ANOTHER TURN MADE

The cost for local governments to borrow in the "Muni Market" has come back to planet earth. This is one more sign that the credit markets are "getting over" the "sub-prime poison".

GOVERNMENT REGULATION STRIKES AGAIN!

Once again, the good congress in its attempts to "protect the public", has shot the public in the foot. Millions of dollars have been lost due to the excessive write downs in the credit markets. The big companies that have written assets down to cents on the dollar will recover. Those people who sold assets at depressed prices are victims of over government regulation. Company management simply cannot risk jail time for making improper estimates. As a result, they are missing badly on the "conservative side". The good news is that the write up of these assets over the months and years ahead will yield steady earnings increases for the firms that hold these assets.

NEGATIVE REAL INTEREST RATES

Rare times indeed! There were a few months soon after the recession of 90-91when real interest rates were in negative territory. Prior to that, one has to go back to the inflation days of 79 to find negative interest rates. Investors should remember the "unknown truth" that inflation, which is partly a response to fewer goods being produced during a slowdown, is a late cycle phenomenon. The boost in inflation that comes along just as the economy is in a slow down is a sigh that the worst is over, the turn is here. Stocks will increase in value long before the numbers show the economy has turned. Commodity prices normally turn down with interest rates but, my contention is that gold and oil are being held up by geopolitical tensions. Core inflation rates are as high as they have been in some time but even the core rate will fall once the froth comes off the headline numbers.

THE XENOPHOBIC PUBLIC

When asked to rank the GDP of the European Union, the USA, Japan Germany and China, the public misses badly. They list China, the USA, European Union, Japan and Germany (which is part of the European Union). The correct ranking is: 1) European Union, 2) USA, 3) Japan, 4) Germany, 5) China, 6) UK, 7) France. The problem is the hysteria about China and India. The common belief is that these countries are going to "take over the world". The USA is going to lose its place as number one. It is a real shame for a country known as the melting pot of the world to be Xenophobic. "Those people are ...." is the refrain we hear. America is rich because of the input of peoples from all corners of the globe. The more we observe, the more clear it becomes that the education of children in the USA leaves a lot to be desired. I believe that China could easily pass the US and the EU to become the "biggest economy" with the next 50 years. I hope the USA never has as many people as are currently living in China but I hope the people in China enjoy a standard of living that is on a par with ours. In 50 years, I expect to see people of all nations working less time to acquire all the comforts we enjoy today.

BE A PATRIOTIC AMERICAN

One can be a Patriotic American without believing America is perfect. America is a land with serious problems that need solutions. We simply need to be careful not to create big problems out of solutions.

Greg Mankiw has blogged about the "three strikes and out law" in California. Before getting to Greg's point let me note that America has a much higher percentage of our population in prison than does the average nation by far. We treat our prisoners better than most other nations. Under these "favorable conditions", doing a "hitch in jail" is not such a terrible thing. Those who struggle to live a decent life "on the outside" may even feel comfortable and safe in jail. Greg notes that the three strikes law in California definitely influences the behavior of two time offenders. One of the ways is that the third offense is "ratcheted up". The attitude of some is, "if I am going away for a long time, I might as well 'get my money's worth'". Armed robbery or even murder rates are higher as the third offense. Another fact is that California "exports" two time offenders to other states. In other words, criminals shop for the lowest jail to crime ratio. The purse snatcher who faces a long mandatory sentence for the third offense might move to another state where the risk/reward ratio is not so harsh.

Yes, America as a land individual responsibility grants to its citizens great freedoms. What a blessing?! We have much to say grace over! At the same time, our nation takes away freedoms in order to make us socially responsible for one another and our freedoms are in a constant state of flux. The wisdom of the framers of our constitution never fades. The framers designed a federalist system of government and would certainly be amazed to see the power accumulated in Washington but, the system works. There are far too many people feeding off government, democrats and republicans, rich and poor, young and old. In this election year, it is my hope that Americans will study the issues and vote their convictions. We live in a great country and have the responsibility to do our part to keep it great.

