HUCK, HUCK, HUCK

A few weeks ago, close friends suggested that I take a good look at Mike Huckabee for President. Saturday, after I noticed how the polls have starting swinging hard in Huckabee's favor, I decided it was time to take my friends advice. I spent a couple of hours watching videos and reading about Mike at http://www.mikehuckabee.com . I was surprised and impressed.

A week ago, when I thought Huck had no chance of winning, I discounted his message, including his "fair tax plan". My mind set was that the promise to do away with the IRS was just another politicians empty promise. Now, I believe the tax plan is one of many reasons Huck should be supported.


In our current system, the tax code is complicated and more importantly destructive to maximum economic efficiency. Our current code leads to billions of wasted dollars. Billions are wasted because it is expensive to figure out how to comply with the many complications. Billions are wasted because the code offers incentives to mis-allocate resources. Most of all, billions are wasted because America's productivity is taxed.

A few months ago, I was excited to learn that both liberals and conservatives in Congress have quietly indicated support for lower income taxes in combination with off setting taxes on carbon consumption. Such a plan would dramatically simplify the tax code. However, the "fair tax" does an even better job of raising revenue, simplifying the process and taxing all consumption while eliminating all taxes on income.

TAKE A LOOK AT HTTP://WWW.MIKEHUCKABEE.COM

I hope you will take a good look at Huck's candidacy. Among other things, he pledges to make the US energy independent in less than 8 years. I believe his energy plan would be easily successful if his tax plan were passed. The US economy would boom, boom, boom under his tax plan because wage earners would collect 100% of their pay on payday! There would be no withholding. In addition, all citizens would get a check from the government at the first of each month to cover the tax on essentials. There would be no tax on dividends, interest, savings, inheritance, or wages. There would not even be a payroll tax.

FAITH. FAMILY. FREEDOM.

The best three word campaign slogan I have ever heard.

SLOW, SLOW, SLOW -- GO, GO, GO

The signs of slower world wide growth are welcome. Europe and the US continue to put the heat on China to let the Yuan float up so that some of the slowdown is spread more quickly to China. It is only a matter of time before slower growth in the developed nations bite the undeveloped nations hard. Stock markets in several developing nations have been pounded hard in recent weeks. Over the next 4 or 5 years, the number of stocks around the world that have out performed will gradually shrink. More and more money will pile into ownership in the biggest of all companies. Over the next several weeks, and possibly the next several months, the opposite will be true. When the markets blast off, the little companies and the speculative companies will join the party big time, at least for a few weeks. The "Santa Claus Rally" and the "New Year Effect" will give the little guys a nice boost. The slope of the yield curve will help regional banks do well. High value goods manufactures will enjoy high exports now that the dollar gives US companies a huge competitive advantage. Investors from around the world will pour more and more money into US companies to enjoy the rebound for the slow down and to enjoy the bonus of the appreciating dollar.

BUY, BUY, BUY. It is a rare time when sentiment is very negative and when insiders are buying so many shares. Any number of events could bounce the markets around in the short term but any one of these events could set the market "on fire." For example, OPEC meets Wednesday, the ECB meets Thursday and the FOMC meets on December 11. Hold onto your hat!

GREAT NEWS IS BAD NEWS TO THE FEARFUL

I cannot resist pointing out yet another false "BAD NEWS" story.

The headlines about a major increase in fairs by Southwest Airlines have been along the lines of "SOUTHWEST TO GO COMPETE FOR BUSINESS TRAVELERS".

The headlines and the articles imply that the move by LUV to dramatically raise prices to business travelers is bad news for companies such as CAL. The fact is that after the change, business travelers will average higher ticket prices on both airlines.


Southwest recently offered about 8 prices for the same seats on its typical flight. Under the new scheme, the same seats will be offered at 15 different prices. Frequent fliers who pay extra will be given the best seat locations available and "a free cocktail". Wow! How nice of them to give away free drinks.

The price increase is starting out at $10 to $30 per seat. After the new plan has been in operation for a while, do you think it might be easy to increase some of the fairs more? Do you think that higher fares at LUV will give the legacy carriers a reason to lower fares or to raise them?

The market is fearful that Congress will not settle major issues by the November 16 deadline. The funding for the new air traffic control system has already been deferred to next year. The nation needs the new system and it should be paid for by the users. The congress will fight this battle next year but in the mean time the airlines will keep on flying full planes and they will keep on raising fares as necessary to offset fuel price increases. The very old fleet of US planes cannot haul more people, when demand exceeds supply the price goes up. The news media did LUV the favor of avoiding saying that business fares are jumping but the fact is that they are.

BUY, BUY, BUY. Add money if you can and buy more stock!

SEE - SAW, SEE - SAW, SEE - SAW

The see-saws are moving. When merger mania and hyper leveraged transactions ended, the big investment banks dropped. Regular banking activity is ready to boom. Business construction has largely taken the place of residential housing and the construction loans are being handled through "normal" banking transactions.

See-saws are all over the place. Exxon Mobile, at the king of the hill, has taken a hit. While the price of oil has moved from 82 to 95 the price of the stock moved from 92 to 95 and then back to 92. Believe it or not, the average price the consumer has paid for a gallon of gas this year is less than the average at the same time last year. The oil companies are having a more and more difficult time of passing through the higher prices of oil, demand destruction has occurred. Refining margins have collapsed. The traditional see-saw, oil on one end and high tech on the other is in evidence.

If you don't believe these two segments see and saw, take a look at the past blow off peaks. During 1999, when the tech bubble was fully extended, the price of a barrel of oil was $12. During the oil record setting days of 1980, technology stocks were at selling at decade low PE ratios, Business Week's front cover was about the death of tech. The current boom in tech is well underway, tech stocks are up an average of better than 30% year over year. Even Microsoft, which had been stagnate for years, is moving up sharply relative to oil stocks.


Yesterday, the US Dollar rose on the same day that interest rates were cut. The pundits suggest this was because the FOMC cut only a quarter when they could have cut a half. The fact is that the US economy is very strong and growing and there is reason to buy dollars. The GNP grew 3.85% the last quarter, this is the inflation adjusted rate of growth and it is well above the long term trend. Real disposable income growth was off the chart. The "see" has already "sawed" in regard to export and import growth, in the past year, US growth in manufactured exports was over 16% and imports of goods grew by less than 3%. The see-saw in export-imports will lead to the turn in the dollar (assuming Congress fails to override the Bush veto of the billion dollar tax increases offered by Congress).

NO USED PIANOS PLEASE

In response to my piano story yesterday, I got feedback from a friend who just sold her baby grand. Her kids are almost grown and she needed the space for other things. She confirmed my story. The value of all but the very best of used pianos has fallen dramatically. Charities, churches and auction houses often refuse pianos. I feel compelled to reiterate this situation because it is the crux of the disinflation story and since writing the story I heard two more TV pundits talking about how the government inflation numbers are false. TV pundits, like "news" reporters, fall into the trap of telling half truths because only those who tell exciting stories get more air time. One pundit mentioned this morning that if you have children headed toward college then you understand that the inflation rate is still very high.

Sorry Charlie, the full price of college tuition is paid by only the very few. The great majority of students get very substantial discounts in one way or another. At my alma mater, UNC-CH, the top 10% of the students now get a totally free ride! By jacking up the price, the perceived benefit of the scholarships are greater. When a top student has the opportunity to accept the $100,000 scholarship from one school or the $80,000 scholarship from the other, he is inclined to take the free ride at the $100,000 school. Under such circumstances, the price at the $80,000 school is apt to rise quickly to the $100,000 price.

College tuition and the price of a hospital operation are just two of the misleading numbers people use to say that inflation rates posted by the government are false. Both are misleading because almost no one pays the full tuition cost and almost no one pays the posted hospital operation price. If the price of an operation soars from $20,000 to $40,000, was the inflation rate 100%? What if a number of new programs were offered to allow large discounts to those who have no insurance? What if the large insurance companies went from a 20% discount to a 50% discount? In other words, if the Medicaid reimbursement rate went from $7,000 to $9,000 and if the private pay persons best negotiated rate went from $15,000 to $22,000 and the insurance reimbursement rate went from $17,000 to $25,000 then the real inflation rate was a weighted average of the various payment rates. When the government agrees to pay x percent of the total price, there is strong incentive for the price to be raised.

The same phenomenon happens in private industry all the time. For example, airline seat pricing follows a similar pattern. One legacy airline might raise prices and wait to see who follows. Chances are, the price increases are rolled back on 70% of the routes due to competition from low cost carriers. Then many of the highest priced seats are offered "on sale." The net increase is often only a tiny fraction of initially announced price increase. There were something like 17 across-the-board ticket price increases in 2006 and 9 so far in 2007 but the average price of an airplane ticket per mile flown is still about 15% below the price available in the year 2000. The point is that one cannot look at the head line numbers to determine the rate of inflation.

TV pundits who like to obsess over the price of oil fail to consider the efficiency of the US economy. We use a tiny fraction of the oil we used 30 years ago to do any particular task. In the "old days" huge quantities of oil were used in "non-transportation" pursuits. Today, the problem to be addressed is to convert transportation away from the use of liquid fuels. That process will take time but the market will make the switch smoothly if the politicians will stay out of the way. As usual politicians shoot the smooth process in the foot by such things as silly regulations. They might enact CAFE standards to try to force the issue, but mandating high mileage cars takes away the incentive from the consumer to make the more fundamental changes needed. Why ride the buss or move closer to town if the price of fuel is held down through regulations? In other words, we need to let the see-saw in this area as it does daily in all other non restricted areas.

INTERNATIONAL - DOMESTIC, SMALL - LARGE

The science of constructing an investment portfolio is a complicated process. The good news is that one does not need to understand the science of the internal combustion engine to drive a car well and one does not need to understand all the give and take involved in portfolio construction in order to invest well. Indeed, the person who thinks he is the best is often the person who has the biggest wreck or the one who goes out too far out on a financial limb.

