SHORT RATES UP! WHICH STOCKS DOWN?

Historical data reveal that within 12 months of the first rate hike in a cycle, consumer discretionary stocks and technology stocks are down.

It has been 5 months since the first rate hike. The following is the performance of John Murphy's industry list since the first rate hike.

Internet +27%
Oil Service +26%
Gold and Silver +21%
Brokers +20%
Retailing +20%
Banks +9%
Biotech +5%
Pharma -7%
Semis -7%

The performance for the last three weeks follows:

Oil Services +7
Internet +4
Pharma +1
Biotec + 1
Banks -1
Semis -1
Retail -2
Gold -10

Three weeks can easily be a trading move and not a trend but it at least appears that Greenspan has been able to take the fear of inflation out of gold. As should be expected, Banks, Semis and Retail are struggling against the higher rates.

The big question remains in oil and oil services. There is still a hint of the late 70's in the oil markets. If energy is behind the curve, it could take a lot more pressure from prices to rationalize supply and demand. In case you were not around in the 70's, oil drilling stocks were the 50 baggers of the decade.

Pharma has gone from one of the worst performers to one of the best. When a sector is performing well in the midst of extra bad news, the "big boys" are buying! If you don't like the risk of any one company, consider PPH for purchase. PPH is one of the exchange traded funds.

I am treating the three week list as an indication of what is heating up and what is cooling down. Gold may still bounce higher. The dollar was down again today against the Euro. I am avoiding gold and studying oil drillers but am treating the rest of the list as trend setting. Add to positions in the groups with positive performance and trim back where they are negative.

Keep in mind that you have to think twice about how to categorize certain stocks. AMZN is the same price as last year so you could say it is suffering. It is simply starting to trade more on its fundamentals as a fast growing retailer. It no longer trades with the emotion of an internet high flyer. This is not such a bad thing. WMT is 13 times the size of AMZN and still growing its sales by 7 to 11% per year! This is an amazing feat but AMZN is growing sales at 20 to 30% per year, equally amazing. One challenge for AMZN is the growth of WMTs online sales. WMT does not break out its on-line numbers but is growing fast. One must figure that the profile of AMZN customers is more up-scale than WMT customers and that they will both continue to steal market share. The rate of growth for WMT is now fastest in the international markets.

Tech stocks are down but ETrade is doing very well. Etrade is a consumer of technology. As Etrade is able to lower costs by purchasing fast low price computers, it is able to increase its operating margins. Etrade offers many banking products and brokerage products. It is a low cost producer and has seamlessly integrated banking functions in addition to brokerage services. I trade with BrownCo as I am most interested in low costs, quick executions and low margin rates. Etrade is one of my favorite investments. Etrade is a high beta stock but one that I plan to hold through the good and the bad. It will trade with excitement when the market is strong but may be less volatile than AMTD. AMTD is more of a pure trade on brokerage commissions. I hold both stocks and view them as internet services company.

I keep looking at oil services companies because the price of oil usually hits its low before cold weather and then is up until prime driving season. It appears that we may have seen the bottom.

DON'T BELIEVE A WORD OF IT!

I have always enjoyed reading the popular business magazines. These magazines reflect what is interesting to the public right now. The public is usually interested in knowing what investments have been working well or they like to read about how terrible a situation has become. This is good information that usually needs to be used as a contrary indicator.

A couple of weeks back, I wrote that the bottom has been called in Coke (KO) because the company was featured on the front cover of Business Week. In preparing to write about this phenomena, I came across THE BIG PICTURE. A blog written by Barry L. Ritholz. Ritholz does an excellent job of explaining the concept. The following several paragraphs are excerpts from his blog.

"What exactly are Contrary Indicators?

Contrary Indicators are the data points, signs, and events whose actual significance to the market is the exact opposite of what their initial impression suggests. These counterintuitive signals can reveal when great masses of investors are collectively reacting emotionally to a given event or stimulus. When the herd becomes violently emotional, they typically shoot first, and ask questions later. This invariably results in poor investment decisions.

Contrary Indicators are rather simple in operation; They reveal when a significant number of investors (often a majority) have become too enthusiastic or too pessimistic reflecting moments of excessive fear or greed. This excess gusto occurs prior to, or coincident with, major inflection points.

Investors (individuals, mutual fund managers, pension fund directors) with a longer time horizon should be aware of external indicators before deploying fresh capital.