HEADED FOR THE BEACH

My oldest turned 30 yesterday, my youngest is engaged to be married in October and my grand daughter will be two on the 25th. It is time for a family celebration at the beach. The reports that DAL pilots are in talks with NWA pilots and that Iranian officials are in talks with US officials give me hope that good news will hit while I'm gone. Again, we live in a great country and there are many reasons for us to be optimistic. Have a great week end!

FUNDAMENTALS -- BAH HUMBUG!

For a long time, I have been writing about how "far off" we have gotten from the "fundamentals". A regular reader just sent an article from the Wall Street Journal that shows how silly the "peak oil argument" is. The article relates how the world has used only 1 trillion of the 12 to 16 trillions of barrels of oil under the earths surface. As techniques are improved, more of this oil will be recoverable.

One of the things I have written about is the move toward electric and hybrid electric vehicles. Economically these vehicles make no sense what so ever (they hold promise based on the hope that mass production will bring down costs but the current cost is extreme). It is a good argument that the coal burned to produce electricity for a car cost less than the cost of oil burned in a car but batteries are expensive. The capital cost of electrics and hybrid electrics is still too high. Dramatic improvements have been made but even $100 oil requires a "casting off of fundamentals" for one to "go electric".

As I wrote the other day, there is a lot of activity in this area. Every major car company is building or planning to build some sort of electric vehicle. These plans have been made primarily for psychological (public relation) reasons. "Green mania" has taken hold. Elementary school kids around the globe have been taught that the world will end because of greedy, dirty men. Cities, such as New York, have mandated "green taxis". If a car company wants to feed off the government trough, and now a days virtually every company feeds off the government trough, it must be part of the "green in-crowd".

Batteries are horrible for the environment. A mandate to cut emissions in California is a mandate to push pollution to some place else. Yes, I do envision the time when batteries will help shave the peak loads at power plants at low enough cost to make battery power competitive. However, the reason most cars are powered by gasoline is because nature has provided substantial quantities of cheap oil. It took thousands of years for this oil to be produced. Using competing technologies while there are trillions of barrels of the "good stuff" still available is a psychological answer to a political question. It is not an answer to a rational economic question.

ON THE EDGE OF WAR OR A COLLAPSE IN OIL PRICES?

Why is the treat of war between Columbia and Venezuela, between Israel and Hezbollah, and between Iran and the US all surfacing now?

The price of gold and the price of oil suggest that conflict is ready to start. From "The Oil Drum" we find the following, "I was struck by just how fast the US has built gasoline inventories. ... The last time gasoline inventories stood at this level was in 1994."

Are gasoline supplies jumping because US demand is slowing rapidly or because the oil companies are preparing for a shut down of tanker traffic?

Bush jaw boned OPEC and won a reprieve. Normally at this time of year, OPEC cuts production as the winter heating season is over. Bush publicly lobbied for an increase in production and expressed disappointment at OPEC's decision to maintain production, but both sides got what they wanted; Bush kept production running and OPEC was able to stand up to Bush. The $4 jump in price will be short lived, unless conflict really is about to begin.

In the meantime, Iran is once again holding meetings with the USA in regard to "solving" the insurgency in Iraq. Iran is still funding terror and supplying bombs. Hezbollah is still active in Lebanon. Condi Rice is pushing Israel and Palestine officials to renew peace talks. All of these things are connected. Iran is the key to a lot of "stuff".

For two or three years, I have written that I expect significant "progress" before the 2008 elections. Nothing has happened to change my view. Bush has a deadline to meet. He will succeed or fail before he leaves office. Real success implies a "deal" well before the November elections.

