Happy Thanksgiving

The image to the right shows what the Dow Jones Industrial Average has done over the last 3 months. This is not a pretty picture, and represents about a 9% slide in the stock market. This is all due to the recent credit "crisis", which is more appropriately a credit "loss of confidence", which started the cascading effect that we are still witnessing.

The silver lining is that we've had a recent upturn in the last 2 weeks, the Fed has signaled that it is in easing mode, and the big banks are starting to take huge (ultra-conservative) write-downs. Why is this important? Well, if the banks take a massive write-down now, each subsequent quarter these written-down loans are again marked to market. Eventually, there will be a market in these securities, and eventually these assets will be marked to market at higher prices than currently. At this point, maybe in 6-9 months, banks will stage a rally.

Curb the Curbs

The last week of stock market downside volatility is only made worse by the use of curbs by the stock exchange. As the market trades downward, the use of curbs only adds uncertainty to the mix, and keeps buyers away. Taking curbs out, and letting the market fall to a point where buyers will step in is what causes equilibrium in the markets.

For instance, let's say a curb is set to stop trading with a market decline of 250 points. What if a big buyer has a program trade in place to step in and buy securities if the market declines 275 points or more? What happens is....nothing. And with the added uncertainty, less liquidity due to curbs, etc. typically more sellers appear than buyers. This is not efficient, and increases the odds that more curbs and less liquidity will occur the next day-- this just exacerbates and slows down the process of reaching market equilibrium.

So I say "Curb the Curbs"!

Hot Air? Save the Whales

There was a very thought-provoking OpEd in today's WSJ by Daniel Botkin titled "Global Warming Delusions". It was a very sane piece lamenting the current political/societal debate over what global warming means. Botkin laments the fact that "beliefs" have pushed scientific facts and reasoning into the background, while along the way squashing the inconvenient findings of renowned scientists. For instance, one overlooked study attributes the causation of the melting of the snows of Kiliminjaro to increased solar radiation, not to changing air temperatures (i.e. global warming). Why is this significant? Because at that altitude the air is below freezing 365 days/year, and the melting patterns are consistent with increased solar radiation.

I of course bring up this controversial topic because it has huge implications for global policy, political rationing, and ultimately of the rationing and efficiency of future capital projects. Future estimated costs of $10 Trillion over 100 years is a big number; and this is just to prevent the rising of global temperatures by 1 degree Celsius. Reasoned discourse, intellectual curiosity and science must guide this debate, or we could go bankrupt trying to solve what could be a natural cyclical phenomenon. Climate change of course has merit; the real question is "how to we attribute changes in temperature"? And "how do we measure these changes"?

In terms of alternative fuels, a comprehensive U.S. energy policy that rewards exploration of any and all alternative fuel generation is paramount. Hand out tax breaks, and accelerated depreciation, and no taxes for 30 years! With oil at $88/barrell right now, the economics of making this a reality have never been better! This problem could be solved in 10 years using the ingenuity of free-market participants. In a little-reflected fact, oil actually is/was a free-market based alternative fuel; its discovery and plentitude actually saved the whales from extinction!

Necessity truly is the mother of invention; long may she thrive.

Inflation Reflation

With the Fed's recent lowering of the Fed funds rate by .5%, and the discount rate by .5%, the stock market experienced the largest one-day rally in 4 years. At the same time, commodities prices exploded higher. So what's going on? First, short covering in the stock market is part of the rise, and the added liquidity rushing into the market was caused by the surprise move. Commodities also pushed higher, including gold, because the Fed's move is seen as inflationary. Lowering rates like this will continue to weigh on the U.S. $, which is inherently inflationary to U.S. consumers who lose purchasing power, though certain asset classes have benefited in the short term.

Right now this Fed move should favor two trends: commodities and commodities-related company earnings, and U.S. multinational corporate earnings (whose foreign receipts are converted back into a weak U.S. $, which greatly improves their net earnings due to currency translation).

Great OpEd from WSJ: The Greenspan Myth

I couldn't say it any better than this, so I've added this OpEd from today's WSJ...

