Home Improvement Question

The following question was cut from a response from a regular reader.

Do you think Home Depot or Lowes might be good investments? With the slump in real estate, does that lead to people doing more home improvement projects, rather than buying new homes? Both stocks have been down recently, but could be a buying opportunity?


Today, one of the big investment banks probably called a bottom on Home Depot when it down graded the stock and lowered the 12 month price target to about the current price. My guess is that either of the big two will do well over the long haul. As was stated in the question, it is true that home improvement projects tend to flourish during slow home building cycles.

On the other hand, David Dreman, the author of several books about contrarian investment strategy, wrote a long time ago that after a major "event" it is easy to jump in early. If one jumps in early, the wait can seem to be endless. One has to have great patience in these situations. What commonly happens is that after a year or two of mediocre performance, stocks in this situation have one more test of the low. It is a common mistake for those who got in too early to be flushed out by the test.

I have great respect for Bill Miller, manager of billions of dollars of funds at Legg Mason. Bill is one of those guys that exudes smarts. His record of beating the S&P by better than 2.5% for 15 years in a row speaks volumes. Bill says it is time to buy financial stocks and home builders. Because Bill builds huge positions, he must jump in early to accumulate all the shares he wants.

On more than one occasion, I have ridden his coattails with great success. For example, long after he bought Nextel, I bought shares at $2.90 per share and sold all shares at around $28. He has the great disadvantage of not being able to get in and out so easily. He still owns thousands of shares but has stated that he will trim a number of holdings to make his move into home building and financials. I have seen no indication that he plans to trim his substantial holdings in the airlines. One of his funds carries a weight of around 7.5% in airlines. He does not own CAL.

Dreman says it is usually best to wait about a year after a major "event". Again, I have had good success when using this strategy. The trick is to keep the stock in mind and not forget about it when it is not so "in the news."

By the way, the reader who asked the above question is the same one who brought CREE to my attention. I had followed the stock for a long time and had the intent to buy it some day. Many thanks for bringing this one to mind.

Profits, profits and more profits

Singapore Airlines and Japan Airlines have each announced soaring profits. This year, US carriers, as group, will make substantial profits for the first time in many years. The exception to airline profits is in China's regulated market. China, India and others, who regulate prices, including the price of fuel, must constantly battle the risk of serious resource mis-allocation.

In case you have not noticed, this business cycle is one of unprecedented demand. The price of oil did not go up because supply was restricted. The price of oil and other commodities is a result of a dramatic drop in other costs of producing goods. Even after 5 years of economic strength, the price of finished goods continues to moderate. This is good news for investors.


GOOGLE PRODUCTIVITY

This morning, I am looking forward to hearing the details of the new Google mobile platform. The best guess is that the system will be Linux based with a heavy dose of JAVA scripts. The key point is that it will be wide open. MSFT just paid $240 million for a tiny peace of Facebook. Since then, Google has shown that all sorts of web systems are going to offer "social network" features. Google's individual homepages and its mobile platform is expected to build on this concept. The key point is that one can share all the information one wants to share with the rest of the world. These networks can be restricted to use by members of a company or organization or they can be wide open. As with all innovations, it will take time before we even begin to understand all the ways these systems will be used. In any event, we know that the more readily available information and knowledge, the more productive we are.

The ability to search millions of documents in fractions of a second is a powerful ability. Google is the king of search. Now the world is in the process of going Internet Mobile. It will be a huge benefit to consumers to have an open source system available. As this system is implemented, I see another surge in the growth cycle. One sigmoid curve of growth is being layered on top of another and another.

THE END IS NOT NEAR

The book written by GAVECAL Research, "The End is Not Near", details how the China phenomenon has many more years to go. The main point of the book could easily have been that the information technology phenomenon has many more years.

The bubble in stock Chinese stock prices is extreme. I do not recommend attempting to profit directly. However, I agree that the world growth story will continue. It is not just a China story. Business growth is happening far and wide. JAL said its profits soared because business travelers booked more of the seats. Business travel is "big money" travel. The poorest of African nations are building airports and starting airlines. The poorest of the poor have the most to gain from learning from America. The hub systems of the major carriers are designed to aggregate passengers for the long haul flight, with continuing service to final destinations.

