Wednesday, October 31, 2007


Dick Army gave me a chuckle this morning. He noted that the AMT was invented by Democrats in their attempt to tax the rich and the SCHIP program was invented to give healthcare to the poor. Today, the problem is that the most recent expansion to the SCHIP program would make some people eligible for both the AMT and the SCHIP! Government madness gone wild!


Again, my concern is that people might buy into the concept of raising taxes in order to replace lost AMT revenues. How can the AMT revenues be lost if they were never collected and were never intended to be collected from the 20 million or so families that will be caught in the AMT trap for the first time this year?

The best way to "patch the AMT" is to suspend the pay-go rules. Government revenues are growing by leaps and bounds, no need to add new taxes now.


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.


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.


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!


Friday, October 26, 2007



Many investors are holding back because they fear the economy is entering a recession. For me, the economic question is, "Are we in the late stages of the mid cycle contraction or are we in the early expansion phase that follows the mid cycle correction?"

I could easily argue either case because in the late contraction phase the bond market rallies and in the early stage of expansion technology stocks lead the way up. The key point is that there is almost always an overlap in the bond market rally and in the move in stocks. For example, during the 80's mid cycle turn, the bond market rallied from June of 1984 until November of 1986. The stock market rally was slow to crank up but did well in 1985, not bad in 1986 and then exploded up in 1987.

The overlap is already here. The bond market has rallied for months. Indeed the current rally started all the way back in July of 2006. The excitement is in the stock market. The big move by Microsoft today shows that the next economic phase of expansion is underway.

The fly in the ointment has been the price of oil. In the typical cycle, the peak in commodity prices would occur just before the big up turn in stocks. The current blow off in oil makes it look too early for the big upturn in US growth stocks but the weight of the evidence is that the big turn is already here. The blow off in oil is just that. Oil option speculators are making such high returns that they are now giddy with delight. This is a sign of a top. As always, I must state that tops are impossible to call. They are much tougher to call than bottoms which are also almost impossible to call. Yes the infinite is even bigger than we think!

Just because the big turn is here, it does not mean that stocks will go up in a straight line. There is still much uncertainty about tax laws that congress would like to pass. The majority in Congress are hungry for new dollars to spend. The democrats in control desire to shift the automatic tax increase of the AMT to other taxes. The fact is that the government has done well without these new taxes. The 20 million or so taxpayers who have not been subject to AMT will not know the difference if the AMT was repealed. The game of substituting other taxes increases for these tax increases is nothing more than the power hungry wanting more power.

The good news is that the Bush veto will hold. Only minor tax increases will pass this year. I still believe there is a tiny chance that a major reform will be negotiated, but the more probable scenario is that this Congress will leave town as one of the many "do nothings". There has been thousands of hours of talk but so far no accomplishments. Gridlock at the federal level is often a good thing.

Given the likelyhood of no major damage to the economy, large US companies are in the sweet spot. Foreign investors will buy American once the dollar turns. Small profits will be amplified into big profits. There are BIG MARKET PROFITS AHEAD!


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.


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.


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.


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.


Thursday, October 25, 2007


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

Wednesday, October 24, 2007


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.


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 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.


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.


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 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.


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.


Tuesday, October 23, 2007


The "turn around" continues and it is showing up in ways that might surprise you. For example, oil pipelines that flowed from the Gulf Coast to the Midwest a couple of years ago are now flowing from the Midwest to the Gulf Coast. The amount of "new oil" flowing from Canada to the US is one of those facts that do not fit the stories being told by the media. The media has been forced to mention that refineries in Indiana and Illinois are expanding but the story they tell is about the additional pollution these refineries will cause. Even the TransCanadian pipeline is a pollution story. Of course, an underground pipeline is much cleaner than transporting fuel in railroad cars but again that fact does not fit the story being told. The plan to build a new refinery in South Dakota has been mentioned a few times but again with a focus on the fact that this refinery will process the dirties to oil out of Alberta. In truth, the doubling of capacity at Port Arthur would not be going forward without the reversal of several pipelines. In one case, a pipeline is flowing from the US to Alberta to send the "lubricants" needed to "liquefy" the tar sand goo. Since oil reserves are only reported if the price supports the actual recovery of the oil, Canadian reserves are about to increase dramatically. There is as much oil in Canada as there is in Saudi Arabia. Indeed there is more oil in Colorado and Wyoming than there is in Saudi Arabia. This oil puts a lid on price.

There are many "turn arounds" in progress.

Aluminum is falling in price. Copper will follow. Silver is falling in price. Gold will follow. The British Pound is falling. The Euro will follow. The Yen appears to have finally bottomed, the US Dollar will follow the Yen higher. The Chinese Yuan has appreciated better than 6% against the dollar, US manufacturing exports grew at better than 16% over the past 12 months. Imports grew at less than 4%. The price of lumber has fallen as has the 30 year mortgage rate, new homes are becoming more affordable. US interest rates are falling, which is in and of itself disinflation. Over in Mossel Bay, natural gas is being converted to liquid fuel, "turn arounds" take many forms.


