise not to save the planet and never allow drilling. The pending movement in energy prices is a huge plus for republicans. Democrats will counter that the price is down because the economy is down and republicans will counter that the economy is down because democrats made bank executives criminally liable if their bank did not lend to unqualified borrowers. People who have never heard of the Community Reinvestment Act are going to learn about it between now and the election.


VICTORY NUMBER 3


Against very long odds, the Bush administration has guided the nuclear 123 agreement with India through the congress. India is already moving forward rapidly to further develop nuclear power. Negotiations between India and France are well underway. India expects to spend 80 Billion US Dollars on nuclear plants over the next several years. Now that the bill has passed, US firms such as the GE-HIT partnership will be allowed to bid on Indian projects.


In the mean time, in response to Russia's invasion of Georgia, Australia is backing away from its plan to sell $1 Billion of uranium to Russia annually. Turkey is backing away from its plan to have Russia build and supply its next plant. The USA pulled the Russia 123 Treaty from Congressional consideration about a month ago. Russia is paying a significant price for its invasion of a sovereign country.


The deal Russia had with Australia highlights the way Russia is trying to corner the energy markets. Russia is willing to pay a premium price for ore, even if it means leaving its own ore in the ground, so that it can be the biggest seller of refined uranium on the planet. The US was willing to cut out the competition of the "little guys" provided Russia was willing to help cut supplies off from Iran. It seems unfair to make a uranium supply deal with India, which has not signed the NPT, while penalizing Iran, but Iran has been open about its willingness to use nuclear bombs on Israel. India has acquired nuclear bombs for defensive purposes. The new rules will make it much more difficult and costly for other nations to develop nuclear bombs.


The passage of the 123 Agreement with India was important, partly because it has made it possible for the US to compete with Russia for another major nuclear consumers business. Russia is once again being left out in the cold; but, only because it is willing to play by "iron rules" rather than cooperating with its neighbors.


It is still amazing how infrequently we hear about nuclear power as being the best alternative to dirty coal. We continue to spew out tons of carcinogens while clean nuclear power plants turn out cheap electricity. The amount of nuclear power generated is going to grow significantly over the next 5 years and then it will grow at a rapid pace for the next 10, 20 or more years. Politicians on both the left and the right, who are for nuclear power, tend to talk about clean alternatives while avoiding using the word nuclear. Obama professes to be for nuclear power, but he adds his tag line in regard to the safe disposition of waste. He is for off shore drilling provided the tax revenues go to the "alternative fuels slush fund" instead of the states. Of course the states will not allow drilling unless they share in the revenues. Neither is Obama willing to acknowledge that the waste is being stored safely or that new technology has turned the waste into very valuable fuel. McCain is one of the few politicians who engages in "straight talk" and declares his support for nuclear power.


I am anxious to know when the first "nuclear battery" will be delivered. It will probably take a few years to make but the developer already has orders in hand. These nuclear batteries can be safely hauled on the back of a flat bed truck and they require no upkeep or maintenance during 7 to 10 years of operating life. Their use would lower the cost of heating tar sand oil by 70%!


Russia would very much like to be involved in this field of commerce. I will not be surprised if Russia agrees to withdraw from Georgia to get back into the good graces of most of the rest of the world. Russia can probably bully Ukraine, Kazakhstan, a few other former Soviet states and a few renegades such as Venezuela, Nicaragua and Iran into buying uranium from Russia, but Russia must be a good neighbor if it wants to do business with the rest of the world. VICTORY will come if the processes championed by Bush are allowed to play out over then next year or two.

VIOLATING US LAW -- THE SUPREME LAW

Tom Coburn gave an 8 minute talk in the senate. The congress is violating the law of the land by passing bills that exceed the powers granted to congress in the Constitution.


Here is the link:


http://www.youtube.com/watch?v=P-PxA5nUjkg

BATTLESHIPS FRONT AND CENTER

Stratfor just issued its first of the month update on the deployment of the US Navy. There has been a lot of activity. Battle strike forces have moved into positions near North Korea, and Iran. The USS George Washington and other ships are now stationed in Japan, between the eastern ports of Russia and the Middle East. The USS Ronald Reagan has been in the Arabian Sea for several months, supporting US operations in Afghanistan. The USS Iwo Jima and its complement just left the Mediterranean Sea via the Suez canal and is now just south of the Ronald Reagan.