4) The Magazine Cover Indicator

The covers of national news magazines and business publications show what's making news today. The markets, on the other hand, are a future discounting mechanism, anticipating future events, and reflecting them in price and trend.

Magazine covers sell magazines; Covers stories are featured because they are resonating with the public at that moment. When an editorial committee decides something is worthy of their publication's highest profile, it usually means that trend has already reached its climax.

Why does this work as a contrary indicator? When a magazine covers focus on the Bear Market for example, it's already been priced into the market. Whatever response the magazine engenders is typically the last spasm of its cover subject.

The July 2002, Time Magazine's cover had this title: "Will You Ever Be Able to Retire?" The cover graphic was an elderly person serving burgers to teens at a drive-thru window, while another graphic showed a senior working as a lifeguard. The implication was that people's retirement accounts were so irredeemably damaged that Senior Citizens should plan to work at McDonalds through their golden years.

It's not just the popular press that works this way: Even business publications can mark the top or bottom for both companies and sectors. "The Great Telecom Crash" was the cover story for July 18th 2002 Economist. That cover story nailed the July lows in the sector by a matter of days."

Barry L. Ritholtz, Market Strategist

Ritholtz writes about the magazine covers and other contrarian indicators but the magazine portion of the story is bigger than just the cover. David Dreman has written at least a couple of books some years ago that detailed several aspects of the phenomena. A couple of the titles I recall are The Contrarian Investment Strategy and The New Contrarian Investment Strategy. Dreman puts his money where his mouth is. For the past fifteen years, he has beaten the S&P 500 by better than 3% per year compounded! Had one invested $10,000 in the S&P one would now have $41,000 but $10,000 in Dreman's fund would now be $61,700!

The above explanation by Barry is largely correct but there may even be devious purposes involved in the published stories. Consider the following comment of author Michael Crichton, "There are many groups in contemporary society who find in their interest to promote fears. A free society, a free press, has a lot of good features, but giving you an accurate view at the world is not one".

I read somewhere that Business Week has, since 1994, published nine stories from one author about potential take-overs. The record is 0 for 9. If this is actually true, there are several possible reasons. It could really be part of the phenomena of the magazine finding stories that it knows its readers will enjoy. However, 0 for 9 sounds so weak to suggest that someone is feeding bad information on purpose.

I don't suggest that you draw conclusions from heresy. However, my study of the markets for 40 plus years has brought me to the belief that much of what is published in national business magazines should be used as contrary indicators.

The Business Week year-end double issues is currently for sale. In it I find article after article that I will use as contrary indicators. Some of these are simply too easy. Others may not give a clear answer as to how an investor should respond but only the direction to avoid. Leave a comment if you have experience with contrary indicators.

1. Sellers should sell options to increase income. Nope! The majority of all investors should avoid options all together. At best, they will increase their transaction costs. One likely result is that their best stocks will get called away right when they break out on a long positive move. The old saw says it best; "Option traders never die, they just expire worthless".

2. Investors should seek higher yielding bonds and trust accounts. Nope! The current spreads between high risk corporate bonds and muni-bonds gives little boost in yields in exchange for the added risk. International bonds were mentioned as another source of high income but currency risk should be avoided. Another mention was high yielding energy trust. Avoid! Energy trust can decline in value if oil declines in value. Only pros should play high risk games.

It is true that potential rewards go up as risks go up. Perhaps a good analogy is of a game of 7 card stud. If you play well in a game of penny ante, you may win often and you will never win or lose a lot. However, should you step-up to a $100-$200 game, your potential to make a lot of money will increase from zero to some positive number but if you have joined a professional game, chances are you will lose a lot. If you must buy bonds in the current market, stick with bonds that do not require sophisticated credit or other analysis.

3. Buy international companies. Specifically mentioned were Brazil, Russia, India and China. Not Me! I am buying big American companies. Now that the US Dollar has declined dramatically, I believe it will be American companies that will do well. Russian and Indian stocks are hard to buy except in mutual funds that have high operating expenses. Russia is in the middle of nationalizing its largest oil company; more could follow. Brazil stocks are up about 400% in 3 years. There are low fee ETFs (Exchange Traded Funds) for Brazil and China but the China fund is only a few months old. In the same way that making the front cover is a contrary indicator, starting a new fund is also. The two most ballyhooed new funds were the gold funds and the China fund, I would avoid buying either.