Growth stocks are soaring while value stocks are rolling over. QLD which is largely composed of big cap growth stocks is enjoying one break out after another. APPLE is leading the way but on other days it is RIM or EMC or GOOGLE or others. I bought the biggest chunks of QLD at or below $68 in July of 2006, yesterday, this basket of 100 stocks traded at $115. While it is certainly true that individual stocks within the basket have gone up much more but hitting the best of the individual stocks is always only easy in hindsight. I have had confidence in the QLD to perform and it has.


The legacy carriers are telling the story one after another. Today it was UAUA that blew the doors off. Its profits were up 76%. It beat the street estimates for revenues, for costs and of course for bottom line results. As you all know, the amazing part of this story is that the legacy carriers have recovered even while the price of fuel has soared. Fuel prices will be tight until the industry gets one barrel extra. The next big surge of supply will be the start up of the Cuban refinery in December. No, Cuba will not start exporting oil to the US and indeed this refinery is relatively small but Cuba will no longer be bidding on the same oil that supplies the US. It appears that the turn around in Vietnam will be delayed, but when both refineries are on line, Vietnam will have gone from importing 100% of its fuel to a fuel exporter.

In case you have not noticed, there has been a relative cease fire in US airfare wars. Instead of battling to offer the lowest priced domestic flight, the carriers are finding ways to expand without going head to head. The profits just announced by UAUA were partially the result of cutting out low margin competitive domestic routes. Assets have been sold to the far east or they have been redeployed to international routes. International growth should continue for many years and delays in the production of the next generation of planes will give a boost to current earnings. In another year or so, the average price of the average ticket will be back to the highs reached in 2000. Of course, the price adjusted for inflation is still very low. Today, even the "middle class" of the third world nations can afford to fly.


For two days in a row, energy stock prices have fallen. I expect oil stock prices to rise over but not like growth stocks. Those who do not follow markets closely do not realize that commodities out performed the stock market from 2000 to 2007. Over long periods of time, stocks go up but commodity prices go down. Many say that this time is different or that this move will last 25 years or so. While it is true that nuclear plants need to be finished before we are once again on the surplus side of energy, the substitution effects are starting to make a difference.


Based on the perfect 18.3 year real estate cycle, the tax simplification turn is past due. However, the real world real estate cycle is routinely a 17 to 22 year cycle. The Kemp-Roth tax went into effect in August of 1986, 21 years ago. Until a few days ago, Charlie Rangel, (Chairman of the House Ways and Means Committee where all US tax laws must start) was unwilling to separate the committees bill to fix the AMT from his "mother of all tax reform bills". Now it must be seen how big a reform will be built around this lesser bill. It appears that democrats will break their pay-go rules in order to get out of hot water. The congress simply does not have the votes to increase other taxes enough to offset the AMT. The congress does not want to stick 19 million tax payers with the automatic AMT increases that would average better than $3,000 this year.

Assuming that the change in the law is put off, similar to what happened in 1969, the pressure will be on the new congress and president after the election. The way it worked in 1969 was that successive bills made progress toward "simplification". By the time the third bill was passed, the tax advantages enjoyed by real estate investors were dramatically reduced and there was a heck of a real estate recession in 1973-74. The reform in 1986 was sure and swift but the big real estate recession still did not happen until 4 years later. Chances are that real estate will take relatively minor hits as a part of the AMT one year patch. The next bill, no mater who is president, will simplify the tax rates which means that real estate deductions will be devalued.


Many investors are finally starting to turn around. One fellow I know moved 100% of his 401-K to fixed income after 9/11. Now he is about to retire. For the past 5 years I have encouraged him to move at least a portion into equity. The last time we spoke, he talked about being on a fixed income. I pointed out that he needs to avoid being on a fixed income by putting a chunk of his funds into equity. He sheepishly admitted that he is now up to 30% in equity. Folks, this is the nature of the human beast. His account should have been moved to 100% equity more than 5 years ago. The date to move large sums out of equity and into fixed income is approaching. Over the next two or three years, the flow will continue in the equity direction. Of course, about the time that most people finally go "all in" it will be the exact wrong time. If you have not gotten on board the equity train, it is time to do so now. Do not gradually get on at ever higher prices. Once the prices begin to get unreasonable, it will be time to get off the train.


My old friend just sold his Baidu. He enjoyed a two year run and decided that the China market is now too hot. What can I say? I missed the great ride and acknowledge that this market looks like a bubble that could easily break. On the other hand, tops are very difficult to call. I suspect that there is even more to come and long term Baidu is the Google of China, "we ain't seen nothing yet".

As you all know, I can hardly wait for the day of the true Internet phone. I believe Google will offer the best of services. It marketing power of an Internet phone scares most people. Most would say that they would not want to be solicited by Star Bucks when they are near the store. The key is that we will be much in control. The big story about Google adds is that they are not forced upon us. I continue to wonder how long it will take folks like Time Warner to understand that they lose when they force commercials down our throats.

The major point for investors is that the potential revenues from mobile Internet far exceed the revenue potential from desk top Internet. There are more phones in the world than computers and one is almost always near ones phone. The world in turning into a new place.


Sunday, October 21, 2007


Suddenly there is the smell of fear in the market. The DOW dropped Friday and the Asian markets are following the path down this morning.