Was all this movement made to intimidation Russians or Iranians or was it part of the Paulson $700 Billion Dollar "Oh My the World is Coming to an End" scare tactic? Did the public rush into gold and t-bills at the bottom of the stock market because of the financial crisis or are they concerned about international affairs? Probably the former as few pay attention to international affairs.


Or, is there more to come? Will the USA follow through on the previous "mini blockade" that kept Iran from selling oil during the month of May? The Russians have prevented new UN sanctions, but the previous "mini blockade" was done under terms of prior sanctions, which have not been repealed. Should the USA enforce a gasoline delivery blockade to Iran, there is little that Russia could do. Iran has been working feverishly to convert autos to run off of natural gas. The Russian Navy is in route to the coast of Somalia, where a Ukrainian ship, carrying Russian tanks, has been hijacked (did the USA encourage the pirates?) and other Russian ships have made port at Syria. In any event, he Russian Navy does not hold a candle to the US Navy. The USA does not want to do battle with the Russians, but the Russians are even more certain that they do not want to do battle with the USA. Who knows how many submarines are lying in wait?


It is possible that the US and our European allies have privately given Iran a final deadline to stop making nuclear bombs. The delivery of our most sophisticated radar defense system to Israel (staffed and maintained in private by US forces), two or three weeks ago, and the sale of F-35's to Israel suggest that the US is prepared for any response, from Iran or Russia. Because several deals have been very close to conclusion, I very much want to believe that the US has issued a final deadline and that Iran will follow the obvious best route, which is to conclude the final steps to a deal.


Syria has demonstrated its support for a pending deal by massing troops along its boarder with Lebanon. Yesterday, Syria admitted that it has not been able to stop the smuggling of arms from Iran to Hezbollah. Syria has called on the government of Lebanon to provide assistance. These are signs that Syria wants the negotiated deals between Israel and Lebanon and between Israel and Syria to be concluded.


It is hard for me to believe that several major battle groups have been deployed just to show Russia or Iran that we have them. The price of crude oil continues to remain stubbornly high, even after the Saudis have started producing 500,000 barrels per day no yet another new field and in the face of billions of barrels of new discoveries in Brazil and, yes, in the face of the end to the moratorium on US offshore drilling. The price of oil and gold continue to be held up in part by geopolitical risks.


With or without the successful conclusion of a deal with Iran, the Obama plan, which was to have withdrawn from Iraq a year ago, was clearly the wrong choice. Iraqi soldiers continue to take the place of US forces in battle. Death rates continue to fall and the political reconciliation process continues to make progress. The coming next vote in Iraq will show that the people have bought into the concept of democracy!

INVESTORS MAKE A RUN FOR THE GOLD!

In September, investments in Gold ETF's increased by 4 BILLION DOLLARS! We are hitting the hair pin curve of the turn very hard and yet the public is going the wrong way around the curve! They are in a scramble to see who can run right smack into a freight train first.


Today, the evidence is as strong as ever that the turn is here. Basic material stocks are down almost 10% in one day! Conglomerates, energy stocks and capital goods stocks are are down n the 5% to 7% range. With the basic commodities such as oil down 4% (gold down 5%), it may seem strange that the transportation index is down 7%! Take a look and you will see it is the railroads that are taking the bulk of the hit. The demand to haul coal, iron ore and forest products is falling and the advantage that trains have over trucks is falling with each decline in the price of fuel.


The numbers are compelling. Four Billion Dollars in Gold Funds, the government ran out of the popular gold buffalo coin and one month treasury securities pay almost nothing. Warren says to buy when other are fearful. You nor I can get the same sweet deals as Warren but Warren is buying highly leveraged positions. He purchased shares in Goldman and in GE. GE, among other things, is a lender. If you buy GS and GE, you will make money, not as high a return as Warren but you will make money.

Re: ATTITUDE INTERVENTION NEEDED

We must remember that there is a tug of war going on to control the steering wheel. When the vehicle is about to go into the ditch, it takes more than a tug from the middle to get it back on course. Democrats drove the banking system into the left hand ditch. Now they are trying to blame the right and at the same time trying to take credit for steering out of the ditch. Anyone who has done a small amount of research on the history of Fannie Mae or the Community Reinvestment Act knows that this vehicle could not have run into the ditch without the tugging on the wheel by the left. Anyone can easily see that the very bill that is supposed to steer us out of the left hand ditch was loaded up with more than $78 Billion Dollars of mostly wasteful subsidies. This stuff is not middle of the road stuff. It is the immoral taking from many citizens in order to give a selected group of friends undeserved payments from the government. It is nothing more than a continuation of charging poor and middle class people more for cokes, corn bread and corn chips in order to provide payoffs to wealthy campaign contributors.

