A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Saturday, December 31, 2005

End of the Year Market Dis

(The stock picks and plays are at the end.) 2005 was a flat year for stocks. Why? The Right Wing spin machine tells us the economy is booming. The president has done all he can to promote Wall Street. Beginning tomorrow, January 1, for example, a couple of new tax breaks cut in for the rich, and as we learned here before the top ten percent owns nine-tenths of all stocks.

Before we get to our answer to why stocks are flat and where they may be going, context is necessary. This corner is Demand Side economics. We do not believe stocks are priced exclusively according to their "fundamentals," nor that the true value is computed by the magic mind of the market in response to each new mote of information. This latter contention is promoted by some of the most prominent academic departments in the country, under the rubric Efficient Market Hypothesis, in spite of all evidence to the contrary.

The joke was, "How many economists does it take to screw in a light bulb?" Answer: None. If the light bulb had needed screwing in, the market would have already done it. All information was supposedly factored in immediately. It was impossible to outguess the market.

It is a theory that belongs on the scrap heap of history, along with Monetarism and next to the predictions of Dow 36,000 and the Great Depression of 1990. Unfortunately, once a theory gets into the halls of academia, it is impossible to dislodge it with facts, such as the dramatic boom and bust we have witnessed over the past decade.

Make no mistake, the market does factor in information, with alarming efficiency, but that information is often:

Wrong, as with the scandals of WorldCom and Enron, where the books were cooked with creative accounting to gin the stock price.

Irrelevant, as with parts of the dot.com bubble, where for example, market share was translated into high stock values, even when it was bought by untenable business models. Amazon, for example, basically gave away ten dollar bills with every order and dominated its niche. The market rewarded it with stock prices over the top. Now that it is profitable, its stock price is 4 percent of what it once was.

Serves only to price things relatively, as putting GE above Global Crossings, for example. The absolute value, for the sake of our discussion here, is determined by demand for the stock.

There are two crude and inexact dynamics at work in the judging of stocks and the prospects for the future. Regarding prospects, the dominant prognostication is that the trend of the past three years or so will continue into the dim future, barring any explicit information to the contrary. Regarding the judging of stocks, beating the market is similar to winning a certain type of beauty judging contest. Both were proposed by the great economist John Maynard Keynes (pron. KANES, get it right).

The first is relatively self-explanatory. We assume that, for example, we can continue to run $500 billion deficits as we have at the same interest rates and underfund education and infrastructure and so on.

The second involves a metaphor familiar to Keynes that needs some explanation. In the 1920s and 30s, newspapers ran contests involving the photographs of 100 or so pretty girls. The winner of the contest was the one who could pick out the five or six prettiest girls -- as judged by all contest entrants. That is, it was not the individual's perception of who was prettiest, but the ability to tap the perception of the herd. Fundamentals were and are beside the point, because speculators are primarily concerned with liquidity, the current market value. This is no place for patience. (One of the interesting implications is that the most unanimous market is also the most unstable.)

So, I am not going to bore you with which sector is sexiest, or which company has the best prospects, I am going to bore you with Demand Side keys to stock prices.

* More people buy stocks when the prices go up consistently. Prices go up consistently when more people buy stocks.

* People who are getting older buy stocks. During the 1990s, the baby boomers, the so-called demographic pig in the python, bid up the price of stocks in anticipation of retiring.

* People who have dollars buy stocks. Who is this? The rich! you say, remembering the beginning of this post and the billions of dollars in tax cuts. Wrong. Well, not wrong, but the net amount of tax cuts in the Bush economic blunder scheme needs to be borrowed back to finance the government. Conceptually, it is the same money, we're just paying interest on it under Bush.

The people who have the dollars I'm talking about are the Asians who are financing our trade deficits. We are giving them dollars in trade for their goods. In normal times we would be trading our goods for their goods through the medium of currency. Now we are running massive trade deficits and trading dollars for goods. Dollars don't spend so good there. Not like they do here, anyway, so they are buying American stocks and government bonds, liquid assets priced in dollars.

Which brings us to the last category.

* Outsiders who like the dollar buy stocks. This is the George Soros play. When you buy a stock, you are also buying the currency that underlies it. If you hold it a year or two and it does nothing, but the underlying currency appreciates, then when you sell you have still made a profit. (The strong and stable dollar was another reason people put money in American stocks in the 1990s. It seemed like a continent of sanity in an ocean of currency chaos.

So during 2005 the stock market was flat. It was dull. What does that mean? One thing, obviously, people have moved from stocks to bonds and real estate. Notice the relatively low return on bonds in spite of the immense federal deficits, indicating demand. Notice the high prices of homes, the housing bubble which I have posted so much about.

Another thing, it means stocks are not getting bid up by baby boomers, foreign investors, or people who like the dollar. This is weakness. It means other things, but the 14 people who actually reached this point on a New Year's Eve need to be rewarded, not punished, so I'll save the rest.

Beware! Republicans are no good for stocks, because they are no good for business. But, you say, Republicans provide all those tax breaks and roll over for Corporate America at every opportunity. The corporatization of the government is reaching the level of Benito's Italy.

It is because the business of "business" is demand. "How's business?" means "How much are you selling?" Democrats supply only one thing for business. Customers. Democrats mean jobs. Jobs means customers. Always remember, the budget has never been balanced except at full employment, and the economy has always grown best at full employment. That is the definition of "a healthy economy." Everybody is contributing. People have money and purpose.

Now, the sexy market plays

Buy Boeing on the weakness of the dollar against the euro. Boeing's competition is Airbus. The people with dollars above like airplanes. When the euro appreciated against the dollar, Boeing made advances against Airbus. The euro ran up to $1.30 and higher a year ago at this time, but has stalled and is down in the $1.17 neighborhood. (If they ever start making planes in Asia, sell, sell, sell.)

Buy natural gas futures based on the price of oil. Oil leads all energy prices by 3-12 months. When oil goes up, natural gas is sure to follow, and the reverse. It's true for electrical energy, coal and alternative energy as well. This play is tired right now, but watch in the future.

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