Double Journey

This can’t be good.  Oil has been on a tear from its lows in the mid thirties.  Some would argue that this is a sign that the economy will turn around because people are showing the belief that there will be demand for oil as the economy grows.

But I look at it from the other angle.  I, as a consumer, have a couple of problems.

• I might have lost my job
• I probably have huge credit card debt
• I probably have less credit because a few cards have probably been closed
• I probably have missed a few mortgage payments
• My retirement savings have been killed even factoring in this 35% run in the last three months
• I am paying $3 a gallon for gas

That last one is just adding insult to injury. At least with a bad economy, I might be able to spend less on gas than I was last year. But with oil continuing to be strong with no sign of weakness in sight, I have to wonder how strong the rebound will be in our economy.

That being said, I think the energy names look attractive here.  Most of those stocks have not run up as much as Oil have and they do not have $70 oil priced in.  Names like Exxon Mobile, Conoco Phillips as well as drillers like Schlumberger and Petroleo Brasileiro look attractive to me.  Why worry about rising gas prices?  Might as well just make money off of it.

On Friday, the Bush administration opened up the TARP funds to bailout the Auto Industry.  Yet another example of the government not fully understanding the law of unintended consequences.

I love analyzing unintended consequences.  It challenges our assumptions about the things we only think we know.  Those who follow this blog know I have alway opposed the TARP.  So my disdain for the Auto Bailout is just an extension of my hatred for any sort of government intervention into private enterprise.  Remember, it is OUR tax money that is going to save the ass of these PRIVATE companies.  I really really hate the idea of private gains and socialized losses.  When these companies were doing well, did the taxpayers see any benefit?  Now that they are losing money, why are expected to share in teh losses?  How can any capitalistic system work when parties do not have to pay for the consequences of the risks that they take?

At any rate, I am fairly certain that the government actions at this point are doing more harm then good.

The goal of the TARP, at least initially, was to unfreeze the credit markets.  If capital stops moving around, then the entire economy freezes.  People cannot get loans to buy cars.  Businesses cannot receive credit to buy merchandise.  They have to lay people off since they have no goods to sell.  Banks refuse to loan money to people and businesses that have bleak prospects, which is everyone.  This would put the economy in a death spiral which the government was not willing to risk.  Now, while I disagree that this would have been the outcome, at the very least I can understand why they did it.   It is truly impossible to know what would have happened.

But for me, it is easy to take a good guess about what has and what will happen because of this.   I just have to look at the incentives that the government is creating.

First, I just look at what has happened.  It is clear that the markets are frozen in part because of what the government is doing.  I as an investor have no idea what the government is going to do next.  This makes it very hard for me to be able to figure out what I should be doing.  I would love to get long or short certain stocks but I simply cannot.  For example, I think commercial real estate needs to go down from here but I cannot easily get in because the government might try to bail them out next.  While on the surface it may seem like a good thing that people are fearful to go short, you have to remember that a healthy market has both winners and losers.  Losers are taken out quickly and shot.  This means there is more capital to deploy to healthier companies.

But this cannot happen so long as the government props up failing businesses.  Money will continue to flow to places it should not because the government might do something unexpected.  Look at what almost happened to oil.  Barack wanted to implement a “Windfall Profit” tax.   Now oil is down to about 30% of where it was before.  If there would have been a windfall profits tax it would have constrained supply causing the price of gas to go higher.  When left alone, you can see what happened.  Oil corrected ridiculously fast and now I am buying gas at around $1.60 a gallon.  This is how markets are supposed to function, we eventually reach equilibrium.

But this cannot happen so long as the government continues to interfere.  So what is next?  I have no doubt the market will continue to freeze.  Why should private investors step in when they are being crowded out by the government?  Why would any business want to take money from private parties when they can get money from the government for free?  More and more companies are going to start coming with their hands out asking for a bailout.   We will see at least a few more industries claiming they are crucial to the economy and that letting them fail will mean millions of jobs.

The market will stick around this range for a while.  It will not rally or drop too much from here.  People are at a standstill because there really is no way to tell which way to go.  Some people may welcome the relief from the volatility.  But I see a bigger problem; we could easily end up like Japan and just stay stagnant for years.  It is like ripping off a band aid.  We should have just tore it off and hit bottom as quickly as possible so that the recovery could happen just as quickly.  But that is not what is going to happen.  We will no doubt get a few rallies that may seem like there are brighter skies ahead.  But we will not know what the government will do next, and since I do not know the rules of the game, I am most likely to not play.