On Thu, Oct 2, 2008 at 12:28 PM, Al wrote:

In 1976, I was in very rural southeastern Utah driving a van that was towing a travel trailer. I found myself on a narrow road with no guard rails, that ran along the top of a ridge which dropped off steeply on both sides. This experience brought the phrase " middle of the road" into reality. As life tempered me over the years since this experience, it has become more and more oblivious that real progress can only be made by holding close to the middle of the road. At times a little shift to the right or left may be required to negotiate the hazards on the road, but veering too far either way results in disaster. The economy and politics are deeply intertwined and at times it is nearly impossible to separate them to find reality. Almost all political decisions are made for economic reasons, not ideological reasons. This leads to the haunting question for political decisions, "Who is benefiting economically?"

I believe that the easing of credit to make home ownership available to more people had its root cause in illegal immigration, which was helping business in the US to increase its profits in many ways, the least of which was through their employment. Along with the normal increase in population through births and legal immigration over the last decade, a new market of over a million people a year was created for goods and services. More housing has been needed by these immigrants and it has usually been low end of the scale where no one but the government invests money for new construction. Imagine the outcry if this has been proposed! The solution was to make it easier for existing citizens to become home owners. Thus opening up lower strata rental units for illegals. It also delayed the cries to stop illegal immigration because everyone else felt they were moving up the economic ladder, the Great American Dream. But, too much deregulation and lack of policing existing regulations created a market too lucrative that the temptation of greed could not be resisted by some. As in any overheated segment of the economy, a correction followed.

The real question is "Which side of the van and trailer have their wheels off the road?"

Re: ATTITUDE INTERVENTION NEEDED

We must remember that there is a tug of war going on to control the steering wheel. When the vehicle is about to go into the ditch, it takes more than a tug from the middle to get it back on course. Democrats drove the banking system into the left hand ditch. Now they are trying to blame the right and at the same time trying to take credit for steering out of the ditch. Anyone who has done a small amount of research on the history of Fannie Mae or the Community Reinvestment Act knows that this vehicle could not have run into the ditch without the tugging on the wheel by the left. Anyone can easily see that the very bill that is supposed to steer us out of the left hand ditch was loaded up with more than $78 Billion Dollars of mostly wasteful subsidies. This stuff is not middle of the road stuff. It is the immoral taking from many citizens in order to give a selected group of friends undeserved payments from the government. It is nothing more than a continuation of charging poor and middle class people more for cokes, corn bread and corn chips in order to provide payoffs to wealthy campaign contributors.

On Thu, Oct 2, 2008 at 12:28 PM, Al wrote:

In 1976, I was in very rural southeastern Utah driving a van that was towing a travel trailer. I found myself on a narrow road with no guard rails, that ran along the top of a ridge which dropped off steeply on both sides. This experience brought the phrase " middle of the road" into reality. As life tempered me over the years since this experience, it has become more and more oblivious that real progress can only be made by holding close to the middle of the road. At times a little shift to the right or left may be required to negotiate the hazards on the road, but veering too far either way results in disaster. The economy and politics are deeply intertwined and at times it is nearly impossible to separate them to find reality. Almost all political decisions are made for economic reasons, not ideological reasons. This leads to the haunting question for political decisions, "Who is benefiting economically?"

I believe that the easing of credit to make home ownership available to more people had its root cause in illegal immigration, which was helping business in the US to increase its profits in many ways, the least of which was through their employment. Along with the normal increase in population through births and legal immigration over the last decade, a new market of over a million people a year was created for goods and services. More housing has been needed by these immigrants and it has usually been low end of the scale where no one but the government invests money for new construction. Imagine the outcry if this has been proposed! The solution was to make it easier for existing citizens to become home owners. Thus opening up lower strata rental units for illegals. It also delayed the cries to stop illegal immigration because everyone else felt they were moving up the economic ladder, the Great American Dream. But, too much deregulation and lack of policing existing regulations created a market too lucrative that the temptation of greed could not be resisted by some. As in any overheated segment of the economy, a correction followed.

The real question is "Which side of the van and trailer have their wheels off the road?"

Re: BIG RALLY

When democrats pushed the unqualified into home loans, it was very good for bank business. Banks enjoyed year after year of lower loan defaults and soaring fee income while the prices of homes soared.