Columbia has made good progress against FARC, the "terrorist of the South". Venezuela has the air power to give Columbia a difficult time. Does Venezuela dare to attack Columbia? If so, would the US respond? Oil is up $4 per barrel despite slowing demand and high inventories. Politically, Chavez and Amadenijad are weak because both nations have suffered severe economic hardship as a result of anti American policies. Will the people support armed conflict? The US would not need to invade either nation to cut back their exports. Bush has continued to add to the US SPR even after the price hit $100.

I do not believe war is about to break out. However, I believe that the US would be hurt less than Venezuela or Iran if there is a war. It is the strength of the US military that protects us from the necessity of war. The consensus view is that the US military has been stretched thin, but the reality is that the "shock and awe" used against Iraq is available from carriers in the South and in the Middle East. War is not likely because the US is prepared to wage war if necessary. The government of Columbia has the legitimate right to take on the menace of FARC and Iran has no right to sponsor Hezbollah and other terrorist organizations.

FURTHERMORE

After writing about the "fundamentals", I found a post about a bio-fuels stock, VSE. It has fallen from its peak price of $21.47 to $7.75. I would not touch the shares with a ten foot pole.

While the constant stream of media stories has been about alternative energy, big research money has also been spent on improving technology for hydro carbon extraction and use. There has been significant progress. For example, a new method has been discovered to convert tons of radioactive nuclear waste into harmless and manageable substances. Even more interesting is all the laboratory success in learning how to dramatically increase the speed at which deep earth hydro carbons are converted to clean burning natural gas.

The fundamentals are that gold and commodities are priced up partly because of fear. Warren Buffet once said that in the short run the market is a voting machine and in the long run it is a weighing machine. In other words, psychology can push stocks in the short run but in the long run it is the fundamentals that count. Knowing this "fundamental truth", we simply must be willing to hold for the long run (if we only knew how long the anxiety and the opportunity would be reduced).

THE FOUR LEGGED STOOL

The following reader comments show that psychology is weighing down the market:

"Interesting that in the last 20 odd years, the Fed has pumped the system with liquidity and each of those times we have run smack into some type of bubble. You would remember better than I the bubbles of the 80's but we had the tech bubble in the 90's and then the liquidity ran dry and now they are pumping the system and the money, so they say, is flooding into oil and commodities. When the music stops this time and it will, the money will rush out and I think the tidal move out will be as almost as ugly as the tech deflation. It probably will not happen with Bush in the White House."

"When Warren Buffet says we are in a recession, people listen. The fundamental measures do not matter in my opinion, the psychology is the reality right now."

Readers who quote Warren should remember that he was the one to say that the key to making money in the market is to buy when others are fearful.

Readers should also remember that the strongest buy signal is when the market is supported by the "four legged stool" and one of those legs is skeptical psychology.

The readers comments are consistent with the comments of OPEC members who, under pressure from Bush to increase production, maintained production. The spokesman said that the current price is not consistent with the fundamentals. He is right in many ways. The fundamentals include oil prices well above the equivalent price of natural gas (although the extra cold winter has caused this gap to tighten) and increasing inventories in the US for 7 weeks in a row as a clear result of slowing demand in a slowing economy. What is not included is the fundamental that Iran is being backed into a corner or that Venezuela has chosen to rattle sabers next to Columbia. It is fundamental to me that the price of gold and oil includes an extended risk premium at a time when the country with the second largest reserves in the middle east is under extreme pressure.

Another fundamental is that major investments of all kinds are about to produce fruit, therefore, it is time for the powerful to "create the psychology" needed to unload massive quantities of investments. Investors should always remember that the rich and powerful own or have friends who own media outlets.

A GOOD POKER PLAYER

A good poker player is not terribly upset when he gets caught running a bluff. A good player does not bluff often and he tries to win his bluffs, but, getting caught only serves as the "advertisement" needed to induce callers against really powerful hands. What do you think about George Bush and ethanol? Do you really believe this "good old boy, Texan" really supports converting corn to oil? I don't have access to the Karl Rove play book but I find it interesting that after a few years of silly spending on corn oil, there are suddenly a couple of hundred more coal fired electricity plants and 30 nuclear power plants in various stages of development. Do you think it is possible that Bush has been willing to give the environmental crowd enough rope to hang themselves with?