4. Renewable energy stocks! HA! HA! HA! How many times have you heard this one. Although there is no doubt that Iowa Bob will work at getting corn or soybean oil into the next energy bill, the fact remains that the current price of oil does not support the use of renewable energy sources. The laws of economics are simple and do not waiver. If energy of one type cost too much, an alternative will be substituted. Will the natural gas pipeline to Alaska be built? Absolutely yes! The state of Alaska and the US Government will each reap tremendous benefits as will the American and Canadian consumer. Will it take ten years? Yes! Will car companies increase production of hybrids? Yes! But remember, hybrid cars use gas as their fuel. That's right, oil provides the fuel for hybrid cars. Will they one day be fueled by hydrogen? Probably? Will that be anytime soon? NO! Since Libya capitulated, the rush is on to develop 30 Billion proven reserves in Libya. Iraq, Russia and China will each develop fields with proven reserves of 20 Billion or more. The US has enough coal to last 250 years and clean technology is available and at current prices making sense. In the state of Indiana there are currently 13 coal fired utility plants approved for construction. It is likely that clean burning coal utilities will use electricity at night to produce hydrogen. Do not chase windmills or solar panels. Even after significant tax incentives, these technologies are marginally cost effective in just a few situations.
5. Buy companies with big operating margins. It may sound silly to go contrary to this one but I think my Food Lion example of past generations is the best example. Grocery stores have very small margins but they sell a lot of suff. Some of the most successful investments over the next 5 years or more will be investments in low margin businesses that have pricing power. Plenty of high margin businesses will find that they have no pricing power. When their costs go up, their margins will be squeezed and their stock price will come down. Wal-Mart operates with a small operating margin. Don't you only wish you had mortgaged your house to buy Wal-Mart 25 years ago!

6. "Under-neath the twin peaks of Yahoo and Google--both pricy after sharp run-ups--a prosperous industry is taking shape." Bah Hum-Bug! The article goes on to tell about companies such as Double Click and i-Village. The fact is that Double Click has offered itself for sale and can't find a buyer and i-Village is having trouble competing in a tough market. In the mean-time, Yahoo and Google (and EBAY for that matter) continue to buy sizeable businesses cheaply and they continue to add services. For example, Yahoo recently added MusicMatch to its stable of media broadcasting companies and it has contracts with virtually all cell phone companies to offer internet services of one type or another. It recently added traffic reports to its map's of communities. Google and Yahoo are serving up about 40% and 29% of all ads in the internet world. Double Click may find a buyer someday but Google and Yahoo are two of my largest holdings and I sold my Double Click months ago.

7. Big banks are take-over targets. This implies that one should buy big banks. This one is really interesting. Merger and acquisition activity is on fire. Consolidation is occurring in most industries. In recent weeks we have seen mergers in software, healthcare, electric utilities, wireless phone service and internet services. My family has been lucky to participate in several of these. I have suggested that the public needs to buy stocks while they are cheap relative to bonds. Otherwise the company will buy its stock back or another company will swallow it up. Big banks have been consolidating for years and I would not be surprised if another deal is announced soon. However, the take-overs where I have made the most have been when I bought stocks that were fundamentally cheap.

Banks tend to struggle when the yield curve flattens and when interest rates go up. The fed has raised the cost of funds to the banks 5 times in the past 5 months. The spread between funds borrowed at short rates and funds lent at long rates has fallen. Also, refinancing fees have recently dropped like a rock. When interest rates were on the way down, some folks refinanced several times. The bank made fees each time but are now stuck with a low rate loan on the books. I plan to avoid bank stocks, mortgage companies, REITs and utilities because I see their costs rising. I will continue to hold shares in BB&T which is a very well run regional bank but I do not expect to add to the shares for the next several years.

8. Magazine cries wolf in regard to housing again! I wish I had a nickel for every article that has been written about the housing problem in the past 5 years. Ironically, we are finally getting close to an inflection point but the prescribed solutions are ridiculous. If it is really such a crisis that one needs to protect against, then one should sell his house. The reality is that housing values continue to increase as a result of supply and demand. It is true that the interest rate is a part of the total cost and therefore the total increase in value has helped by low interest rates. It is also true that house prices would have been going up even if rates had been higher. Again, it may be that supply is about to finally catch up to demand.