The rotation continues but it also continues to go forward a eighth of a turn only to back up a 16th or so before making its next move. The big drop Friday was in energy shares, with a 4.15% decline in the broad category and a 10% hit to SLB. A couple of years ago, congress was investigating for price gouging, again. Of course, the free market for oil is too big for anyone to get away with price gouging for very long. Today, the margins for refining oil have collapsed. The price of oil has been pushed up due to the fear of war, raising the cost of the raw material while the final demand has not increased.

Pundits all around the world take the sharp rise in oil and gold to be an inflation signal. They conveniently ignore the flight to quality in the bond market. The bond market agrees with the CPI reports. Inflation is falling. The best way to understand this situation is to remember what happened during the great depression. The price of gold and bonds went up as fear trumped reason. The flight to gold was not a fear of inflation but fear of the total collapse of the currency. Fear trumps ration during tough times. Fear can spread quickly. Should Turkey invade Kurdistan, which is doubtful, the amount of oil coming out of Iraq will be changed very little. The fact that the market has moved so sharply to a "non event" shows that traders nerves are on edge. Investors should remember the Warren Buffet adage to be greedy when others are fearful.

As I have written many times during the past several months, one of the last events before the prosperity phase kick in is a strong rally in the bond market. The big bond market move is currently in full swing. The fall in bond rates gives the FOMC the room to lower short rates again. The probability of another cut in the fed funds rate just jumped.

The fantastic strength in the world economy made it seem like further cuts might not be necessary. In particular, it seemed that the congress might be ready to make significant fiscal policy changes which would have stimulated the economy even more than a cut in the fed funds rate. When Charlie Rangel decided to give up on the "monster of all tax reforms" last week, he threw us all back into the "do nothing congress tar pit". With government receipts surging at the annual rate of better than 7% and government outlays growing at only 2.7%, THE GOVERNMENT IS TAKING IN TOO MUCH MONEY and it needs to respond. Unfortunately, it does not appear that a major compromise can be reached this session.

Over the past several days, the risk of recession has jumped. Whenever the US government starts to soak up such a huge amount of money, the risk to economic expansion is great. The good news is that the congress is still in a heck of a box and it might be forced into fiscal stimulus. Trying to pass even a one year patch to the AMT is going to be difficult. The congress will need to pass about $65 Billion of tax increases to patch the AMT. The congress will need 60 votes in the Senate to pass these offsets. I wish them lots of luck.

To pass even a one or two year patch, the congress might need to recognize that the AMT does not need to be offset. The truth is that the congress never expected to realize the extra taxes from the 19 million families that will be caught in the AMT trap for the first time next year. A few powerful Senate leaders on both sides of the isle are willing to pass an AMT tax without offsets. Wow, a sticky wicket indeed!

Bush and the republican congress have been lambasted for deficit spending. Can you believe that during the first term after the take over by the democrats that tons of earmarks will be passed and then not paid for according to the democratic "pay go rule"?

Even though the odds of comprehensive tax reform keeps dropping, it is still the best "way out". It is needed by the American people, it would stimulate the economy, solve the AMT problem once and for all and it would dramatically cut carbon emissions. The beautiful thing about the proposed reform is that conservatives would win energy independence while environmentalist would win the fight against global warming.


The FOMC will most likely cut short term interest rates on October 31. Given that there is a high probability of a cut, you want to stay 100% invested in the market. However, the next 10 days might try your patience once again. Indeed, the congress is likely to pass a poor set of bills while knowing that they will be vetoed. They will continue to try to push through the SCHIP funding. The current deadline for congress is November 16.

Again, getting out of town in one piece is going to be tough. The option is to be a do nothing congress that failed to live by its own rules or to enact major reform. Either option is going to be tough.


The war in Iraq continues to go our way. The terrorist are being "fingered" by the citizens of Iraq. A year ago, 161 Iraqis were being murdered on the average week. The rate has recently fallen to about 5 murders per week. In the USA, about 42 of our people are murdered per week. With continued success, troops will be coming home or they will be redeployed to finish the job in Afghanistan. No American president can allow Iran to develop nuclear warheads for use against Israel. Israel has sent a delegation to China to lobby for the sanctions needed to "break the will" of Iran. Continued success in Iraq and Afghanistan will add to the pressure on Iran. Unfortunately, the situation is Pakistan is still volatile, however, there is a good chance that the new administration will be even more pro USA. A strong pro American administration in Pakistan could put the squeeze on the terrorist hiding in the mountains of Afghanistan and Pakistan.


We are living through a "Ken Fisher moment". The majority of the people have a very low opinion of congress, the war, the president, the tax law and they simply have about negative attitudes. The result is opportunity. There is likely to be a strong sentiment shift as the election cycle progresses. Even without positive results from congress, the politicians will be able to brag on the nearly balanced federal budget. The success in Iraq will be reported time and again. One of the more accurate market indicators is that the market does well when the public opinion of the president and congress has been very poor but then rises to at least the 35% positive rating. The set up is here. BUY, BUY, BUY! When Fear turns to Greed, you want to be out in front!

Friday, October 19, 2007


Big tax cuts are needed and big tax cuts are being considered!

