The Real Cost of Living

Wednesday night I argued on Kudlow & Co. on CNBC that inflation is problematic. I mentioned soaring gasoline and food prices. Larry Kudlow took me to task saying those volatile components are rightly excluded when measuring core inflation. He said the prices of other things like televisions and cell phones have been falling. He didn't care for my argument that consumers buy gasoline and food every week, but that they might buy a cell phone only once every two or three years. He said I was being silly.

After thinking about it for a while, I realized that even the costs of watching television or making a phone call have risen. Take television. Granted, quality has improved dramatically, but the cost of watching television has gone up tremendously. I purchased a color television set in 1987 for $299 and paid an additional $200 to have a rotational antenna installed on my house. That allowed me to capture stations from Baltimore to Philadelphia. There were no additional costs involved. I received all my programming for free.

These days you would have to buy a high-definition television set. I know prices for HDTVs are falling, but they still cost about $1,000 or more. You also have to subscribe to premium cable or satellite services that cost at least $60 per month. And even though you can now get hundreds of stations, it is still difficult to find much that is worth watching. So, economists may argue that the cost of a television has fallen if you factor in the vastly improved quality. Yet the fact is that the cost of watching television today is much higher than it was in the 1980s.

As for cell phones, they were certainly a rarity back in 1987. Those who wanted one installed in their car had to pay a fortune. These days cell phones are ubiquitous. Yet I can't say that I have noticed a decrease in the price of making a call. Even cell phone prices don't seem to have fallen much in recent years. Yes, the phones are getting cooler and cooler. They do offer lots of features I never thought I needed. But when you consider all those hidden fees and taxes, the cost of making a call just seems to go higher and higher.

There are many such examples. Technology has brought us lots of products we couldn't even have imagined just a couple of decades ago. And if these products come with added features with only a marginal increase in price, economists actually consider that a price decrease. Yet the cost of daily life keeps rising. Think of all the things you do on a regular basis. You spend money on housing and clothing. You have to eat and drive to work. You might watch television and listen to satellite radio. You might go out to dinner and a movie. You might take a vacation. Perhaps the quality of the things you buy on a regular basis has improved, but the costs of daily life are certainly not falling.

Life is Good Without a Car or Food

Is there or is there not an inflation problem in the U.S. economy? Anyone who buys gasoline knows inflation is rampant. Filling up the average sized gas tank costs about $50 these days. Just a few years ago you would have needed only about $30. Food prices are also way up. Even Starbucks is complaining that high dairy prices are pinching profit margins.

Yet Fed officials and most economists say inflation is not so bad because they prefer to focus on core inflation. In other words, they want to know how much prices are rising if we exclude gasoline and food. They believe gasoline and food prices are just too volatile to provide a meaningful measure of inflation, so they simply ignore them.

But investors are waking up to the fact that gasoline and food really matter. Consumers know these items are taking a bigger and bigger bite out of their paychecks. The effects are starting to show as consumer spending becomes strained. For example, Wal-Mart has been complaining for some time about higher gasoline prices weakening their customers' purchasing power. It turns out some of those customers are making up for this by resorting to the 5-finger discount. Wal-Mart is getting fed up with the increased levels of shoplifting activity it is seeing, so it announced plans to be more aggressive about prosecuting violators.

In the meantime the housing market continues to implode and foreclosures keep rising. Even S&P and Moody's have finally figured out that sub-prime mortgages are indeed risky. Housing prices are falling nationwide. Of course, the high-end of the market will probably fare well. But average prices are likely to fall enough to put some homeowners in a negative equity position.

As for jobs, so far so good. The economy is still creating jobs and the unemployment rate remains low. Nonetheless, incomes are not doing so hot. According to the Commerce Department, inflation-adjusted incomes actually fell in May. Of course, that's using overall inflation, which includes those volatile gasoline and food prices. Those of you who are lucky enough not to have to drive or eat, well it turns out you're doing pretty well!

More Worrying Signs of Market Weakness

Yesterday the Fed said it would hold the fed funds rate steady at 5.25%. This was widely expected. But market traders were placing bets on the wording of the statement. They said if the Fed took "elevated" out when referring to inflation, we would see a nice rally. The dreaded word is gone, yet the Dow finished slightly lower for the day.

The Blackstone Group was one of the most highly anticipated IPOs in recent times. It went public last Friday. The offering price was $31 per share. As commonly happens with an IPO, the stock opened much higher. It finished the first day of trading at $35. That's considered a success. But the stock has closed lower every day since. Just two days later, it was selling below the offering price. That's considered a miserable failure. Compare Blackstone to Google, which never sold below its offering price.

In recent periods, investors were reacting positively to all news. Good news was considered grounds for a rally. So was bad news. But now there seems to be more skepticism in the markets. Even on days when stocks initially rally, they later give up much of the gains. This bull market is losing its steam.

Speculating on a Microsoft and Yahoo! Deal

Google (GOOG), one of my favorite overvalued stocks, is a great company. It dominates internet search and makes a bundle selling ads. Microsoft (MSFT) and Yahoo! (YHOO) haven't been able to compete. Will they finally team up to beat Google?

This is pure speculation, but there is reason to believe that Microsoft and Yahoo! will be cooperating more closely in the near future. Yesterday, Yahoo! announced that CEO Terry Semel is resigning. He is being replaced by founder Jerry Yang. But the most interesting part of the management shake-up is that CFO Susan Decker is being promoted to president. The media is already speculating that one day soon Decker will be named Yahoo!'s CEO.

Decker's promotion is key to a Microsoft deal. I say this because Decker was recently appointed to Berkshire Hathaway's board of directors. Warren Buffett's board also includes Microsoft founder Bill Gates. This arrangement will give Decker and Gates plenty of opportunity to get to know one another much better. They will primarily be discussing Berkshire business at Berkshire board meetings, but you can bet they will also have lots of time to strategize about how Microsoft and Yahoo! can work together to battle Google.

Enlightened Leadership Should Encourage Guidance

Here we go again. The latest attack on quarterly earnings guidance comes from the Aspen Institute, a non-profit organization that according to its website is "dedicated to fostering enlightened leadership and open-minded dialogue." Promoting the elimination of guidance, however, is anything but enlightened. So in the hope of fostering some dialogue, here is my argument against eliminating guidance.

There is a widespread misconception that earnings guidance is bad because it causes investors and corporate executives to focus on short-term results rather than the long term. While no one doubts that running a corporation with the long term in mind is the better approach, it is wrong to believe that guidance is the problem. Investors certainly do focus on quarterly earnings numbers, but not because corporations give out guidance. They focus on quarterly results for only one reason--the SEC requires corporations to report results on a quarterly basis. It is because of this SEC requirement that investors form quarterly expectations. If the SEC told corporations to report results on a monthly basis, investors would form monthly expectations. This has nothing to do with guidance. Eliminating guidance will in no way stop investors from forming expectations.

Guidance is valuable information. After all, who knows better what a corporation is likely to earn, a bunch of Wall Street analysts or the corporation's own management? If guidance is not provided, analysts' earnings estimates will simply become more inaccurate. Earnings surprises would become bigger. By the way, there are at least two academic studies in circulation that prove this point. And in an era in which regulators are trying to promote more disclosure, how much sense does it really make to tell corporations to stop providing guidance?

The truth is that those who want to end guidance are upset about the volatility that occurs when corporations miss the earnings estimate by just a penny or two. They believe the ensuing sell-off is unjustified. They are probably right about this. However, instead of grabbing the opportunity to buy more shares at a lower price, as any self-respecting long-term investor should do, they want to eliminate volatility by eliminating guidance.

Furthermore, if they would really like to see a greater focus on the long term, perhaps they should petition the SEC to eliminate quarterly reporting altogether. There was a time when corporations had to report results just once a year. However, many corporations reported quarterly results long before a change in the law required them to do so. They did this for one simple reason: their investors demanded the information. This is exactly why corporations provide guidance. If investors want quarterly guidance, should we not be encouraging corporations to provide it?

Interest Rate Sell Off

Stocks are selling off as the yield on the 10-year note climbs. At last look, it's standing at 5.26%. Just a couple of months ago, it was down around 4.5%. My expectation that interest rates would rise was one reason I cited for my bearishness on stocks in the June 18 issue of Forbes magazine.

Many economists have been betting that the Fed would cut short-term interest rates. I've been saying that what the Fed does is largely irrelevant. The yield on the 10-year note is much more important. I believe the Fed was hoping that the 10-year yield would rise so it would not have to raise short-term rates anymore. Now that it has, the Fed can breathe more easily.

The Fed's next opportunity to change rates comes on June 28. Now that the yield curve is cooperating with its wishes, my guess is that the Fed will take no action. The higher 10-year yield will keep a lid on inflation by keeping the economy from overheating. The bigger risk right now is too much of an economic slowdown.

