Thursday, July 20, 2006

INVESTMENT CONDITIONS: NOT PERFECT BUT CLOSEAS THEY GET

I like the mental picture painted by John Rutledge in regard to inflation. Rutledge says the commodity bulge is like the snake that swallows an egg; the egg is consumed and the snake enjoys the meal but, until the egg is assimilated, it makes for an ugly looking snake. Rutledge is a top economic advisor. He spends a fair amount of time as a paid consultant to the Chinese government. The growth in China is remarkable. China is making the change from an agrarian society to a service economy about as fast as possible. The huge move from agriculture to industrial production was the cause of the commodities "egg". However, this huge country is already spending heavily on IT which will lead the country out of the industrial age and into the service age. It is working. The productivity numbers are unprecedented; the country is growing at an 11% rate with little inflation and productivity has hit as high as 17%! The result will be a dramatic improvment in the use of resources, the "egg" will be assimilated! The buyers of goods made in China are enjoying the low prices that are only available because of the high productivity gains.

There are two major investment camps playing a game of tug of war right now. The one group believes inflation, as evidenced by the price of gold, oil and other raw materials, is making a major historic move to the upside. The other camp, believes that inflation is really not bad, as evidenced by the relatively tame wage market, the falling price of thousands of electronic goods and services and the total elimination of many costs as a result of new technologies. Being in this camp does not require one to believe that the price of gold, etc. are going to decline sharply. We have have high demand for commodities and low inflation because the cost of most any product is better than 70% labor costs. The proof is in the fact that many of the goods that require metals for production, such as computer chips, are falling in price.

It is clear to me that inflation is tame. Another strong indication is evidenced by corporate profits. Folks, companies are setting historic profit growth records. I don't believe there has ever been another time in history when so many companies have increased profits by such large percentages year after year for four years or more. The reason the Federal Budget Deficit improved by about 100 Billion last quarter was because corporations made lot of money and paid lot of tax. Nominal GNP is not all that much above average for this stage of the business cycle but real GNP roared along during the first quarter. The only way this is possible is for real profits to be high and for inflation to be a smaller portion of GNP.

Over the past couple of months, I have correctly suggested that the economy will slow. Housing in particular has been hit by higher interest rates. However, moderate inflation is the ideal investment climate and the slowdown in interest sensitive sectors of the economy will not kill the economy but it will pop the break this inflation egg. The bulk of the increase in the price of oil from $25 to $75 has already been squeezed through the economy, another "oil egg" will only pass through if oil goes up in price from here, yet, oil is in abundant supply and is priced extra high due to fear of a fight with Iran. The reality is that thousands of "Iranian Foot Soldiers" are under severe duress right now as a result of their fight with Israel. Israel dropped 23 tones of explosives on a bunker where Hezbollah leaders were known to hang out. Because life is precious, it is my hope that the 23 tones did the job intended and took the lives of those who are willing to kill the innocent.

It is easy to become paralyzed by the news of conflict in the Middle East and by the fear of inflation as expressed by those who do not appreciate that billions of decisions are made every day that substitute raw materials that are in abundant supply for goods that are currently scarce. My latest example is that 787 airplanes are being made with composite materials not aluminum.

Moderate inflation is good news for investments in stocks, bonds and real estate. Momentum is about to make a turn. Soon and very soon, those who are running from the market with fear in their heart will be chasing the market with greed in their heart.

Low inflation is ideal for real estate and stock investments. A slowing economy is good for bond investments. Of the three, stocks are poised to do the best. Real estate is likely to test some of the peaks made last spring but many a stock is going to set new all time highs and then some. BUY THE BULL!

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