Housing starts declined last month. The magazine suggest that one should protect ones self by signing up for as large a credit line as possible but then not borrow the money. This is financial folly. Why pay fees to set up a line of credit based on a variable rate when rates are on the way up? If rates are indeed about to rise, one should lock into a fixed 30 year loan and pay the least amount per month as possible. One should use the resulting improvement in cash flow to make sure all variable rate debts are paid off. In today's tax environment, one should avoid car loans and credit card loans. The debt against your home is probably at a lower rate than car loan rates and the house loan is tax deductible.

9. Value stocks pricy, buy growth stocks. Wow! This one is almost wrong by definition. I own growth stocks such as EBAY, GOOG and YAHO so I know a pricy stock when I see one. The magazine article goes on to recommend international, energy, real estate and global resources. Again, I say, buy big American consumer staples and health care stocks. Remember, I put some more money where my mouth is on Friday. I bought several hundred shares of PFE on the opening at $23.52. Drug stocks have been hammered with bad news for at least a couple of years. One should buy stocks based on what is expected for the future not on what happened in the past. America is aging quickly. The baby boomers of my generation will spend billions on drugs in the next 10 years.

10. Without going back to find the actual market predictions, let me encourage you to read the previous report about Ken Fisher's forecast. The summary is that the results in the first year of the presidential cycle tend to be a single digit average but almost never a single digit result. In other words, it tends to be a really good or really bad year. The Business Week consensus was for a single digit year. My guess is for a 15% or better total return for the S&P.

NEW TOYS IN THE WORKS

Rumor has it that Motorola and Apple are planning an i-pod cell phone. The XMSR portable radio has TIVO style recording features. Motorola is working on a dual phone for Sprint/Nextel that will offer the NXTL direct connect and the sprint internet and media network. Yahoo has signed contracts with every cell phone company and has added traffic updates to its cell phone maps. QCOM is building a whole separate network for radio and video by phone. Fox, NBC and ESPN are producing 1 minute videos. And, Steve Jobs is working on a video i-pod.

From December 13-16 interviews with 50 sales clerk from major stores show that SIRI is getting good sales through Radio Shack and Wal-Mart is moving the XMSR out the door. JP Morgan estimates that SIRI will have 1.02 million subscribers at year end and XMSR will have 3.15 million. The really sad way to view the SIRI subscriber and shareholder numbers is to note that the owners of 145,000 shares of SIRI have 1 customer! If the customer pays $12 per month the revenue per share per month is .000008 cents.

Both XMSR and SIRI are expected to grow rapidly as NFL, MLB, and other programming is added. However, the terrestial radio stations are gearing up for a business and a legal fight. Many of them have contracts for local baseball teams. The satellite deal is supposed to exclude these cities but there is some leakage that will be fought over. Terrestial radio is gearing up to offer digital radio with superior features.

Dell's pocket DJ and DJ-20 is on backorder. Apple and IBM were once the leaders in selling personal computers. APPL now has about 2% of the market and IBM just sold 80% of its pc business to a Chinese firm. Dell, as the low cost producer and low cost distributor, has a large market share and is now building share in printers and consumer electronics devices.

Morningstar Research does not rate Apple highly. The stock sells at 5 times book, 90 times trailing earnings (maybe 75 times projected earnings) and produces returns on assets of less than 4%. Morningstar thinks it has zero moat (barriers to competition). On the other hand, JP Morgan thinks that Jobs has been smart to develop a proprietary music format and, if i-pod can move forward quickly with the video i-pod, it can own the VHS-Beta Max war of this decade. Big speculative bets are being made on the most speculative of these companies.

I have been selling out of the most speculative areas and have added to slower growth and more out of favor positions. (I still own some speculative issues including TIVO and NFLX but have sold most of my SIRI and XMSR positions). I sold some of my smaller equipment companies and added to my transportation stocks.

I still own TXN and MOT. TXN was able to spend billions on a plant that gives it the lowest costs on some of the best chips for digital light functions required in video applications. Competition will remain stiff. Margins will stay tight and the old consumers staples may look more and more attractive as the makers of toys battle it out.

Each time I think through the list of players, some conclusions remain the same. These include that Yahoo, QCOM, DELL, MOT and TXN are all competitive survivors. YAHO will arrange for MusicMatch to be be available on billions of cell phones and much of the equipment will be made by MOT and TXN. DELL will eventually sell more pocket DJs than Apple will sell i-pods.