Here Comes the Bear

The June 18 issue of Forbes magazine contains my column explaining why I am bearish on stocks. Although Google is one stock I panned, it just keeps going up. I firmly believe that the growth rate assumptions built into Google's valuation are unsustainable. After all, if Google's growth doesn't slow, it will eventually own all the assets in the world. When a high growth firm realizes that growth is slowing, it often starts acquiring other high growth companies. That often ends in trouble. Google seems to be going down this path.

The two other stocks I panned, Starbucks and Whole Foods, are already showing signs of weakness. I've been bearish on Starbucks for a while--largely because of rising gasoline prices. I just don't see how anyone but the very rich can afford to buy $5 lattes on a daily basis.

Giving Thanks to the Military

I'm spending the week in Carlisle, PA at a National Security Seminar at the U.S. Army War College. Civilian guests such as myself have been put into small seminar groups that consist primarily of military officers from all the various branches. The groups also include a small number of officers from select foreign nations. We've been debating all kinds of issues from the war in Iraq to the economy. The experience has been absolutely outstanding. I would say that the most surprising--and pleasant--thing I have discovered is the tremendous degree of independent thought and diversity of opinion that exists in the military. While I have always held in high esteem those who serve our country through military service, my respect for them has grown tremendously. It is extremely comforting to know that our military ranks are filled with so many intelligent individuals. Knowing how much these people sacrifice for our country, I can't help but feel a little ashamed that I have never served in the same way.

All News is Good News

The market is in one of its euphoric phases where all news is good news. Gasoline prices set all-time highs and stocks rally. Oil prices go higher and stocks rally. The housing market shows signs of falling apart and stocks rally. GDP growth all but disappears and stocks rally. The yield on the 10-year note closes in on 5% and stocks rally.

In fact, other than a fairly robust jobs market, there really isn't a lot of good news out there. Yet investors keep pushing stock prices higher. As I explain in the new issue of the Forbes Growth Investor, demand for shares is strong thanks to private equity firms, M&A activity, and share buybacks. And in my column in the June 18 issue of Forbes magazine, I explain why I'm bearish on the market. I also pan some stocks that I think could get hurt when consumer spending slows.

Gasoline Above $3.20 Per Gallon

According to the AAA, the national average price for a gallon of gasoline broke through $3.20 per gallon. This is an all-time high even on an inflation-adjusted basis.

I have been interviewed on MSNBC at least a half dozen times in recent weeks about rising gasoline prices. I have to admit, I am surprised by the extent of this increase. I thought we might see about $3.10 or so, then slide back down. The fact that we're still going up tells me that drivers don't yet feel the pain. Demand for gasoline is actually rising despite the higher prices. Prices will keep rising until drivers start making adjustments. For example, if they are convinced that high prices are here to stay, they will consider buying more fuel-efficient cars. But as long they are willing to drive SUVs, and long as demand for gasoline goes up, that tells me prices are not too high.

What about supply? Some say refiners need to produce more gasoline. Perhaps they could have done a better job maintaining refineries and making the seasonal switch to summer blends, but they are not likely to invest in more capacity. If you were a refiner would you be keen to invest $2 billion or so and several years building a new refinery when you know you will have to battle regulators and environmentalists? Furthermore, you see that our government is promoting and subsidizing alternative fuels such as ethanol. After investing all that time and money to build a new refinery, you might find there is too much gasoline on the market and not enough demand. Before you know it, gasoline prices may go much lower and your investment will provide no payback.

In the short term, our best hope for more supply is imports. As a result, we will become dependent on foreign gasoline as well as foreign oil. The alternative is to get serious about cutting demand. The best way to do this is to put a high floor on gasoline prices. However, just about all politicians are looking to do the opposite. They want to find ways to decrease price rather than increase it.

Nonetheless, it looks like consumers will have to adjust to higher prices whether they like it or not. The long-predicted effect on consumer spending may finally materialize. Companies like Starbucks and Whole Foods that sell overpriced and unnecessary goods might find that growth will slow. These two stocks have already fallen well off their highs. Chances are they will go lower still.

The Bearish Case

Last week on Kudlow & Co. on CNBC, I explained why I am bearish on the markets. It boils down to three things: 1) Slowing earnings growth, 2) Rising interest rates, and 3) Higher taxes.

There is no question that earnings are strong. Corporations have been doing great. Those that do a significant amount of business abroad have been doing particularly well. Some of this is due to strong foreign economies, but much of it is due to a weak U.S. dollar that keeps weakening on a regular basis. More importantly, however, corporate earnings growth is actually slowing. Furthermore, the growth in net earnings is significantly less than the growth in earnings per share. This is because of all the share buybacks going on. Corporations know investors focus on EPS. They also know they can easily boost EPS by buying back shares. I will interview S&P's Howard Silverblatt about earnings tomorrow. This MoneyMasters interview will be posted on Forbes.com on May 17.

Interest rates are a bit more interesting. I actually think there is a better chance the Fed will lower rates than raise them. But as we've learned in recent years, what the Fed does has little influence on the longer end of the yield curve. GDP growth has slowed considerably, and the most recent employment figures were disappointing. Results like these should make the Fed feel more comfortable about lowering interest rates. However, I continue to worry about rising energy prices. Gasoline prices are near an all-time record. Although I expect them to back off a little from this level, they certainly aren't going to plummet. Eventually they will feed inflation causing the yield on the 10-year note to rise. Furthermore, I also believe credit spreads will widen.

Finally, there are taxes. I often laugh when I hear liberals rail against the Bush tax cuts. I really haven't noticed any tax cuts. When you factor in my state and property taxes, and the fact that I can't deduct these on my federal form because of the AMT, my taxes have risen quite a bit. And now that the Democrats control Congress, it's pretty much a sure bet that taxes will not be going lower. Even if the Republicans manage to hold onto the White House, the best we can hope for is a veto of any tax increase. Don't hold your breath for a cut.

So why do stocks keep going up? Investor sentiment has a lot to do with it. That's really all that matters in the short run. Add to that hedge funds using lots of leverage, private equity firms buying public companies, the new merger wave, and all those share repurchases. The demand for stocks is greater than the supply. This may go on for a while, but it won't last over the long term.

Investment Newsletter Performance

Subscribers to my investment newsletters sometimes ask exactly how well our recommendations are doing. They don't have to take my word for it because our performance is regularly monitored by the Hulbert Financial Digest, which also tracks the performance of almost 200 other investment newsletters. According to Hulbert, the Forbes Special Situation Survey (SSS) returned 26.5% (excluding dividends) over the year ending March 31, making it the third-best performing investment newsletter during that period. In comparison, the Dow Jones Industrial Average gained just 11.2%. What’s more, if you compare us to newsletters that focus only on domestic equities like we do, we are actually No. 1.

Furthermore, SSS has been consistent over the long term. Ever since Hulbert began tracking us in January 2002, we have produced an annualized return of 14.6%. The annualized return on the Dow during the same time is only 4.1%. It is true that a handful of newsletters managed to beat us, but at least some of them relied on the use of margin, short selling, or derivatives. Their performance is not necessarily due to good stock picking. It can be explained at least in part by market timing and the use of leverage. In contrast, SSS does not assume that subscribers buy stocks on margin or employ other kinds of strategies. Our returns are solely the result of stock-picking ability.

The Forbes Growth Investor (FGI), which relies on a quantitative, momentum-based model also did well, significantly outperforming the market averages since Hulbert began tracking it. It has produced an annualized return of 9.0% since January 2002. Because this newsletter has a diversified recommended list of 50 stocks, it tends to be less volatile than SSS.

We credit these outstanding results to our disciplined screening process. Most importantly, for SSS, we rely on our proprietary discounted cash flow (DCF) model. We are sometimes told that our model is not realistic. This is absolutely true. Indeed, our model is overly conservative. For example, if we believe a company can realistically grow revenues by 10% each year, we might model only 5% growth. If we believe the operating profit margin is likely to be around 15%, we might model only 10%. We do this because we are not trying to determine what a stock is actually worth. Instead, we are trying to determine what it is worth at a minimum. In other words, our methodology is designed to find reasons not to recommend a stock. However, if despite all our conservative assumptions we derive a minimum intrinsic value that is greater than the stock’s market price, that stock becomes a candidate for recommendation.

It is interesting to note that Warren Buffett, perhaps the greatest investor of all time, also relies on a DCF methodology to determine a company’s intrinsic value. He points out, however, that two analysts using this methodology will rarely derive the same intrinsic value. This is because DCF analysis is as much art as it is science. It is prone to error because it requires making assumptions about the future. It is precisely for this reason that we try to make our assumptions as conservative as possible.

DCF analysis does not always work. For example, during the dotcom boom of the late 1990s stocks that DCF analysis flagged as overvalued continued to go up. This was because of overly optimistic investor sentiment. Barring such unusual periods, we believe a conservative DCF approach is the best way to pick undervalued stocks over the long term.

For FGI, we rely on a proprietary quantitative model. This product is more short-term oriented and puts a lot of weight on price and earnings momentum.