As we move toward the end of an economic cycle, it will become more and more important to buy big companies. However, there is no rush to go all "big" right now. As a general rule, buying "big" adds a defensive element to a portfolio. Indeed it is intuitive to think that buying growth rather than value adds an aggressive element to a portfolio. Such cross currents can easily confuse even the "experts". As I have often stated, about 90% of performance is a result of asset allocation. Stock picking can be fun, exciting, highly profitable and very humbling but not at all a necessary investment skill. Indeed, most people would be better off using the dart board approach to stock selection. THE REASON THIS IS TRUE IS THAT STOCKS ARE SOLD THROUGH THE NEWS MEDIA AND IF A STOCK IS IN THE NEWS IT IS NOT THE BEST ONE TO BUY!

It is easy to conform to the opinion of others, the good news is that the herd is typically right during the first couple of years of the prosperity phase. Right now, one does not have to go it alone to make serious money.

At the current time, if an investor wants to try the dart board approach now, I suggest that he limit his dart board to big cap US companies. I say this knowing that over the long haul, small stocks beat large stocks and international growth beats US growth. I doubt that my message is clear because it is time to be very aggressive in the defensive area of "big cap".

When one end of a see-saw goes up, the other end must go down. The difference between see-saw movement and stock market movement is in order of magnitude and in terms of relativity. If oil stocks go up 20% over the next 4 years while tech stocks go up 100%, then there was a see and saw. Big oil integrated oil is "big cap value", the QQQ index is big cap growth. My forecast is that the QQQ will outperform big oil considerably over the next few years.

IT TAKES MONEY TO GROW A BUSINESS

Anyone with experience running a small business knows that the reason so many small businesses go out of business is because of inadequate cash. New business owners often incorrectly assume that profits are the key to success. Of course, in the very long run, a business needs to turn a profit. Having run a resort rental business, I can tell you that cash is king. Year after year, for decades we experienced tough cash flow and negative profits. The good news was that the value of the properties appreciated dramatically while all the rents and then some went to pay all the expenses.

Now that the economic mid cycle turn is here, the availability of financing is tighter. Starting a small business will be harder than it was over the past 5 years. Venture capital will be more and more dear. Funding will be available to profitable businesses but they will need solid balance sheets.

The reason to favor large caps in the current environment is that large caps tend to be "self funding." The current run up in Microsoft (most all of my friends own Microsoft through their ownership of the Q's) makes the point well. Microsoft has accumulated billions of dollars of cash and has all the more cash flowing-in. The coming build out of the mobile Internet (it will be an ongoing renovation over the next 50 years) will require huge amounts of money. Big companies which have the cash to move on opportunities have the advantage.

The smartest of the smart will continue to bring forth innovations. Facebook is an example of innovation capturing imagination and making the founder a multi-billionaire quickly. However, the only way for you to own a piece of Facebook right now is for you to own a piece of Microsoft. At the same time, Google is making big move after big move to compete directly with Facebook. It is my belief that churches, businesses and other organizations will soon adopt the Facebook "method of communication." Programs like Facebook and Myspace started as "virtual homes for teenagers" but are proving to be a valuable productivity tool for business. A number of businesses offer password protected communities of users. Email will eventually be relatively passe'.

The battle for dominance in all the the fast growth areas is ongoing. Millions of innovations fail to catch-on. Now is not the time to try to find the next Google, Yahoo, Myspace or Facebook. These companies have a head start on systems that have room to grow. As you all know by now, I believe Google's location specific mobile platform adds will be the most profitable of all time. Besides, by the time Facebook shares are available to you directly, they will cost an arm and a leg.

BIG PHARMA

Since a number of my readers work for big pharmaceutical companies, I must mention that the good times are upon you. The see saw of healthcare is swinging back into your direction. The momentum will grow at a gradual pace during the early part of the prosperity phase but like a see saw the speed will increase right to the apogee of the move. Within a few years, the compounded returns will be better than most "expert" expectations.

BUY, BUY, BUY!

HOLD ON TO THE BUCKING BRONCO

With the Dow down 342 points, I feel compelled to sent out a pep talk.

You do not own the Dow. The big drop in the Dow is coming from "roll over" stocks. Big oil is having to pay high prices but can't raise its selling price to compensate. Big finance, no longer able to raise the funds to do company buyouts, is suffering the heartburn from prior deals. All the while, Microsoft, one of the biggies of the big cap growth stocks, has made the turn.


This bucking bronco is doing its best to buck off the weak riders. It is time to load up this pack horse with so much weight that he can't even buck anymore. BUY, BUY, BUY!

The mid cycle stock market "bottom" is near. I know how silly that sounds with the broad averages still near all time record levels but it is just the way this cycle is working out. The big fall in the Dow and the market averages will be composed of "old cycle stocks" falling off. The NASDAQ will continue to out perform and then suddenly the US Dollar will start to climb. When the climb in the dollar gets going, the flood of investments will start coming home. Those who are loaded up in international stocks will feel pain and gradually decide that China is fun no more. Foreign investors will join the party. It is going to be a grand old party. Today's drop is big enough to have follow through in the days ahead but don't try to take advantage of short term moves. The next big move to the upside is going to break through long dated resistance. You do not want to be on the wrong side of the next move.

Those who shorted oil futures will eventually prove to be very right but very early. Those who are short must find oil to deliver. They are not having fun. Once the level of futures contracts comes back out of the stratosphere, the oil markets will return to rationality. It is pretty amazing that there has been such incredible levels of speculation that even Exxon Mobil can make no money off the refining of oil to gasoline, the crack spread is too low to cover the cost.

In the past, when I wrote about China's plan to build 40 nuclear power plants, my readers seemed to yawn. Last week, when I reported that China will build an average of one new coal fired electricity plant per week for the next 10 years, at least a couple of readers were impressed. The fact that the Chinese are using electric train engines to haul the coal was icing on the cake. At least one reader found a few extra dollars and purchased shares in GE. In case you are not aware, GE makes train engines, turbine blades for power plants and airplane engines. The company also is one of the top corporate tax managers. The failure of Congress to reform taxes does not hurt GE because it uses every technique know to man to reduce its tax burden. The same reader just took a huge profit on Baidu. He may have sold this one early but you never go broke taking profits.

A new coal train is under construction in Wyoming. The USA will build 150 coal fired power plants over the next 10 years. Yes, I believe a carbon tax should be passed as a way to reduce the tax burden on income and as a way to increase the costs of burning the dirtiest of fuels, however, the energy demands of the world are huge. The passage of a carbon tax would increase the mix of nuclear plants while reducing the mix of coal plants. A lot of coal plants would still be built but the incentive to use clean coal technology would or at least should be a part of the carbon tax law.

It appears that most of these issues could be left as fodder for electioneering purposes. It appears that Charlie Rangel will go along with the suspension of the pay-go rules so that a one year patch to the AMT can go through without the passage of much of the democratic tax plan. In other words, the economy is too strong to be hurt by minor changes to the tax code. THE MOST RECENT YEAR OVER YEAR GROWTH IN PERSONAL DISPOSABLE INCOME WAS OVER 7%! With no additional declines in the price of gasoline, the American consumer is ready to spend, spend, spend.

The Don Hayes group presented a neat chart today (subscription required). It shows the change in wealth by averaging the change in average home price with the change in stock market value. Of course, it showed a huge drop from 2000 through most of 2002. Since 2002, prosperity has returned to America. Even the recent decline in home prices has been off set by the climb in stock prices.

The site uses the story of the Chinese Piano to make a powerful point. The price of new pianos, available from China has fallen so much that there is no longer a market for used pianos. Auction houses, churches and charities have stopped accepting pianos. One auction house recently worked 15 minutes to get a $20 bid just so they would not have to pay to remove the piano. Those who continue to focus on oil and gold to suggest that inflation is still raging tend to ignore the price of goods such as pianos. The common comment by inflation hawks is that the price of the things they buy, including food and energy continue to cost more. The fact is that the average American spent 6.3% of his disposable income on energy in 1980 and this percentage has fallen consistently in all the years hence. The number is now down to 4.2%. In regard to food, the decline has been far greater. If memory serves, the decline was from around 18% to the current level of about 6%. The percentage spent on recreation is close to the mirror image of the food expenditures.

Never before has a piano or thousands of other goods been so affordable. We live in good times. The news is bad but the times are good. BUY, BUY, BUY!

BELOW AVERAGE, AVERAGE AND ABOVE AVERAGE RETURNS

Few people are stock market "wizards." The good news is that one does not need to be a good stock picker to make lots of money. The asset allocation decision is the most important factor in investment success.

The bad news and the good news is that the great majority of investors achieve returns that are less than average. The reason this is good news is that the under performance of the many makes it very nice for those who decide to take above average returns.


The best way clear up the above comments is by way of examples. The actions of family A and family B tell the whole story.

A and B live almost identical lives. The primary bread winner in each family has the same job and makes the same money. Both families live in $300,000 homes in the same neighborhood. The big difference between the finances of the two families is that family A is paying off their home at a more rapid pace than family B. Family B has made smaller monthly payments each month but has invested the difference in a total world stock market index.

Family A has equity in their home of $200,000 and family B has equity of $100,000 in the home and another $100,000 equity in the whole world stock market index. Each home, being in a good community has appreciated just slightly above the average long term rate for homes and the stock market fund has also appreciated at just about average long term expectations. The following are the expected returns for the next 12 months.

Family A will see their home appreciate by 6% of $300,000 -- $18,000. Their return on equity will be $18,000 divided by $200,000 or 9%.

Family B will see their home appreciate by 6% of $300,000 -- $18,000. They will also see their stock account appreciate by 12% or $12,000. Family B will pay 6% of $100,000 or $6,000 more in interest on their home than family A. Thus the total return of family B will be $18,000 plus $12,000 minus $6,000 or $24,000. Their return on equity will be $24,000 divided by $200,000 or 12%.

The primary reason family A wants to get the home paid off early is for their "peace of mind." Forty years later, when family B has extra equity of $5,000,000, which is $6,000 invested and compounded annually for 40 years, I submit that it will be family B who has "peace of mind."