It is hard to imagine that a democratic congress is considering tax cuts. Maybe they really are and maybe they really are not.

Charlie Rangel appears to have given up on making the grand deal to eliminate the AMT. Perhaps even his "give up" is negotiating strategy. Has he thrown out a carrot or just campaign fodder?

Charlie just split his AMT bill and his tax bill into two parts. Next week there will be votes on each. The tax bill will go nowhere even though he will propose that the corporate rates be reduced from 40% to 25%. The devil is in how he would pay for the reductions.

For the last few weeks, Hank Paulson has been negotiating with Charlie. The attempt was to come up with a massive income tax reform simplification bill. The latest "give-up" indicates that instead of reaching a compromise, the democrats will put forth a bill with some goodies attached that cannot be passed, the republican president will veto the bill, a weak compromise bill will be passed and the two parties will run against each other on what could have been.


Near the end of the JFK-LBJ reign, the ever escalating tax system had run its course. By 1969, personal income taxes reached a peak of 10.8% of GDP. Trouble was at hand. The USA experienced a double dip recession with the second one, the 1973-74 being a humdinger. The "tax simplification act" in this particular cycle was a small compromise tax reform in 1969 that was added too piece meal over the next several years.

Near the end of the Jimmy Carter years, personal income taxes had reached another big peak of 11% in 1981. Another huge recession followed in 1982. The early Reagan tax cuts turned the situation around and the market malaise that had lasted from 1969 until 1982 was over. The big, big bull market started its stampede in the fall of 1982. Reagan continued the progress on lower taxes when the Kemp-Roth bill made it through congress in 1986.

Near the end of the Bill Clinton era, personal income taxes reached the highest peak of all with personal income taxes reaching 13% of GNP in 2000. As usual, once the government gets its hands on too much of the national economy, the public protest is a change in party. Bush took over, just as Nixon and Reagan right at the start of a tough recession. Once again it was clear that tax cuts were needed and the congress went along with the Bush cuts. The result of the tax cuts, in all cases (I should have gone back one more cycle to include the JFK tax cuts because they worked as well, but then so did those of Grover Cleveland) was to stimulate the economy and to ultimately increase the total tax revenue even at the lower rates.

Here we go again! The federal government is once again taking too big a piece of the pie. This year, personal taxes are pushing up hard. The current level is 10.8% of GNP. Because the democrats plan to increase the top marginal rates, billions of dollars will be pulled out of IRA accounts for the next three years. All investors should take a look at their marginal brackets and consider withdrawing a portion of their IRAs early. In particular those who are over 59.5 years of age should take a look. Because 100% of withdrawals from retirement accounts is taxable at ordinary rates, the advantage of tax deferral will become a disadvantage if rates are going to climb.

Let me mention once again that the simple explanation for the great depression was that the federal government held too large a share of the GNP. Today it is common for the average man to rail against the federal deficit without remembering that each of the recessions mentioned above came as a result of sharp pay-downs of government debt. Democrats love to mention that Clinton balanced the budget, what they do not like to admit is that as a result of the excessive level of personal tax the economy was in a recession by the time Bill left office. Saying that the down turn in the economy was a result of the tech bubble bust is similar to what is done to show that carbon is causing the warming of the earth. The very gradual rise in the temperature of the earth started before the rise in carbon but a graph of recent history shows the two numbers going up together.

In any event, our banking system is a fractional system and we actually need small levels of inflation to avoid disruptive allocations of resources. Indeed, the FOMC needs the leverage of debt to be able to stimulate the economy at those critical times of need.


Charlie Rangel would raise a lot of taxes in order to patch the AMT and to lower the corporate income tax. It is widely recognized that America needs lower corporate rates to "bring businesses back home". If any one of you were CEO of a multinational company, you would have to choose a European subsidiary for a new project given that the tax of 24% would yield a higher profit than the US tax of 40%. If patriotism for the US caused you to make a different choice, the shareholders would remove you from office pretty quick.


One of the big signs posted by the market place has been the cancellation of 16 new coal fired electrical plants in recent weeks. The AP reports that there is a growing belief that either a cap and trade carbon tax system or a straight forward carbon tax will be passed. My estimate of the probability of passage by the current congress was on the rise again until Charlie announced his split of the AMT bill. It will now be much easier for a one year patch to be reached with the big compromise being done after a hard fought election.

This is a sad situation. Politicians need to do the peoples work. Instead we are going to hear endless advertisements about how bad President Bush is and about how bad the democratic congress is. We are going to hear a lot of that in any case but I had high hopes that the obvious compromise would be reached. A third grade student can tell you that the US needs to tax income less and dirty coal more.

BUT MAYBE, JUST MAYBE? I cannot imagine a bill going through that would retroactively tax power plants already constructed. There is still inconsistency among the signs. Games are being played to make the energy "crisis" seem worse than it really is. The bone thrown out by Rangel, of lower corporate rates, is surely at least a fishing hook.

Again, we all know that two bills will be vetoed. Anyone who has negotiated the purchase of a business or even a car knows that you have to be willing to "walk away" sometimes more than once before you can discover the best deal. Democrats could go a long way toward shedding their "tax and spend" label if they were to pass tax reductions that must eventually be passed anyway.