China vs. India

This is the final day of the Forbes cruise. We are actually pulling into Hong Kong at the moment. I see a lot of mountains and many beautiful tall buildings. I will spend one more night on the ship then fly back to New York tomorrow afternoon.

Jim Michaels, former Editor of Forbes magazine, moderated a spirited discussion yesterday about the merits of investing in China and India. John Dessauer, who travels to China frequently, was not keen on investing there. He thinks there is insufficient transparency. He would not even recommend buying ADRs of Chinese companies. He prefers to invest in large U.S. conglomerates such as Citigroup and Wal-Mart that are conducting business in China. But Arjuna Mahendran was willing to pick a few Chinese stocks. He particularly favors oil company CNOOC. Warren Buffett also likes Chinese oil, but he prefers PetroChina.

Despite all the excitement over China, Jim Michaels thinks India offers better opportunities for investors. He said the Chinese are focused on manufacturing low-cost items, but the Indians are specializing in high-skilled services.

Bulls on Board

Forbes magazine Publisher Rich Karlgaard started off the 11th Forbes Cruise for Investors this morning with an excellent presentation. He said Americans seem to hate a good economy, but that’s a good thing for investors because it keeps expectations low. He pointed out that there is a correlation between one’s view of the economy and one’s view of President Bush. He also talked about the media and how it tends to lean left and focus on the negative. He even made some predictions about real estate. He said the gap between real estate prices on the coasts and prices in the interior is greater than it has ever been. He believes that baby boomers will increasingly retire to interior regions of the country. He favors college towns in low tax, non-union states.

John Dessauer spoke next. He was extremely bullish about the stock market. He sees stocks going much higher primarily because of corporate earnings growth. He says stock price appreciation has lagged earnings growth rates. Therefore, he believes it will require a strong rally in stocks to straighten things out. According to Dessauer, those who warn about slowing earnings growth are simply wrong.

In addition to the presentations, the cruise has been wonderful. As usual, the food is great. However, the seas have been extremely rough the last couple of days. Running on a tread mill was all but impossible. I finally had to give up after half a mile. In fact, most people look drunk simply walking around on board trying to keep their balance.

Cho Was Purely Evil

Now we know his name. Cho Seung-Hui is the Virginia Tech student who in just a flash of time killed 32 innocent people, injured 14 others, and disrupted the lives of tens of thousands. He was a loner who talked to no one and had no friends. Today he is world famous and will never be forgotten by the loved ones of those he killed. By the time the media is through, we will know all his deepest and darkest secrets. And we will hear all the experts theorize about what went wrong and how an immigrant Korean child could grow up to become one of the greatest evil doers in American history.

Just a couple of days ago I briefly wrote about my favorable impression of Koreans. I have no doubt that Koreans all over the world are absolutely shocked by Cho’s crimes. I am sure many are now feeling shame and trying to understand how one of their own could have done so much evil. This is nonsense. Cho was not one of their own. He was not one of anyone’s own. The fact that he was of Korean descent is about as relevant as his height or his weight or the color of his hair. This guy was pure evil. And as we know, evil comes in all colors, lives in all countries, and practices all religions.

Investing Like Buffett

The 11th Forbes Cruise for Investors continues. Today we heard from Marilyn Cohen, a fixed-income specialist who also writes a regular column in Forbes magazine. We also heard from Arjuna Mahendran, Chief Strategist Asia Pacific at Credit Suisse. Both made excellent presentations. I also gave a presentation, which focused on my research on Warren Buffett. For the past several months I have been writing a book about Buffett. While there are a number of books already in publication, they are all “love” stories. I believe my book is the most objective one by far. While I criticize Buffett for advocating certain views that I believe hurt investors, I also conclude that he is clearly the greatest investor of all time. My respect for him has grown immensely since I began this project. If all goes according to plan, the book will on the market by next spring.

Horror in Blacksburg

I’m on the high seas cruising from Osaka to Hong Kong. I woke up Tuesday morning at 5:00 am our time (which was 5:00 pm Monday in New York) and turned on the television to find out how the stock market had done. Instead, I was horrified to hear news of what was being called “The Virginia Tech Massacre.” I was stunned. I spent five years of my life studying at Virginia Tech where I earned two graduate degrees. Blacksburg is one of my favorite places in the whole world. I absolutely love it. I also considered it one the safest places to live. I couldn’t believe this kind of horrible tragedy could occur in such a wonderful place. I extend my deepest sympathies to the families and loved ones of all the innocent victims of this terrible crime.

Polite Societies

I'm in Osaka, Japan. I just boarded the Crystal Symphony for the second half of the 11th Forbes Cruise for Investors. I arrived Saturday evening, which of course, was Saturday morning in New York. I'm still jet-lagged.

I haven't been in Asia long, but I have made a number of observations. Let me start with the flight. I took Korean Airlines from New York to Seoul then changed planes for Osaka. The service was outstanding. The stewards and stewardesses were wonderful. The food was as good as anything you would expect to find in a fine restaurant. I had steak for lunch and an arrangement of seafood wrapped in phyllo dough for dinner. I had a second codfish dinner on the flight from Seoul to Osaka. Both planes were Boeing 747s. Since I flew business class, there was plenty of leg room. The seats reclined to an almost horizontal position, making it much easier to get some sleep.

Getting from Kansai International Airport in Osaka to the Westin Hotel was easier than I expected. The airport is not near the city and I heard cab fare runs around $200. So I took a bus to the New Hankyu Hotel and a taxi from there to the Westin. That cost about $25 in total. The Westin was very nice, but there was no wireless Internet access and no wired access in the rooms. The next morning I had a delicious traditional Japanese breakfast. I'm not exactly sure what I ate, but I do know there was a lot of seafood involved. In any case, I really liked it. I've had plenty of sushi back home, but this was the first time I ate a real Japanese breakfast. By the way, the tea was excellent. It was much better than what I've had in typical Japanese restaurants in American.

After breakfast, I returned to my room and read The Daily Yomiuri, an English-language newspaper. One story really caught my attention. It turns out that "more than 400 Osaka municipal government workers lied about their academic backgrounds when they applied for posts designed for workers who had only graduated from high school or middle school." That’s right; these people actually denied having graduated from college! I've heard plenty of cases of people embellishing their resumes in order to secure better jobs than they were qualified for, but these workers had done exactly the opposite. They had purposely downplayed their qualifications. Either finding a job in Osaka is very difficult, or this is a society that suffers from an extreme case of humility.

Perhaps the one thing that strikes me most about the Koreans and Japanese is how incredibly polite they are. I realize my perception may be skewed. After all, I was primarily exposed to people working in service industries. They are required to treat customers nicely. But the workers here seem to be in a league of their own. Of course, we are all aware of what happened to all those manufacturing jobs that used to be found in the U.S. If customer service jobs could be outsourced as easily, I'm not sure what kind of work would be left in America.

Ethanol Is Not The Solution

With crude oil and gasoline prices at high levels, it makes sense to look for alternatives. President Bush seems convinced that ethanol is the best solution to our energy problems. Ethanol certainly has a lot going for it. Most importantly, it is relatively easy to manufacture automobile engines that can run on high ethanol-content fuel.

But like gasoline, ethanol comes with its own share of problems. For example, it isn't as efficient as gasoline. As a result, it takes more ethanol than gasoline to drive the same number of miles. Also, growing demand for ethanol is pushing up food prices all over the world. This is because today's ethanol is made from sugar or corn. Both products are widely used in all kinds of foods. President Bush says we should make ethanol from switch grass, but that's not so easy.

So in the end, will we be trading our dependence on expensive gasoline for even more expensive ethanol? In order to protect U.S. farmers, our government taxes ethanol imports, but can the U.S. even make enough ethanol to meet its expected needs? And what will happen when those tariffs are eventually reduced or eliminated? Instead of being dependent on the Organization of Petroleum Exporting Countries (OPEC), will we become dependent on a new Organization of Ethanol Exporting Countries (OEEC)?

I'm not saying we should not use any ethanol. Ethanol certainly will help reduce our reliance on oil and gasoline. That's a good thing. But I am saying that ethanol by itself is not the answer. What we really need are technologies that allow us to drive more miles at a lower cost. One way to achieve that is with more fuel-efficient cars. Don't get me wrong. I am not in favor of government mandates that dictate how many miles per gallon cars must get. Rather, I prefer market forces. Let gasoline rise to $4 or $5 per gallon and we will quickly see new solutions. In my opinion, the best solution in the near term is the plug-in hybrid vehicle. Since most people drive less than 50 miles a day, a car that can go that far on electricity before having to switch over to gasoline will significantly reduce our appetite for foreign oil.

Of course, a more immediate solution is to drive smarter. The last time gasoline prices topped $3 per gallon, demand actually fell. That's because people took matters into their own hands. Many who own gas guzzling SUVs also own more fuel-efficient passenger cars. They parked the SUV and drove the car. Some started car-pooling. Others began using public transportation. Those who couldn't do these things began planning better to minimize the number of miles driven.