What is going on with Traffic lately?  It has gotten noticeably worse for me no matter what route I take or what time I leave.  Is it just the post-summer bounce and people are all coming back from vacation at the same time?  Is it that oil continues to get cheaper and gas is now under $4 per gallon in California?  Did people just get used to the high price of gas and decide that the alternative means of transportation just doesn’t work?

Oil dropped precipitously today, off as much as $9 in today’s trading.  This seems to be the exact opposite of what happened just a few months ago as oil skyrocketed to over $140 a barrel.  What’s going on.  I believe it is two things.

Normal market activity.  There was definitely speculation on the way up.  There is now the reverse trend happening.  This is a GOOD thing.  Over the last few months, “speculation” has become a dirty word.  However, I am of the belief that it is a good thing when markets are allowed to function the way they are designed to do.  This is exactly why.  As fast as the market was able to go up, the market is able to take it back down.  While this volatility may be painful to some, it allows there to be liquidity in the market.

The dollar is getting stronger.  Don’t look now, but there have been a few weeks of sustained gains by the dollar after years of a downtrend against the Euro.  As much as I’m not a fan of the U.S. market, the foreign markets are looking equally weak.  I have a lot of money invested in foreign funds, so this is probably not a good trend for me.  Just might be one of those things where I have always imagined that the grass was greener when it probably was not.  If this continues, I will probably try to make a bet on the dollar.  Easiest way to do this is to play the dollar ETF, UUP.

What do you think?  Do you think it likely that the US economy will perform better than foreign economies over the next few years?

There has been plenty of talk about how the high price of oil is changing habits for American consumers.  American’s are finding ways to save money by combining shopping trips, finding alternative ways to get to work, and trading in their SUVs.   The pain that American’s are just beginning to face is very real.  But note the key words, “just beginning”.  While demand is softening in the United States, demand worldwide is still quite strong and getting stronger.  On the other end, supplies are still restricted and it doesn’t seem like OPEC can do much about it.

The change in behavior hits all segments.  Its funny how that can happen even to the people that it doesn’t really affect.  That’s the problem with inflation, its all about expectations.  If people expect inflation, it happens.  With the expectation of inflation people are going to change their behavior.  Take myself for example.  I do think about the price of gas and I let it affect my decisions.  While I am still driving to work (having decided the train isn’t for me) I’m taking my girlfriend’s car that gets better gas mileage.  I live close to lots of stores, and have resorted to walking so long as I don’t have to carry anything back.  My weekly trips to Best Buy just to look?  Curtailed it and now I only go when I’m headed in that direction anyway.  So if this is affecting someone like me, one can only imagine what it is doing to the rest of the population.

With oil now back under $130 (it’s odd that people now think of $130 oil as low) and looking weak, will this trend continue?  If we suddenly wake up and oil is “only” $80 or even $50 a barrel, will America’s addiction to oil continue, or did this summer’s events just let the genie out of the bottle?  However awful it sounds, I actually hope that oil stays high.   I see people making changes, and they are changes that I think are good in the long run.  I would hate to see energy prices suddenly fall and people go back to the way things used to be because the next time it happens, it will be like the boy who cried wolf, only this time it will be the boy who called high oil prices.

What about you, have you let high gas prices change your habits?  Do you think high prices are here to stay?

The market is down almost 20% over the last few months, signaling that we are indeed in a bear market.  So what to do from here?

For me, I’m well positioned.  I’ve actually taken my lumps like a lot of people, some of them far far worse than the market, but I’m in relatively good position because I’ve maintained a large position in cash.  In fact, I’m about 70% cash right now and have been for a long time.  As the market crashes around me, I’m going to update my shopping list (which I haven’t done in a while) and start to look for things to buy.  So what are my thoughts right now?

• Financials are cheap, but going cheaper - I really want to buy some banks right now, and probably will soon.  Nobody wants to own them right now, and that’s the best time to own them.  People are running away from the financials because of problems faced at Indy Mac, and Frannie and Freddie.  I’m not one to try and pick a bottom, so i’ll start looking at which ones I want to own soon.  Two of the banks I have my eye on are US Bancorp and Wells Fargo.  I might also get into some of the brokers like Goldman Sachs.  But like I said, the financials are going cheaper from here so if you can’t take the pain short term, avoid.
• Oil is up, and going higher - People keep waiting for the bottom to drop out of oil.  I’m not one of them.  I for one think that the high price of oil is here to stay for the foreseeable future.  I believe that worldwide demand is going to remain high and if the oil producing countries could bring down the price of oil right now, they would.  I still think some of the better oil names have a ways to go like Schlumberger or Conoco Phillips (which I own)
• Short the market, just get ready for the bounce - I think the market could easily go down another 20% from here.  That being said, it won’t go down forever, so be ready for a quick bounce back up.  I would  just hedge my bets.  If I start buying a tech company or two, I would probably short the Nasdaq (QID).  This way, you hedge against the market doing anything crazy.
• Buy high quality names - I still like a lot of the bigger names.  I am still loving Johnson and Johnson.  They announce earnings tomorrow and I think they will do well there.  Even if they don’t, I still like their long term prospects.  This is the best time to pick up some of the best names because they are so cheap.