As regular readers know, I like the compromise of combining the Ryan bill with the Dingle bill. I do not like the Lieberman bill because the carbon cap and trade system is too easily gamed. Another "fishing hook" has been thrown out by republican negotiators. The original plan offered was acceptance of a 50 cent per gallon and $50 per tonne gas and carbon tax in exchange for a very simple, two bracket income tax; 10 percent on the first $100,000 of income and 25% on all over $100,000. The latest "hook" is acceptance of a 4% surcharge on all above $200,000. It was known from the beginning that democrats would not accept the 10/25 system, but republicans have reached out with the idea of a 4% surcharge in the same way that Rangel has reached out with the cut in the corporate rate. Please notice that Rangel's proffer is a 25% corporate rate which is in line with the 10/25 rate wanted by republicans. The idea is that real simplification can only happen if the corporate and the top personal rate is the same. This is key for the owners of farms and small businesses who might have the option of paying out more or less of the earnings as personal income.


CAL put out some great numbers but you would not know it by reading the news reports. For example, one article talked about a 2% rise in revenues and said that earnings dropped from $2.17 per share to $2.15 because the number of shares outstanding increased by 1.8%. The truth is that the $2.17 of 2006 included .86 of one time gains from the sale of securities and the $2.15 included a one time hit to the pension fund of 10 cents per share. Indeed, I suspect that earnings were further reduced by the massive amounts added to pension funds this quarter. The bottom line is that the 2 cent drop was really an increase in operating earnings from $1.31 to $2.25, at least. The year over year increase was 71%!


On the other hand, Google did about as well as expected but the news has been hyped and hyped some more. I am still in love with the company, with its products and with the direction I see its future products taking the world. Still, I do not plan to add to my holdings now. The stock has had a big run and it continues to trade at a very high price. It will take years of growth for this company to be "worth" its current valuation, however, because I expect it to grow for many years, it will continue to receive a premium even after it is "worth" the current price.

Over the next several years, Google will go head to head against the "big boys". The major telephone companies have been around for a long time and they are willing to play rough. The big media companies, such as Viacom, know how to play hardball. Microsoft is spending billions to be more like Google. The list goes on. Google will face stiff challenges.

Again, please do not get me wrong. For almost four years, I have strongly recommended Google. It was one of the first three stocks my 19 month old grand daughter purchased. I like it, I like it. However, the stock will probably continue to climb in a pattern similar to the last couple of years. After a good run, the stock will be in the news constantly. Then it will go sideways or fade back for a long stretch before the next run begins. It is impossible to catch these cycles accurately. The best policy is to buy and hold the stock. If the mobile phone becomes what I believe it will become, Google will help billions of people navigate life daily.


Statistics show that those who invest regular amounts on a regular basis achieve higher returns than those who add money in chunks (when they feel good about the market). Last week I wrote that a pull back was likely because the sentiment had gotten too strong. This week, the sentiment is weakening. The talk about the 1987 crash and about $100 oil and war with the Turks is taking its toll. We need a little more fear to set up another great run. Congress will most likely finish its October 1 fiscal year budget before the Thanksgiving Holidays (Harry Reid says he is willing to call the folks back for a December session if necessary but I doubt it will happen). Chances are a weak budget will be passed by November 14. I still give a strong bill with great compromises a 20% chance.

Thursday, October 18, 2007


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 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!


Wednesday, October 17, 2007


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.


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.


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.


Tuesday, October 16, 2007


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.

Sunday, October 14, 2007


As regular readers know, I wrote a couple of times in the past couple of days that the market was over bought and ripe for a pull back. Yesterday we got great news and a great turnaround during the day. The tech stocks in particular made a big turn and closed down. I also wrote that should a downturn happen, I did not believe one could time it well enough to sell out and get back in before the next upward move. At the current time, those who have significant sums not in the market are the ones who face the most risk. The game of wealth is a game of relativity, should you maintain your current wealth long enough, you will ultimately be a very poor person.

Yesterday's great news was about the declining trade imbalance. Over the past year, exports from the USA have grown by almost 12% while imports have grown by between 3 and 4 percent (exports of manufactured goods grew by better than 16%!). The jump in exports is growing our economy. The next GNP report should show growth of better than 3%. About 1% of this will be "stolen growth" from other nations. Actually it is kind of like we loaned the growth to others and are now taking it back. The hit to other economies will make the central bankers in those economies think twice before raising their interest rates.

Once again, all the carping about the weak dollar has missed its mark. The turn in the J-curve has been made and the US is climbing the steep staff of the J. At current dollar levels, exports will continue to expand. The time intensive capital goods orders produced by the USA will continue to feed into the export totals for several years (one irony is that the government numbers often exclude aircraft orders because of volatility while Boeing keeps adding a steady stream of "accounting exports" for orders already on the books). All next year, the presidential election year, the expansion of exports will add to the economic boom; all year long, the GNP numbers will be increased by 1% or so as a result of the boom in exports. Incumbent politicians on both sides of the isle will try to take credit for the economic boom; will congress pass major legislation before leaving for the campaign trail? The boom is already here but it is not getting the publicity that it will get as the election grows closer. Of course, the democratic nominee for president is not going to be real happy to see the boom numbers. As you may have noticed, Hillary is not running on the slogan, "It's the economy, stupid".