MISSING THE BOAT

The "informed" American citizen who watches network news knows a lot about Brittany Spears but is not likely to appreciate the magnitude of the world economic boom. Sentiment indicators show that Americans are selling stocks and hunkering down for tough times. Even members of the American Association of Independent Investors as a group have a negative bias about investing in today's market.

Of course there are cross currents. The volume on the NASDAQ is very high and the number of oil futures contracts are out the roof. In other words, aggressive speculation lives at the same time the public is avoiding "traditional" American stocks. BUY and HOLD big cap American stocks for the next few years and you will be a happy investor.

It can be argued that Google, RIM, APPLE and other technology leaders are priced to perfection. On the other hand, the scores of companies that will use the latest and greatest of productivity enhancing products are cheap! BUY BIG USA AND SLEEP WELL!

SANCTIONS AND MORE SANCTIONS, BUY, BUY, BUY

The "big six" have agreed to language for the next round of UN sanctions against Iran. Iran is once again being given the chance to negotiate a settlement. Saudi Arabia has offered to join a consortium that would supply Iran and other Middle Eastern Countries with power grade uranium.

Progress toward peace continues. The deal between Turkey, Iraq and the USA to work jointly to stop the PKK is just one more step toward peace.


More than 1,000 years ago, one of the great bandits of all time lived in the mountains of this region. He lived well. He would pick a target country, rape, pillage and kill. He took his plunder back to the mountains and stayed until the furor over his actions had died. A few years later, he would carefully select another country to plunder.

There are two reasons that bandits have survived for 1,000's of years in this area. The first is because the hideouts in the mountains are remote and easy to defend. The second is because the attacked countries failed to unite against the terror.

The Kurds have had more than their share of problems. The people have maintained their identity even after Britain and France (?) partitioned their territory among several countries. Significant regions of Turkey, Iraq and Iran are predominately Kurdish territories. Ironically the Kurdish area of Iraq has been the most stable, peaceful and economically successful of the regions in Iraq. It is time to take on the bandits from the hills. The civil war between the Turks and the Kurds has continued since 1984. It is good news that the governments of Iraq, Turkey and the US have joined together. If Iran could be persuaded to cooperate, the end of conflict might come without much additional bloodshed. Unfortunately, the problem is similar to the problem in the mountainous regions of Afghanistan and Pakistan. For those who think it should be easy to find and kill the bandits of these mountains, I would remind them of the American Abortion Clinic Bandit, Rudolph, who hid out in the mountains of North Carolina for a few years. North Carolina mountains are about one third as difficult to scale as the mountains of the middle east.

GOLD AT 27 YEAR HIGHS

The price of gold hit 27 year highs today while oil has pushed toward the highs of 1980. In China a man was killed after he broke the line for rationed fuel.

Over the coming weeks, China will continue to raise interest rates and to let its currency float upward. Economic and political forces require this action. The invisible hand of Adam Smith has not been repealed. Over time, politicians will get the message that current political scheme to convert food products to fuel is a harmful policy. Over time, the silliness of not using oil reserves will be obvious. Over time, the law of substitution will work.

In the short run, the question has become, how much of the current run up is hedging action against the possibility of war in Iran and how much of it is growth in final demand? The final blow off rallies are always extremely powerful. As you may recall, in 1999 and early 2000, tech stocks went 10 times as high as reason would have suggested. It is my belief that oil is currently in a blow off rally. The optimist in me says that the problem will be solved when Iran agrees to suspend production of nuclear materials while sitting at the bargaining table. The pessimist in me says that the hoarding of fuel will continue for several more months.

France has released 2 million barrels of oil from its strategic reserve. This turned out to be a drop in the bucket for the speculators to absorb. The straw that breaks the back of the oil surge will be bigger than the release of a few million barrels of reserves. Of course, a world wide recession would do the trick. I believe the governments of the world will keep the pressure on Iran until a deal is made. The next recession will be postponed for a few years and the powerful substitution process will finally be the big straw.

CARBON CAP AND TRADE

The Lieberman cap and trade bill has at least a slim chance of being passed. Such a bill would increase the price of clean fuels such as oil and natural gas because the use of coal would be in effect restricted. It has been reported that Pelosi is most interested in getting her energy bill through congress and that her team has been in negotiation with the presidents team. As you know, I prefer a carbon tax off set by cuts in other taxes.

