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Monday, October 08, 2007

 

Why Stocks are so Strong

The housing market is months, maybe years, from bottoming. Its economic side effects are only beginning to impact earnings in the banks, home improvement retailers, and truckers. The dollar is weak, and the Fed is reducing interest rates in the face of it, perhaps exacerbating future inflation. The Federal Government, already in deficit despite burgeoning tax receipts, faces a change in administration in the midst of a foreign war, and must take steps to fix the AMT and estate taxes or there will be a popular uprising. And if Congress does nothing, the Bush tax cuts could expire under the new administration, dampening the economy, ironically reducing tax collections, and causing a harsher investment climate when dividend and capital gains tax rates increase.

And what are the candidates talking about? National health care, a new entitlement causing bigger than ever deficits and more inflation.

So why is this market rising? Aren't higher taxes, a weak dollar and inflation bad for stocks?

Well, yes and no. What people forget is that stocks are called equities for a reason. In the short run, inflation is a worry for investors, and may cause them to sell. In the long run, stocks maintain their real value and go up in dollar terms when the dollar is weak and inflates. Furthermore, all but the most disciplined governments inflate the currency. Inflation reduces the real cost of the public debt, and aids exports. As the dollar inflates, corporate revenues and earnings go up in nominal terms. Stock prices inevitably follow earnings, revenues and book values.

Short run irrationality in the stock market is normal, but in the long run, the market reflects the values of the company assets the shares represent. Inflation causes stock prices to rise in nominal terms in the long haul. Those prices may reflect less or more value depending on the severity of the inflation.

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This morning brought news of another takeover of one of my stocks, United Industrial Corp. (UIC), a builder of pilotless aircraft, by Textron, the defense oriented conglomerate that was built by the legendary Royal Little. Though I got a nice bounce in UIC today, and will have a nice profit once I pull the sell trigger (probably Wednesday), I have mixed emotions. I thought, despite its high price to book ratio. that this stock had further to go. Also, I've already got excess cash from the PWI takeover, so this will mean more buying in a market that is making new highs. However, the "formula" will be followed. Also, I will give Textron yet another look and could add it to my buy/hold list.

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Let's talk global warming, since we are in the midst of an unusual October heat wave. At this point, no one disputes that the climate is in a warming trend, but there continues to be differences of opinion about when it started and what are its causes. Clearly, the musings author lacks the technical knowledge to have an informed opinion about those questions, but there would be nothing wrong with adopting policies to conserve organic fuels and clean up the air and water. I still believe that nuclear and hydrogen power have the best potential to solve the world's energy problems. I would not favor measures that would have the impact of reducing economic activity in the developed and developing world, as the anti-globalization crowd has demanded. Improving economies are almost invariably correlated with better human health, safer environments both at work and at home, and decelerating population growth thanks to lower birth rates.

A much more difficult issue concerns the growing danger of significant species extinction, and here man's role is indisputable. Destruction of jungle and other natural habitats, pollution, and overfishing are some of the ways that man has made it difficult for other of earth's creatures to survive. China, in particular, is an environmental disaster area (as was the Soviet Union).

Man has the power to think and understand the impact (s)he has, unique among animals. One could argue that man is simply another animal, and his activities are no less natural than any other animal's. However, we can see the consequence of our activities. Disruption of the food chain is a serious issue.

It brings to mind that classic Seinfeld episode where Kramer is asked to apologize to a zoo chimpanzee that he insulted after the chimp threw some food object at him. "That chimp is an innocent primate," says the zoo's administrator. "So am I," replies Kramer. True enough, but we're smart enough to rise above our innocence.

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Last Wednesday, I bought another 1000 shares of FSI International (FSII) for 2.05, an average down that may be getting out of hand. Today, I bought 100 shares of Shulman (SHLM) at 21. Good time for the disclaimer - Neither redwavemusings nor its author are investment advisors, and the securities and transactions mentioned here are not recommended for anyone else, and may not be suitable for anyone else (or even for me). The blog merely serves as a place to record the transactions for the interest of readers, but does not constitute advice of any kind.

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