Family A feels good in the short run, family B feels good in the long run. Both have a huge advantage over family C because family C has run up $10,000 on credit cards. The annual cost of $1,800 could be invested at the stock market average of 12% to produce $19,000,000 during a lifetime. Family C gives up $19,000,000 in order to buy some stuff this year rather than waiting until next year.

In the examples above, Family A is the below average return investor, Family B is the average investor and Family C is the family who enjoys punishment. Now let's look at Family D, the family of high risk according to the jealous comments of A, B and C.

Family D also lives in the neighborhood in a $300,000 house. This family made the smallest down payment allowed and refinanced to a 30 year fixed rate loan when interest rates were low. They have zero equity in their home but they have $200,000 equity in the total world market index fund. Indeed, they actually own $250,000 of the fund and they have a $50,000 loan against the account. Over the next 12 months, again assuming returns equal to the long term averages, Family D will see their home appreciate $18,000. Their stock account will appreciate $30,000. They will pay $12,000 more in interest on their home than Family A (in this example I am using the payment toward the first $100,000 as the "owners rent"). They will pay another $3,000 in interest on the $50,000 stock loan. Their increase in net worth will be $18,000 plus $30,000 minus $12,000 minus $3,000 or $33,000. Their return on equity will be $33,000 divided by $200,000 or 16.5%.

The following are the returns achieved:

Family A 9%
Family B 12%
Family C 8.1%
Family D 16.5%

Like I said, family D will be perceived by the others as the family who takes high risk. The reality is that family D will achieve great wealth partly because family D has reduced its risk.

Let's suppose all four heads of household are laid off from work. Which families have a source of cash? Family B has $100,000 liquid and family D has $250,000 liquid!

Which family would have the negotiating power to miss a few house payments if push came to shove? If family A is behind on its house payments, it is in big trouble. The pressure in on his neighborhood banker to reduce non performing loans. If the bank forecloses on family A, the bank will get a non performing loan off the books without taking a financial loss. Family D will be last on the foreclosure list. Family D has no equity in the home so the bank will likely lose money should it foreclose on this loan.

Financial Advisors are by nature risk adverse. Big money is made by the Financial Advisor who can convince his clients to broadly diversify into high fee mutual funds. Many an advisor has built themselves annuities by accumulating large positions in funds. Year after year the advisor "earns" his fee without any additional work on his part. Advisors often promote Mutual Fund Families for "annuity reasons." If a client gets frustrated with the performance of one fund, they might switch to a different fund in the same family and keep the river of fees flowing to the investment advisor. Financial Advisors know that frogs will boil to death if heat is added to the pot slowly. They also know that rapid changes will cause the frogs to jump. Financial Advisors make big money off of those people who are willing to sit for years in funds that offer mediocre returns. Advisors frequently promote "lifestyle funds", "balanced funds", "income funds" and many other variations and combinations of "diversified" funds. The result is the problem noted by John Maynard Keynes so many years ago, that with maximum diversification there is no profit.

The moral of this story is that it is easy to be an above average investor. All one has to do is allocate ones assets for long term growth while avoiding paying high fees.

MORE WORDS ON THE TURN, TURN, TURN

I was asked if I thought Merrill Lynch is a good investment now that it has dropped so much in price. My answer is an emphatic NO!

On several occasions I have described the economic turn as being similar to turning around a battleship. It takes a long time to turn around an economy or a battleship and once the turn is made, each will run in the new direction a long way. In each sector, there are first half and second half stocks. In the financial sector the first half stocks are the big investment banks but in the second half it is the small regional bank. During the second half of the cycle, small companies grow their business. When they expand, they are likely to borrow funds. The typical small business will do its borrowing from the small regional bank. The merger and acquisition fee train will slow during the second half as the Merrill Lynch's of the world will not be involved when the typical small business opens one new factory.

Another reader wants to know how I can be so sure that there is abundant supplies of energy? My answer is that I have seen the coal trains leaving Wyoming and Colorado. Did you know that there are 150 new coal fired power plants projected for construction in the USA over the next 10 years? DID YOU KNOW THAT CHINA IS ADDING AN AVERAGE OF ONE NEW COAL FIRED ELECTRICAL PLANT PER WEEK? DID YOU KNOW THAT THE NUMBER OF GAS RIGS DRILLING FOR NATURAL GAS IN THE USA HAS FALLEN BY 95 IN RECENT WEEKS AND THE REASON IS THAT THERE IS NO MORE STORAGE ROOM FOR NATURAL GAS?

The fact that China is building electric train engines to haul their coal is perhaps the most powerful way for me to get my point across. The law of substitution is more powerful than the rules or regulations of any government. Yes, it is a time consuming process to replace transportation fuels. The first step is to continue the process of removing oil from the power generating equation. This process is well underway. Everyday, trillions of decisions are made to increase the us of electricity and to reduce the use of the internal combustion engine. Over the next several years, more and more oil refineries will come on line, but even more importantly, enough time will have passed for substitution projects to have "kicked-in."

At the turn in 1995, the price of oil or gold did not collapse at the first hint of the turn, however, by late in the year, the dollar was soaring in value and the price of gold and oil was falling. Over the past 5 years, oil in dollar terms has risen about 240% but in Euro Dollar terms it has risen half as much. Once the dollar starts to appreciate, it will be the Europeans that feel the heat of the price of oil.

GDP

This morning, the GDP report came in at 3.8%! No recession here! However, as we know from recent data and from the price of treasury securities, the economy has slowed. The risk of recession has grown. This is one of those "bad news is good news stories". The pressure is on the FOMC to reduce short term rates. A cut in these rates will provide the "fuel" for economic recovery from the mid cycle correction. Investors should be sure to remember that the market leads the economy by at least 6 to 9 months. The weakest of economic numbers this cycle will be reported over the next two quarters. The market is already looking past this economic down turn and to the boom, boom, boom of the election year. Join the party now. Don't sheepishly accept below average returns! There is safety in keeping more of your assets in liquid investments that perform best over the long term!

BUY, BUY, BUY!

ROUNDING THE BIG CURVE, WE ARE IN THE TURN

It is fun to own the Q's during this turn. Almost every day, a different stock leads the way to higher prices. Today, Microsoft will lead several of the Q's higher. Wow! Microsoft has finally made the turn! Microsoft dramatically outperformed the market from 1986 until 2000. Microsoft is one of those "almost super rich stocks for me". I came very close to "loading the boat" with it in 1986 and would have made 10's of millions of dollars had I done so. Since 2000, the stock has dramatically underperformed. The turn is here.

After beating the estimates and raising the guidance after the market closed yesterday, the stock is up better than 11% in pre-market trading. Of course, companies like Dell, Intel and HP will be pulled along for a nice ride. The boom, boom, boom of the world economy means that billions of computers will sold during the coming prosperity phase of the business cycle. As we all know, it costs Microsoft virtually nothing to make another copy of VISTA. Billions of copies will be sold. Of course, even more billions of smart phones and games will be sold.


TURN, TURN, TURN

This morning on CNBC, John Snow repeated one of the great false beliefs of the TV pundits. Those, with the mind set that a recession is surely near, find it easy to suggest that the consumer is about to stop spending because he is no longer able to use his home as an "ATM Machine". We have been hearing this garbage for three years or more and it has not happened yet. It will not happen because it never was the case. You cannot stop doing something if you never started doing it in the first place. Even at the peak of the home refinancing binge, only 9% of home borrowing went to make other purchases, such as SUV, and most of these purchases would have been made anyway. The home was wisely used to lower the cost of financing but in only a relatively few cases was it used to expand financing beyond the buyers capacity to repay.

The sub prime story also continues to be used to suggest things that are simply not true. Of those who bought homes with no money down, 85% of them will keep making the payments and they will have been converted from renters to owners. Of the other 15%, the opportunity to own has not turned into the blessing that it could have been but a renter who temporarily "owns a home" with no money invested will lose no equity when he loses his deed. When politicians cry about the poor people who are losing their homes, they imply that consumers are losing billions in equity to greedy and evil hedge fun managers. What really happened was that these aggressive investors borrowed money at very cheap rates of interest to benefit by lending these funds to poor credit risk buyers. The aggressive investors made out like bandits during the good times. If you borrow $95,000 at 1% interest and lend $100,000 at 4.5% (including your $5,000 equity) your annual net interest income is $3,550 or 71% return on equity. Those who are losing their $5,000 equity right now have in most cases had several years of $3,550 net earnings on that same $5,000.

The bottom line is that this story is being used to put fear into the hearts of investors when it is time to be an aggressive investor.

SO FAR, I HAVE BEEN PARTIALLY WRONG ABOUT OIL

The price of gasoline has come down as I suggested it would but the raw commodity has not yet rolled over. Who would have guessed that after 8 to 10 increases in interest rates and after 8 to 10 increases in reserve requirements, that China would continue to grow so fast? The good folks at GAVEKAL research wrote a good book titled "THE END IS NOT NEAR" but who really believed those guys? The GNP of China has once again grown by better than 11%. Where is the clearing price? Of course, if I could predict the precise answer to that question, given that no one else can, I would be a multi-billionaire. We really should think of China like a great growth stock. The current price of shares is very high but there is still great potential for growth. Still, given my belief that the US dollar is about to climb and that within 4 or 5 years high returns will be found in fewer and fewer of the biggest companies around, I am not excited about investments in China right now.

A major oil supply company executive says that there are plentiful supplies of oil. In the liquid market, he can buy all he wants and then some. He says financial speculators are jumping on all news of potential international conflict and bidding up the price. He points out that the skirmishes between Turkey and Kurdistan are not even close to where the oil flows.

We are now at such an extreme level that the break will be like the bursting of a damn. The speculators will not be able to get off the long side fast enough. It is my belief that a deal with Iran is brewing. Once a deal is made, about $30 per barrel in risk premium will fall out of the price.

Keep in mind, the turn in Microsoft is a part of the same process of the turn in oil. The substitution effect includes enormous spending on electronics as a way to reduce dependence on oil. The USA and many other countries have dramatically reduced our use of oil over many years. China is investing heavily to reduce its dependence. Some of these investments will take years to complete but many others are already producing results. Indeed, China is in the process of building 30 nuclear power plants which will replace oil in many a manufacturing process. In the USA, oil usage declined .7% during a year of dramatic export growth. Pundits who say there is no evidence of reduced demand are not looking at the total picture.