The House has passed a one year patch to the AMT but it has not been funded yet. The House has also cut out about 20 Billion of extra spending. In other words, there is finally a little movement toward a compromise that would allow the Congress to leave town. There is still a lot of ground to cover. The best bet at this point in time is that no major deals will be made. The Congress will be forced to do a patch without raising other taxes by nearly as much.

The Senate has once again passed the SCHIP bill that will be once again vetoed. Bush is starting to have a lot of fun. He will once again get to hit this softball out of the park. Passing this bill without sending any appropriations bill to the President, 5 weeks into the fiscal year is an act of absurdity and an act of political suicide. Democrats might lose their majority if they do not get their act together. Dick Army summed the situation up well when he noted that the rich and the poor are meeting in the middle. There are some families who would be eligible for the new SCHIP rules while they would also be classified as rich enough to pay AMT taxes! What a farce?

SORRY

It is a fact of life there are constant intersections between ones political beliefs and ones economic beliefs. I write my thoughts down in an attempt to clarify what I believe about the financial markets, the goal of these letters is to help me and you make better than average investment returns. None of us want politics to get in the way of that goal. I hope you will go along for the financial ride with me regardless of your political beliefs.

For a long time, I tried to write without openly stating my political beliefs; it was hard to do. For the past couple of years or so, I have openly expressed my political thoughts which are complex. My strong beliefs in individual responsibility, free trade, strong defense and limited government have lead me to a strong republican bias. At the same time, I am appalled by many of the actions of the republicans. I do not want to judge anyone but it seems that there is hatred in the hearts of many republicans. I do not want to "win" for the sake of "winning" but it seems that some republicans are willing to "do anything to win the spoils of war". Government is and will always be an ugly process. I believe in keeping government on a starvation diet because as we have seen in recent years, on both sides of the isle, politicians will gorge themselves and their friends on the spoils of political "wins".

When I answer polls, such as the one offered by Al, I typically disagree strongly with all candidates on a number of issues. My strong support of the two party system means that I must select the most important issues and go with the candidate that fits those issues best. I believe the polls would be improved if they ranked all 10 questions by order of importance. Anyway, for what its worth, I find myself becoming a Rudy Giuliani fan.

RUDY, RUDY, RUDY!

My perception is that Rudy would cut red tape, reduce excessive litigation, strengthen the dollar, protect the homeland, and lead the nation to solve the tough issues of the day such as tax reform, social security solvency and immigration. His success as Mayor of New York is perhaps one of the great political feats of all time. As with all candidates, his blemishes are obvious, but he believes in America and he clearly has an understanding of the sacrifices made and those that must be made to keep freedom alive.

It is most interesting to note that of all the Democratic contenders, Hillary comes out on top in every poll I take. like Rudy, Hillary is a closet centrist. She, like her husband, knows how to speak as a liberal without closing the door to more centrist policies if needed. As was proven during Bill's term, divided government tends to work best. The major accomplishments made by Bill happened after Republicans gained control of Congress. Rudy got the Democrats in New York to pass unbelievable reforms. Rudy and Hillary are pragmatic at their core. If allowed, Hillary would run the US into the left hand ditch and Rudy might run into the right hand ditch. Assuming that Democrats maintain control of congress, it is important to me that Rudy win over Hillary.

In my opinion, the drop off from Hillary to Obama or Edwards is severe. On the Republican side, several other candidates would do well as President as they would tame the urge of a Democratic Congress to steer into an economic ditch.

IRAQ, IRAN, ECONOMY

The war in Iraq is being mentioned less and less by the democratic contenders. With troops continued success and troops coming home, Iraq could become a republican issue. Iran is being mentioned often but a deal could remove that issue from the debate and the price of gasoline could easily trade for less than $2.40 per gallon by the election day.

The class warfare argument will fail if wage and employment gains continue on their current rapid pace. Today, the markets were surprised by the addition of 160,000 more jobs last month. The jump in jobs was taken as bad news because bond interest rates rose and the prospects of further rate cuts fell. However, by the end of the day the 10 year note traded at 4.32% and the market closed up. The bottom line is that Americans are seeing their net worth, incomes and standards of living rise. A long term record in regard to the real increase in disposable income was just broken. The price of goods, from hand held gadgets to pianos continues to fall.

BUY, BUY, BUY

Yes, an election year surge in public sentiment is about to happen. Congress is going to get out of town without doing major harm and then the roses will begin to bloom. If you want to make serious money in the stock market, Monday morning is the time to push a big stack of chips onto the table. BUY, BUY, BUY!