Unfortunately, when people respond in this manner and demand falls, gasoline prices also fall. After a while, people notice the lower prices and revert to their old ways. Demand rises again and so do prices. We end up in a vicious cycle. If we really want to get serious about energy conservation, perhaps it is time to consider a floor on gasoline prices. This is a solution many economists favor, but you certainly won't find any politicians talking about it.

Forbes Investors Roundtable Discussion

Last week we hosted a Roundtable discussion with a few notable investment experts at our headquarters at Forbes. Participants included Barbara Marcin, Mike Holland, Joe Battipaglia, and Nikhil Hutheesing. Our discussion began with an overview of the economy and stock market. Barbara, Mike, and Nikhil were all bullish. Joe and I were bearish. Each of the participants also presented some of their best investment ideas for the year. The full report is available only to subscribers of the Forbes Growth Investor and Special Situation Survey investment newsletters.

Largest Supply of New Homes Since 1995

Just a few days ago, I heard an analyst defend the home building industry. He said home builders were cutting back on construction in order to reduce inventories. He seemed certain business would soon pick up.

Not soon enough according to today's report from the Department of Commerce. It turns out that on a seasonally-adjusted and annualized basis, only an estimated 848,000 new homes were sold in February. That's down 3.9% from the revised January estimate, which is itself down 5.9% from the initial January estimate reported a month ago. At this rate, we could conceivably see today's figure eventually revised to less than 800,000.

Regardless of any future revisions, it is clear that problems persist in housing. While home builders may be reducing inventories, they are also selling fewer homes, which means supply is actually rising. In fact, according to the latest report, there is now an 8.1 months' supply of new homes on the market. That's the highest amount of supply since December 1995.

Amazingly, prices are holding up. In fact, February's median price of $250,000 was up 2.8% from January. But prices should be taken with a grain of salt. Home builders are making all kinds of concessions to move houses. They are throwing in every conceivable upgrade to hold the line on price.

What does this mean for the economy? I think the Fed will worry more about slowing growth than rising inflation. In my view, today's report raises the odds of a Fed rate cut by year-end.

American Superconductor May Soon Turn the Corner

In the interest of full disclosure, let me first say that I am an American Superconductor (AMSC) shareholder and have been on and off since the late 1990s. The stock has been one of my favorites—and most profitable—even though the company has yet to make any money. But now I am starting to believe that profitability is just around the corner.

AMSC has three segments: Wires, SuperMachines, and Power Electronics. Power Electronics, the largest by far, recently turned profitable on an operating basis. However, profits in this segment are dwarfed by operating losses in the other two segments. This is because management is pouring a ton of money into R&D. It is no longer manufacturing its first-generation high temperature superconducting wires. Instead, it has moved on to making second generation (344 and 348) wires, which will provide superior performance and eventually incur much lower manufacturing costs.

Another promising area is ship-propulsion systems. AMSC has been working on a 36.5 megawatt superconducting motor for the U.S. Navy. Superconducting motors deliver the same power as conventional motors, but are much smaller and lighter. They are quieter, too. That is particularly important in military applications.

The company's January acquisition of Windtec is one the primary reasons I am turning more optimistic about future profitability. Windtec is an Austrian company that designs wind turbine systems that rely on AMSC's PowerModule systems. The acquisition makes strategic sense and already appears to be paying off in the form of major orders from Sinovel Wind Corp. of Beijing. Windtec is also receiving orders from South Korea.

Warning—this is an extremely risky and volatile stock. It has already run up about 50% so far this year. And the company is still burning cash. This means management may decide to take advantage of the recent rally by issuing more shares, which would likely push the price back down. Nonetheless, I think there is a good chance the company may break even in fiscal 2008, which begins next month.

You can view a MoneyMasters interview I conducted with CEO Greg Yurek back in December. It's called "Powering the Future."

Chances of a Rate Cut Are Better Than you Think

With the Fed wrapping up its two-day meeting, investors are betting on the outcome. Conventional wisdom is calling for no change in interest rates. Indeed, CBOT futures are pricing in a 98% probability that the Fed will stand pat and just a 2% probability that it will cuts rates by a quarter point.

I believe chances for a rate reduction are higher than the numbers indicate. I am convinced the Fed is seriously concerned about the housing market. Fed officials are fully aware that higher rates at the longer-end of the yield curve could accelerate the pace of mortgage defaults and foreclosures. The sub-prime market has already been hit. If troubles spread to the alt-A and prime markets, the economy would easily be thrown into recession.

So is the Fed willing to risk a little inflation in order to prevent a housing meltdown? Inflation is currently running a bit higher than the Fed's so-called comfort zone. That's why many investors believe the Fed won't cut. But inflation is still quite low by historical standards. As a result, the Fed can feel comfortable about cutting rates at this time. A rate cut, however, would scare the markets and could result in a significant sell-off because it would send the message that recession is a likely possibility.

Of course, like most investors, I'm betting against a rate cut. Nonetheless, I won't be surprised if it happens today.

Housing Still Hasn't Bottomed

Housing starts for February came in at a better-than-expected 1.525 million. Several commentators jumped on this as evidence that the housing market has bottomed and that the economy is strong. They shouldn't celebrate.

Although the figure was 9% better than January's 1.399 million estimate, the 90% confidence interval is ±10.2 percentage points. In other words, there is a good chance housing starts did not rise at all. Furthermore, February's figure is 28.5% lower than it was a year earlier.

Housing is not out of the woods. The bust in the sub-prime mortgage market will continue, especially if the yield on the 10-year note starts to rise. This will force more homeowners into default as their monthly payments rise. The prime market, however, should be fine; unless the economy slows further and the unemployment rate begins to rise. At this time, I don't expect current problems in housing to cause a recession. Yet there is little doubt that economic growth will be more anemic than many economists had previously expected.

Less Guidance Means More Risk

Earnings guidance is a topic that is near and dear to my heart. I have written a number of articles that criticize efforts to ban guidance. The first two, In Defense of Earnings Guidance and Is Buffett Hazardous to Your Wealth?, were published in 2003. The third, Gimme Guidance, was co-authored with Mike Ozanian and published in 2006.

Guidance is in the news again because the U.S. Chamber of Commerce recently came out with a report encouraging companies to put an end to the practice. Even Warren Buffett, perhaps the most successful investor of all-time, opposes guidance.

There are a number of objections to guidance. However, the one that gets the most play is that guidance encourages executives to focus on the short term rather than the long term. As a result, managers worry more about managing earnings than they do about managing the business. For example, it is argued that managers who provide guidance are more likely to reduce R&D spending in order to "meet the number." Doing something like this will boost short-term profits at the expense of long-term profits. Everyone, include myself, agrees this is a bad idea.

The problem with the argument is that it falsely assumes that "short-termism" is caused by guidance. It isn't. The fact is that investors will form expectations whether guidance is provided or not. They currently form quarterly expectations simply because the SEC requires corporations to report earnings every quarter. If the SEC required monthly reports, investors would form monthly expectations.

Guidance plays a valuable role because it ensures that investor expectations don't get out of hand. I have theorized about this in the past and said that without guidance, the disparity between actual earnings and the consensus estimate will only be larger than it already is. Now there is empirical evidence that supports this theory. Baruch Lev of NYU and his co-authors, Joel Houston and Jennifer Tucker of Florida, have a very interesting paper in circulation called "To Guide or Not to Guide?" They find that earnings estimates do indeed become less accurate when companies stop providing guidance. What's worse, they find absolutely no evidence that those companies that end guidance increase the focus on the long term. Companies that end guidance do not increase R&D spending, they do not increase capital expenditures, and they do not provide investors with any additional information.

A second study in circulation by Shuping Chen, Dawn Matsumoto, and Shiva Rajogopal of the University of Washington called "Is Silence Golden?" finds that eliminating guidance destroys shareholder wealth. When companies announce an end to guidance, they suffer a statistically significant decline in stock returns.

There really is only one thing that can be said for sure about ending guidance. Less guidance results in less information. And all investors know that less information creates greater uncertainty, which means more risk. It seems odd in the post-dotcom era when regulators are trying to encourage more disclosure, that some of the most vocal corporate critics of the past are now telling corporations to keep mum.

24 Hours a Day

An energy analyst recently said that demand for gasoline will rise because of daylight savings time (DST). She believes people are happy to have an extra hour to drive.

Of course, they don't have an extra hour to drive or do anything else for that matter. Despite DST, there are still only 24 hours in a day. What she apparently means is that the additional hour of daylight in the evening (at the cost of an hour of daylight in the morning) will somehow convince people to drive their cars more.

I don't buy this argument. Neither do I buy the argument that DST saves energy. Even if it did, how much energy could it possibly save? People will run their refrigerators and computers just as much as they did before. They will still heat or cool their homes, vacuum their houses, and blow-dry their hair. Perhaps they might use a little less lighting in the evening, but compared to everything else, light bulbs don't use that much energy.