The good news is that the world has been hit by the blows of higher oil and taken the punch well. One key ingredient has been the success of economic science. The central bankers have not dried up all the money to stop inflation and thus thrown the world into recession. Instead, money has been available and it has been used to "go around" the "oil problem". Billions of dollars are being spent on billions of projects from coating windows with film to sun powered algae farms.

Those who use high gasoline prices as an example in their constant complaints about inflation do not want to acknowledge that the cost of manufactured goods continues to come down. When China buys oil at ever higher prices but produces end products for less than their prior prices, the net result is not inflation.

CHINA MUST SLOW DOWN

Sooner or later, growth in China must slow. The combination of the rising Yuan with higher interest rates and higher reserve requirements will ultimately do the job. A slow down in growth from 11% to 6% would be a huge event. The China stock markets could be hit very hard by such an event. Always remember that the price of shares is set by the value of the future earnings discounted to present value. If growth slows, future earnings slows and prices fall.

BUY USA, BUY USA, BUY USA GO MICROSOFT GO!

TIME RUNNING OUT

Time is running out on Iran. A long list of new sanctions will be imposed on Iran today. Any company that does any business with the Iranian Revolutionary Guard will face repercussions from the US. I believe a deal is near.

Time is running out on Congress. Hank Paulson says that the tax refunds due 50 million Americans will be delayed next year if the congress does not pass the AMT patch by November 7. Rangel will present his list of tax increases tomorrow. The bill as written will go nowhere. Could this game of chicken end with no AMT patch? I doubt it.


Time is running out on terrorists in Iraq. The death rate in Iraq continues to fall. The citizens of Iraq are no longer willing to harbor terrorists. Even the Kurds are showing signs of helping with the PKK problem. The government needs to compromise on energy revenue distributions and a few other things and many more American troops will be withdrawn.

Time is running out on the commodities bubble. A Texas energy economist estimates that $30 of the price of oil is risk premium. Just the hint of a settlement agreement with Iran could cause the price of oil to plunge.

The FOMC will meet next Wednesday. Financial Futures contracts suggest there will be another 25 basis point cut. Recent data suggest the cut will be 50 basis points.

This business cycle has been a record breaker. No one would have predicted a strong economy in the face of $90 oil. Lower oil prices, lower interest rates and relative peace in the Middle East would be a powerful market stimulator. Hold on to your hat! BUY, BUY, BUY

THE BIG $$$$$ TURNS ARE HERE!

Big money turns are happening all around the world. For example, Cisco just purchased a WiMax company. Up until now, Cisco was not a player in the WiMax market and did not feel the need to be there. The problem for Cisco is that WiMax is proving to be the key to the rapid coverage of huge areas of Brazil, India, China and other developing nations. The growth in telecoms and Internet services in developing countries is huge and quick because there is no competition from a previously built fixed wire system.

The standardization of WiMax protocols is causing the system to spread at a rapid pace even in the USA. Sprint and ClearWire are just two of the early USA leaders. Google has inked a partnership deal with these guys and because Google has purchased billions of dollars of fiber optic capacity and telephone nodes, the speculation continues that Google could build out a nationwide WiMax supplemented Internet/Phone system in a hurry. My guess is that the next big Google move will be to start a VOIP system. Much of the system is already in place. Adding the 700mz TV spectrum, the stuff that goes through walls, would give Google the ability to cover the whole country quickly. The big phone companies are dug in deep and a country wide network would cost billions so several partners may be involved. Even Apple has expressed an interest in buying spectrum. Google will attempt to remain the software provider and let others sell the hardware and the service.


Since Google became public, the stock has risen from $85 to $650+. During that time, Apple has gone up twice as much. I believe Apple is over valued but it certainly has momentum. I continue to hold shares in accounts and inside QQQQ, QLD and other funds. If I had enough money to buy all of Apple, I would buy Google instead and invest the other half in something else. This statement may sound silly but I have used this logic to great advantage in the past. For example, when I suggested buying CAL at $6 per share, I wrote that LUV at $17 per share was dramatically over priced. I said that if I had the money to buy all of LUV that I would buy CAL, AMR, UAUA, DAL and NWA instead and invest the remaining 9 Billion Dollars elsewhere. Since that time, LUV has gone nowhere and CAL has gone up from $6 to $36. Even today, those who do not understand the situation are over paying for LUV while the growth in international traffic is huge.

Back to the big mobile turn, Google's purchase of Jaiku shows us once again just how much change is in store. Jaiku has the potential to automate everything from your address book to your photo album. It is kind of a Twitter on steroids. Give your teenage child a Jaiku phone and you will know his location, to whom he is talking, see the world from his camera lens and keep records of all his activities. It sounds like a spooky big brother deal but those who like it are crazy about it. Coworkers have found Jaiku to be a huge time saver; notes and contacts are automatically shared across the network. Husbands who stop for groceries access the list prepared by their spouse and automatically leave the message that the shopping has been done. Put a Jaiku on a child and he will not get lost for long.

The big turn in the Internet is that it will go mobile big time over the next several years. Buy the QQQQ's and hang on for the ride. Ideas are coming hard and fast. I did not buy more VM Ware when it was spun off from EMC but I have enjoyed the ride since EMC still owns 86% of the stock. It is impossible to see which of the big firms will produce the next winner. Ebay is babying another fascinating purchase and Amazon is selling high dollar goods rapidly while the pundits keep talking about the consumer being tapped out.

BIG, BIG, BIG TURN AHEAD

Understanding what most others do not understand is the path to BIG MONEY. The REALLY BIG MONEY TURN is close at hand but most investors expect the dollar to continue to fall.

The really big money turn is that the value of the US Dollar relative to most other world currencies is about to climb rapidly. The brief history of the dollar is that it was very weak in 1986 and again in 1995 just before those mid cycle turns, once the dollar turned, it climbed and climbed and climbed some more. In the latest cycle, it peaked in the year 2000 just as the average American went "all-in" during the Internet bubble. Since that time, the dollar has fallen and fallen some more and it is now at about the same level as it was in 1995. In the year 2000, one could buy a Euro with a dollar and get back about 20 cents in change. Today, one needs $1.42 to buy one Euro. The consequences are huge. The reason US manufactured exports grew at the huge rate of 16.1% over the past year is because our goods are now very cheap. If you do not believe that the dollar is down, take a trip to London and be sure not to forget your American Express Card. The exception has been the Japanese Yen. Japan is the other major exporter of capital goods. China, on the other hand is at the other end of the see saw. China is the ultimate labor intensive goods producer. Even so, in the past year, the Chinese Yuan has appreciated against the dollar.

How many .27 basis point interest rate moves are enough to slow this country down? The Chinese government is tightening the screws. The coming slowdown in China will not be a bust. Still, if growth were to be cut by half or two thirds, the demand for commodities will be curtailed. The big turn in commodity prices is at hand. Prices will not collapse but the relative performance of high tech companies which use commodities will far out do the performance of the resource companies.

THE BIG TURN

The dramatic slowdown in the US housing market, which has taken down the price of lumber and which is pushing down of the price of other materials, is giving US Central bankers the motivation to cut short term interest rates. A cut in short term interest rates will stimulate the US economy. The strong growth in the US will increase the demand for dollars. As the dollar increases in value, it will create its own demand for more dollars because foreign investors are paid a bonus when US investments go up in dollar terms. The US and Japan make the most sophisticated capital goods products. Now that the recovery is over, it is capital goods producers that will benefit from future economic growth.

During the past 5 years, the carry trade has been a big winner for the big investment banks and the hedge funds. These investors borrowed Yen at very low rates of interest and swapped for other currencies in order to earn higher rates. The problem is that the big turn is also here in regard to the Yen. The Yen is the other currency that will appreciate dramatically over the coming years. The big turmoil in the financial markets for the past couple of months have been the result of the unwinding of the carry trade. The sub-prime mess is not nearly as big a problem as is perceived. Indeed, the largest of all mortgage lenders, Country Wide, announced today that it will provide refinancing for sub-prime loans.

Let me put it this way, on my way around Winston-Salem today I counted dozens of commercial projects underway. The construction includes everything from office buildings, manufacturing facilities, health care facilities, bridges, roads and restaurants. Yes, housing construction has fallen 48% !!!! since the peak of January 2006, however, even now housing construction is about double the units that were built during the 1993 slump! Adjust for size and features and the down turn is not nearly as big as it looks. About 35% of new houses being built today have three car garages, extra baths and even home theaters. I visited a three-bedroom three-bath Parade of Homes property this past Saturday and was surprised to see that it had three car garages on either side. In my book, it takes a boy with toys to want a 6 car garage home. Now, do not tell me that a recession is at hand. Housing construction has fallen dramatically but the current 6 and a fraction % home mortgage rate makes homes far more affordable than the last time oil prices were at $80 per barrel, at that time mortgages were priced at 15%! With more people at the prime age to upgrade to a larger home, I expect the housing market to turn up strong within a few months. TURN, TURN, TURN, TO EVERY THING THERE IS A SEASON!

THE BOTTOM LINE IS that investors should recognize that the coming turn in the dollar will mean that US stocks will generally out perform international stocks. It is time to under weight international stocks. The second half of the business cycle is a time when big cap growth will generally out perform small cap value. By the end of the cycle, the big mutual funds will be crowded into fewer and fewer big cap stocks. In other words you can get a jump on the crowd by buying IBM and GE. You will not make as much with these in the short run but they will keep on moving up for several years.

YES WHAT I WROTE YESTERDAY ABOUT AT LEAST TWO US PIPELINES IS TRUE

There is now enough new tar sand oil flowing from Canada that two pipelines that historically carried oil from the Gulf Coast to the mid west have been reversed. This situation will continue until the large refinery in Illinois and the large refinery in Indiana are upgraded, the permits have already been approved! If the new refinery planned for South Dakota is constructed, it will be fed by yet a new pipeline from Canada. This new Canadian oil will be a significant factor among many that will cause the turn around in the price of oil.

