PPI DO NOT PANIC!

The latest Chart of the Day shows how tough inflation is on the stock market. The problem is that this is the wrong topic for the time. The fact is that the PPI was exploding YOY just a couple of months ago but now the year over year comparisons are quickly moderating. The latest number of .7% was high but the core rate was only .1%.

In a similar economic environment in 1994, the PPI was driven down when the fed raised short rates several months in a row; does this sound familiar? The rise in short rates the past 8 months appear to be doing their job. The world economy (with the China numbers the big exception) has slowed. Steel prices and other material prices have fallen off their peaks. Oil dropped from $58 and is bouncing around 50-51. Chairman Greenspan's favorite measure of inflation, the PCED, is showing a 1.6% annual rate. Wage inflation, the biggest component of inflation is still very tame.

Earnings announcements have generally been very good so far. I believe Google is going to cause excitement in the market by reporting very good numbers. Stock buy back announcements are being announced daily. The stock buy backs can be read a couple of ways but the bottom line effect is that they increase operating leverage and therefore boost projected earnings for growing businesses. Another way to express the effect is that the fewer shares left divide up essentially the same earnings. The interest earnings of the cash in the corporate accounts is obviously lower than the earnings being earned by the same money invested in company shares.

There are powerful anti-inflationary forces acting on behalf of investors. Some of these factors are railed against by the media and politicians with axes to grind but they are still positive factors that reduce inflation. Things like immigration that gives us low cost labor, open trade with China, India, et. al., lower corporate tax rates, and the process of "creative destruction" that the US is going through.

American surgeons are currently using robotics to do surgeries that were impossible weeks, months and years ago. How many years pay will the head of a manufacturing plant in China give to an American hospital to save the life of a family member? There is nothing wrong with paying poor Chinese to manufacture socks and shoes for us cheaply and then charging them a fair price for a GE turbine or a heart valve repair.

The Chinese and Americans are benefiting by our trade "partnership". The whining of politicians about unfairly pegging the currencies is necessary to keep the heat of the under educated and under informed off the politicians backs. The market sets prices! If the currency is truly under-priced, it will not take jawboning to bring it up.

Should Florida decide to subsidize the price of tomatoes in order to out-sell California tomatoes, how long would it last? How long would the citizens of Florida be willing to give all tomato buying citizens in North Carolina a penny every time we buy a Florida tomato. Yes, in the very short run, California growers may have to cut back production of tomatoes or convince the citizens of California to pay North Carolina a penny or more to win back the business. The more logical stance of California would be to grow more oranges, grapes or asparagus. If Florida can indeed grow and ship to NC for the lowest price, NC citizens are likely to buy tomatoes from Florida and the citizens of the state do not need to pay us extra money to buy the product. If the citizens of Florida decide to sell at an extra low price, it would be the citizens of NC that would benefit, not the citizens of Florida!

Buy US stocks, companies are making money, buying back shares and growing their businesses. There is no need to worry over every negative comment made about the market potential. Half of what you hear is being presented by someone who has an ax to grind. Half of what you hear is dead wrong. The truth is that the person who invested his retirement funds steadily in the stock market every month for the past 20,30, 40, 50, or 60 years has made a higher return than 90% of the professional managers in those 50 years. His compounded rate of return has beaten CDs, Bonds, Savings and Real Estate. It is a mathematical fact that corporations will not over the long-term pay more interest on bonds than the rate earned on the companies equity!

Holding Back On Buyback Big Boys - Forbes.com

Holding Back On Buyback Big Boys - Forbes.com

Which company is buying which company? With valuations so reasonable a lot of companies are buying shares. In most cases, the companies are buying their own stock. There have been plenty of mergers but companies are flush with cash and if they don't see a good acquisition they are buying back their own shares.

What is an investor to do? Beat the companies to the punch. Buy big American companies. The earnings yield of the average American company is better than 6%. The ten year bond at 4.2% is not even close and the interest is taxable!

Eye On Stocks For Wednesday, Apr. 20 - Forbes.com

Eye On Stocks For Wednesday, Apr. 20 - Forbes.com

Sprint (FON) continues to be one of our favorite long term holdings. Forbes reports that Merrill Lynch has reiterated its buy on the company. The reason I like it is its unique position in the cell phone business.

Comcast and other cable companies may contract with Sprint to offer combo phone service. The cable companies are not likely to pair up with the Baby Bells. ESPN and several others plan to offer cell service through the back bone of FON.

WSJ.com - US Airways Talks To America West About a Merger

WSJ.com - US Airways Talks To America West About a Merger

USAir has continued to wiggle through bankruptcy court. It has made deals with regional airlines for financing. Now it is in talks to merge with America West. It makes sense to me. The industry needs consolidation. Costs have been cut but capacity needs to be reduced. The moves by Continental to move assets to foreign destinations is a rational move. Slowly but surely the industry is going to fix itself. Increasing business and consumer travel will help.

GOOD NEWS FROM BAD NEWS!

Recently I posted charts indicating the level of negative sentiment. Negative sentiment is a contrary indicator; stocks normally go up about the time most traders are sure that they will not. In addition to continuing to find negative comments on blogs, such as "this is probably a dead cat bounce" I have found full service brokers to be hurting. The months of sideways movement in stocks have slowed investment activities. At a Merrill Lynch office in the eastern and western sections of NC, brokers speak in depressing words about the market and business prospects.