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!

MYRTLE BEACH REAL ESTATE

The following response is to reader emails.

Resort real estate prices peaked in 1985 and again in 2005. After the peak in 1985, investors still had the opportunity to sell at slightly higher nominal prices in 1987. The loss incurred by owners from 1985 to 1987 was an opportunity loss, they could have made great returns in stocks while they were stuck waiting for the "last bounce" in real estate prices.

Today, we are in a similar "in between time". The peak in resort prices was in the spring of 2005 but the declines since that time have been relatively small in most cases.


The fact is that there are major forces playing a game of tug of war in regard to housing.

On one side:

1) residential housing is over built, and
2) the supply of empty homes has never been greater, and
3) the news media is having a field day reporting various real estate "problems", and
4) a couple of million "owners" of homes have no equity, and
5) we are near the end of the 17 to 22 year (18.3 year average) real estate cycle, and
6) the final down turn in the real estate market is "kicked off" by simplification of the tax laws.

On the other side:

1) their are more people of prime age to purchase a second home than ever before, and
2) mortgage rates have fallen over the past several weeks and are back to levels seldom seen in my life time, and
3) income and wealth is soaring, and
4) despite the current high price of oil, the percentage of income needed for the necessities of food, clothing and fuel has fallen dramatically over the past 27 years and the sharp declines continue, and
5) as a result of open trade and technological innovation, the people of the world are enjoying an "unknown level of prosperity", and
6) tax compromise that would eliminate interest expense deductions could take another year or two to come to reality, and
7) the past three economic cycles have been stretched and there are signs that this one will be the longest on record, and
8) the real estate bounce after the peak in 1985 reached its secondary peak in August of 1987 but well after the "big economic turn", and
9) the big economic turn of this decade is still an ongoing event,
10) the bounce in real estate could be significant given that next year will be the "year of prosperity" as the country moves through the presidential election cycle.

After the 1985 peak, it took better than 5 years to reach the next trough. The peak of "walking away" from resort property did not occur until early in 1991. Adding 5 years to the 2005 peak gets us to 2010 but, again, this cycle appears to be on its way to the longest in history. The real estate cycle has been measured for hundreds of years as a 17 to 22 year cycle. Adding 22 years to 1991 would project 2013 as the year of the next trough. As you may recall, Harry Dent, who has written a number of books detailing the demographics of the real estate cycle, has already updated his "Next Great Bubble Boom" from the Greatest Boom in History : 2005 to 2009 to: the Greatest Boom in History: 2005 to 2021. Since that rewrite, the cycle has been slow to progress.

One can argue that the business cycle has been tamed. Those who made that argument in the late 1960's rue the day. The second recession of the 1970's, the 1973 recession was one of the worst. More financial institutions went out of business in 1973 than in any other year in history.

The bottom line is that investors should avoid buying resort property for at least 3 more years. My family sold a lot of property in 2004 and 2005 and we should have sold more. We are prepared to lower our offering prices at the beach aggressively if the coming year of prosperity does not flow over to beach home prices. We expect to be totally sold out before the presidential election.

The big crunch is in the last year of the real estate cycle. In 1990, the average return on equity in commercial real estate was negative 40%! The numbers for resort properties is not available but it was probably worse. Those who choose to speculate on the current downturn may do well to buy resort property today and to sell in in less than a year. I believe the risk is too great relative to the potential reward.

Thank you all for asking questions. I hope the above is the information and opinion that will help you.

NEGOTIATE, NEGOTIATE, NEGOTIATE

THREE SETS OF MAJOR NEGOTIATIONS ARE UNDER WAY

Condi Rice has been involved in negotiations concerning the "two state solution" in the Middle East for several years. She is preparing to hold a big pow wow with representatives of several Middle Eastern Countries. We know that big pow wows are not held to negotiate an agreement but to announce agreements that have already been reached. It seems unlikely that great progress has been made, but we should know more by November 14th.

We should all say an extra prayer or two for peace in the Middle East. Many of the battles in this part of the world have their roots in battles fought centuries ago. Some say there will never be relative peace in this part of the world but the truth is that peace has broken out in large parts of this area. Several countries in the area are progressing rapidly up the economic scale. One lesson from history is that well fed prosperous people are not as likely to initiate war with their neighbors. One of my reasons for believing so strongly in free trade is that neighbors who trade seldom go to war.