OPEC having pledged to increase production by 500,000 barrels per day effective November 1 has jumped the gun. High oil prices are apparently causing cartel members to cheat by several hundred thousand barrels per day. In addition, production increases keep coming from Angola, Canada, Brazil and a large number of places that are hard to spell or hard to find on a map. Another place where the pipeline flow is being reversed is between Kenya and Uganda. Once again this is probably a temporary condition. After big discoveries in Uganda, several of which are just across the border from Kenya, Kenya is eager to get in on the goodies. A Canadian major has just signed contracts to explore the area. A few billion barrels here and there and you eventually get to that marginal price break.

The cross currents are incredible. The US congress is about ready to give up on its latest and craziest energy bill. Yes, if the bill were to pass, the wealthiest of corn farmers would get about 100 million dollars more in subsidies. This time the subsides would be paid for by increasing the tax on oil companies. Duh! we need more oil so lets tax the production of it more? The good news is this bill is another that cannot get past a Bush veto. In the meantime, the UAE government has issued $2 Billion in bonds in order to help with its purchase of Canada's Prime West Energy. The turn is certainly here when a middle eastern country is borrowing money to buy oil assets! I suppose the bonds were sold at a discount to avoid the payment of interest but the move is still significant.

PROGRESS IN IRAN

It is hard to see the progress toward a solution to the Iranian "problem". However, the US, Russia and Iran are currently doing a triple tango. The US has signaled that it will delay the construction of the European Missile Defense System if Russia will help stop the Iranian Nukes. Russia has signaled Iran that it will support Iran militarily if Iran will stop making the hard dangerous stuff. The leadership of Iran has done the a two step. The grand leader has undercut the power of the public leader. Stay tuned. A settlement would reduce the oil risk premium by $10 to $20 per barrel!

THE TURKS AND THE KURDS ARE OUR FRIENDS.

The war in Turkey is now 23 years long. More than 30,000 Turks have been killed. Most Americans do not even know about the war. I suspect that the recent big public brouhaha was carefully timed for political and economic reasons but this does not matter. The key point is that peace is finally a possibility. The semi-autonomous region of Kurdistan is enjoying relative peace and prosperity. Oil producers from around the world are beating a path to the countries door. The leaders of Iraq have quickly "outlawed" the rebel PKK factions that have been fighting the Turks. Iraq will join the Turks in putting down the rebellion. Of course, some of the Kurds within Turkey will continue the fight but the pressure to end the madness is coming from all sides. Turkey and Kurdistan are both middle east success stories. Turkey has a large and growing economy. In a show of support, the US has given Turkey several surplus war ships.

By the way, the source of much of the international information is Stratfor. You should sign up for a trial subscription if you are interested in international affairs. Some of the tech information is from GigOM which is a free Internet service.

CONGRESS CONGRESS CONGRESS

The democratic congress continues to find itself in a very deep hole. The problems keep piling up. Yesterday, Hank Paulson wrote a letter saying how important it is to get the AMT fix done promptly. If Congress does not act very soon, about $75 Billion of tax refunds to the public will be delayed. The cut off for reprogramming IRS computers is upon us. Last year, a few refunds were delayed and the recipients were not happy. The problem is that there are currently about 20 million people effected by the AMT for the very first time. In addition, there are other tax breaks that must be extended as a part of the same bill. Trent Lott and John Kyle are starting to have lots of fun while pushing democrats to act.

The latest proposal is to allow the democrats to suspend their pay-go rules, provided that they will give Republicans equal amounts of tax breaks. In other words, the democrats can patch the AMT for one year to the tune of about $65 Billion if $65 Billion of the Bush tax cuts are extended. Oh what a tangled web?

Democrats have vowed to try to pass the SCHIP $35 Billion increase one more time. The interesting thing is that if they are successful, they will need to find about $100 Billion of tax increases to offset the combination of the AMT and the SCHIP! Oh what a tangled web?

The pending bills include approximately 13,000 earmarks. The total value of these earmarks is around $9 Billion Dollars. This is enough money to double fund SCHIP this year. It really seems that the democratic congress is between a very hard rock and very hard place. As a person who believes that free trade is the foundation of prosperity, it pains me to know that the subsidies for wealth corn farmers is the reason that other nations refuse to purchase our agricultural products. I can't blame the other nations but the actions of republicans and democrats in congress to hurt the nation in exchange for political contributions from the special interest is shameful.

Believe it or not, the federal budget that should have been passed well before the start of the fiscal year on October 1, may be passed as an omnibus bill around November 16; not the way to run a railroad! The process for passing an omnibus bill is for a relatively small group of people to sit down and edit thousands of pages in the matter of a few days. The final vote will be made by 535 people who have not even read the final product. Shameful indeed.

Good News Good News Good News

I do not want to end on a negative note so here are a few pieces of good news.

1) The moderate leader Bhutto is still alive. We will all know that change is in the air if this woman is elected to lead Pakistan.

2) Real wages in the USA have increased at an average of 3.7% for the past two years. Let the good times roll! The prosperity phase of the business cycle is at hand!

3) While there will be lots of "bad economic news" surfacing over the next few weeks, this "bad news" is good news as it will confirm that "Big Ben" will cut US interest rates again. The average return of the average stock has been 19% in the year after the last 8 first interest rate cuts. That 19% figure hides the rotation effect. Many stocks will rise 50% or more over the next year.

4) CAL signed contracts today that will save the company another 100 million per year. UAUA soared on great earnings and on its progress toward outsourcing high cost service. UAUA is also one of the airlines that is considering selling its frequent flier program.

BUY, BUY, BUY!

CAL EARNINGS

CAL increased revenues per seat mile by 6% while cost per seat mile went up 3.1%. One never knows how the market will react (some folks are always disappointed with good numbers) but from my perspective the net yield gain was a home run.

The cost per mile was an especially good number given that fuel cost went up 4.3% and fuel use went up 4.9%. The company is clearly keeping a lid on non fuel costs. Even the 4.9% increase in fuel use was less than the traffic increase so once again the company is doing a great job to control costs.

The reported earnings, $2.15, were reduced by a 10 cents charge for pension contributions. Adjusting the number to $2.25 makes it 21% higher than the forecast of just two months ago and better than a 70% increase over the prior year quarter!

LONG BOND

Long term interest rates are falling. The 10 year bond is trading around 4.5%! What inflation? With the average wage up better than 8% over the past two years and with inflation dying, prosperity is breaking out. Consumers are paying down debt and buying more stuff all at the same time!

BUY, BUY, BUY!

FENCES, FENCES AND MORE FENCES

Today's news is that the earnings improvement in the airline business continues. Today's good report by AMR followed the prior good numbers delivered by DAL and NWA. AMR's profits are up from 6 cents per share last year to 74 cents this year. Projections are for continued improvement even though the company is projecting higher fuel costs.

AMR has decided not to prebook all the middle seats. The idea is to provide space for those who might be hit by canceled flights. In other words, AMR will voluntarily shrink its capacity. This action will lead to further price increases and an improvement in the travel experience of the passengers. In the meantime, purely domestic carriers, such as Southwest Airlines are getting hit especially hard by higher fuel prices. Thus, LUV will lead a series of fare increases. The average fare is still 11% below the 2000 peak. Adjusted for inflation, fares are 24% below the prior peak. With continued growth in demand, you can expect significant fare increases over the coming years. International carriers, such as CAL, have already raised ticket prices on long flights to offset higher fuel. International carriers have used contract carriers to go toe to toe with domestic carriers. They are able to match price while providing continuing service to other destinations and while offering better perks such as airport clubs and frequent flier programs. Last week, AMR lead a round of fare increases on non domestic flights and this week LUV is the leader on the next round of bumps.


Today, analysts have used the numbers reported by AMR, DAL and NWA to adjust their CAL estimates. The biggest adjustment came from the most positive analyst at Credit Suisse. The result is a penny lower consensus of $2.17 and a reduction for 2008 to just below $5. The reduction to next year is part of the "game" of letting this improving industry build on its track record of beating analyst estimates. In an earlier report I detailed the high average percentage "beat" by CAL.

Over at Legg Mason, Bill Miller continues to manage a few billion dollars well. One of his funds is better has an allocation of better than 7% in airline stocks. He owns all the majors with the exception of CAL. As you know, I believe getting the sector right is 90% of stock market performance. I am confident that Bill's fund will do well.

FENCES, FENCES AND MORE FENCES

The Great Wall of China was built to keep out the bad guys. The Berlin Wall was built to keep in the good guys. The proposed Mexican Wall will be to keep out the good guys. Only the Great Wall was constructed with common sense in mind but the world has changed just a little over the centuries. Thousands of daily airline flights "over the top of the wall" make today's fence the least wise of all.

TECHNOLOGY TO THE RESCUE

A mad rush is on to develop a new electronic fence. Boeing will report results in a few weeks. The push is to develop a new border security plan before the final compromise budget bills are passed by the congress. It is estimated that this electronic fence will cost about 8 billion bucks, double what has been budgeted for a standard fence that would not cover the entire border. I expect the final version to ultimately cost 6 or more times as much but what is a few billion to the federal government?

Mark my words, Congress knows that with public approval ratings hitting near or in the single digits, the pressure is on congress to pass all 12 of the appropriations bills. Because the must do something about the AMT, I expect that they will be willing to compromise with Bush to pass significant measures.

One of the potential "big wins" will be a last minute compromise on immigration reform. It seems like a long shot now but something big is coming down the pike. The fiscal year began on October 1 and even now Charlie Rangel, John Dingle and others are dragging their feet while the bureaucrats who report to Hank Paulson are engaged daily in negotiations with the staffs of congressional leaders.

FENCES MIGHT FALL! The Mexican Wall might be good news in the sense that we sometimes must swallow "silly pills" to get the good stuff done. As you know, the compromise I like is the joining the proposed 10/25% flat tax with a 50/50 cent carbon/gasoline tax.

Congress has the option of leaving town as a "do nothing congress" with their tails between their legs or as the congress that saved the world from global warming, the congress that save the middle class from the evil AMT and, perhaps even the congress that saved the nation from the horrors of Mexican workers and terrorist sneaking across the border.