There is no doubt that the fundamentals will eventually support alternative energy in a major way, but the capital spending binge of the railroads suggests that replacing coal and oil is going to take a "super invention or two".

It is interesting that a lot of alternative energy technologies "work" while oil is trading at over $100 per barrel. For example, the GM partner that uses enzymes to digest every thing from corn stalks to tires claims it can produce at the wholesale equivalent of $1 per gallon of gasoline. I expect that price to be a bit of an exaggeration but it is interesting that that is about the cost of extracting oil from abundant supplies of tar sands in Canada.

The last two "elephant fields" including the monster in Brazil, will be expensive to develop as far as oil fields go, still, the wholesale per gallon cost from either will be significantly less than $1. So, the fundamentals tell us that even with a lot of oil and coal around that is cheaper than ethanol, wind, and solar, we choose to spend large amounts of government money on ethanol, wind and solar.

In other words, if we want to talk about government, there is a huge gap between fundamentals and spending. As far as the markets are concerned, prices of stocks have been pushed down by psychology and prices of gold and oil have been pushed up by psychology but psychology can only push so hard. The other three legs of the investment stool are supporting prices.

If you want to play the game of "how bad can things get?", we still have a very long way to go to the absolute bottom. I can't remember the exact number but I believe price earnings ratios went to around 5 or 6 near the bottom in 1982. On this measure, stocks are still double where they could go and of course the bottom in 1982 was nothing like the bottom during the great depression.

On the other hand, the prime interest rate in 1981 or 1982 was at 21%. Stock prices were facing powerful head winds.

BACK TO MY FAVORITE EXAMPLE

In the past couple of days, British Airways and American Airlines each announced traffic increases of better than 5%. China announced increases of better than 8%. Both British Airways and American are dealing with labor negotiations but their numbers show that the fundamentals of the business are not causing the low share prices. Here you have an industry sitting on the edge of its "bubble cycle" while the share prices are low. The companies are making money even in the face of unrealistic and unsustainable fuel prices. So, yes, prices are out of line with fundamentals. What an opportunity!

THE BIG SQUEEZE

People around the world are feeling the squeeze of higher food and energy prices. The short term and largely phony financial numbers make the situation look worse than it is but, that said, the squeeze is real and it is being felt. BCA Financial reports that US consumers are now paying 56% of disposable income for "necessities"; food, energy, medical and financial payments. With the poorest countries of the world growing the fastest, Moises Naim, Foreign Policy Magazine, has asked the question, "Can we afford a middle class?"

The irony is that great prosperity is causing the angst this time around. In the "old days", Thomas Malthus had good data to support the concept that the world would periodically suffer very large food crunches in which millions of people would starve during the worst of times. Today, there are only a few areas left in the world which are in a constant battle to grow enough food. The problem today, a growing middle class which has pushed up the price of food for everyone. Moises offers the following statistical summary: the total world population has grown by about 1 billion people over the past 12 years, during that same 12 years the size of the "middle class" has grown by 1.8 Billion people. Since the middle class consumes several times as much production as do the poor, the demand for food and other goods has exploded.

Poor people eat lots of grains. Middle class people feed much more grain to animals and then they consume meat. It takes about 8 pounds of grain to produce one pound of beef. Meat consumption on the planet has doubled in the past 20 years. The production of grain required to produce that meat has also doubled. Recently, we enjoyed saying, "So What? we now produce crops far more efficiently". Eight times the amount of rice is grown per acre than what was grown just a few years ago! The more recent problem is that countries around the world have been led by "group think" and misguided "junk science" to practice silly strategies such as using food supplies as fuel for vehicles. Group think causes us to leave oil in the ground while feeding our cars corn oil.