Why did the stock market turn after the numbers were so strong? Yesterday, one pundit threw up his hands and said, "Only God knows!".

The economic reason is that the strength in the economy reduces the probability for another cut in short term interest rates. In the short run, the market saw this economic strength and pushed oil prices higher and bond prices lower. A strike in the Nigerian Oil Industry was also part of the reason for the higher oil prices. Keep in mind that if short term interest rates stay high, the cost of holding gold and oil inventories stays high. The key is that short rates are higher than the inflation rate. A two percent real interest rate compounded over a number of years makes holding gold painful. Oil and gold have a very high r square. If it is expensive to hold gold, it is expensive to hold oil. Over long periods of time, commodity prices fall in real terms. Stones were of great relative value during the stone age but that was before it was known how to forge metals. Man continues to find ways to replace expensive materials with cheap materials. Can you believe that cheaper materials are about to replace sand as a component of micro computer chips? Just in time because the production of computer chips is about to hit a whole new gear. Trillions of computer chips will be made in the coming years. One of many plant expansions is about to take place in Greensboro.; RFMD will build a new plant there.


Republican representative, Paul Ryan, the ranking republican on the house ways and means committee got tired of waiting for the Charlie Rangel tax bill. Rangel, as chair of the house ways and means committee, the one that is responsible for all new tax laws, holds a powerful spot. Rangel very much would like to repeal the AMT. His problem is in finding the revenues to replace the tax. So far, his committee has been bogged down in minutia. For example, much time was spent trying to come up with a way to eliminate the tax on the phantom income that is a result of foreclosure. Rangel "solved the problem" by adding new complications to the tax law in regard to second homes. The tax break on second homes was reduced, but we do not need to go into the details here; trying to make heads or tails out of the current maze of tax laws is a worthless pursuit.

It is anticipated that Rangel will propose a jump in tax brackets in order to eliminate the AMT. He will propose that the maximum rate be increased to 36%. Bush has pledged to veto an increase. Rangel has been dragging his feet to find the compromise that might work. In the mean time, democrats are working over time to try to over-ride the presidential veto of the SCHIP law. This "health care for poor children" is a test. When the test fails, the congress will be back at square one; what can Rangel to do? He does not want to pass another one year patch but the democrats certainly do not want to be responsible for forcing about 20 million Americans to pay an extra tax during an election year. Rangel wants to cut out the AMT but his party has said that it must play by "pay-go" rules; any cut in one area must be met with an increase elsewhere. This requirement will force many more complications to the tax law unless a sweeping reform bill can be passed.

The introduction of Ryan's bill is reminiscent of the one introduced in 1986. The Kemp-Roth bill came out of the blue to become the law of the land. At the time, few people had even heard of Jack Kemp, but, like today, the complicated income tax law was ripe for reform.

The Ryan bill is simple. The tax on the first $100,000 worth of income would be 10% and the tax on all income above $100,000 would be 25%. In one fell swoop, scores of complicated rules would be abolished along with scores of itemized deductions. A $25,000 standard deduction, personal exemptions of close to $4,000 and head of household exemptions would all be allowed. A family of 4 would pay zero income taxes on the first $39,000 of income. The bill defeats the fairness question; what can be more fair than the jump from 10% to 25% on all high income money. The Bush capital gains tax cuts would be made permanent.

The name of the bill comes from the fact that tax payers will be given the choice of paying taxes according to the current law or under this new "flat tax system". About 5% of taxpayers, those who give the most to charity and have the highest deductions, might choose to file under the current system. A bill that simplifies taxes for 95% of the population is a good bill!


Because a number of key republicans are willing to trade a carbon tax for lower income tax rates, but are politically unable to propose such a tax, the hook has been baited. The Ryan bill makes no attempt to recover the trillion dollars of revenues to be generated by the AMT over the next 10 years. Since, there are several democratic versions of carbon tax bills already in circulation, "VICTORY" is at hand for the growing group of democrats who would "fix global warming and the energy crisis" by passing a carbon tax.

I believe the combination of Ryan's simple, two bracket tax and a tax on carbon would be well received by the public. There would be griping about the carbon tax at first, but most of the complaining would go away when it came time to fill out a postage card sized income tax form next April. The benefits would become more and more "apparent" during the economic boom of 2008. The politicians will speak proudly about their accomplishment and use the economic numbers and falling oil prices to show that they have done a great thing. The introduction of a carbon tax, combined with a cut in income taxes owed would give the auto industry a shot in the arm. A scramble to replace big trucks with fuel miser cars would take place. Because the carbon tax would be phased-in, with a 10 cents per gallon tax on gasoline being added each year for 5 years, the shock of the higher tax on gas would be less than the benefit from the lower income tax. The wisdom of those who have purchased smaller cars would be in evidence. More and more cars would be "up-graded".