At current prices and earnings, I am not willing to speculate on APPL, XMSR and SIRI. Of the others, YAHO and QCOM are clearly my favorites with DELL running a close third. I am a bit nervous over the cut-throat competition on the equipment side but these stocks are relatively beaten down. TXN has thousands of patents, a super efficient manufacturing program and thousands of super engineers. MOT went through a tough slump during the reign of the 4th generation of the founder but has since been doing the job right. MOT spun off its semi-conductor business and I sold the shares.

My most speculative position in the entire area is Real Networks. RNWK is still active in a 5 year old European law suit against Microsoft. It has some solid relationships in the music an video business. Microsoft would like to settle the lawsuit. Microsoft seems to be willing to unbundle the Windows Media Player and pay a fine of a few hundred million dollars. In a few months, I believe RNWK and Liberty Media will be ready to offer a new internet media box. The pressure to settle the suit will become very large. It seems very possible that two or three or even four competing formats could each be very successful and if RNWK can resume a leadership role in this huge business, the upside is huge.

If you buy into any of these stocks, please use a discount broker to keep your costs low. Also be sure to balance the portfolio. Remember that it is Hersheys, Maxwell House Coffee, Colgate Polmolive, Proctor and Gamble, Pepsi and other similar companies that have recently shown pricing power. These companies are not as exciting or glamorous as satellite radio companies but they make money for their owners.

EXPERIENCED INVESTOR-CPA-FRIEND SAYS HSAs ROCK

MY OLD MERRILL PAL, who is an experienced investor and a Certified Public Accountant, made the following response to an earlier blog about the new Health Savings Accounts:

"A huge economic benefit has already been bestowed upon the American people in the form of the HSA or Health Savings Account. All Americans in high deductible health insurance plans can now contribute to their personal health plan. The basics are: it is tax deductible, easy to manage with little government oversight and can be used tax free for health expenses.

Now how bout these two kickers, one, you write the checks personally for the expenses when you wish to use the money for health costs and second, you can leave the money in to grow tax deferred and withdraw at 65 as normal income. In other words it serves as a potential second IRA.

Believe me the Doctor is right, this has the potential to relieve the pressures of nationalizing our healthcare. People have not caught on to this great news yet. It will come!"

Editors note: the nickname Doctor stuck because of my skill of putting a basketball in the hoop with a running one hander. My son-in-law and others who have seen me play ball will be the ones who have a hard time believing that someone calls me Doctor or Doctor J.

Great Comment But:

It is truly hard to state or to even exaggerate the potential of the Health Savings Accounts. They are better than they sound. They include incentives for all to sign up for relatively inexpensive catastrophic coverage, which by itself will benefit millions of Americans. Furthermore, the current system requires that insured patients dramatically over-pay to cover those who avoid buying expensive coverage. This vicious circle causes more folks to drop out and the percentage of fully covered Americans is going down.

Those on an HSA plan, can buy a bottle of aspirin at any store with tax free dollars and pay for it using their Health Savings Debit card. Like OMP says, if you don't spend the money, you get to keep it! The compounded value becomes an extra tax deferred retirement account!

The real key is that the consumer is given reasons to ask doctors for generic drugs or the lower cost treatments or to eliminate the extra defensive tests. If the consumer has a sick child, his anxiety is reduced because he knows he has the cost covered, however, if it is just a cold, the consumer may rightfully decide to avoid an unnecessary doctors visit.

It is true that tort reform goes hand in hand with HSAs to cut medical costs. If both are adopted, the savings to the US economy will be absolutely mind boggling.

There are at least three ways to make money off this deal. One can sign up for an account at ones first opportunity or one can buy the firms such as United Heath or Cigna that offer HSAs or one can buy any American company.

Yes, the benefits are so large that the US will improve its competitive global position. Most firms in the US will save a considerable sum even if they are the last to convert! The reason is that the whole mind set of the Health Care industry will change. The Health Care firms that will make money will be those who provide efficient care at low costs. It will not be the firms that run 20 test on every patient. The doctors will not need to run unnecessary test just to avoid the potential devastating law suit.

By the way, my blog about the decline in housing starts may seem off the deep-end but it is an interesting concept and perhaps a startling discovery. It ties together several pieces of information that have not been fitting together particularly well. The blog concludes that long rates are not necessarily going up anytime soon and could even go down in the face of a very strong economy.