Negotiation Number 2

The negotiations continue between Iran and the International Atomic Energy folk. I never can remember the full name of the agency that is in the thick of the negotiations or even the head of the negotiations but progress has been made. Under the latest sanctions, the pressure on Iran to "make a deal" has increased. There is room for compromise. Russia, which is the supplier of nuclear equipment to Iran, does not have any desire for Iran to have nuclear weapon capability. Even China is too close to Iran for comfort. Over in North Korea, the USA will supervise the dismantling of the nuclear facilities. The world is a safer place when rouge governments are kept from having nuclear weapons. On September 6, 2007, Israel bombed the start of facilities in Syria. While the USA would prefer to reach a negotiated settlement, there is no doubt that either the USA or Israel will bomb the Iranian nuclear facilities before nuclear bomb capability is reached. As usual, an aerial campaign has limitations and the Iranian facilities have been spread out and hardened. I do not believe the situation will require bombing because I believe the Iranians have more to gain by negotiating peace. Scores of major projects, including projects to build out Iranian oil fields, will start soon after a compromise is reached. The USA has no problem with Iran use of uranium for the production of electricity. Russia has offered to supply the fuel for the plants. Countries such as Pakistan and India, which have nuclear capabilities, make leaders in Iran jealous but adding additional nuclear bombs in Iran does not solve other problems. Negotiations between the USA and India in regard to nuclear capacities are in progress.

Negotiation Number 3

The Bush administration is apparently focusing its budget and tax negotiations with Nancy Pelosi. Nancy has become know in the House of Representatives as the "Committee of One." She does not support the proposals made by Charlie Rangel's Ways and Means Committee. The word is that she especially desires to pass an energy bill this session. The problem is that the democratic solution to energy is the piling on of wasteful incentives. Hillary, for one, has openly declared war on oil company profits, saying that she will use these profits to fund alternative energy sources. As we know from Econ 101, the market will automatically find the most efficient resource allocation. Again, the current energy bill in Congress is an add on of CAFE standards, additional payments to farmers and other programs that actually harm the long term progress toward energy independence. For example, when the government forces people to buy cars that use less gas, they encourage people to drive more miles. A regulated price does not produce the same results as a free market price. Indeed, one of the seeds of the current problem is the price controls on US oil that were in place during the late 60's or early 70's. Can you imagine that at the time it was thought to be good policy to hold the price of US drilled oil to $4 per barrel!!

A statement was just released from the United Nations saying that the use of corn for fuel is a crime against humanity. I think I heard the official say that the 100 bushels required to make 13 gallons of ethanol is enough to feed a starving child for one year. The exact numbers do not matter because the point is valid; children are starving because wealthy people are paying to convert human food stocks to auto fuel.

WHAT IS CONGRESS WAITING TO DO?

One month after the start of the 2008 fiscal year, Congress has yet to submit a single budget bill to Bush. Obviously, there is still hope for a significant break through of some kind. It could be that democrats believe that they will ultimately force through the budget busting SCHIP bill (it was passed once again by the Senate late yesterday). Once Bush is defeated once, the logic goes, he will be weak and Congress can then steam roll through other measures. I doubt that the SCHIP will pass in its current form.

The more likely scenario is that a major compromise is still a possibility. The budget negotiations have been in progress for many months. Hank Paulson left his job at Goldman, one in which he reportedly earned about $200 million per year, in order to pass the real "mother of all tax bills." This would be a repeat of the big Regan (Kemp-Roth) compromise. As you may recall, in that case, Don Regan left a similarly powerful job as Chair of Merrill Lynch to negotiate what was the "mother of all tax bills" at the time.

As I have mentioned, based on the very powerful real estate market cycle, we are over due for a massive tax reform bill. Mike Huckabee is moving up on the right. He has become a dark horse possibility for the republican presidential nomination. He has proposed the eliminating the IRS. He would substitute a consumption tax. The Regan tax revolution began about 26 years ago. It has taken a lot of work and a lot of compromise to reach the point where a move to a relatively flat tax would not be risky or potentially too disruptive. The Ryan proposal, 10% tax on the first $100,000 of income and 25% on all over $100,000, with standard deductions but no itemized deductions, is a doable compromise. It would do away with the AMT while producing tax revenues equal to the current law. Of course, democrats would insist on a third bracket for the rich and tax payers would be given the option to take itemized deductions by filing under the current system. Huckabee has a great idea but the risk of a massive conversion is too great. The wisdom of the framers of the constitution is always most apparent when the boldest and most risky ideas gain momentum.