Forcing people into health care programs will be good for insurance firms for a number of years. Later on, when politicians force non market pricing on the insurers, they will put them in the same position as the banks are in today.


The reason the free market, without question, allocates resources the best is because pricing is set by the wisdom of the collective market instead of by the few who know think they are smarter or more caring than the market.

On Thu, Oct 2, 2008 at 12:47 PM, Al wrote:

My wife works for Aetna and just this week, CEO Ron Williams, issued a vidio in which he stated that the company's fundamentals are very sound. He feels that most of the decline in stock is due to general market conditions as Aetna is the market leader in the health insurance industry. One area of business is to to bring low cost insurance to young single people. Aetna is also the leader in managing self insured companies.n Ron Williams has made several visits to the Bush Whitehouse talking about healthcare, but currently indicates that an Obama Whitehouse will be very good for Aetna's future.

BIG RALLY

There is a huge rally in progress. It is a rally in the bond market. This rally is partially hidden from view because the rally is centered overseas.


Bond data from around the world is not readily available free of charge. Bits and pieces are available on sites like Bloomberg. English Guilts have been extremely strong since last June. Euro Bunds were not too far behind. US bonds started the big move all the way back in July of 2007. In these later stages, US bonds have rallied but they have also had violent short term corrections. Of course, the big rally in foreign bonds have been accompanied by a huge rally in the US Dollar. The rally in foreign bonds shows that foreign economies are slowing.


When bonds rally, they kick off the rally in bank stocks. Once again, using the S&P SPDR Sector Funds as our guide, financial stocks are out performing the other end of the see-saw, which is basic materials. Energy stocks are following right behind basic materials which means that consumers are about to find extra money in their pockets. The rally in financial stocks will be accompanied and followed by a rally in consumer cyclical stocks.


INTERESTING TECHNOLOGY DEVELOPMENTS


Amazon has decided to operate its cloud with Microsoft Exchange Server Software. The battle between Google and Microsoft is engaged. So far, Google has show the ability to run the most efficient of clouds. The pace of movement of computing to cloud computers is picking up. Who wants the hassle of backing up files and running a back office when experts can do it for you cheaply?


In other news, the advantage of the IBM cell computing technology is shining through. The battle between INTC, AMD and IBM is continuing to drive the cost of computing down. The lower the cost, the more computing we will see and we ain't seen nothing yet. The day is on the way when we will routinely speak and computers will routinely answer.


HEALTH CARE


The probable big winners in health care have switched back to the providers. If we assume that McCain will win or if we assume that an Obama Presidency will be limited by budget restraints, national health care is going nowhere or it will have to be heavily reliant on private companies; companies, such as Aetna and United Health Care. Given the performance of AET, until recently, it seems at odds to mention it as a part of a turn. The company has done extremely well but is down from 60 to 37 in only a few months.


AGAIN


The event that overlaps and follows the world wide rally in bonds is the financial rally and the poor performance of basic materials. China actually and suddenly has a surplus of coal! The price of coal has dropped to $129 per tonne. The price of dry freight has fallen as the demand for coal, steel and other industrial supplies and products has fallen. While it is true that the production of nuclear power stations is picking up, this is not enough to offset the tremendous decline in construction in other areas and the mining that must be done to support it. Highway budgets around the world have been hit hard by the decline in fuel tax revenues. The industrial production index in Europe was reported at 41 yesterday. The see-saw is on the move! Take advantage. If you already have your fill of bank stocks, do not be afraid to buy GM and Ford!

ATTITUDE INTERVENTION NEEDED

The bail out bill is likely to pass the house on Friday. The bill will include billions of dollars worth of wasteful spending.


Last night, after unloading the pumpkin truck at church, two friends and I discussed the cure for what ails America. It would seem that if three guys off the pumpkin truck "get it" then surely the congress can as well.


During our discussion, the cry went out for reducing the federal deficit. I invoked the ghost of Milton Friedman, one of the greatest economist of all time. Milton was not as worried about the deficit as about how the money was spent. Most people understand that borrowing money for a productive reason is not a problem. Businesses and individuals make rational decisions to borrow money every day. The business that borrows at 7% to earn 15% makes wise use of these resources. The individual that needs a refrigerator, today, makes a rational decision to borrow. Sure, he should have had an emergency fund, but he didn't. Rather than eating out for the rest of his life and rather than taking a 10% penalty for withdrawing from a retirement account, it even makes sense to make a short term 18% credit card loan.