No matter what the outcome in congress and no matter the current negative focus of the media, the world economy is on a roll that will pick up the pace in the coming year. IN CASE YOU HAVE NOT HEARD, WAGES HAVE GROWN AT BETTER THAN 8% OVER THE PAST TWO YEARS WHILE UNEMPLOYMENT IS RUNNING AT BELOW 5%.

When talk of Jimmy Carter days surfaced on Fox TV, Brit Hume dryly asked if Jimmy Carter was the President who left us with mortgage rates of 21%, inflation rates of 14% and unemployment rates of 9%? When the interviewer asked Mr. Carter what he would have done differently he said he would have sent another helicopter into Iran during the hostage crisis. Folks, by next summer, the majority of Americans will have begun to recognize that "times are good". The change in sentiment will give stock PE ratios a boost.

BUY, BUY, BUY!

BLOW OFF RALLIES -- HUGE PROFITS

The blow off rally in oil, gold and currencies has been blamed on every thing from hurricanes to a potential battle between the Turks and the Kurds. Blow off rallies come near the end of a major run. They can last a good while and exact tops are impossible to call; exact bottoms are easier but still impossible. :) In any event, huge projects are in the works; projects that will ultimately send the prices across the "spider web" curve. Over the past 5 years or so, the dollar has dropped to a clearing price level. Total US export growth in the past year was better than 12% and manufactured goods exports grew by better than 16%. Imports growth was in the 3% range! All the while, finished goods prices jumped by 4.5%! If you want to see a slew of earnings surprises, combine 16% export growth with price increases of 4.5%; a powerful combination for profits.



I read a few numbers late last night and did not write them down but the following are close approximations. In the last year, the dollar has dropped something like 12% against the Euro and 5.5% against the Chinese Yuan. It was not so long ago that Europeans had to spend 1.2 Euros to get on US dollar. Today, they spend a Euro and get back 42 pence in change! Those who worry over the trade imbalance are worried about a problem already solved.



CAL will hold its earnings web conference Thursday morning. Google and many others earnings reports will follow. The CAL estimates have been increased many times over the past couple of months. The low end of the range is now up to $1.87, the high end at $2.50 with the median at $2.17 (up from $2.14 a few days ago). I will not be surprised by $2.60.



Warning: should Congress reach a compromise carbon tax bill, one that would fund the FAA through an increase in the tax on jet fuel, the initial reaction of the market might be negative. Keep in mind that the higher the price of fuel the more sense to riding the bus or the air-bus. The average price of the average CAL ticket works out to less than 12 cents per mile as the crow flies. An increase in the fuel tax in combination with new anti congestion rules will clear a path for quicker landings. The higher price of fuel will make the "air-bus" savings per passenger larger.



By the way, I spent a great weekend at Table Rock, which is at the south end of Linville Gorge. It was a beautiful weekend. Our "Old Goats Patrol" made up of former scout masters enjoyed good times, great food, great views and a fun time at the "old liars campfire." I am behind on individual emails but following the market closely. The over bought enthusiasm is already at least halfway cured. This little correction should be over soon. BUY, BUY, BUY for the long term.

JOBS, JOBS, JOBS

At the turn of the twentieth century, about 70% of all Americans live on a farm. Today, 2% live on farms. In China, there are a billion people ready to leave the farm if work can be found. What will all those people do?

The poor are not concentrated in China. In Asia and Africa there are billions of people who live off the equivalent of $2 per day. Suddenly, the cell phone is changing their lives. Poor "peasant farmers" now scrap together $20 or so to purchase a used cell phone. They pay a high per minute usage charge, but they are extremely frugal with their minutes. Indeed, they prepay for a few minutes or even for just a few seconds of time. They make very short phone calls or they send abbreviated text messages.

When I was in the 7th to 10th grades, I stayed after school for extracurricular activities such as football practice. When practice was over, I would start walking toward home which was four miles from school. Before starting to walk, I would send a "flash" message to my home. In those days, the pay phone across from the school required a nickel to make a 3 minute local call. To save the nickel, my siblings or I would call our home (party line) number and let the phone ring less than one complete ring and then we would hang up. Since the call was not completed, our nickel would come back. In later years, a prearrange "flash definition" might mean that a family member was leaving the Atlanta airport which meant it was almost time to drive to the Greensboro airport to pick up the traveler. A "flash" would also be sent upon arrival back at college.

Going to such extremes to save a nickel on a local call or a dollar and a half on a long distance call seems silly today but the $1.50 long distance call was equal to three hot, dirty and hard hours in the tobacco fields for the older kids and 6 hours of handing up by the younger kids. My oh my how do things change!? When my Dad was a boy, he worked in the tobacco fields for 12 cents per day. It is hard to believe but true that millions of Americans were as poor in the 1930's as billions of Africans are today. I am thankful that the "flash" has come to Asia -- Africa.

Business Week magazine reports that the cell phone is literally saving lives. It is also having a huge impact on the economies of the poorest of nations. One very short message might save a peasant farmer a 20 mile walk to a market or it might encourage him to head to the market where his particular goods might be in short supply. Phone transfers are even being used to send money. Cell phone communication beats banging on a drum any day of the week. Usage is surging and profits are substantial! While each phone generates only a few dollars of revenue per year, the total revenues are substantial because there are billions of phones. The number of cell phones in under developed nations just went over the 3 billion mark and the 5 billion mark is expected to be reached in 7 or 8 years.

WE ARE LIVING THROUGH EXTRAORDINARY TIMES!

Those who believe a mile US economic slow down is going to turn into a world wide recession or depression are ignoring the most tremendous "boom" in world history. While this boom has resulted in a temporary strain on the worlds resources, it has also resulted in enormous benefits from free trade. The productivity gains in many cases are by factors that are almost beyond belief. Can you imagine a three letter text message saving you a 20 mile walk through a rain forest?

The citizens of the USA are benefiting greatly. The demand for our goods and services is soaring. The annualized rate of growth of US services is currently running at better than 13%! The rate of growth in exports of goods is running at better than 16%! Jobs in America are plentiful and unfortunately a large number of excellent but "illegal citizens" are in the process of being thrown out of work in America. I am still hopeful that Congress will pass an immigration reform bill before essentially closing down for the 2008 elections before Thanksgiving. So far, the only "progress" being made is to fund a $3 billion fence that will not do diddle squat.

Exports from America will continue to soar because the world economy is super strong but all the while the really big growth in jobs and incomes will occur over seas. It is hard to believe but America is no longer the land of the free. Today, the USA taxes American businesses at higher rates than do foreign governments. One problem is that in America, we tax business profits when they are made and then we tax them again when the owners of the business shift money from one pocket to the other through the payout of dividends.

TAKE ADVANTAGE OF THE WORLD WIDE BOOM!

All of those billions of phones require computer chips, communications networks and knowledge to operate them. Powerful rifle shot ads will be "pushed" through billions of phones and Google will send a substantial number of these ads. Hardware, software, educational facilities and airlines are just a few areas that will see benefits from the massive build-out that is underway. Google has opted to partially fund a new under the Pacific fiber optic cable in exchange for wholesale priced usage. The name for the number of bytes of information that will be sent is some thing like Tera bytes. The total amount of information being sent and received will grow at exponential rates for many years to come.

BEARS, BEARS AND MORE BEARS!

Stock Market Bears are more than plentiful. One of today's problems is that market players, myself included, tend to look back at history to discover a "similar time to the current time"; there has never been a time like this. Even the industrial revolution does not compare. It took a few hundred years for the industrial revolution to creep all the way around the world and it never did make it all the way. The information revolution has spread like wild fire. The powerful thing is that it is a powerful dis-inflationary force. I think the bears would have an easier time understanding if they would focus on the huge productivity gains instead of on the inflation of food and energy. Food is now a very small part of GNP and the amount of energy used per dollar of GNP has fallen dramatically. As I have said before, the stone age did not end because man ran out of rocks but because he learned to use metals to his advantage. In the same way, we will never run out of oil. Indeed, the planet earth is a carbon sink that is experiencing net growth in resources daily.

ONE BULL AND ONE BEAR REACH THE SAME CONCLUSION!

Bill Gross is the most famous bond investor on the planet; bond investors are by nature pessimistic. Don Hayes is an optimistic and successful growth stock investor. Both men believe that short term and long term interest rates are going to fall over the next year or so. Bill says that the Fed Funds Rate will drop to 3.5 to 3.75% because the USA will experience an economic slowdown. Don Hayes offers the same interest rate forecast but his reasons are largely what I have detailed above; strong gains in productivity and low prices because of technological advances and free trade.

I am mostly in the Don Hayes camp because I believe the stock market will soar by 30% or so over the next year. However, I am not convinced that interest rates will fall so hard. I see low inflation but also very strong economic growth. Certainly, the current quarter will be a bit below trend as the "hit of the credit market freeze-up" and the housing building slump will have an effect. However, by the second and third quarters of next year, we just might see 5% real growth. Even if inflation is down to 1.25% or so, the long bond will likely be trading at 6.25% or better. Such "high rates" might even become a part of the Wall of Worry that the stock market will climb.

BUY BUY BUY GROWTH STOCKS, SELL SELL SELL BONDS!

It may be patriotic to BUY AMERICAN, but it is fair to buy from the low cost producer. By doing so, the poorest of the poor will get earn food for their families and Americans will spend their time more productively. It was psychologically hard for American families to leave the farm and today it is psychologically hard to believe that America does not need manufacturing jobs. The fact is that goods are plentiful for a fair price. Be happy that you do not have to "flash" a phone call to save a penny and be kind to those who must!

OUCH, OUCH, OUCH

Many people who live south of the Sahara desert are suffering. Many of the poorest of the African nations have no food and no education. Attempts to feed the poor have not lead to great success but in a number of countries education is starting to make a difference. I am told that some of the hardest workers in North Carolina are refugees from the poorest of African countries. I don't know much about the situation but I am thankful that the Methodist Church contributes to educational facilities in the area.