The good news is that even the most brain washed people eventually "wake up to reality". Paul Krugman just wrote in the NY Times that ethanol is "bad for the economy, bad for consumers and bad for the planet". I have forgotten the persons name, but one of the leading proponents of ethanol some years ago, is now a member of the "Clean and Safe Organization" that is promoting the renaissance of nuclear power. There are now 30 nuclear plants on USA drawing boards. Nuclear power plants produce very little greenhouse gases and the power can be used as a substitute for oil, leaving our corn and soy beans as food.

Based on the numerous announcements of auto companies around the world, the type of auto that is going to see an explosion of growth is the electric and the electric hybrid. Even many of the new hybrids will be plug-in models. At the same time, the pace of construction of coal and nuclear power plants is ready to kick into third gear. The beauty of the plug-in hybrids is that they are part of the "off-peak" or "load shaving" system. Once started, it makes sense to run coal and nuclear plants 24/7. Thus, the cost of electricity at night is very cheap and very expensive at peak hours. By charging car batteries at night and by leaving them plugged into the grid during the day, infrequently used cars could actually earn an income as a "power shaving device". It might even make sense for hybrid engines to be run at peak power times just to supply energy to the grid.

The competition for alternative energy solutions is moving forward quickly. All the competing solutions will help expose the silliness of using food products as fuel. The food squeeze is on but it will not last. The worst is upon us because the past couple of years of tighter interest rates has done its intended job to slow production. Since inflation is a measure of money chasing goods, the slow down of goods leads to a "J Curve" effect where inflation is high in the short run.

FROM RUSSIA WITH LOVE

Russia has once again asked Iran to comply with UN resolutions. Iran is stubbornly resisting but the weight of the world is getting to heavy, Iran is feeling the squeeze. Turning Iran away from the sponsorship of terror is going to be an important time in history. The various terror groups spread out around the world will wither away on the vine after the roots of this terror sponsor are pulled up.

THE BIG SQUEEZE IS ON BUT THE RECOIL WILL BE SUBSTANTIAL

To each action there is an equal and opposite reaction. The pressure being put on the markets today will result in a recoil reaction in the near future. Get ready! Get Set! Go!

IT'S A BIRD, IT'S A PLANE, IT'S A PREDATOR FIRING A MISSILE!

The USA has been demonstrating good intelligence lately. Every few weeks, an al-Qaeda leader is being torched. The bad guys are not even seeing the damage coming their way. One was taken out by a car bomb but the others are being hit from the sky. A couple of days ago, the hit was from a Predator drone, launched in cooperation with the Pakistani government and fired in the hills of Pakistan. The report this morning was of a strike in Somalia. The nationalities of those biting the dust has included a Saudi Arabian and an Egyptian.

In Iraq, the US lost the least number of soldiers in the month of January, 29. A significant loss but at about the rate of death per 1,000 in America. The death in America from guns is more than 2,500 per month and the death from auto accidents is over 3,500 per month. Should more tears be shed for the soldiers who die trying to rid the world of terrorist or for the drunk teenager and his victims in a head-on collision?

Civilian deaths in Iraq were up 36% last month. Even though the war is "going well". Hundreds of innocent people are being blown up by terrorist in various parts of the world. Several of the leaders and hundreds of their followers died last month.

In some cases, critics attack both the war and the USA. I can't remember where I read that a professor asked his students for a 6 word US slogan. The winner was "Our Worst Critics Prefer to Stay".

GOLD AND OIL

The price of gold and oil remains caught in the grips of geopolitical risk, putting downward pressure on the price of stocks. The long awaited "event" in Iran is almost upon us. The "bad news" of Iran is not likely to take the market much lower. Turns are showing up. Have you noticed that the housing stock index has bounced 20% off the bottom? Have you noticed that there is a new buyout every day or so? This morning it was Diebold under the gun of UTX. How about the continuation of insider buying? Insiders have bought a ton and a half of stocks at each of the market dips for the past 6 months. Mark Dodson of Hayes Advisors reports that the ISEE Sentiment has reached an all time record buy call. Iran is about to go under water for the third time. This latest set of sanctions do not appear to be so tough but, with unemployment above 20%, there is unrest in the body politic. The third time should be the charm.
TECHNOLOGY ALL OVER THE PLACE

