Thoughts from the Frontline

There has been more important and interesting economic analysis that has come across my desk in the last few weeks than at any time I can remember. I have spent a lot of time pondering the meaning of several very different items, and trying to see how the dots connect. I think it will give us some clues as to what our investment posture should be. I think you will find this letter to be much different from the usual economic analysis. First, I have masochistically thought long and hard about Greenspan's recent speech in Idaho. Most of the analysis I have read seems to say that Greenspan was saying: "...

September is the month set into my personal rhythms, and that of my generation, as a time to reflect upon the past and look to the future. The first week of school was always a time for review and to get a sense of what we would be looking forward to in the new school year. Even though school has been in session for several weeks, to those of us who went to school in the 50's and 60's, it does not feel right until after Labor Day. With that cycle in mind, it seems that we should briefly look at the broad investment themes that have been so much a part of this letter, and speculate as to their future usefulness. That will give us a launching pad to look at some very disconcerting economic news from around the globe, and see how it all fits into our personal investment portfolios. Pay attention, class. There will be a test.

Housing, deflation, bonds, and the dollar are all inextricably linked, if you connect the dots between numerous studies which have come out in the past few weeks. We'll do that and more as we explore the implications of even a small housing bubble and what it will mean to you. I frequently get email from readers asking whether they should buy or sell a house in a particular area. The short answer is, "I don't know." Today I am going to give you the tools which will help you answer this question for yourself. Plus, the analysis will have implications for the rest of your investment portfolio.

I confess. I like jig-saw puzzles. My bride indulges this quaint past time by buying me a new puzzle from time to time. This last month, I must have done something bad, however, as she purchased a particularly fiendish puzzle, where too many pieces look the same. It is proving quite the challenge. I bring this personal anecdote up, because the recent economic news is in somewhat the same vein. Trying to develop useful themes from the recent spate of very interesting statistics is quite troublesome. Is this chart or that article a piece of the bearish landscape or does it fit into the bullish blue sky? Let's review and see if we can get a picture that makes sense.

Today we examine several fundamental and criticaly questions, to see if they give us come clues as to the direction of the economy and the stock markets: "Why do we have no inflation since the Fed has been growing the money supply at very high levels for a very long time?"; the ever popular, "Is the Fed pushing on a string?" and "Is the United States headed down the same path as Japan?"

This week I have asked Greg Weldon, whom I frequently refer to, to give us a few examples of how seemingly different economic trends actually fit together, like pieces of a puzzle. If you can figure out how the puzzle pieces fit, you can develop ideas to profit from the picture they create. Greg is very good at seeing economic relationships and finding ways to make money from theme. Every day, Greg gets up at 3 am and starts to work, so that by the time I come in, I usually have my first letter from him. He typically writes 3 investment letters each day, analyzing macro-economic trends and showing his clients how to profit from them. His clients are mostly hedge funds and large institutional traders who pay $400 per month. I find his analysis to be some of the most useful and on target letters I read anywhere.

What would real profits be for NASDAQ companies if options were expensed? What would the stock price be for the biggest companies in America if investors started to price them based upon correct earnings figures? I give you the numbers in today's E-letter, plus we look at why the dollar is rallying, the economy and more. It should all make for interesting reading.

Today we look at why oil prices are likely heading down, how brilliant economists come to the wrong conclusions and of course a few comments on the recent market action. Let's jump right in. More Lies, Damned Lies and Statistics Since I criticized the trade policies of President Bush last week, maybe I can work up enough nerve to critique a recent article by one of the more well-known economists in the country, Arthur Laffer, of Laffer Curve fame.

For the past two weeks, I have presented a host of evidence that Price to Earnings (P/E) ratios would have trouble improving, even as actual profits and earnings grow in a modestly recovering economy. Changes in accounting standards, corporate governance and public perception will so change the rules as to how we measure profits, that public corporations will be fighting a strong head wind to show improved P/E ratios. Since this is a primary measure of the value of a stock, this "new profits era" will be a major downward pressure on stock prices for several years.

The end of this week's e-letter will be Part Two of "Why P/E Ratios Will Not Rise As They Normally Do After a Recession." The whole piece will be a chapter in my new book, Absolute Returns. Of course, I will have to think of a snappier chapter title. But snappy or not, it is important you understand the dynamics that are working to hold down P/E ratios today, and why this means the long term secular bear market now in session will remain so for several years to come.

This morning I saw economist Larry Kudlow on CNBC once again telling us the markets would turn back up at some point because the economy is getting better. Kudlow is a smart man, and I pay attention to his thoughtful style. But in this matter he is dead wrong. Over the past few weeks, I think I have made the point that the connection between a growing economy and the stock market is tenuous at best, and sometimes non-existent. A growing economy and a rising stock market co-exist in a secular bull market cycle. It is a virtuous circle. But in secular bear markets, growing economies are not reflected in the stock market.

"The time has come," the Walrus said, "to talk of many things." This week we talk about whether we are in a housing bubble, look at stock and bond market directions, the problems with the dollar and much more. It is that semi-annual time when I make predictions (which is the term for educated guess), and then watch to see what actually occurs. This week I begin with a look at the housing market. I probably get more questions on housing and real estate than on any topic, other than stocks. I am going to try and do a quick analysis, and then let that be the jumping off point for my economic predictions.