Pepsi just showed how a well managed company can survive and prosper under adverse conditions. Pepsi has faced higher corn prices and won. The sweetness of Pepsi beverages comes from corn syrup. Pepsi's Frito-Lay is a corn cooking company. Prices of finished products have been increased to keep profit margins sweet. At the same time, the public is growing tired of paying higher prices for food while corn farmers are being subsidized for converting corn into a poor substitute for gasoline in cars. The oil industry is clearly dragging its feet in regard to installing E-85 pumps. The oil industry understands the science of fueling cars better than the rest of us. The industry would prefer that the high octane good stuff be used, but the industry has gone along with adding a small quantity of ethanol to the mix. However, spending $200,000 per pump to install separate E-85 pumps makes no sense to these companies. The ongoing cost to maintain the extra pumps is considerable. The companies drag their feet in the hope that rational alternatives will be found.

My attraction to a carbon tax (as a replacement for other taxes) is all about adding market efficiency to resource allocation. We know that burning fossil fuels is detrimental to our health. The deal is the same as smoking in a restaurant; people should have the right to smoke if they must but they should not be allowed to smoke near my dinner table. I can not help but breathe the air polluted by the coal and oil; the pollution costs are not included in the price of coal or oil or other burning, but it should be.

The USA has abundant reserves of coal and we have the choice of building nuclear power plants. The moratorium on nuclear power plants has resulted in the burning of trillions of tonnes of additional coal over the past 20 years. Coal fired electrical plants are being added to the mix at a steady clip. I recall writing a year or so ago about the 14 coal fired plants that were under construction in the state of Illinois. The environmentalist make the evening news on earth day but they have failed to stop the construction of thousands of coal fired power plants. They are not powerful enough to stop the growth in US power consumption; a growing population requires energy for the production of food and heat for the home. More and more and more electricity is being produced. Our choice is how to produce it while maintaining the beauty and wonder of the good earth. Great strides have been made. Several hundred years ago, pollution had gotten so bad that the air in London was black and one could not walk down the street and keep ones feet out of human and animal excrement. More needs to be done and taxing the most dirty fuels the most is the way to allow the market to work its magic.

With a carbon tax in place, many a silly subsidy would not be renewed, yet there would be extra incentives to expand the research into plant based renewable fuels. When scientist are able to efficiently convert plants to high quality fuel, the oil industry will beat a path to their doors. Forcing consumers to put corn oil in gas tanks is the height of folly. There is no need to subsidize windmills, corn oil, solar panels, soy beans or anything else if the cost of burning fossil fuels includes the cost to the environment. The law of substitution is more powerful than any act of congress. No matter what the politicians do, the world will continue to find ways to make more stuff while using fewer resources per unit of stuff. A carbon tax would give all users of fuel extra incentive to use less. Since the tax would be highest on the dirtiest fuels, the usage of dirty fuels would be reduced the most.

As I mentioned before, one part of the good news would be that the price of gasoline would go up by less than the amount of the tax. In effect, Iran, Saudi Arabia and Canada would pay a portion of the tax for us. In the past quarter, the USA used about .6% less fuel than in the corresponding year ago quarter. A carbon tax, installed over the next 5 years, would cause consumption to decline. The result would be a tax cut for all Americans!


Rice is in flight to meet with Putin. Russia has more to lose by allowing Iran to build a nuclear bomb than does most of the rest of the world. Crunch time is here. I believe Russia and China will go along with crushing sanctions on Iran if a deal is not made soon. Iran is going to come to terms or suffer. It is in the interest of the Iranians to enjoy peaceful use of nuclear power without developing a nuclear bomb.

International dominoes appear ready to fall. North Korea will dismantle its nuclear facilities soon and peace has broken out in a number of Iraqi areas. A proposal is being floated to reduce the total number of troops in Iraq and Afghanistan by around 26,000. The plan being considered is to move all the marines in Iraq to Afghanistan and to bring home about that many army personnel. With peace starting to poke its head up in Iraq, the idea of going back to "finish the job" in Afghanistan has political appeal. Guess what? Troops will be coming home during an election year.

Yes, peace in Iraq is hard to see because peace is still ducking behind senseless bombings. The thing that is different now is that the Iraqi people have turned against those who would continue the war. Radical Sunni and Shiite are being "fingered" by the masses. The task of finding and eliminating the "bad guys" has grown easier. The "enemy" is on the run. National unity is catching hold. There is a love of country developing. The success of the national soccer team has played a significant role. I love it.


Yes, I am beating the same old drum. No one knows exactly which stocks will do the best. It seems to me that a lot of prices are currently out of whack. For example, EMC owns 86% of the hottest stock around and yet the total market value of EMC is about the same as the value of the hot stock. If I were to buy into this situation, I would buy the EMC rather than the hot stock and get the EMC computer storage business for free. Most of you own shares in EMC through your ownership of QQQQ or QLD. You are participating in the dramatic run up of the speculative stock while holding the long term solid winner.

With prices jumping around in crazy patterns, investors should be careful. On the other hand, it is important to be in the market. Small mistakes will be easily forgiven by a surging market but crazy prices can turn in a hurry. This is one of those many times when one can throw darts at the stock page and make a lot more money than the average investor will make. The average investor will buy the hot stuff. He will achieve success when the momentum plays continue. The problem comes when it is time to sale but there is no economic rational to buy for even 10% of the trading price. My word of caution is that playing with fire is a good way to get burned.