US citizens together have a net worth of 58 Trillion Dollars, we produce another 13 Trillion Dollars worth of goods and services each year, our common debt is about 9 Trillion Dollars. Bring the above numbers down to a scale that does not blow our minds and you have a family with a net worth of $580,000 which earns $130,000 per year and has a total of $90,000 in debt ( this family has total assets of $670,000, debts of $90,000 and net worth of $580,000). America is in sound financial condition. The myth that the interest on the debt is killing us is obviously false. Year after year, our increase in income averages more than our increase in interest payments on the debt and our net worth grows by more than the debt.


Arguments can be made on both sides of the above numbers. The total net assets do not include hundreds of millions of acres of land and trees and many other resources. The 9 Billion in debt does not include unfunded liabilities such as social security payments. The fact remains that, financially America is very sound.


However, the family with a net worth of $580,000 will not remain financially sound if it starts giving all its friends annual checks of $1,000 each. The passage of the bail out bill concerns me, but not for the obvious reasons. The most disturbing part is that additional wasteful spending was added. Our legislators are hooked on spending. They could not even pass an "emergency bill" without adding pork barrel spending. Every person in America, poor and rich, will subsidize billionaire T. Boone Pickens as a result of this bill. T. Boone had the money to spend on advertising needed to help the lefties sell 30 cent on the dollar subsidies for expensive wind mills.


We need an ATTITUDE INTERVENTION! The house members who voted against this bill the first time are being rolled. As Dick Armey said this morning, this congress is like the fellow who would not date a girl that had acne and is now being asked to date a girl with leprosy.



HEROES IN THE MAKING


Because this bail out was carefully timed, it will "work". The prices of the great majority of houses across the country have already fallen to their clearing prices. New construction has virtually ceased. Dramatically lower priced fuel, money, and housing costs has made houses once again very affordable. The average citizen will see a significant "tax cut" in the next few weeks as his price of gasoline falls to $3 or less. The savings on energy will allow mortgages to be paid or taken over by stronger hands. Mortgage backed paper that has been written down to 40 cents on the dollar will prove to be worth 85 cents, giving the government room to buy this paper for 55 cents and to make the public a profit when it is resold for 65 cents. This monstrous problem, created with the complicity of Democrat Congressional Leaders, will make heroes out of the same leaders. Those whose bias favors big government over big business will see these leaders as the saviors of democracy.


The FOMC and other central banks have already taken their feet off the the brakes and jammed the accelerators to the floor. The FOMC needs to lower the Fed Funds Rate by one half of one percent to put it in line with what the FOMC is doing in the market place. Right now, the FOMC is like the fellow who has his house up for sale. He has suddenly lowered the price in multiple listing but he has not yet put the reduced sign in his yard.


Investors should take advantage. Buy several regional banks and hold on for a nice ride.


HELP GET THE STORY OUT


The Youtube link I sent earlier is a good link to spread around. We need to get the story out.



It is a complicated story but between now and the election, it is a story that needs to be told and retold. Chris Dodd and Barney Frank were among those that pressured Fannie Mae and Freddie Mac to loan to unqualified buyers. Chis Dodd with the support of Barry Obama blocked reform in 2003. Dodd and Obama were well "paid" for their "service" with massive campaign contributions. Yesterday, Harry Reid held up Dodd as the great one for steering the bail out bill through the Senate.


It is clear that the republican minority in the senate can be rolled. The senate needed a negative vote of 40% to block the pork included in this bill, the pressure was just too great, because the people back home support those who bring back local pork. A fifty percent vote is needed in the house and republicans start out in the minority.


My friend Al, says that pork is the wheel grease that makes the legislature roll. It certainly appears to be the case. Not even an "emergency" can be addressed without adding wheel grease.


Humans make mistakes. We ban together to protect and support one another but the bigger the grouping the bigger the potential mistakes. The best way to prevent massive wasteful spending is to keep the government coffers bare. Keep the money flow to congress lean and the only choices congress will have is to cut spending or to borrow to spend. They will do both. The borrowing will not cease but they will be forced to cut the worst of abusive spending.


