Thoughts from the Frontline

Today we begin what will be an intermittent series on oil and energy. Each and every year there is a need for more and more energy of all kinds. The one thing we can say with confidence is that energy demand and usage in the next 20 years is going to increase dramatically as more than half the world aspires to middle class (and more!) life styles, which will put huge demands on our energy resources. Will oil production slow down and then peak in the future? Quick answer: yes. Will we run out of energy? Quick answer: no. But that implies a shift in how we currently produce and use energy. But first, I am really excited to be able to announce that I have a new relationship with EFG Capital, an affiliate of EFG Bank, which is the third largest bank in Switzerland (based in Zurich). EFG will be working with me in helping clients in Latin America, Switzerland, the Middle East and Asia. They join a growing family of partners with whom I work: Altegris Investments in the US, Absolute Return Partners in Europe and Pro-Hedge Investments in Canada. Our mission is to help accredited investors find alternative investments like hedge funds and commodity funds, as well as other investments, that make sense in today's investment climate. Rather than traditional long only stock portfolios, we look for managers who have discovered a niche where "alpha" is lurking and who have developed a system for attempting to mine that alpha. One of the nice things about having an international group of partners is that each firm does a lot of research in trying to discover managers and funds, and by sharing that work, it multiplies the "reach" of the entire network. The sum is indeed greater than the individual parts. EFG is going to be a real important part of the family and I am really happy to have them as a new partner. (Past performance is not indicative of future results, and there is no guarantee that any investment program will result in positive gains.)

"The U.S. outlook is all about the property market, which has been the wind beneath consumers' wings this decade." Paul McCulley, Managing Director, Pimco The world seems to be breaking down into two camps: those who, like McCulley, think housing is critical to the growth of consumer spending and believe the housing market may be in for some rough weather, although the forecasts vary greatly from a mild frost to blizzard conditions. On the other side there are those who think the housing market is in fine shape, will not be in for anything more than somewhat less growth and the American consumer will figure out a way to continue to spend more than he makes.

This week we look into my worry closet and ponder whether the Dubai port debacle is a one-off thing or does it signal a rise in protectionism. The recent polls suggest I will upset about 90% of you, but I look at the deal from the very negative economic impact it could have on this country. We then briefly look at the potential for more Fed rate increases and at a disturbing Federal Reserve Bank report on US wealth. But first, a brief paragraph on a new feature of the letter. We have added a new link at the top of this letter which allows you to easily send Thoughts from the Frontline to a friend with a comment by you. You can use it every week, but there is also a link where they can subscribe directly should you suggest that to them. Thank you in advance for helping this letter continue to grow. It is hard to believe that just over five years ago we started with only a few thousand names and now send the letter out to over 1.5 million names each week. To those who have recommended the letter to friends over the years, I do appreciate your support.

"Central Bankers of the World, Unite!" That at least seems to be the theme from the central banker's playbook. The US Federal Reserve, The European Central Bank and now even the Bank of Japan all seem to be in a mood to tighten the global money supply. What does this mean? We explore that thought and look at the US saving rate (or lack thereof), foreclosure rates and more. But first, I want to once again mention that I along with my partners Altegris Investments will be hosting our third annual Strategic Investment Conference in La Jolla, California next May 18-20. As usual, we have a powerhouse lineup of speakers. Martin Barnes of Bank Credit Analyst, Dennis Gartman, Richard Russell, Louis-Vincent Gave, Mark Finn and my personal (as well as someone called Oprah's) doctor Dr. Michael Roizen (who wrote the RealAge series of books and the recent blockbuster bestseller You - The Owner's Manual). With this lineup you can expect not only solid information and some fun, but some very serious debates. One of my rules in designing a conference is to get speakers who are going to help make me a better investor and analyst. I think we have done that and more this year.

This week we look at the possible direction of interest rates both at the long end and the short end. Bottom line: history suggests there is some serious volatility in the future on the long end of the interest rate curve later in the year. The yield curve and the 6/50 Rule when looked at together reveal some very interesting insights. (This letter may print longer than usual, but that is because there are a lot of charts. In words it is actually shorter than most letters.) But first, I want to once again mention that I along with my partners Altegris Investments will be hosting our third annual Strategic Investment Conference in La Jolla, California next May 18-20. As usual, we have a powerhouse lineup of speakers. Martin Barnes of Bank Credit Analyst, Dennis Gartman, Richard Russell, Louis-Vincent Gave, Mark Finn and my personal (as well as someone called Oprah's) doctor Dr. Michael Roizen (who wrote the RealAge series of books and the recent blockbuster bestseller You - The Owner's Manual). With this lineup you can expect not only solid information and some fun, but some very serious debates. One of my rules in designing a conference is to get speakers who are going to help make me a better investor and analyst. I think we have done that and more this year.

One of the positive things about international travel is that it gives me a large amount of time to read and think. This week we are going to look at some of that reading on the current issues surrounding the apparent willingness of investors to court ever increasing amounts of risk in the face of not only US central bank tightening but tightening by central banks everywhere, which has historically not been a bullish environment. I trust it will stimulate your own thinking. But first, I want to announce that I along with my partners Altegris Investments will be hosting our third annual Strategic Investment Conference in La Jolla, California next May 18-20. As usual, we have a powerhouse lineup of speakers. Martin Barnes of Bank Credit Analyst, Dennis Gartman, Richard Russell, Louis-Vincent Gave, Mark Finn and my personal (as well as someone called Oprah's) doctor Dr. Michael Roizen (who wrote the RealAge series of books and the recent blockbuster bestseller You - The Owner's Manual). With this lineup you can expect not only solid information and some fun, but some very serious debates. One of my rules in designing a conference is to get speakers who are going to help make me a better investor and analyst. I think we have done that and more this year.