Congress will not likely leave town for about a month. The pressure is no congress, Iran and Iraq to perform.

PLEASE, PLEASE, PLEASE do me the kind favor of forwarding this message to a friend or two. I put a lot of time into the creation of this document and would like for it to be shared freely.

Thursday, October 11, 2007


I continue to have more to do than I can possibly get done. I will let individual email responses pile up for a few more days, until I can catch my breath. Just a few comments here to let you know the BIG BULL is still preparing for its next charge.

1) Yes, commodities are rolling over. A couple of readers continue to make the case that oil and gold are near record highs. All I can say is that these two very visible commodities simply do not tell the whole story. Take a look at a chart of Uranium prices. After running and running, all the way to about $140, the price has fallen to around $75 since the peak in June. Aluminum, lumber and others have fallen dramatically. Oil is still high but natural gas, which will be substituted for oil as much as possible this winter, is selling at about half the price of oil on a BTU basis. With warm winter weather, oil could easily trade at $50 per barrel by January.

2) The Democratic controlled congress continues to talk a big game while quietly backing away from confrontation. The latest quiet move was to remove the provision of increasing the tax on partnerships. John Rutledge noted that 15.5 million Americans would have been hit by the higher tax. The loud talk is mostly about SCHIP "poor children's health assistance". Republicans in tight races are being lobbied to vote to override the Bush veto. Democrats know that if they can't get the votes to help "poor children" then there is no hope of "winning" on "big" issues this year. Rope-a-dope seems to be the strategy of the day. The odds have increased that the congress will pass another one year patch to the AMT and leave big change to the tax system as a campaign issue.

3) Jobs, jobs, jobs for the illegals. For a number of months, a large number of workers have been expecting lay offs. These workers social security numbers are either 000-00-0000 or numbers that do not match the names of the workers. In many cases the numbers match the names of dead people. After the latest attempt at immigration reform failed, the Bush administration warned employers to "cleanse their payrolls". A month or so ago, a court suspended the plan and, yesterday, it ruled the plan to be out of bounds. The bottom line is that immigration reform is still needed. Piece meal attempts to "fix" the problem will not work. The ruling of the court pretty much puts us back at square one. The good news is that millions of jobs will continue to be filled by "illegal immigrants" and great pain to the US economy will be delayed to a future time.

So, for the next year, you can count on hearing a lot about tax reform, energy reform and immigration reform. Tax reform will be defined by democrats as raising taxes on capital gains, corporations and "the rich" in order to give $1,000 checks and such to the rest of us. Tax reform for the Republicans will be defined as simplifying the tax code while reducing the tax on capital in order to restore the competitive position of the US in world markets.

In the area of energy, constant calls for increases in the government mandate for ethanol use have started falling on deaf ears. Poor people in some countries are literally starving as a result of higher food prices. Commons sense says that forcing the burning of food products in vehicles is not the best solution.

Democrats will talk about energy in terms of global warming. Republicans will push for energy independence as a national security measure. Democrats will propose a "Manhattan Energy Project" in order to create jobs and solve the global warming crisis. The reason for the push does not matter. The pressure will grow to use the abundant resources available, including coal and nuclear power. The push by democrats to tax carbon fuels could turn the price of uranium around one more time. The huge drop in the price since June is an indication by the market that the current congress will not be able to reach a cap and trade system or a carbon tax compromise. An increase in the tax on carbon will make the nuclear power numbers all the more compelling.


The bottom line for investors is that the business cycle is clearly moving into the prosperity phase. In this phase, as the price of commodities rolls down, headline inflation rates roll down, giving an automatic boost to real incomes (the simple case is of the consumer who fills his gas tank for less). Full employment brought on partly by commercial construction will provide another boost to real incomes. Spending increases by some will become the income of others and the multiplier effect will kick-in. BOOM, BOOM, BOOM; economic prosperity is at hand!

Those who say that Hillary has a lock on the Presidency ignore history and the economic cycle. We know that neither Bill Clinton or George Bush won a majority of votes. With the exception of Goldwater's run, presidential elections tend to be very close. The economic times will not ever be much better than they will be by next summer and fall and voters do tend to "vote their pocket books". Investors should take advantage of the situation and make money now. While the down turn will not be immediately after the election, do not wait until all the numbers say we are in a boom, boom, boom before you go 100% into the market. It is my opinion that the biggest mistake made by the average investor is wait until near the top to be fully invested. One needs to get in early and get out "too early". Keep in mind that most folk find it most difficult to start scaling out when "everyone" is making big money. Our "hard wiring" makes us want to enjoy the party with all the other guests, once everyone has joined the party it is time to leave. This BIG BULL began with a roar 5 years ago. The big money made during the first half of the cycle was made from October 2002 to June of 2004. The second half is under way. The cycle has two to four more years to run. It is similar to a baseball game with each inning representing a year but 9 years is an average game not the required length. Don't wait for the last year or two before you try to start hitting home runs. This baseball game is more than half over.

A number of indicators suggest the market is over bought in the short run. A pullback would not be a surprise, but the risk of being out of the market is greater than the risk of being in the market.

I have overstayed my allotted time. Got to run, run, run. Have a great day!