I’ve sat on the sidelines for a while, and avoided much of the pain that a lot of traders have faced.  But things are starting to look interesting, so I may decided to jump back in soon.

Because I follow the market so much and because I’m fascinated (from an economics perspective) with the rising price of gas, I find the calls for Saudi Arabia and other oil-producing nations to produce more oil to be pretty silly.  Yes, I get the fact that American consumers are feeling the pain at the pump.  This is causing all sorts of other problems and will probably lead to the double whammy of inflation and recession, stagflation.  Believe me, I don’t want to see that.

But I find the whole situation amusing for a few reasons.   First off, I really think it might be in the best interest of the United States to just let oil stay this hi.  There are already signs that America is pulling back on their gas guzzling ways.  By most accounts, SUV sales are down anywhere between 20%-40% as Americans switch to smaller cars.  Air travel is also down as more and more people are opting to stay at home.  I think in the long term, America will be better off weaning itself from our oil loving ways.  If oil stays this hi, alternatives will be found.  Nothing motivates people like money.  When oil is cheap, nobody has any incentive to find another alternative.  With oil this expensive, the alternatives start looking a lot more attractive.

But here is the kicker.  The oil producing countries get this! I really don’t think they want the world’s addiction to oil to end any time soon.  But it is hilarious to me to see the United States ask, cajole, and demand these countries to produce more oil.  These countries have every incentive in the world to pump more oil.  Oil, even hard to reach oil, probably only cost about $50 a barrel to produce.  Yet it sells on the market for almost triple that.  Now think about it.  What would you do if you could produce a product and sell it for triple what it cost you to produce?  You would make as much of it as possible as fast as you could!  There really is no reason for the US to keep asking to increase production.  However much the oil industry is a “cartel” believe me, they cheat when they can.  Although they artificially keep supply low on purpose, all the OPEC countries have a huge incentive to cheat on the quota.  They have done it in the past when oil wasn’t this hi.  The incentive to cheat is even greater now so what makes anyone think they won’t?

So let OPEC do whatever they want to do.  I honestly think the United States, it its smart, can win either way.   Then again, that may be asking too much.

I’m taking public transportation. There, I said it. Only two weeks ago, I talked about how oil sped past the $100 mark. Shortly thereafter, I complained about my commute and how I was going to start taking the train to work. Well oil hit $110 a barrel today. Up until recently, you haven’t seen the spiking price of oil translate into higher prices at the pump, but I think that is about to end. The odd thing is is that there is no reason why oil should be this high.

I liken it to the speculation that was rampant in the housing market. Nothing was supporting the run-up in housing prices other than the fact that lots of other people wanted to buy houses despite the actual lack of demand for housing. The same thing is going on here. There isn’t a high demand for oil. People, like myself, are starting to take a hard look at alternatives. The supply of oil is actually rising, not falling, so it is clear that there is actually an oversupply of oil at these prices.

At some point, like housing, oil prices will retreat, fundamentals always catch up. That’s not to say I don’t think it will hit $120 before too long. That’s the thing about speculation, it can go far longer than you ever expect. I thought housing was crazy in 2004 but it went on for several more years.

Most people can’t change their routine very easily. Either there isn’t convenient transportation to work or there really is no alternative to driving. So the money comes from somewhere, and it has to come from either savings or from spending diverted from somewhere else. With the economy already in a recession, that is going to make the situation that much worse.

How has the rising price of gas affected you?

Oil shot past $101 today in after-hours trading.

I love news like this actually. The picture is actually starting to look pretty bleak. Housing is bad, and in my opinion will get worse, no matter what the crooks, I mean real estate industry has to say. The US looks headed for a recession. The superstars of tomorrow are having problems. High energy prices mean that inflation is likely.

Inflation + Recession = Stagflation

which is the worse thing that could happen to our economy.  So despite all this doom and gloom, why would this type of thing make me smile? Because things are starting to get to a point where I might be interested in buying. Granted, I probably can’t double my money this year, but long term, there are starting to be some interesting plays. Best time to buy stocks is when nobody else wants to, and right now, a lot of people are fleeing stocks.