This week we look at an interesting index of greed and fear, look at the yield curve and the new 30 year Treasury bond, the latest unemployment numbers and a lot more. What do they tell us? Is there a theme or at least a rhyme? Or is it all random noise sent by the market gods to lull us back into the mistakes of the past? The markets are a race between greed and fear. Right now Greed is looking like Seabiscuit beating War Admiral by four lengths at the stretch. (As an aside, you can read the greatest descriptions of that race - and one of the truly great sports columns of all time - by the incomparable Grantland Rice at http://www.secondrunning.com/seabiscuit_war%20admiral.htm. That man could stir the soul with his words, and this was Rice at his best.) Good friend James Montier over at Dresdner Kleinwort Wasserstein in London has been tracking his own measure of fear and greed for the last few years. It is a fairly simple measurement but it does show some very interesting patterns. He admittedly has not looked at the index for awhile (it is rather like watching paint dry on a week to week basis), so he dusted off his old data files and updated his index. What a difference a year makes. The index has only reached this level of greed in September of 1987 and May of 1996.

Last week we started a series on a very important book by friend Joe Ellis called "Ahead of the Curve." We continue this week looking at specific indicators that Joe thinks give us a heads up when the economy is about to slow down and the stock market will being a bear market. I am then going to marry those thoughts with some work on the yield curve, especially looking at what the yield curve may be telling us today. Cutting to the chase, I am going to make an argument that it is high time for you to start thinking about taking a defensive posture on your stock market investments. None of the indicators we will be looking at give us anything close to exact timing, but there are enough red flashing lights to give us cause for concern about the direction of the market in the coming quarters.

The economy grew at a much slower pace last quarter, with GDP only moving forward by 1.1%. This week we look at why and see if we can mine the consumer spending data to give us clues about future growth. We are going to start a two part series inspired by a remarkable new book I am reading called "Ahead of the Curve," sub-titled "A Commonsense Guide to Forecasting Business and Market Cycles." Joe Ellis was a partner at Goldman Sachs and was ranked as Wall Street's #1 retail analyst for 18 consecutive years by Institutional Investor. I caught up with Joe last time I was in New York as he explained his prediction process. I think there is real value here, and I suggest serious investors get a copy. Even though it was published by Harvard Business School Press, it is a very readable book. You can get your own at Amazon.com

The economy created 215,000 new jobs in November. A paltry 11,000 were manufacturing. Is that good enough? In previous recoveries we would have been seeing jobs created at a much higher level. But that number is not quite the story. Actually, we saw 4,586,000 new hires in November. That is not a typo. The reality of employment in the US is quite a bit different than the employment numbers often suggest. We look at a relatively new database that sheds some very interesting light on how amazingly dynamic the job market in the US is. I write this week's letter as I fly from Toronto to Miami. It will be a little shorter than a regular letter, but I also include a chapter from Just One Thing. It is Dennis Gartman's Rules of Trading. I saw Dennis briefly last night, as we were both speaking at an RBC (Royal Bank of Canada) conference, and was reminded after a few of his great stories of just what a really smart trader he is. For those new to this letter, Just One Thing is my latest book which features the writing of 11 of my friends and your humble analyst writing about the one thing we find most important that we have learned in our careers. You won't find stock tips or the latest how-to-turn a thousand into a million in five easy lessons, but you will get solid philosophical grounding on the basic principles of economics and investing from a group of really smart, successful guys (and then my musings as well). You can get your copy at your local bookstore or go to Amazon at www.amazon.com/justonething.

This week we will look at a few very interesting items that did not make it into last week's forecast, as that letter was already overly long. Bernanke's arrival, the importance of the housing market to the economy, the length of the recent rally and a note from good friend James Montier on why it both pays, and is painful, to be a contrarian. I include a quick note to some of my fellow brokers at the end of the letter along with a few places to visit on the web for fun. I think we will find a few tidbits to enlighten us. But first, I must issue a correction and an apology to Elaine Garzarelli. Business Week showed her as the most bullish of forecasters, predicting the Dow to go to 14,000. In an attempt at humor, I asked her what she was smoking? She wrote me a very polite note, saying that she does not normally forecast the Dow and the Nasdaq. "Based on the S&P 500 forecast my staff took the percentage change forecast for the S&P and applied it to the Dow for the Business Week article. I was in Europe." And she noted in a hand-written comment, "I unfortunately do not smoke or drink."

Once again it's time for me to demonstrate the foolhardy part of my nature by putting to electronic pen my forecast for 2006. I spend more research time on this one letter than on any four or five combined, simply reading hundreds of pages of research, looking at mountains of data all in an effort to try and catch the gist of the markets. It is a daunting task, but one to which I actually look forward, as it challenges the mind like few other endeavors. If I go into as much detail as I usually do on each topic, there is the potential for this e-letter to be much too long. Therefore I will try and take the larger picture, make specific and shorter predictions and save the details and the arguments for later issues. Let's begin by quickly reviewing how we did last year.