The historical model for an economic recovery has been for the consumer to carry the water during the early years and for business spending to kick in in later years. We may be ready to stop building so many houses in America and to start building more factories. In the Winston-Salem area, there are numerous new manufacturing jobs being announced for the first time in years.

I am still a bond bear because I do not believe the probability of capital gains in bonds is nearly as high as the probability for stocks. However, the gradual slowing of housing demand could occur while avoiding the popping of the "housing bubble" and even while avoiding the traditional spike in long rates.

OMP, it was probably 18 years ago when Gillon put forth the hypothesis that future economic peaks and valleys may be smoother as a result of changes in the tax codes. He could be right! The science of managing the macroeconomy has perhaps improved.

The keys to making money in this environment are to keep your costs low by buying through discount brokers, by avoiding excessive trading, by avoiding hidden mutual fund fees, by avoiding high management fees, by avoiding locking into long-term bonds and by buying a diversified portfolio of solid American companies.

BOUGHT PFE ON OPENING $23.52

This morning before the market opened, Pfizer (PFE) announced that a heavy dose study of Celbrex showed an increase of heart attack risks. A second lower dose study did not show the risk. $5 per share on PFE is bigger in total market value than the drop in MRK and it is very possible that MRK hid study results. PFE announced the results immediate.

PFE may suffer the loss of a sales leader but I don't see the potential for big lawsuits. I bought on the opening and paid $23.52 per share with a $5 total commission. This story will continue for weeks but so far I am up several hundred dollars already.

I hope you are using a discount broker for your trades. I encourage my moderated accounts to use BrownCo. We get trades for a total commission of $5 and it does not matter how many shares we buy or sell. Our margin rates are very low and research is supplied free of charge through JP Morgan.

The blog preceding this one is perhaps the most important I have written. It is complicated and wordy but I feel like I found the last three pieces to a jigsaw puzzle.

HOUSING STARTS DROP! IMPORTANT POSSIBILITIES! BIG PROFITS PREDICTED!

The most recent housing report shows an unexpected 13% drop in housing starts! Is it possible that the housing boom is about to slow without an increase in mortgage rates? What if the housing market makes an upside down and backward move like we have never seen before?

For the past several years, market mavens have cried wolf numerous times in regard to the housing market. The housing market shrugged the cries off and more homes have been built in the past 5 years than any other five year period in the history of our country. In previous cycles we may have gotten to about the same peak level but this time we stayed at unusually high levels for a very long time.

Stock brokers, economist, market analyst and the public at large, myself included, have believed that eventually interest rates will rise enough to slow home construction. Numerous media reports have talked about the "housing bubble". However, in my Whoa! blog, I listed data that show that the dollar still needs to decline to reconcile our economy in relation to the rest of the world and, indeed, that long rates may be headed lower still. How can one reconcile the inherent conflict in having a strong economy and a strong bond market at the same time?

Well maybe, just maybe, we are about to see housing construction slow because we have simply built enough houses in America. After all, we passed the highest percentage level of home ownership we have ever seen in America some months ago. Government programs on the books for the past several years have allowed single persons and poor families to buy homes with no money down.

In my home town, there is hardly a street anywhere that does not have one or more houses for sale or for rent. Sales prices are going up steadily as families move to larger newer homes. On the other hand, small condos and apartments are not renting well. Some folks have left the apartments to move into starter homes. Some folks have bought the big new home while still waiting for their old home to sale but others are waiting to sell the old home before buying the new. Investors cannot buy the smaller rental houses or condos because the rents are not sufficient to cover the payments or costs.

In the 60's and especially the 70's, it was assumed that there was an unlimited demand to borrow money. However, under the current tax code, the tax incentives are gone in regard to credit card loans, car loans or other personal loans. The tax laws still encourage the purchase of a home or second home on borrowed money but little else.

Americans are not as dumb about finances as many pundits suggest. The numbers show that the public has taken full advantage of the tax laws. In the 70's, Americans borrowed at tax deductible rates that were below the inflation rate to buy cars and personal items. Now many citizens have paid off their high cost non-tax deductible credit card debt by refinancing and increasing the mortgage balance on their home.

Americans now have the highest debt to equity ratio on their home as they have ever had. However, they are in great financial condition. Americans now own over 56 Trillion Dollars of assets and they owe a total of less than 12 Trillion Dollars. Yes, Americans have a net worth of more than 44 Trillion Dollars. Their net worth is approximately five times their disposable income.