Public attitude is reflected in the brokers words. Real estate is still hot but stocks are not. It is time to sell rental real estate property and time to buy stocks. The crowd will probably push real estate higher this year. It is a game of chicken to hold for the peak price. Ironically the peak in real estate will probably be supported by the next run in stocks. Everyone will be feeling great when stocks run, oil prices fall and real estate peaks. You have to remember that peaks are not noticeable until one is able to sneak a peak in ones rear view mirror.

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven D. Levitt and Stephen J. Dubner - William Morrow, 2005

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven D. Levitt and Stephen J. Dubner - William Morrow, 2005

Twice in the same day a friend has told me that I would enjoy Freakonomics. I was hooked when I read the first sentence in the advertisement: Which is more dangerous, a gun or a swimming pool?

As many of you know, I have often suggested that many things work exactly the opposite of the way most people think they work. Also, people tend to over-estimate the probability of horrific events or results. Thus when the dollar falls relative to foreign currencies, people are frightened into doing the wrong thing at the wrong time.

One of the most common examples of upside down thinking is the effect of increases in short-term interest rates. The belief is that an increase in short rates means long rates will go up. The reality is that an increase in short rates slows the economy thus lowering the probability of an increase in long rates. In an over heated economy, the probability of an increase in long rates and short rates is high but the increase in short rates does not mean that long rates will rise!

I am currently reading an excellent book: The Bottomless Well; The twilight of fuel, the virtue of waste, and why we will never run out of energy. I like to skim books several times without ever actually reading every page. I will skim this one a hundred times because it includes powerful ideas and data I have not seen before. I have written how most folks have little clue in regard to the power of the law of substitution. Few people have any understanding of how the consumer price index can say inflation is 2.7% while the PCED says that inflation is 1.6%. A one percent difference in the inflation rate alters billions of economic decisions.

I am currently also working my way through The Future for Investors. The section about growth will cause me to do independent study in the coming weeks. Somehow, I have to work in a quick read of Freakonomics. Economics is the dismal science and I love it.

Betty asked, Should She Ride This Roller Coaster?

The stock market is a roller coaster only in the short-term. We get a different perspective when we see things close or from afar. Did you know that the surface of a pool ball is more irregular than the surface of the earth! We see mountains and valleys on the earth but we see a pool ball as being smooth.

Take a look at page 171 of Jeremy Siegel's latest book, The Future for Investors. It is not in libraries yet but Barnes and Noble and the other big stores have it. In the book you will see that the graph of stocks from 1801 to present looks pretty smooth. The decline in 1929 is very small relative to the moves of the previous or subsequent 20 years. It also shows the huge long-term advantage of stocks over bonds.

It is the job of the portfolio manager to smooth out the bumps. This is done by committing more cash when stocks are down and adding cash when stocks are up, balancing by sector and balancing with fixed income securities. Balancing is nothing more than a sophisticated form of dollar cost averaging.

We must be thankful that we are small relative to the earths mountains and valleys; they are beautiful! The peaks and valleys in the stock market are also beautiful. They give one the opportunity to do tax swaps, to correct mistakes and to make higher than average returns. In addition, the peaks and valleys give us hours and hours of entertainment.

It is easy to do well in the stock market. Benjamin Graham said that folks underestimate how easy it is to do average. He was right. One can invest 80 percent of ones funds in an index fund, the other 20% in a medium term bond fund and rebalance each quarter. Your returns will be better than probably 80 or 90% of all managed accounts; with lower volatility! You would reduce your returns a little and the volatility a little by making the account 70% stocks and 30% bonds. But, you would not have much fun and you would automatically buy new S&P stocks at inflated prices.

It is a mathematically neat trick that the weighted average return of stocks and bonds will be surpassed automatically if one balances the weights on a regular basis. In other words, over long periods of time, stocks might average 11% and bonds 6%. One might surmise that an 80/20 portfolio will produce 8.8 plus 1.2 for a total return of 10%. The good news is that the portfolio will come closer to 11% than to 10%. The balancing action forces more stocks to be bought when they are cheap and to be sold when they are dear.

Ben Graham also said investors underestimate how difficult it is to beat the market. He was right. It takes education, experience, work and luck. Experience can be a very mean teacher as there are many hidden potholes in the market road. Therefore, one should diversify, keep trading costs low and keep the faith in tough times. If you buy more stock when the market is down, you will be rewarded when the market goes up. If you let winners run and cut losers short, you will benefit from tax savings and by avoiding big mistakes.

The bottom line is that you can easily earn and average of 11 to 12% in the stock market over 20 years; if you are willing to hold individual stocks thereby reducing the carrying fees. By taking an educated but aggressive approach, you might do 2 to 4% better or 2 to 4% worse. Those who try too hard are the ones who make the big mistakes and yes the horror stories are true. Aggressive leveraged accounts can take huge losses in a hurry. It is easy to increase trading costs, to panic when an over-invested portfolio gets whacked or to take too much out of the market waiting for the time to enter. Cash is most often a drag on a portfolio. Many of the best in the business stay fully invested at all time. Those who use leverage on stocks had better be prepared to soar like an eagle and dive like a dophin.

There is no need to be overly aggressive. If you earn 11 or 12% over time, you will be pleased with the growth. Twelve percent doubles your money in 6 years. The last doubling is the big one!

Thank you so very much for writing. I hope you will keep in touch. Without using your full name, I will post your question and much of my response. By the way, I trade through BrownCo where the commission to buy stock is $5. I help manage the accounts of a few friends and family members. I do not charge a fee. I would be happy to assist you in any way I can. In any event, please keep reading and let me know if there is a specific topic that I should cover.

Jack