It was dark this morning when my alarm went off. As a result, I had to turn on the lights. I didn't have to do that last week. I might have my lights on for an hour less in the evenings, but I'm making up for it in the mornings. I don't believe DST makes a meaningful dent in energy consumption; and I certainly don't believe it has any impact on gasoline demand.

Why Are Gasoline Prices Rising?

I'm often asked to comment on energy prices. MSNBC asked me today why gasoline prices are rising again. First, since oil prices are up about 20% from their early January lows, it isn't surprising to see gasoline prices up about the same amount after a bit of a lag. Second, because gasoline is a refined product, refinery problems add to its cost. For example, we recently had a couple of refinery fires. Also, many refineries are down for routine maintenance. In addition, refineries are now switching to more expensive summer blends that produce less smog.

People often wonder why gasoline prices vary so much from state to state. Many New Yorkers, for example, make a point of filling up in New Jersey whenever they can. Price differences have to do with state and local taxes that are added on top of federal taxes. California has the highest gasoline prices in the country. It also has the highest taxes. In addition, California demands a much cleaner burning fuel than is required by federal laws. It is simply more expensive to produce "California" gasoline.

I'm also often asked why gasoline prices go up faster than they come down. I'm not convinced they do, but economists have studied this issue of sticky prices for many goods. When input prices go up, manufacturers often raise prices for finished goods in order to protect profit margins. But when input prices fall, they aren't as quick to reduce finished goods prices. This may be partly due to a belief that the drop in input prices will prove to be temporary. It may also be due to a desire to enjoy fat profit margins for a while. Yet, I haven't seen any evidence that gasoline prices are any stickier than the prices of other consumer goods. On the contrary, it appears that gasoline prices are extremely responsive to a change in oil prices. The correlation coefficient between gasoline and oil prices is well over 90%.

Commentary from Forbes Growth Investor

I released the March issue of the Forbes Growth Investor yesterday to my subscribers. Here is the front-page commentary:

For many months, market watchers had been wondering what had happened to the risk premium. Investors seemed to have no fear of risk. Volatility had all but disappeared. But all that changed on Feb. 27. For reasons that are not completely clear, investors decided in mass they didn't like risk anymore. They sold stocks like crazy and bought bonds. Down volume on the New York Stock Exchange was 100 times larger than up volume. The system that tracks the Dow fell behind because trading volume was too much for it to handle. When it finally caught up, investors were shocked to see the Dow down by more than 500 points. Stocks did manage to gain some of that back by the end of the trading day, but the Dow still closed 416 points lower. As for bonds, the credit risk premium expanded as the yield on the 10-year Treasury note plummeted to 4.5%. Just two weeks earlier, it had been above 4.8%.

When stocks fall this much in a single day, inquiring minds want to know why. The media hunt for pundits and put them on the spot. What was the catalyst? If I were superstitious I would say it had something to do with the fact that I had lunch that day with Robert Shiller, author of "Irrational Exuberance," the book that correctly called a market top in 2000. But there are other explanations. Some blamed the selloff in New York on the selloff in China that immediately preceded it. Others said stocks fell because former Fed Chairman Alan Greenspan suggested a day or two earlier that a recession was possible by the end of the year. Still others blamed the selling on a disappointing durable goods report that came out that same morning. And at least one reporter said traders were telling him the plunge was in response to a failed attempt by the Taliban to assassinate Vice President Richard Cheney. (I am sure, however, that these traders were not suggesting a successful attempt would have caused a rally.)

Investors were understandably anxious the following morning. Yet stocks stabilized and even inched a little higher at the open even though the Commerce Department said it was revising down its fourth quarter GDP growth estimate to 2.2% from 3.5%. Investors even shrugged off evidence of further weakening in housing as January new home sales plummeted 20% year-over-year and 16% from the prior month. Stocks gained steam when Fed Chairman Ben Bernanke began his testimony to Congress. He expressed strong concern about entitlement programs and deficits, yet investors focused more on statements relating to interest rates. Bernanke said economic growth should remain at moderate levels, which was interpreted to mean that further rate hikes are unlikely. Many traders were disappointed, however, that by the time the markets closed, the Dow had managed to get back only 52 points of the previous day’s loss.

Where do stocks go from here? The signs are troubling. I said in our December issue that rising volatility would be a negative indicator. The CBOE market volatility index, commonly referred to as the VIX, has suddenly reached levels not seen since last July. Oil prices are another concern. After falling back to $50 per barrel, they are now comfortably above $60. And although some say former fed chairmen should keep their opinions to themselves, it is not good news that Alan Greenspan is talking openly about a possible recession. All these factors are making at least a few institutional investors nervous. Individual investors should exercise caution as well.

Start of Something Big?

Robert Shiller published his book, "Irrational Exuberance" in March 2000. The book argued that stocks were overvalued. For those who may have forgotten, March 2000 is also the same exact month that the Nasdaq Composite peaked.

Today, the Dow lost over 400 points. The Nasdaq lost almost a 100. Maybe it is just coincidence, but today I also interviewed Shiller for my MoneyMasters video program. The Dow was down about 140 points when I left my office to go to our studio. After the interview, we went out for lunch. Sam Masucci, CEO of MacroMarkets, joined us. Fortunately, I wasn't aware the sell-off was getting worse; otherwise I might have had indigestion.

Why did the market fall so much today? The simple answer is that there were more sellers than buyers. No one knows for certain why. Perhaps it was the big sell-off in China. Perhaps it was the disappointing durable goods report that came out this morning. Perhaps it was Alan Greenspan's comments about a possible recession by year-end. Or perhaps, investors suddenly decided there really was no good reason for stocks to have rallied in the first place.

Earnings growth is slowing, oil prices are above $60, the housing market is struggling, and the Fed is unlikely to cut rates. Unlikely, that is, unless things get so bad that a rate cut becomes necessary to boost the economy regardless of what that means for inflation.

Although the second edition of "Irrational Exuberance" focuses on overvaluation in the housing market, Shiller told me he still thinks stocks are too expensive. I don't feel comfortable betting against him. My interview with Shiller will be posted on March 8.

Housing Has Not Bottomed

Last Sunday I did a hit on MSNBC with Alex Witt about the housing market. This was partly prompted by remarks by Fed Chairman Ben Bernanke and former Fed Chairman Alan Greenspan that the housing market has bottomed.

My view is quite different. Just about every metric indicates a continuing deterioration. Whether you look at year-over-year sales, building permits, housing starts, orders, or cancellations, things are getting worse with no real evidence of a bottoming.

Let's look at some recent reports by major home builders. Toll Brothers (TOL), which caters to luxury home buyers, reported net income of $54.3 million for fiscal Q1. That's down from $163.9 million in the year earlier period. Much of the decline was due to writing down the book value of land the company owns. Yet even if write-downs were ignored, net income would have been only about $118 million. Signed contracts were down 34%. The company delivered fewer units and signed fewer contracts in every geographic region it serves. It also has significantly less backlog than it did a year ago.

Other home builders such as KB Homes (KBH) and Hovnanian Enterprises (HOV) are reporting similar problems. Indeed the entire housing market seems to be weakening by almost every conceivable measure. Even home prices are showing signs of trouble. Nationwide median prices haven't really fallen, but they have stopped going up. While there are pockets of falling prices all over the country, it seems like it's now just a matter of time before prices start falling in all geographic regions.

Optimists insist the worst is over. But pessimists appear to be more realistic at this time. Those who follow the housing market closely are betting on a continuing decline. Forbes columnist Gary Shilling remains extremely pessimistic. I plan to interview Robert Shiller of Yale University and MacroMarkets on Feb. 27 about his views on the housing market. Shiller recently announced a new home price index he is launching with Standard & Poor's and Fiserv. This index will track actual transaction prices for single-family homes only. I will ask Shiller about this and other issues in our interview, which we plan to post on MoneyMasters on March 8.

Is Bernanke Right?

Although I didn't make it to Disney World, I did spend a few days in Orlando last week. I took part in a panel discussion for the CFA Society of Orlando, and I participated in the World Money Show.

The CFA Society panel discussion focused on the outlook for the markets. It was moderated by Vinny Catalano. The other panelists were Kathleen Camilli, Chief Economist of Camilli Economics; Timothy Hayes, Chief Investment Strategist at Ned Davis Research; and Lee Schultheis, CEO and Chief Investment Strategist at Alternative Investment Partners, LLC.

Catalano pointed out that most strategists these days are bullish. So far, they've been right. Stocks continue to flirt with new highs. The Dow is closing in on 13,000. His concern is that there is too much consensus. I think he is right. A few concerns that came up during the discussion were the sub-prime mortgage markets and investor complacency when it comes to emerging markets.