The tried and true "method of democracy" is to "muddle through". The founders, knowing that power corrupts, had the good sense to provide numerous checks and balances. We have reached the difficult situation where there are more people who are net recipients from the government than there are net contributors to the government. The recipients are using the power of the majority vote to take more. The results are apparent in the current financial crisis. The question remains, do enough people understand that it was excessive government intervention, trying to turn government from a "service organization to a charitable foundation" that was the root of the problem? If not, the next bail out will be a monster.

Computer Voices

A regular reader forwarded the following letter. Nuance continues to move forward with voice recognition. So far, the big productivity has been in dictation of medical transcripts. Eventually, we will talk to our computers and they will talk back, a life changing system.



Sent: Wednesday, October 01, 2008 6:07 AM
To: All Employees
Subject: New Acquisition by Nuance
Importance: High


Dear Colleagues,

I am pleased to report that today Nuance announced that we have acquired Philips Speech Recognition Systems (PSRS), a business unit of Royal Philips Electronics. PSRS is headquartered in Vienna, Austria and is the leader in providing speech recognition solutions to the European healthcare market.

This acquisition is an important strategic move for the company as it extends our presence in the healthcare market beyond North America, where we've focused most of our efforts up until now. PSRS' technology helps physicians document clinical notes accurately and efficiently with advanced dictation and speech recognition solutions, and provides Nuance with an immediate leadership position in healthcare speech recognition for Europe. The combination of Nuance and PSRS will accelerate our ability to provide our worldwide healthcare customers with a full suite of speech driven clinical documentation and communication solutions that improve patient care and safety, reduce operating costs and increase overall revenue for healthcare provider organizations.

With the addition of PSRS' expanded speech recognition vocabularies (medical, legal, insurance and correspondence) Nuance gains significant language coverage and enhanced recognition accuracy for its solutions. Nuance is also pleased to add Philip's strong worldwide patent portfolio, primarily focused in the areas of speech recognition and associated workflow solutions and expects core recognition accuracy improvements to its speech based solutions for businesses and consumers worldwide.

We are excited to welcome the talented employees of PSRS, who are primarily located in Austria, with smaller teams located in Germany, Spain, UK, and France. We will keep you updated on our progress as we move through the integration process and our teams begin to work toward a combined organization. In the meantime, I invite you to review the attached press release for much more detail about this transaction.

I appreciate your continued support as we make major progress towards meeting our company's goals. I am excited about the possibilities that PSRS offers Nuance and anticipate great success in the future.

Regards,

Bob Wise
President, Healthcare Division

Sneaking Through the $78 Billion for T. Boone and Friends

The Senate is attaching the bail out to, among other things, a $78 Billion Subsidy for T. Boone and his friends.

WHICH BANK STOCKS TO BUY?

A reader asks the proverbial $64,000 question? If you like bank stocks, which ones do you buy? And the corollary question, do you buy an ETF?


There are good things and bad things about ETFs. Numerous popular books come down for and against EFT's. I like good old American stocks. I dislike having to buy both the "see" and the "saw" of an industry. Buy a health care fund and you are buying the hospital that is a labor intensive buyer of drugs and you are buying the drug company that spits out expensive pills at a mile a minute and sells them to hospitals. (After spending millions to develop them). The two stocks are very different animals.


I like regional banks. The smaller ones are going to be take over targets for years to come. One way to buy a boat load of them is in the Russell 2000 Value Fund, symbol IWN, however, when you buy this fund, you also buy a boat load of basic materials stocks. You are buying the "see-saw". You are also paying an annual fee to hold those shares; the combination of up and down minus a fee will make your average return average less the fee.


The IAT EFT is a pure play on regional banks. It holds mid sized banks such as BBT, a bank that I like which is about 5% of the fund. Here again, you pay an annual fee to hold the shares. The fee is only .48% but over the long haul we are talking about serious money. A good strategy is to look up the bank holdings in the IWN and buy a few bank stocks at random. Test after test show that random selection helps eliminate negative selection biases. Also select two or three from the holdings in the IAT fund. The idea is to buy a mix of small and middle sizes. You can find a list of the holdings at Yahoo Finance or at Google Finance.


Don't delay. On average, the market recovers something like half of the bear market losses in the first month or two of the turn. It is a huge mistake to wait for a clear market bottom. Part of the reason not to wait is that the market bottom will be made when the big capital goods, energy and basic material stocks hit bottom. This will not happen until bank stocks are well on their way to recovery.


Please note that the bottom in bank stocks (which apparently happened months ago) is accompanied by the bottom in real estate. If you ever plan to buy a second home, now is the time to get the best deal. Since fixed rate mortgages do not yet reflect the full decline in bond rates, one should start with a low spread variable rate loan.