NC State is starting an advanced transportation center where initial efforts will be focused on the most efficient hybrid vehicle. Down the road a few miles, Duke University is installing 2,500 wireless routers which will blanket the 6 million square feet campus with high speed Internet service. The revolution in digital downloads continues around the country. Apple has moved up to the number 2 spot, behind Wal-Mart and just ahead of Best Buy and Amazon. Over in Afghanistan, the Taliban is trying to get the cell towers turned off at night. They are tired of having their stealthily moves tracked by cell phone connection pings. Advances in the area of nano-technology also continue at a hurried pace. The discovery of tubes that reflect 100 times less than the black ink on this page holds the promise of a number of commercial possibilities. Another of the fascinating technology races is in regard to hydrocarbon eating bacteria. Demonstration plants are being built that use competing techniques to "chew-up" every thing from old tires and trash to coal or oil tars. Several researchers believe their technology will produce clean burning fuels for less than $1 per equivalent wholesale gallon of gasoline, while reducing pollution. If correct, the current price of gasoline is about double what it will be in a few years. Of course, the risk of investing in these technologies is that as the latest elephant oil fields come on line, the price of gasoline could drop below $1.50 per gallon.

All of these competing forces must stay ahead of the progress being made in the area of solar power. A massive solar power plant is scheduled to go on line by 2011 in Arizona. This one focuses the sunlight onto water tubes and the hot water drives turbines, nothing real fancy, but it works!

GOOD TIMES -- WORLD WIDE

Even this old "skeptical republican" enjoyed the "Four Block World" post last week. It shows that drivers who want to go forward should use the letter D and those who want to go backward should use the letter R and that voters who want to go forward should use the letter R while those who want to go backwards should use the letter D.

Most of the rest of the world, is moving forward. The miracle in Hong Kong, as illustrated on the Carpe Diem site, is a good example. The per capita income has increased from $2,000 to $30,000 since WWII. Sixty percent of the citizens pay zero income tax. The top 8% pay 57% of all the tax. How does one convince the richest of the land to pay such a disproportionate share of the taxes? The country has lowered both individual and corporate tax rates. The city-states low tax policies have created an economic boom that has lasted for many years. The story is not over, rates are being cut again. The corporate is about to be lowered to 16.5%, just 1.5% higher than the 15% flat rate on individuals. In addition, there is no extra tax imposed on dividends, interest or capital gains.

Oh, you say Hong Kong is a special situation? I guess Russia is as well. Since cutting income rates to a flat 13.5% rate in 2001, the economy has boomed. What about Iceland, Ireland, and 20 other nations? Are all of these economic success stories "special situations"? The reality is that the risk of higher taxes in America is hurting our economy. Why would an international company consider building a solar panel factory in America if its production is going to be sold around the world? Why pay higher taxes here when the plant can be built elsewhere?

THE OBAMA CURSE

A review of Obama's policies reveals that he supports legislation that would dictate that America spend trillions of dollars "helping the poor of the world" and at the same time he is opposed to US free trade agreements. This is the international equivalent of the old welfare scheme where people were kept in poverty by the "helping hand" that was seeking votes not solutions. In the past 20 years, billions of people have seen a dramatic rise in their real incomes as a result of "free" trade. Those who have benefited live all around the globe, including the many "Wal-Mart Shoppers" in the USA. It is a hard lesson to learn but feeding a man a fish each day is not being kind to the man. Teach a man to fish and buy a portion of his daily catch is "right" strategy.

On the other hand, if the man is willing to strap explosive charges onto his friends, spouse or children in order to blow up his "enemies" then it is appropriate to fire him up with a Hel-cat missile. It is good to know that 140 plus terrorist leaders have been blown away "from a distance"!