I moved on to the World Money Show, which was filled with newsletter editors and money managers. There I took part in a panel discussion of several Forbes newsletter editors including Ken Kam, Jim Lowell, John Christy, Richard Lehmann, and James Stack. Interestingly, this group did not seem overly bullish. Caution was the rule of the day. One thing I pointed out in both discussions is that OPEC and other oil exporters have learned that the world can easily tolerate higher oil prices. They no longer fear causing recessions by restricting supply and raising prices. That's not very comforting.

Yet Ben Bernanke is pleased with moderating energy prices, which he says takes some heat off inflationary pressures. In other words, don't expect another rate hike. That's why stocks rallied today. But what if he's wrong and energy prices move higher. Oil is already up almost 20% since bottoming recently at $50 per barrel. And what if the housing market has not bottomed as many expect. Each day seems to bring more bad news about canceled orders and fewer homes being built. Yet investors are not giving up on the housing stocks. I think those who remain cautious are right to do so.

Oil Prices and Interest Rates Are Up Again

Oil prices, which had recently fallen to $50 per barrel a month ago, are once again approaching $60. Despite this 20% increase, gasoline prices have actually fallen 7% during the same time. Yet the average consumer seems convinced that when oil prices go up, gasoline prices go up more; and when oil prices fall, gasoline prices don't fall as much. There is no truth to this. The fact is that gasoline prices are less volatile than oil prices. That's because only 50% of the cost of gasoline depends upon the cost of oil. The other components are refining costs, taxes, marketing, and distribution.

In addition to rising oil prices, another growing risk is rising long-term interest rates. The 10-year bond was yielding less than 4.5% about a month ago. Now it's above 4.8%. Most investors focus on what the Fed might or might not do. But the Fed can only change short-term rates. It influences long-term rates only indirectly. And rising long-term rates are not usually good for stocks.

Outperforming the Market

With just one more day of trading left, stocks are in danger of closing lower for January. As I write this, the Dow is up only 0.4% so far this month. Yet, as my staff and I put together the February issue of the Forbes Growth Investor, we are encouraged by the strong performance we are seeing from our picks. Our model portfolio is currently up 1.6%. Our sub-portfolios are doing even better. The Aggressive Growth portfolio is up 5.3%, benefiting from the 34% surge in MEMC Electronic Materials (WFR). This company recently reported outstanding top-line and bottom-line results and enjoyed several upgrades from Wall Street analysts. We will put out a full report in the February issue, which will be released to subscribers on Feb. 2.

Our Special Situation Survey investment newsletter is also doing great. This model portfolio is up 2.5% year-to-date, also well ahead of all the benchmarks. Ironically, one of our picks, Pilgrim's Pride (PPC) is up more than 4% today alone despite missing earnings estimates and warning of higher expenses in future periods. While I remain cautious about the overall market, I continue to believe it is possible to outperform through superior analysis.

Speaking of the overall market, we will learn more tomorrow when the fourth-quarter advance GDP estimate is released. That comes out before the market opens, so we could see quite a bit of volatility. The consensus estimate is 3.0%. My expectation is something closer to 2.5%. Tomorrow is also the day the Fed wraps up a two-day meeting and announces its decision on interest rates. I'm still surprised by those who believe the Fed will cut rates. If the Fed makes any move at all right now, it is likely to be a rate hike, not a cut. However, I would be very surprised if the Fed does anything other than keeping rates steady.

Increasing Storage vs. Driving Smarter

I've been asked a number times recently what I thought about the president's plan to increase the Strategic Petroleum Reserve from its current maximum capacity of 727 million barrels to about 1.5 billion barrels.

My initial reaction is that expansion of the SPR will support oil prices and keep them from going lower because it increases marginal demand. However, the government will not be filling the expanded capacity all at once. It will do so slowly over a period of several years, so there shouldn't be much impact on world oil prices.

Yet I still have to wonder if storing all that oil makes sense. After all, oil is already stored. It is stored in the desert in Saudi Arabia. It is stored in Iran, Iraq, and Venezuela. The SPR merely transports oil from one storage facility to another. Does this make sense?

The purpose of the SPR is to provide a margin of safety in case one of our major suppliers decides to impose a boycott. That happened in the 1970s. However, despite some temporary shortages at that time, the only serious consequence was higher oil prices. And we saw that higher prices quickly eliminate shortages. What oil producer can resist saying no when the price is high enough?

I'm not convinced we need to expand the SPR. We still have enough room to store an addition 40 million barrels in the current SPR. In fact, we already have about 60 days worth of import protection.

Reducing consumption is far more effective than increasing reserves. The president also called for a 20% reduction in gasoline consumption over the next 10 years. This is not an unreasonable goal. But it won't be achieved with ethanol alone. The most promising technology on the immediate horizon to help reduce consumption is the plug-in hybrid. Several automobile manufacturers are planning to introduce these. Furthermore, demand for gas-guzzling SUVs is way down. Chrysler is even planning to bring the Smart Car to the U.S. We can immediately reduce consumption by a considerable amount simply by driving smarter. It looks like last summer's $3 per gallon gasoline price was all we needed to move us in the right direction.

Oil Prices on Slippery Slope

I've been doing quite a few hits on TV lately talking about oil prices. The two questions I'm asked the most are 1) why are oil prices falling, and 2) why aren't gasoline prices falling as much.

As is almost always the case, prices change due to supply and demand constraints. We've been seeing for some time now that there is plenty of oil around. In fact, the Saudis had been complaining about the lack of oil tankers to transport oil. That's because all the available tankers were already full and had no place to unload quickly. Furthermore, the mild winter (at least so far) in the Northeastern United States helped keep crude supplies at higher-than-expected levels.

So there is plenty of supply. What about demand? When gasoline prices hit $3 per gallon last summer, consumers suddenly woke up. For the first time in quite a while, average miles driven actually fell. Demand for gas guzzlers also fell. People started thinking seriously about car pooling and avoiding unnecessary trips. Overall demand is down.

This combination of greater-than-expected supplies and lower-than-expected demand has driven oil prices lower. Yet many consumers and commentators are complaining that gasoline prices haven't fallen in lockstep with oil prices. That's true, but that's normal. Gasoline prices lag oil prices. Yes, even on the way up. Nonetheless, gasoline prices and oil prices are highly correlated. In fact, the correlation coefficient for weekly price changes from June 2006 to the present is well over 90%.

Gasoline prices will go lower in the very near term. Especially if demand stays weak. As for the longer term, a cold snap in the Northeast will drive oil and gasoline prices higher. For the much longer term, demand in the U.S. may remain weak as we move toward alternatives such as ethanol, bio-diesels, and true hybrids. But that won't be enough to stem growing demand from India and China. This should keep oil prices firmly in the $40-60 range. I would be very surprised if prices ever fall below $30 again.

When Securities Laws Hurt Shareholders

When a company is owned and managed by one individual, there are no conflicts of interest. If that individual uses corporate funds to pay for personal travel, or wastes money on other kinds of perquisites, he is only robbing from himself.

However, the ownership of the typical modern public corporation is greatly dispersed. There is also a separation of ownership and control. This is why we have securities laws and a Securities and Exchange Commission. The purpose is to protect shareholders.

So what should happen to Steve Jobs, Apple's CEO, now that he has become entangled in the stock options backdating scandal plaguing corporate America? It turns out that backdating is far more common than anyone could have imagined back when the story first broke in early 2006. Now the SEC is overloaded with cases under investigation.

Should Steve Jobs be forced out of Apple? If he is, you can bet Apple's share price will sink. How does that protect shareholders? Even if Jobs resigns voluntarily, the stock will sell-off sharply. Shareholders will lose.

We've seen many examples of wealthy corporate executives trying to add a few more bucks to their pockets, but it is difficult to imagine someone as wealthy and as revered as Jobs doing the same. Perhaps the laws regulating options are too convoluted and difficult to understand. Perhaps it is too easy for even well-intentioned executives to violate these laws without fully realizing it.

On the other hand, suppose Jobs knew exactly what he was doing. Suppose he also realized that what he was doing was wrong. If laws are supposed to apply to everyone equally, should Jobs be forced out if he knowingly violated the law?

It's easier to answer that question in the affirmative if you don't own any shares of Apple. I don't. But you can bet I would oppose any attempts to get rid of Jobs if I did. There are few present-day CEOs who are more closely tied to the success of their companies than he is. Firing Jobs would be a disaster for Apple's shareholders.

There are no easy anwers to this dilemma. In my opinion, the board of directors must choose the lesser of two evils. They can call for tighter controls at the company. They can demand that all options in question be returned. But they should also make sure Jobs remains as CEO.

Stock Picking vs. Market Timing

I am thrilled once again that the Forbes Growth Investor and Special Situation Survey investment newsletters outperformed the market in 2006. According to the Hulbert Financial Digest, the three portfolios in the Forbes Growth Investor had an average return of 16%. That puts it ahead of Hulbert's benchmark, the Wilshire 5000. It also places it in the top quartile of all newsletters Hulbert follows. The Special Situation Survey did even better. Hulbert shows it up 20% for 2006, well ahead of the benchmark and also in the top quartile.