WILL HEALTH CARE BE THE NEXT $700 BILLION BAIL OUT

The following George Will quote was lifted from the Carpe Diem web site.

From George Will's column today:

Suppose there had never been implicit government backing of Fannie Mae and Freddie Mac. Better yet, suppose those two had never existed -- there was homeownership before them, just not at a level that the government thought proper. Absent Fannie and Freddie -- absent government manipulation of the housing market -- would there have developed the excessive diversion of capital into the housing stock?

The entitlement mentality fostered by the welfare state includes a felt entitlement to a standard of living untethered from savings.

George is absolutely right. I Fannie Mae had not been there to buy risky mortgages, (and congress not mandated risky loans) banks would not have made them. Housing prices soared during the years that congress pushed the "homeowner entitlement", we are paying the price now.


The price of health care has gone up by excessive amounts since the government started Medicare and Medicaid. In recent years, the cost of primary care has finally started to slow down. One of the reasons is that private companies like Wal-Mart, Wal-Greens and J.C. Penny have been offering low cost generic drugs and health clinics staffed by nurse practitioners. The practitioners help with runny noises and blood pressure maintenance while doing a good job of convincing the seriously ill to see a doctor. If you want to see a massive health insurance company bail out, vote for Obama. Everyone of us has made life threatening mistakes, when the government makes a life threatening mistake it threatens the health of everyone.

THE POLLS SHOW

For the first time, Rasmussen reports that more people believe the war in Iraq has been a success than the other way around. A few years from now, when gasoline sells for less than $2, more people will join in praise. The more important point is the win in a major battle in the war on terror.


For the first time, more people now support the bail out than oppose it. One of the key reasons it will pass this time is because it is attached to the AMT patch. Earlier, the AMT patch was connected to several pork bills for wind mills. I hope this is a clean bill this time. The increase to FDIC insurance should add some votes and the adjustments to mark to market accounting will add still more.


The polls show that a number of battle ground states are up for grabs but McCain needs a big surge to win. As we have just seen, a lot can happen in 30 days.


In late London trading, one again, financial stocks took the lead. The extra dollars the public will have in their pockets, as a result of the decline in gasoline prices, will help the public make their mortgage payments. Numbers in the USA show that consumers continue to see nice gains in disposable income. Disposable income is a leading indicator of economic strength. Industrial production in Europe has gone from solid growth 5 months ago to a shape downturn last month. This is good news for energy prices, inflation rates and interest rates.


Just a few months ago, huge capital expenditures were being made, for example, big CAT equipment was being bought for mining and construction. For the next several years, equipment will be repaired if necessary. The pressure is coming off the price of every thing from oil to money.

REVISED PLAN LIKELY TO PASS

A revised bail out plan is likely to pass. The reasons include: the attachment to a bill that will patch the Alternative Minimum Tax, the addition of an increase in FDIC insurance from $100,000 to $250,000 and the easing up on mark to market accounting rules.


I have not read the 107 page bill, but, reportedly, the Treasury will pay an above market price for the mortgage backed securities. I still do not know how that price will be determined. If priced correctly, the purchases will give relief to the banking system and still allow the government to collect a profit after the market recovers.



One thing that has made the whole process much more difficult has been the insistence of the congress to include warrants. The warrants are much more difficult to price than are the securities. The combination of a security and a warrant purchased from each bank is a much more complicated question than only buying the same tranche, the same security, from several different banks. It is a little bit like trying to compare the value of two cars when one has new high tech features such as a sophisticated GPS system with blue tooth phone features and the other appears to have a bent frame.


In the past 3 months, the DJ Bank Index is up 13.8% while the S&P 500 Index is down 8%. The turn is happening while the news makes it seem the wheels are falling off. The "big boys" have the ability to turn the news upside down at critical times. A few months ago, right at the bank stock bottom, the price of oil was at $147 and going to $200, $250 or $500. Today, a lot of individual investors are buying oil because it is cheap at $100. It may take a few years for oil to get back to $50 but it will get to $50 before it gets to $250. T. Boone is spending millions telling people the price is going back to $150 while he lobbies congress to pass 30 cent on the dollar wind mill subsides.