The people of Iran and Venezuela are also suffering but for totally different reasons. The leaders in each of these countries are willing to cause their people to suffer in exchange for "world influence." There are food shortages in Venezuela, gasoline shortages in Iran and the loss of freedoms in both countries. Each country is rich in natural resources but, they consistently fail to maximize their returns from their resources. Oil production has gone down in each country as they are unwilling to offer fair compensation to exploration and development companies.

The UN has passed two sets of sanctions against Iran and, as a result of pressure from China and Russia, has decided to wait until November before considering tougher measures. Rather than allow the citizens of Iran to have gasoline, Iran has spent billions to arm various waring factions. In the latest move, Iran has threatened to arm Iraqi insurgents with Surface to Air Missiles that would put US helicopters at great risk. On the other hand, it has been reported that the US is considering "surgical air strikes" against targets in Iran that support, train or supply Iraqi insurgents.

Saber rattling has pushed up the price of gold and oil. In May, when a barrel of oil sold in the mid to high 70's price range, the retail price of gasoline hit the $3.20 range. This price was a demand for gasoline driven price. Yesterday, a barrel of oil was selling for better than $80, the price of gas was being cut to the $2.60 range. Based on the price of gasoline, the price of oil should be around $57 per barrel. If Congress can time the passage of carbon taxes just right, they can get a lot of credit with the voters when the price falls before the elections.

Next year, daily refinery capacity will increase by 1.5 million barrels per day. Last year, there was less oil used in the USA than in the year before. Increases in crude supply will come from many parts of the world with three of the largest increases coming from Angola, Iraq and Canada.

Yes, Iraq will put significant resources back on line by next year. Yesterday, the Iraqi army arrested 75 insurgents, discovered a car bomb factory and blew up 18 bombs. The month of September saw a significant decline in both civilian and military deaths. Yesterday, the Senate of the USA passed additional war funding of $150 billion and the House is expected to pass a similar bill today, appropriations will be passed within the next 47 days. Most importantly, thousands of Iraqi citizens are joining the fight on the side of the central government. Having thousands of Sunni's join on the government side is huge. The fight is not over but the continuation of current trends should cause the insurgents to scurry back to Afghanistan. If you do not believe the fight is going well, review the answers by the Democratic Presidential contenders at the last debate. John Edwards was the first to state that he would not guarantee that the troops would be withdrawn soon after his election. The contenders do not want to be the anti war candidate in the face of potential victory.

A major point is that Iran is feeling growing pressure to "make a deal" as it becomes clear that the war in Iraq can be won without the assistance of Iran. An oil supply deal has already been struck between Iraq and Syria. Iran will become all the more isolated if a deal is not made soon. Once a deal is made, a large number of contracts will go forward to develop oil fields in Iran and Iraq.

The handwriting is once again on the Persian Wall. The Democrats in Congress can take partial credit for the "good news" by passing a number of bills that Bush will sign. Right wing conservatives have been marginalized. They are still against this and against that but the democrats have the votes to pass legislation without them. Bush and the Democrats will ultimately pass mostly centrist measures. "Good Times" will be the order of the day as the elections approach.

STOCKS, STOCKS, STOCKS

In 25 of the past 27 fourth quarters of the year, the Dow Jones Averages went up. Today, the market got of to a great fourth quarter start. A nice gain in CAL was reduced late in the day as the market waited for September results. They were reported after the market closed and they looked good to me but some bulls on the stock were looking for better numbers. Again, I liked the numbers.

CAL achieved:
1) the fifth best ever on time performance,
2) the best ever flight completion record,
3) record mainline and record consolidated load factors,
4) a consolidated traffic increase of 5.6% (more than 12% on the highly profitable transatlantic flights),
5) an increase in Revenue Per Available Seat Mile (RASM of 4.5 to 5.5%).

My back-of-the-envelope calculations tell me that total revenues grew by 11% which is a very large number relative to a trailing PE of 8 and a forward PE of 6.5. Even with high fuel prices, Cost Per Available Seat Mile has not climbed as fast as RASM. Margins are going in the right direction.

The action in AMR added excitement to the airline sector. AMR announced that it will prepay $545 million worth of long term debt and it projects its interest expense to have fallen by $130 million dollars this year. I don't recall that CAL has made similar announcements but, last year the company added more than $1 billion cash even after funding the pension plans and after paying down debt by a few hundred million. CASH FLOW, CASH FLOW AND MORE CASH FLOW, WE LIKE CASH FLOW!

GRMN took a hit because Nokia purchased a GSM company. Yes, maps are going to be an important feature on cell phones. GRMN has been a hot stock, one that I am not willing to turn loose of just because the competition is heating up. The growth in this area will be so large that money can be made by a number of players.

FROM OUCH, OUCH, OUCH TO A OK!

There are still more than 1 billion Chinese with annual incomes of $300 or less. For the most part, China and Wal-Mart bashing will continue to be empty rhetoric. Those who want the lowest price will continue to shop at Wal-Mart. More and more of the poor of the world will be blessed as more and more Wal-Marts are built. Times are good and getting better. In another 10 years or so, most of the billions of Chinese will be on their way to relative prosperity. The buyers of the goods will have done themselves a favor while helping the poor. THAT IS A OK BY ME! BUY, BUY, BUY!

HAPPY, HAPPY, HAPPY

It does not take a new high on the Dow Jones Industrial average to make me happy, but it sure does not hurt. After talking about the mid cycle turn for more than a year, I look forward to changing the main topic of these missives. The mid cycle turn will soon be talked about in the past tense.

In 1969,with the Vietnam war was staring me in the face, I got a firsthand perspective of a "scarce resource economy." President Johnson had practiced the strategy of "guns and butter" and the central bank went along with his attempt to have super prosperity while fighting the war with one hand tied behind his back. Then Nixon and Ford fought the ensuing inflation wars with silly price controls. Many people who remember the "Whip Inflation Now" buttons of the Ford administration do not recall that Nixon also tried to use government mandates to hold down prices. Jimmy Carter gave up the fight and by 1980 the markets had witnessed 11 years of commodity markets offering a greater return than offered by the stock market.

The new head of the FOMC, Paul Volcker deserves much of the credit for "Whipping Inflation." Ronald Reagan should get the rest of the credit. President Reagan and Paul Volcker were willing to make the hard choices necessary.

The war in Iraq is a back yard brawl relative to the Vietnam War. Some 56,000 Americans died in Vietnam compared to some 3,800 in Iraq. Human life is most precious but the facts are still the facts. While there are parallels between the 1969 to 1980 time and today's markets, the prior period did not include the benefits of globalization and technological advance that we have today. Indeed, while it was Nixon who broke the ice with China, in or around 1972, the economic revolution in China and the rest of the under developed world has all happened during the past 20 years.

This commodity cycle is only seven years old. When the 1969 to 1980 cycle turned, it turned sharply. To date, this turn has been a slow turn and one that few have even noticed. With oil and gold sitting near all time high nominal prices, many market followers would laugh at me for saying that the turn is under way, but it is. One can see the turn by looking at the broad CRB index but the best place to see the turn is in the stock market. There has been a decisive turn in the market; growth is out performing value and this did not start yesterday. Indeed, growth has out performed value since July. If you plot the IVW index versus the IVE index you will see what I am talking about. Or you can simply look at a long term chart of the NASDAQ 100! This index has broken through resistance that goes all the way back to 2002, before 9/11/2001.

YES, I AM HAPPY, HAPPY, HAPPY. I HOPE YOU ARE TOO. THE PENDING DECISIONS OF CONGRESS SEEM TO BE HANGING OVER OUR HEADS LIKE THE SWORD OF DAMOCLES BUT I BELIEVE THIS IS ONLY A LAYER ON THE WALL OF WORRY THAT WILL BE CLIMBED! IT WILL NOT BE A SMOOTH CLIMB SO HANG ON TO YOUR HATS AND TO THE SADDLE HORN AT THE SAME TIME!

FOLLOW UP TO GOVERNMENT FUNDING

My statement that the government has more than enough revenue has been challenged. I stand by my belief while offering only a few statements in support of my position. When Art Laffer defends the Laffer curve, he evokes the memory of the 14th century Muslim Philosopher, Ibn Khadun, who wrote "at the beginning of the dynasty, taxation yields a small revenue from small assessments, at the end of the dynasty, taxation yields a small revenue from large assessments." I look at it this way, if your goal is to end prosperity then tax it to death. People are willing to pay very high taxes to "insure the common good" but today there is little that the government can offer to do inefficiently that private enterprise cannot do more efficiently.

The current situation is that government revenues are better than 18.5% of GNP which is higher than average. This has been accomplished with lower tax rates. If the US were to lower corporate rates, as so many other countries have done, jobs and investment in the USA would grow. Citizens need to remember that politicians must "fix problems" in order to collect campaign contributions. We must also appreciate that the politicians are "too smart to fix all the problems." Indeed, to really do well financially, they must create problems that will need to be fixed later. A king for a day could fix the AMT, immigration reform, healthcare reform and energy reform. Democracy has proven to offer longer term stability precisely because we must "muddle through", reach broad consensus and fix our problems slowly. In the process, we must always remember that whenever possible, problems should be fixed by private enterprise solutions. The healthcare system should not be a system of lobby fighting lobbies and more lobbies. A good system would be one in which the patient and the doctor decides what care is worthwhile.

I have not verified the following but it sounds like truth. A Canadian claims that the current waiting list for a human to have a hip replacement is three years long. He says that the waiting time for a dog, not covered under the government system is one week.

THANKS FOR THE REMINDER

I left out traffic congestion as one of the externalities of one person per car. Again, I do not agree that car owners should be forced out of their cars and into multi-passenger vehicles. If the tax on fuel is set to include the real total costs, individual decisions will work together as a market to find the best solutions.

BUY, BUY, BUY!

RESPONSE TO RESPONSES

Many thanks to those who respond to my emails. It is humbling to know that you took the time to read my words.

INFLATION:

I have used the example of newspapers and magazines to show that some prices are falling from something to zero; I could have used long distance phone calls, transferring money or maps instead. I personally read many articles from many magazines online without buying a subscription to those magazines. I use a map that plots where I am, calculates the distance and time to my destination and talks me through the turns. Using today's technology, the distribution costs of these services is almost zero. Therefore, the publisher can offer the services in exchange for goodwill or for advertising space.