Measuring performance can be tricky. To do it correctly you must consider two skills: stock-picking ability and market timing. An investment manager or newsletter editor who beats the market when the market is rising isn't necessarily a good stock picker. Any ordinary stock picker can do that in a rising market simply by employing leverage (i.e., buying stocks on margin). In order to determine if someone is truly a good stock picker, you must de-lever the returns. That is, you must compute what the returns would have been if leverage had not been used. This is the only way you can separate stock-picking ability from market-timing skill. It is also the only way you can compare the stock-picking abilities between managers who employ margin and those who don't.

Unfortunately, Hulbert doesn't de-lever returns. However, he often warns readers that some results have benefited from the use of leverage. Neither the Forbes Growth Investor nor the Special Situation Survey employ leverage. Our results are produced solely from pure stock-picking ability.

Jobs is Apple

Apple Computer is now Apple Inc. The company changed its name as it unveiled the new iPhone. The stock immediately jumped higher, closing up more than $7 a share for the day.

Seeing Apple in the news for creating an innovative product is not unusual. It has done this a number of times. The Apple Computer and the iPod are two examples. But in recent weeks all the news about Apple had to do with options backdating. It turns out that even Steve Jobs got caught up in the latest scandal. Believe it or not, there are some shareholder rights groups calling for his head. But before anyone shows Jobs the door, they should ask Apple shareholders what they think.

Jobs is Apple, and Apple is Jobs. Imagine what would happen to Apple's share price if Jobs were forced out. I suspect Apple shareholders would be more than happy to overlook this latest options indiscretion.

Time to Buy BSX?

David Rappa was my guest on MoneyMasters today. He is a portfolio manager with Austin Investment Management. That's a relatively small investment management firm that specializes in global equities. Austin manages about $300 million. Most of that is in separately managed accounts, but it also runs a mutual fund with about $50 million.

Austin uses an intrinsic value approach to finding stocks. Rappa told me he is particularly bullish on pharmaceuticals right now. Over lunch we also talked about Boston Scientific (BSX), one of his new holdings. BSX is a stock I've owned on and off since 1992. It's been one of my biggest money makers. I don't have a position in the stock right now, but I have to admit, I am getting tempted once again. Rappa started buying it not too long ago. The stock is currently around $17-18 per share, down from its 2004 high of about $46. The sell-off is due to reports of problems with drug-coated stents and the company's acquisition of Guidant. BSX paid too much for Guidant. It seems BSX was more interested in keeping Guidant away from Johnson & Johnson (JNJ) than it was in actually acquiring the company itself. Perhaps recent strength in shares of BSX indicate that investors believe the sell-off has gone far enough.

My MoneyMasters interview with David Rappa will be posted Jan. 25. This Thursday, Jan. 11, we will post my interview with David Frankel of firstRain, a research firm.

Expensing Options Didn't End Compensation Abuse

Several years ago, Warren Buffett petitioned regulators to make the expensing of stock options mandatory. Some accused Buffett of trying to get rid of options altogether, but his real motivation was to end the abuse. Several noted economists said expensing options would only make them more rare, but it would not end abuse.

They were right. Today options have to be expensed, and corporations use less of them. Yet executive compensation abuse continues. Home Depot's shareholders are the latest to be ripped off. CEO Robert Nardelli resigned and walked off with $210 million. Less than a year ago, Pfizer shareholders paid the price as CEO Hank McKinnell left with $200 million in his pocket.

Most shareholders don't object to paying someone well if he is doing a good job. But it's not like these guys deserved all that cash. After all, shares of both Home Depot and Pfizer were poor performers under their watch. Nardelli and McKinnell simply proved that one sure road to wealth is to become a CEO, do a poor job, then negotiate a resignation.

Whether stock options should or should not be expensed was never the appropriate battle to be fighting. The real problem is inappropriate executive compensation approved by boards of directors who are too weak-kneed to tell the CEO he can't rob the bank.

When directors discuss how much to pay the CEO, the first thing they do is hire a consultant. The consultant comes up with a list of peer companies. Of course, the CEO makes sure only high-paying firms are included in the list. The directors also convince themselves that their CEO is better than average; therefore, he must be paid better than average. This process drives up pay for all CEOs year after year.

Buffett has some excellent ideas on how to structure executive compensation. These include stock options with escalating exercise prices. He was wrong about expensing options, but so many of his other ideas make good sense.

Ending One Busy Year; Starting Another

I have been tremendously busy lately and haven't had much opportunity to post to my blog. First there was the year-end rush at work. I was trying to get as much done as I could in order to free up some time for the holidays. Then there were the holidays. At least I was able to enjoy them with my family. We did quite a bit of traveling between the Philadelphia and Boston areas visiting relatives and friends.

Before the holidays I managed to get up to Central Connecticut State University to make a presentation to Professor Zakri Bello's finance class. Zakri and I are old friends from our graduate school days at Virginia Tech. He's been teaching at CCSU for a number of years and was kind enough to invite me to speak to his class. It was good practice for a number of events coming up in 2007.

As of now, I am scheduled to attend the Money Show, which runs from Feb. 7-10 in Orlando. I will also be on the 11th Forbes Cruise for Investors, which goes from Beijing to Hong Kong in April.

Fortunately, our stock picks turned in another great year. Both the Forbes Growth Investor and Special Situation Survey outperformed all the major benchmarks. Although I remain bearish on stocks, they continue to rally and post strong gains. I am getting more and more worried, however, that these gains will soon end. I'll have more to say about this in the Jan. issue of the Forbes Growth Investor.

Board Independence is no Guarantee

Several months ago I interviewed former SEC Chairman Harvey Pitt about options backdating for my MoneyMasters video program. Pitt is a strong critic of backdating. He argues it is outright fraud.

Recently, I've been spending a lot of time studying up on Warren Buffett. Buffett is one of America's most admired CEOs. He has a clean reputation. He has been a vocal critic of executive greed. He believes many CEOs are overpaid. He also opposes the use of options to compensate executives.

Berkshire Hathaway, Buffett's company, has long been criticized for poor corporate governance practices. In particular, the board long suffered from a distinct lack of independence. Berkshire has a greater number of independent directors today, but this is only because of new NYSE listing requirements.

Despite poor governance, Berkshire Hathaway has been an outstanding stock. It has gained more than 20% annually for several decades. Indeed, there isn't any convincing evidence that companies with independent boards turn in better stock price performance than companies whose boards are not independent. However, proponents of independence say companies are less likely to end up in some sort of scandal when the board is independent.

But a new study produced by three professors argues that even independent directors may be subject to temptation. According to this study, many outside directors profited from options backdating. Lucian Bebchuk, Yaniv Grinstein, and Urs Peyer claim that 1,400 outside directors from 460 companies benefited from options backdating between 1996 to 2005. Their study indicates that the problem is less common at firms that have a majority of independent directors. But board independence provides no guarantee against options backdating.

The moral of the story is that investing is a risky game. The company's business model may succeed or it may fail. Shareholders can't even be certain the board and executives will always act in their best interests. Even independent directors may choose to enrich themselves at the expense of shareholders. The only way you can be sure that a company you own is being run to your full benefit is to run it yourself.

Fed Continues to Worry More About Inflation

The bond market has been betting for some time that the Fed would soon start cutting interest rates. But today's statement from the Fed indicates that a rate cut in the near future is not likely. The statement did talk about slowing economic growth, but it seemed to focus more on elevated levels of core inflation.

The Fed voted to stand pat on interest rates. Jeffrey Lacker, however, voted for a rate increase. The Fed seems to be leaning more toward raising rates than lowering them.

The statement specifically mentioned "a substantial cooling of the housing market." Some would say the housing market is collapsing. Indeed, that's exactly what Gary Shilling said when I interviewed him today for my MoneyMasters video program. Shilling is worried that we could see a 25% price decline nationwide, leading to an economic recession. This video will be available for viewing on Dec. 28.

High Energy Prices and Weak Housing Will Finally Take Toll on Economy

Energy prices and the health of the housing market are perhaps two of the most important factors affecting our economy today. Stocks have rallied in recent months largely due to optimistic outlooks for both of these factors. My outlook is much more pessimistic.

Oil prices peaked around $78 per barrel in late summer. Investors cheered as prices came back down. But I've been pointing out that prices are still very high. Even at $40 to $50 per barrel, they would be much higher than they were just a few short years ago. These days they are hovering above $60 and OPEC seems to be getting serious about cutting production.

OPEC has learned a very valuable lesson. Oil producing nations like to get as high a price as possible, but OPEC was always worried that if prices went too high, economies might go into recession causing demand for oil to plummet. The lesson they learned is that most economies could easily sustain $40, $50, even $60 per barrel. OPEC's target range for oil prices used to be about $25 to $30 per barrel. Today, $60 is the new $30. Now OPEC fears falling prices more than rising prices. It seems to be getting serious about cutting production to keep prices around $60. That is not good news for the U.S. economy.