The numbers show that Americans are big earners and big spenders. Our economy makes most other economies look puny. For the past couple of years in particular, we have been the locomotive engine pulling the rest of the world economies along. Greenspan has raised US short interest rates the last 5 months in a row to try to avoid over-stimulating our economy. His actions should eventually almost force other world economies to do some of the pulling.

What if housing construction slows due to excess supply of homes?

Normally one of the reasons that long interest rates go up is because housing demand is also demand to borrow large sums of money. If the demand for houses is not there and if capital spending by business does not pick up the slack, then long rates may go down.

If US long rates go down, the dollar will likely also go down. In some instances American industries are becoming net exporters. For example, the chemical industry has switched from being a net importer to a net exporter. Dupont is just one of the strong companies that has made the switch to a net exporter.

If the US dollar declines further from here, US manufacturing will grow even more. For quite some time, the transportation index has been forecasting a very strong US manufacturing economy ahead. Many months ago, I wrote about the tight capacity at CSX railroad and at Yellow Freight. The merger of Yellow and Roadway was over a year ago. NSC made an all time high a couple of weeks back. A few weeks ago, I wrote about General Electric. I said to invest in the "big, dumb and ugly" American companies. Since then, GE is up in price maybe 8% and has announced a 10% dividend increase and a 15 Billion Dollar stock buyback. Two years ago, K-Mart was bankrupt but this year its real estate value was of such value that the company was able to use its shares as currency to buy Sears!

I don't remember all the details but some weeks ago, Ken Fisher wrote a piece titled something like "The Great Melt UP!" In the piece he suggested that the stock market is going to surprise almost everyone in just how strong a move we experience. Ken is one of those guys who is right most of the time.

A fact that seems to be under appreciated is that under the after tax return under the current tax law a dollar earned from a stock is often worth $2 earned from a bond. Bush has stated his high priority of making a dollar earned from a stock a tax free dollar. What is happening is a fundamental realignment that happens only about once or twice in a lifetime.

I can't blame Jimmy Carter for the hyper inflation of the late 70's. Until the tax laws were reformed, the public was being paid to borrow money. The Bush tax law change means that the public is getting paid double to own stocks. A fundamental law is that if you increase the after tax return for an investment, the demand for that investment is going to go up and the price will also go up.

The Chairman of E-Trade was on CNBC Thursday evening. Schwab and E-Trade have each announced trading activity increases of about 23%. The crazy trading in SIRI was about 2% of that increase (I plan to sell the rest of my families SIRI this morning). The relevant point is that the public is just now seriously returning to the market.

When the public returns after a long tough period of time, it marks the beginning of the end of the bull run. Those who are not in the market now should get in quickly because the next leg will probably last months but not years before the next 15% correction.

I have often posted the John Kenneth Gailbreth quote that, "In economics the majority is always wrong". Our egos get in the way and it is easy to believe that we and a few people we read are smart and everyone else is wrong. However, the current jigsaw puzzle has bothered me for a time because all the pieces did not fit.

But, clearly, the majority of Americans believe that interest rates are likely to rise in 2005. Therefore, since "the majority is always wrong", interest rates will actually decline. The dollar will decline and the US stock market will remain very strong for several months to come. This scenario fits with many other pieces; such as the high levels of outflows to foreign mutual funds and small cap mutual funds and the super strong transportation index.

Another interesting way the puzzle all fits together relates to health care stocks and developing nation stocks. The recent bounce in health care stocks means that this group has out-performed the other 7 S&P sectors for a whole month. From earlier blogs, you know that I believe health care will do well in the second phase of the economic growth cycle. You also know that the Brazil and other foreign ETFs have had outstanding performance for several years. The entire Brazil market is up about 4 times and guess what country was just recommended in businesses week. (Business is a great business magazine but it reflects popular sentiment like TV and other media, it only highlights a trend near the end of the trend.)

Anyway, Heath Care is showing strong relative performance and Health Care stocks only have a 34% correlation coefficient with foreign stocks. Technology stocks have a 62% correlation coefficient to emerging market stocks and a 42% correlation to Health Care.

Another piece that fits well is that the correlation coefficient between small stocks and large cap value stocks are respectively 55 and 69%. Growth and Technology are tight with an 84% correlation.

