Monday, 14 January 2008

Random Thoughts from 36000 Feet

Your Cheap Stocks Editor is writing this from 7 miles above the earth en route to Denver. The air is thin up here, so my apologies in advance if none of this makes any sense. We typically don’t write about the markets, or macroeconomic themes, but hey, the air is thin up here, and I have no access to spreadsheets, 10Q's, 10K's, or other financial data.

On Equity Market Volatility

No one should be shocked if the volatility we saw in 2007, and the fourth quarter in particular, follows us deep into 2008. During 2007, there were nearly 60 trading days-21 in the fourth quarter- that the Dow finished plus or minus 1 percent. In case youre wondering, that’s slightly less than 25% of the time. More remarkable, however, the plus and minus 1% days were nearly evenly split. What a roller coaster ride for investors, especially given the endless, up to date news constantly bombarding us; “helping” us to make wise investment decisions. Makes it difficult to think and act like long term investors when the sky is falling one day, and there’s euphoria the next.

The ride has been rocky so far in this new year, and there are a whole host of issues-credit crisis, oil, the Fed, inflation, war, the upcoming elections, recession fears- to name a handful- which will continue to cause uncertainty. What’s the lesson here? Stay informed, but don’t get caught up too much in the daily market movements, economic data releases, or calls for economic armageddon or prosperity. The truth is probably somewhere in the middle.

On The Fed

Expectations are high that the Fed will continue to ratchet down interest rates to stem the credit crisis. Some pundits are calling for a sub 3% Fed Funds rate, and the futures markets are starting to reflect this. The markets love rate cuts, and stocks typically rally in in the aftermath. But watch out if market expectations are not met, ie. if the Fed does not cut as much as expected. While we believe rates will be cut again starting on January 30th, we also believe that the Fed will ultimately stop around 3.5%. The threat of inflation is real, and consumers are already seeing this reflected in many goods they purchase on a weekly basis. Chairman Bernanke is an inflation hawk, as are many of the 2008 Fed members who have a vote, and we believe inflation fears will ultimately stop further cuts. Perhaps the damage has already been done.

On Oil

Most pundits believe that $100 (and higher) oil is here to stay, and often cite supply concerns, Asia’s growing demand, and The Peak Oil Theory, among other reasons. We believe oil will pull back significantly in 2008. The days of $10, $20, or even $40 oil may be over, but we believe we’ll see the $50’s again. The fundamentals just aren’t that bad, and the run-up to $100 has been fueled more by a weak dollar, fear premium, and speculation than increasing demand.

Don’t mistake this for the na├»ve belief that all is well in the land of fossil fuels, and that we are not running out of oil. We will run out, we do need to find alternative sources, and we do need to continue improving technology in order to recover oil from difficult places. $100, we believe, is not justified. Ultimately, the oil markets will again trade on fundamentals.

The air is thin up here........

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