In the current political climate, a great compromise seems impossible. On the other hand, democrats know that despite their massive lead in the polls, that they are vulnerable. The "big issue" that brought them into power has turned. Progress in Iraq continues. The death rate has collapsed. It is too early to know for sure but it appears that the war will be a positive for republicans by the time the election rolls around. The left is not happy with the democratic leadership. No real progress has been made since the last election. Without compromise, there will be no progress. The best of government policy has always been a result of "ruling from the middle." Negotiators have no reason to suggest a deal is close or not. There is nothing to be won by coming close and there is much to be lost if expectations are raised immediately before all deals fall through. In any event, a budget compromise of significant magnitude must be reached. If you want to see a massive dump the incumbents movement, just let Congress try to leave town after only passing a "continuing resolution budget."

TOTAL WORLD MARKET FUNDS

A reader wants to know more about the "total world market funds" that I mentioned yesterday.

There are a number of funds that track the "total" world market. The word total might be inappropriate because there are always a few very small markets excluded. Vanguard is the market leader in very low cost index funds.

PLEASE NOTE: The US dollar is as cheap as it has ever been relative to the Euro and it is also very cheap relative to many other currencies. Even the Yuan has appreciated against the dollar during the past year. As such, I am a strong proponent of "buy the USA" right now. In particular I believe there are bubbles in the Chinese markets. As such, the "safe" way to invest right now is to focus on American stocks. Those who promote diversification on top of diversification disagree with concentrating on investments in any country but even most of these guys would say that if you are going to invest in only one country the USA would be the one.

Once again, I tell you that I am an aggressive investor. It is arrogant for anyone to believe that they are "smarter than the market" in the short run but history shows that there are those who can beat the market in the long run. I have made my share of mistakes but my record is strong. Over the next several years, the USA could prove to be the very best place to have all of ones funds.

OFFENSE AND DEFENSE

In any endeavor, it is easy to get caught up focusing on offense. A church friend of mine just reminded me of this truth when he told me about all the big gains he is enjoying. He named a number of high beta stocks he owns that have soared in recent weeks. I cautioned him and will caution you: remember to play defense.

How does one play defense in the stock market?

Most people would answer the above question with talk about bond allocations, cash allocations or portfolio diversification stories. All good answers but not answers that lead to championship results. If you play not to lose, you will have a hard time winning any championship. The more powerful answer is that one should buy the bigger companies when one is trying to keep running up the score without risking multiple interceptions. The offensive move is to buy the smaller stocks in the country that has the advantage. The problem is that the best time for small stocks, the years immediately after a major recession, has already come and gone during this cycle. Some small stocks will do very well during the years ahead but the proportion will shrink.

Near the end of the 1960's cycle, successful investors piled onto only 50 stocks, these were know as the "Nifty Fifty". At the end of the tech bubble of the 1990's, relatively few stocks had extreme valuations. Companies such as AOL were priced as if they would never stop their rapid growth.

Today, the big bubble is in China. Who knows how high a mountain will be climbed? I missed the big move but will not compound the mistake by "getting in near the top."

The bottom line is that the writer of this letter is currently very aggressive while buying many "defensive stocks." Once again, this is a different definition of defensive stocks that the popular definition. I am not buying consumer staples. I am not saying a recession is near. I am saying that big cap growth stocks, such as the top 100 stocks at the NASDAQ, are likely to do well over the next several years. Yes, I still have a massive overweight in the airline area and not even I can call this investment defensive. My overweight is in the "best of breed", CAL, and it is in American stocks but the company is highly leveraged in a volatile business. Investors should always seek out volatility in the "good times." Of course, volatility is a pocketbook breaker in "tough times."

Small international stocks are among the most volatile but, because I believe we are within 3 or 4 years of "tough" times, it is time to overweight the relatively safe haven of the USA and it is time to under weight international.

LEFT OF HILLARY

I continue to be amazed at how all the democratic candidates have run to the left of Hillary. Hillary has been able to run toward the center and has become the "most attractive of the liberals". Investors should pay attention to the coming election. The potential for moving the markets is great.

Got to run! Have a great weekend.

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!