At least one reader believes inflation is a lot worse than I. This reader still subscribes to his local paper and he notes that his cost of food has soared. One issue this raises is that we each have our own personal inflation rate; the national numbers are the average for all consumers. The consumer who is an early adopter may have inflated his costs when he waited in line all day to buy one of the first iPhones. He paid a high price in time and money. Another consumer can buy today for a substantially lower price. In very short order, the first iPhones are going to be relatively obsolete. They access the internet at a very slow speed relative to what is already available on other networks and extremely slow relative to networks that will be built over the next several years. The price of the next great innovation may be sold at a much higher price but that will not be an inflated price. The fact is that the price of new inventions start high and typically fall and fall some more. The first Xerox machines were leased because few businesses had $100,000 to spend.



Food is important to all of us. Very poor people spend the great majority of their income on food. The sharp run up in the price of food in recent months has caused many very poor people to go hungry. In America, the percentage of incomes spent on food has fallen for as long as charts can be found. I recall a chart from a year or so ago that compared spending on recreation to spending on food. The chart made a big X. The average American spends less than 6% of his income on food. He spends many times as much on recreation. Broad measures of inflation capture the price of all ski lift tickets purchased and the price of all hamburgers purchased.

The typical reaction to the preceding statement is to say, "Oh, so those who can afford a ski lift ticket are the ones who are not seeing inflation." In fact, for the great majority of people, this is exactly wrong. It has been the cost of services, most often purchased by the wealthy, that have gone up the most in price. The inflation rate for a college education, for a heart operation or indeed for a ski lift ticket, have all climbed many times more than the price of a hamburger. One of the wags at GAVEKAL Research quips that "it has never been so expensive to be rich."

Biased people can "mine the numbers" to always show that inflation is better or worse than it really is. We all know that one can prove anything with statistics. The all time best and most consistently correct inflation forecast has been supplied by the bond market. The FOMC likes to look at the implied 5 year and 10 year inflation estimates derived from the spreads on 5 year and 10 year TIPS bonds versus standard 5 and 10 year bonds. Old timers like to rely more on the structure of the treasury market. In other words the willingness of investors to buy 5 year treasuries paying 4.6% says a lot about the markets inflation expectations. Don Hayes uses the 10 year treasury rate chart, to plot inflation a few months into the future. The stats are that this method gives off an r square close to 90! In case you have not noticed, the ten year bond has stayed in a tight range for several years and is currently closer to the bottom of that range than to the top. The inflation risk in today's market is very moderate.

SLOW DOWN OR ECONOMIC RECESSION?

Many a coincidental indicator shows that the world economy is slowing down. Weak economies are most often accompanied by declines in inflation rates. As I noted yesterday, even the decline in interest rates that occurs during slow downs or recessions is by definition a lowering of inflation rates. The USA holds the trump card! Many pundits have "talked-up" their international portfolios. The common theme has been that the world economies have been stronger than the US economy and the stock markets have out performed. The key words in the prior sentence are "have been". Smart investors do not invest in what has been but in what is likely to be. What is likely is that the economy that has the strongest currency is actually "set-up" to suffer the worst during the slow down.

2000 EXAMPLE

In the year 2000, the US dollar was very strong. In 2000 and 2001 the USA was the only major country to suffer through a recession. Yes, 9/11 influenced the US economy but the economic down turn was well before September of 2001. Right now, numbers are starting to flow showing a slow down in Europe. The weak US dollar is a wonderful blessing in these circumstances. US businesses can easily compete with others because the exchange rates with many other nations gives us a strong boost. The great news is that the slow down will lower short interest rates more. We might easily see another 50 basis point cut by the FOMC before year end and with new great prospects for strong growth in the USA we could see the dollar climb out the roof. The big money is made by buying near a currency bottom, just like buying a stock near the bottom.

WHICH STOCKS?

This morning I read a story about a German oil drilling company that has hit another oil gusher in Libya. The company, RWE, has moved from $19 to $88 over the past 5 years. Late last year, it briefly traded above $90 per share. The price had settled back down to about $80 before the gusher was hit. I hope you can how the fact that the price is lower now than it was last year is a signal. The time to buy this stock was 5 years ago. The exact best time to sell the stock was last year when it was trading above $90. The momentum is gone. Those who moved from energy to technology when this stock was at $90 have done well.

The total investment process required to "catch up to the new price of oil" still has many years to play-out. We know many things about the way this process will be completed. For example, we know that Shell and the Saudi will spend $7 billion to more than double the capacity of the Port Arthur, Texas refinery and we know that Kuwait has increased its budget on its new refinery to over $14 billion. We expect that the Port Arthur upgrade to be completed in 2010 and we expect the Kuwait refinery to start-up in 2012. Others refineries will start-up before and after each of the above. While it takes a lot of faith to spend $14 billion on a refinery that will not start until after scores of others have been completed, it does not require faith that the price of oil will stay above $50 per barrel.

The existing Port Arthur refinery has paid for itself many times over at much lower after inflation adjusted prices. It was started way back in the Spindle Top days. It has refined billions of gallons of oil and it is being expanded so that it can refine even billions more over the next many, many years. The investment is being made because the investors expect to make better than a 15% gross return on their investment. They can do that even including a forecast of oil falling back below $50 per barrel. Long term investors can certainly buy oil drilling stocks, hold for decades and make solid returns. However, with the crowd pushing oil stocks hard, you should expect to see these stocks under-perform the market for the next 5 to 10 years. Innovative companies, the ones that are generally finding ways to do things while using only small amounts of energy will do well. Transportation companies that consume large quantities of fuel will also do well.

BANKRUPTCY AT AMERICAN AIRLINES?

After I wrote that AMR faces tough union negotiations in the weeks and months ahead, one reader mentioned that a pilot friend believes AMR is about to be forced into bankruptcy. I strongly disagree. AMR made it though a very difficult time, after 9/11 without filing bankruptcy. Since that time, the company has dramatically reduced its costs and dramatically improved its balance sheet. It has even survived the spike in fuel prices and it will earn at least 65 cents per share this quarter after paying an average of $2.11 per gallon of jet fuel. A few pennies decline in the price of fuel, not due to a recession but due to growing supplies and demand destruction, would boost earnings by perhaps dollars per share.

The big argument being made by the pilots union is that they gave up 30 percent of their pay when it was necessary to save the company from bankruptcy and they now expect to get this pay back. There are at least a couple of big ugly flies in the soup! After AMR pilots "volunteered" to cut their pay, other pilots at other carriers gave up an even higher percentage of pay. In several cases, such as DAL and NWA, the negotiations to reduce costs were held while the companies were in bankruptcy. In the case of CAL, the total give-backs of all union employees were more than a billion dollars per year. The other big fly is that even after the give backs, the AMR pilots are very well paid. So, what you have is a situation where the pilots want 30% raises that cannot be supported by the current market.

It so happens that just this morning the GM -- UAW deal was completed. Thirty years ago, it would have been incredulous to suggest that one day GM workers would give up their company paid health benefits or to accept a contract with no annual cost of living increases. American consumers can rejoice. We have been paying an average of $1,500 in healthcare benefits each time we have bought and American car. Many who can not afford health insurance have paid for it for others.

It is a totally new, global, world in which we live. AMR pilots face the same problem as the GM workers. The fastest growing airlines, which are not based in the USA, expect to dramatically increase their flights to and from the USA. Without doing the searching to prove the point, I am confident in saying that the senior pilots in China do not earn $170,000 per year for 30 hours of work per week. $5,500 per hour plus benefits is not a bad gig but only a very small percentage of the worlds pilots get that rate. Ironically, if the public were willing to trust highly reliable electronic systems, which are much more dependable than the average pilot, the pilots would be not needed at all. Ouch! Believe it or not, in the not too distant future, the competition for travel will include 100% auto pilot crafts. Of course, the politicians would have to stand aside for this to happen and when it does happen it will start with small planes at remote locations.

THE NEAR FUTURE

The new satellite based air traffic control system will be a blessing. It will cost a lot of money but the investment will cut the operating cost of the carriers while, most importantly, reducing the time in the air for tens of thousands of flights daily. Millions of people will save hours daily after the plan is fully implemented. As usual, when the government is the provider of a service, politics get involved and one result is a huge amount of waste. It is only common sense for a 10 passenger jet to have a financial incentive to give up a prime landing spot at a major airport for the benefit of a 300 passenger jet. Giving up this slot should be based on the micro-economics of the situation. In other words, the price of the landing spot should be determined by the market, so that some operators would voluntarily choose smaller airports. Only the individuals involved can determine how important it is to land at the major airport. The government imposed system is the equivalent of Soviet Union system of deciding how many pairs of blue jeans the country should make.

THE IMPORTANT POINT FOR INVESTORS

Investors need to avoid taking one small data point and drawing harmful general conclusions. The core facts are that airlines are operating at record capacity and making money at the start of the prosperity phase of the business cycle. The solid growth in the revenues of these highly levered companies is leading to spectacular growth in earnings. Here in the middle of the mid cycle correction, it was "big news", a couple of days ago, when AMR announced that revenues for the quarter would grow at only 3 to 4%! When a business with very high operating leverage grows revenues by 3%, profits might rise 20%!

What will be the story a year from now? Will the unions still be fighting for a 30% raise that is not going to happen? Are these employees frustrated? Certainly! Do they really expect to make 30% more than their friends at other carriers? Most do not.

BAD NEWS IS GOOD NEWS

The "news" this morning was "bad." Orders of durable goods declined. Duh! Housing starts are way down so there are not as many furnaces or hot water heaters being purchased. The down tick is the "bad news" needed to push interest rates lower and inflation down more. Yes, this is circular logic but that is why they call it a business cycle.

Just remember that interest rates and commodity prices tend to move together. Right on cue, oil supplies recovered a bit this morning and oil prices slipped. The process is slow but sure.

HANG IN, HOLD ON, BUY ALL YOU CAN!

Thanks again for the feedback.