My bottom line is that I will continue to move into big cap, value, US companies. I will trade out of pure technology manufacturing semiconductor type companies. Although GOOG, EBAY, YAHO, AMZN and others use advanced technology, I do not consider them to be technology companies. They certainly are growth companies but I believe the value is there also. I will also continue to hold companies like Dell and IBM. Both these companies receive significant revenues from service contracts and Dell merely assembles high tech parts that are mostly manufactured by others. It is a marketing company.

In a bull market, if one invests in 15 or more stocks, one is almost assured one will make good money. However, markets do rotate from sector to sector. Energy just had a great one year run. Consumer Staples and Health Care are showing leadership now (Clorox was the latest consumer staple company to announce excellent results). Most Health Care stocks have had a horrible year until just recently. Semiconductors were strong early in the year and died later.

The point is that now is the time to evaluate what you have and adjust accordingly. I would be pleased if you would allow me to comment on your specific holdings.



NO! I do not plan to buy bonds any time soon. I plan to continue to invest aggressively in the US stock

WHOA! BOY WHOA! SLOW THIS HORSE DOWN?

I am and have been a bond bear for weeks on end. Based on historical norms, the economy is too strong relative to a ten year yield of 4.2%. The nominal GNP is growing that fast! The implication is that the true inflation is almost 0!

Another interpretation is that the economy is about to slow and another is that the dollar will fall quite a bit more. What do the data say?

Recent data suggest that the dollar could go lower. The trade deficit is large. The average work week in America has softened. New orders for manufactured goods has come off the recent peak. Vendor performance has improved significantly and the yield curve although still very positive has flattened. Manufacturers are keeping inventories extremely lean. Consumer expectations are moderate and, indeed, recent polls show that more Americans believe the economy has been getting worse than believe it is getting better (They are almost correct in the very short term! Except that we are really talking about the second derivative or the rate of change). The feds favorite measure of inflation indicates that inflation is only about 1.5%.

I am a bond bear but who or what is slowing this horse down? The above numbers would lead one to believe that bonds are set to rally from here! Even the ratio of commodity prices to bond rates suggest that bonds are a buy!

In a speech today, The President of the United States suggested that his second term will be one of fiscal conservatism. He is correctly attacking the unfunded liability of the Social Security Fund as a fiscal problem that needs to be fixed. He is trying to get out in front of the na na na nas who are dying to whine that borrowing money is a sorry way to fix a deficit. (The na na na nas do not want to fix the problem, they enjoy the chorus of na na na.)

Bush continues to talk about fixing Social Security, tort law reform, tax breaks to rationalize our economy and balancing the budget; not to mention fighting the war on terrorism. He reminds of the juggler that used to be on the Ed Sullivan show. This clown could bounce several balls with one foot while jumping up and down on the other while balancing a spinning plate on a poll held in his mouth while dealing a bridge hand. It seems impossible until you witness it.

Maybe the market believes that Bush is going to practice the old political game of taking the bad medicine in the first year. Presidents do this in order to have a strong economy by the time the next presidential election year comes around. Maybe Bush believes he will need to spend the first year or more balancing the budgets in order to create a crises that can be fixed by the fiscal stimulus of passing Social Security reform.

No doubt it will take a lot of tit for tat to get SSN reform through the congress. Polls show that young folks want a better return on their money and old folks want to know that they will be protected. No matter how you slice it, moving 2 Trillion to the stock markets should stimulate the markets. The trick will be to buy the stocks before the reform goes through.

Under the circumstances, what should an investor do?

Buy solid stocks now and be willing to hold on even if there is a correction during 2005. The risks of being out of this market are bigger than the risks of being in it. If indeed there is a bond market rally, the stock market will be even more attractive on a relative basis. Even using the feds inflation gage, short rates are still stimulative. The chances of a serious slow down or recession are remote.

Finally please consider the idea that it is not that the US needs to slow down but that Europeans and others need to speed up. Unemployment in Germany, Spain, Belgium and France is 9.9% or higher. The entire Euro area has averaged 8.9% unemployment for the last full year. Euro GDP growth is an anemic 1.8% versus a robust 4% in the US.

Ironically, Americans are buying foreign stocks. There is nothing wrong with diversifying your portfolio with foreign stocks. The answer is to remember to zig when others zag. Buy large American companies now and hold. Returns in 2005 are likely to be 15% or better.