Another 500,000 barrels of oil per day just came on line in Saudi Arabia, pipelines are being considered from Russia to South Korea and from Iran to Europe and Brazil just keeps on discovering more offshore oil. The estimates of the oil in Brazil's three partially explored fields is settling in the 55 Billion to 70 Billion barrel range; another 10 fields will be explored after more is known about the first three. The US still has more than 10 thousand miles of coastal waters that have not been explored. Iraq is about to let bids on discovered but undeveloped southern fields. Iraq oil production is expected to increase from 2.5 to 6 million barrels per day within 10 years.


INNOVATIONS KEEP ON COMING


The pace of innovation continues to quicken. The cost of the electronics needed to fly an unmanned airplane is now below $600. The dream of airplane "taxi" service is coming close to reality. Who needs to build very expensive concrete roads if dozens of one man airplanes can fly at various heights while getting hundreds of miles to the gallon of fuel? No need to own one of these planes or to learn how to fly one. They would be robotic fee for service taxis.


Nissan is one of many firms working on robotic steering systems. One hundred thousand lives could be saved annually by computer aided auto steering. The Nissan system is built around the model of the bee. Bee's fly in swarms without bumping into one another. Electronically controlled cars and airplanes can do the same thing.


Fish farming is being taken to "the next level". In closed loop, commercial scale, systems, fish are feeding vegetable plants and plant roots are cleaning fish tanks. The benefits include saving ninety-nine percent of the water while using only 10% of the land. The placement of "farms" in or near cities is cutting transportation costs.


Innovations in nuclear technology are continuing to cause a rebirth of the industry. The largest uranium producer (located in Canada) is expanding again. There are currently 439 nuclear plants operating, 36 under construction, 97 planned and 221 proposed. This does not count the 4,000 nuclear "batteries" to be constructed by 2013. The left and profiteers such as T. Boone Pickens continue to push for wind and solar subsides. If world wide electricity production is rounded to the nearest percent, the numbers are coal 40%, hydro 19%, nuclear 16%, gas 15% and oil 10%. The amount of electricity produced by wind mills and solar do not make the list.


The GE-Hitachi nuclear plant design is being ordered in increasing numbers. It uses an innovative passive water flow design that eliminates the need for water pumps. Nuclear power had not gotten to the Ford Model T stage, but high oil prices have increased the incentive to innovate.


THE SPEED OF TRUST


Warren Buffet is trusted. As a result, it took about 5 hours for Berkshire Hathaway to negotiate the bail out of Goldman Sachs. The members of congress do not trust each other or the Bush administration, thus the negotiations to bail out the rest of the banks is stuck.


Certain Americans, Russians and Iranians do not trust free markets. They would rather pay through the nose rather than take the chance that a capitalist will made an extra nickel. It is clear that large uranium processing plants, like the one in Canada, can process uranium at a tiny fraction of what it will cost Iran. It is clear that Americans would save a lot of money by trading with Colombia and others. It is clear that tax increases on businesses will cost the middle class dearly. It is clear that Russia and Iran would be better off trading with the west, rather than sparing with the west.


Now that Russia will not support new sanctions on Iran, the US has decided to sell 25 F-35 Strike Fighters to Israel along with options for 50 more. The US has also deployed the FBX-T antimissile radar system in Israel. Skeptics will say that Bush is gearing up to start a war with Iran but the real purpose is to prevent war. These additional armaments would not have been necessary had negotiations to end the production of uranium in Iran worked out. If Iran is going to be allowed to build nuclear bombs, we must build up our defense against them. Russia needs to make a deal with the US. The people of Iran would be so much better off to work with the US, but the leaders of Iran are power hungry.


Russia would also be so much better off, had it continued to work with the west instead of working against us. It appears that it will take many more years for Russia and Iran to learn how to integrate their economies into the new global system. Yesterday, Gorbachev announced the formation of a new party in Russia. He will have a difficult time of breaking Putin's grip. The irony remains that the most successful nation in the world keeps moving toward socialism while the recent success story has been that of previous socialist doing well after moves toward free enterprise.


For nearly two years, I have wagered that, when push comes to shove, the American people will back away from the move toward socialism. In the past week, my optimistic outlook has taken a blow. The risk of a three house democratic sweep has increased. In the short run, democrats will have difficulty paying for Obama's massive programs, but we are finally at the turn in the business cycle. The US should enjoy a strong dollar, strong profit growth and strong stock markets in the years ahead. With democrats pushing very close to a filibuster busting majority, I fear massive programs will be passed within 4 years. The next government induced catastrophe could make the current $700 Billion "wall street" bailout relatively tiny.