The Greenspan Myth
By DONALD L. LUSKINSeptember 13, 2007; Page A17 of WSJ
(partial op ed posting)

"...Mr. Bernanke has already acted more pre-emptively than Mr. Greenspan did in 1998, and similarly to the way Mr. Greenspan did in 1987 and September 2001. And he has done so despite the fact that, judging by the stock market's sturdy performance through the current turmoil -- now down only about 5% from all-time highs -- today's crisis is less threatening than those earlier ones.

It's noteworthy that the enormous volume of Fed open-market operations in the fed funds markets over the last month has been completed at the current rate target of 5.25%. This suggests that no lower rate is required to meet the needs of the banking system. And the discount window has scarcely been used at all, which suggests that the system is not in quite the state of distress that has been advertised.

So why would Mr. Bernanke cut the fed funds rate, unless he became convinced that the overall economy was highly likely to be damaged by the present market turmoil? That was the call Mr. Greenspan made quickly after the 1987 crash and the 2001 attacks, and slowly in 1998 and early 2001. Where's the evidence to support Mr. Bernanke making such a call today? Almost all the evidence is that the economy is remarkably robust, credit crisis or no credit crisis, housing slowdown or no housing slowdown.

Yes, we've had one disappointing jobs report. But with jobs at a level historically regarded as "full employment," must we hurry to cut rates? By historical standards, rates are already low. Since the 1970s, no easing cycle, and no recession, has ever begun when the real funds rate was as low as it is today.

Yet Mr. Bernanke remains under tremendous pressure from markets to cut rates. The prices observed in short-term fixed-income and interest-rate futures markets clearly imply that the markets expect a cut -- and the balance of pundit commentary is calling for one.

If the principled case can be made that a robust economy is significantly at risk, then Mr. Bernanke should do what the markets and the pundits demand -- provided that he sees a rate cut as consistent with his mission to preserve price stability.

But the idea that he must act immediately, in order to be seen as a worthy successor to the "Maestro," is unfair to Mr. Bernanke and too generous to Mr. Greenspan. The current Fed chief deserves our admiration for having acted quickly and appropriately so far, and resisted the temptation to over-react..."

Mr. Luskin is chief investment officer of Trend Macrolytics LLC.

Old News is Good News

Today the stock market was down about 1.5% because of the recent jobs report, which showed the first negative numbers in 4 years. Not surprisingly, many of the jobs lost were in the financial sector (i.e. mortgage lenders). However unsurprising this is, the financial media seems to think that this "news" is new. In fact it is quite old, and has already been baked into the stock prices during the subprime lending meltdown, since who can seriously consider that mortgage lenders would not be cutting jobs in this environment?

So the fact that the market is acting this way, based upon old news, is actually good news. Why? Because the market is more attractively priced based upon a short-term over-reaction. Weakness in the financial sector and this type of "news" are making short-term investors more cautious, but for long-term investors we gain entry into a market that is setting up its next base. Remember that the stock market climbs a wall of worry, fundamental earnings are very positive, valuations are good, and interest rates are still historically very low.

Short-Term Bearish, Long-Term Bullish

That pretty much sums it up. Today we are awaiting the Beige Book report, and the market is nervous that the Fed will not cut rates. Of course speculation that they WILL lower rates has fueled a recent rally. However, nobody really knows what the Fed will do. In the short-term, my best guesstimate is that the Fed will do nothing, but will mention that it is monitoring closely any fallout from the sub-prime mortgage mess.

So in the very short-term, the financial markets could be very rocky. Long-term though the markets are on solid footing with good earnings, still historically low interest rates, and good valuations. In the short term there could be a quick blip down, which I would call a very compelling buying opportunity for select Large Cap stalwarts across the board, especially in Financials, Healthcare, Global Telecomm, Auto, Semiconductor, Retail Grocery-- in other words, most of the sectors that nobody wants right now. Looking out 3-5 years, these sectors should rebound very well, and most of the companies in these sectors pay healthy dividends while you wait.