Housing is also a major problem. Most economists were betting on a soft landing in the housing market. Right now, it looks like the landing may be fairly rough. Inventories are high, prices are falling, cancellation rates are rising, foreclosures are up, and the sub-prime mortgage market is seeing rising defaults.

This double whammy of high energy prices and a collapsing housing market means GDP growth in 2007 will likely be less than 2%.

Housing Stocks Surge in Response to Bad News and Lower Interest Rates

On Nov. 13 I wrote about the options-backdating scandal at KB Home and the resignation of the company's CEO and other top officials. The stock has rallied 20% since then. But it isn't the only homebuilder to surge in the past month. All the stocks in that sector are up including Hovnanian Enterprises and Toll Brothers.

Toll Brothers recently announced fairly lousy financial results, but gave some indication that it may be seeing the bottom. That helped boost the stock. Yet the housing stocks are also responding to lower interest rates. In fact, the rate for a 30-year mortgage is down 25 basis points over the past month to 5.58%. Investors are betting that lower rates will save the industry and once again spur demand for new homes.

Lower rates may stabilize the housing industry, but I seriously doubt we will see a surge in demand. This market is saturated. Speculators have already moved on to other things. Defaults are on the rise--especially in the sub-prime market. Foreclosures are also up. I don't see interest rates falling low enough to save those who are seriously overextended.

Bernanke Thinking About Raising Rates Despite More Weakness in Housing

Today's existing home sales report was mixed. The good news is that October's 6.24 million homes sold is better than expected. It is even slightly higher than September's 6.21 million figure. The bad news is that it is down 11.5% from October 2005. Even worse, the median price is down 3.5% from a year ago. And inventories are up almost 2% over the past month, and 34% over the past year. There is now a 7.4 months supply of previously-occupied homes on the market.

The price drop is particularly worrisome. That's because sellers don't have to sell if they don't like the offer. It's not reassuring for the housing industry that more homes sold than expected, but at lower prices.

After initially rising on the news, shares of homebuilders reversed course and sold off. There is growing concern that the housing market may not have yet bottomed.

On top of all this, Fed Chairman Ben Bernanke gave a talk today that stressed the risks of rising inflation. He disappointed investors by not making any mention of a possible interest rate cut. Many investors had been hoping the Fed would start easing soon. They weren't happy to hear the Fed is thinking more seriously about another interest rate hike.

Sales Up 19%. Sorry, That's 6%

It's funny how numbers are frequently used to promote a specific agenda. The National Retail Federation released spending figures yesterday for Black Friday weekend. Several media outlets jumped on one figure and put it in their headlines: "Retail Sales Jump 19%."

It would truly be astounding if retail sales actually increased 19% in one year. Of course, that is not what happened. The 19% increase refers to the average amount of money spent by shoppers. This year, shoppers spent an average of $360.15. A year ago, they spent $302.81. That's the good news. The bad news is that there were an estimated 5 million fewer shoppers this year; and sales on Black Friday were up only 6% from a year ago. That's still an impressive rate of growth, but no where near the 19% figure highlighted in the headlines. In fact, the NRF is sticking with its forecast of 5% overall growth this holiday season.

Some retailers will be having a very Merry Christmas. Apparently, Wal-Mart is not one of them. The nation's largest retailer said November same-store sales are down 0.1%. On-line retailers are expected to do very well. The on-line market is still small compared to bricks and mortar stores, but on-line is where the real growth is.

White House Says Slower Growth; Higher Inflation

Yesterday Edward Lazear, Chairman of the Council of Economic Advisers at the White House, lowered his growth forecasts. These forecasts are produced twice a year for budgeting purposes.

He called for 3.1% economic growth for 2006. That is a healthy figure, but down significantly from the June forecast of 3.6%. For 2007, he is projecting growth of 2.9%. The reduction in the forecast is primarily due to the slowing housing market.

The White House is also projecting 2.3% inflation for 2006. Despite slowing growth, it expects inflation to rise to 2.6% in 2007. But with unemployment at only 4.4% and calls for a higher minimum wage, there is a good chance that inflation will be higher. And if oil prices reverse themselves and start moving back up toward $70 a barrel, inflation will become problematic.

The housing slump and energy prices are key to what the future holds. The numbers of homes available for sale are rising quickly. Home prices will continue to fall. Homebuilders will continue to report declining earnings.

As for energy, that really depends on what OPEC does. Energy traders are skeptical about OPEC's ability to stick to announced production cuts. Saudi Arabia is the big player in this game. If the Saudis were to cut production significantly, oil prices would move higher. But if the Saudis see that other OPEC countries are not doing their fair share, they may actually raise production to teach them a lesson. That, of course, would cause oil prices to plummet.

Democrats Wait for 2008

I had an interesting discussion with Mike Holland, Chairman of Holland & Co., a New York City private investment firm. Old-timers will recognize his name from his frequent appearances on Louis Rukeyser's Wall Street Week.

Mike and I discussed the Democrats taking over Congress and what this may mean for tax policy. I asked him if the election results will prompt him to change his investment strategies. His answer was no. He still continues to favor large-cap, blue chip, dividend paying stocks. This MoneyMasters discussion is currently available for viewing.

Dining with Investment Legend Jack Bogle

There are few people in my line of work who can be called legends. There are fewer still who are living legends. Warren Buffett is one. Jack Bogle is another.

Yesterday I had the honor of interviewing Bogle for my MoneyMasters video program. Afterwards, I had the pleasure of taking him to lunch. He is a wonderful and gracious man.

As most investors know, Bogle is an advocate for passive investing. Because he believes investors cannot expect to do better than average in the long run, they are best served buying index funds that have very low fees. He has strongly criticized the money management industry for putting its own interests ahead of investors' interests. In particular, he says funds run by public corporations and conglomerates focus on maximizing returns for owners and managers--not for investors.

Bogle is a man who could have been fabulously wealthy. Instead, he created a mutual fund company, The Vanguard Group, based on minimizing fees. His whole life mission has been to increase the wealth of his investors rather than his own. While I'm sure he is comfortably well off, there is no question he could have done better for himself if he had chosen that as his goal. It was extremely refreshing to be in the company of a man who truly cares about ethics.

I learned a lot about Bogle during lunch. He told me how he had to work his way through Princeton, and how he almost failed. He told me he struggled with Paul Samuelson's economics text, but getting through that book marked a turning point in his life. He told me about some of his conversations with Warren Buffett. Many people would be surprised to learn that Buffett actually favors index funds for ordinary investors.

Bogle is an incredibly prolific writer. He has written several books. There are many more written about him. He roams the country delivering speeches. Best of all, he is more than willing to share his knowledge and opinions. You can read many of his writings at his personal website.

While we were having lunch, I noticed many people in the restaurant looking our way. Of course, they recognized Bogle. As we were leaving, one gentleman got up and came over to say hello. He thanked Bogle for sticking up for integrity in the money management industry.

My MoneyMasters interview with Jack Bogle will be available for viewing on Nov. 30. This is one video you won't want to miss.

Housing Foreclosures are on the Rise

Yesterday I heard through a reliable source that the credit union of a major corporation headquartered in Connecticut is suddenly seeing a larger than usual number of employees in financial distress. Several have approached their credit union seeking help.

Most of the problems are housing related. Many of these troubled employees had purchased homes in recent years. Others had refinanced existing mortgages. The problem is they relied on new and exotic mortgages including interest-only mortgages with very low teaser rates. These mortgages are now being adjusted to a higher rate. In addition, borrowers have to start making principal payments. They were already stretching themselves as it was, but suddenly their required monthly mortgage payments have at least doubled.

RealtyTrac, which follows foreclosure rates, says the number of homes nationwide that are in some stage of foreclosure is growing. The highest foreclosure rate is in the Detroit area, which has suffered from the automobile industry's slowdown. Many parts of Florida are also seeing rising numbers of foreclosures.

Yet many economists continue to ignore these warning signs. They all seem to be focused on holiday sales. Perhaps consumers will keep up the spending for a while, but how much longer can that last if some of the air is coming out of the housing bubble?

Options Backdating Scandal Hits KB Home

Way back in 1998, I had breakfast with Bruce Karatz, CEO of KB Home. At the time, the company was still called Kaufman & Broad. Karatz was extremely bullish about the home building industry and the prospects for his company. He turned out to be right. About a year later, I added the stock to the Special Situation Survey's recommendation list, and as everyone now knows by now, home building stocks went on a tear.

Of course, I didn't know at that time that Karatz was personally benefiting from backdating his own employee stock options. Harvey Pitt calls backdating fraud and explains why on my MoneyMasters video. There is no question that backdating is wrong. After all, it requires that you lie about when the options were actually issued. Instead of pricing them on the issuance date, you simply pick a more favorable date from the past.

Ironically, there was no reason for Karatz to backdate his options. After all, the Wall Street Journal reports that Standard & Poor's estimates that Karatz reaped $180 million from the exercise of stock options alone since 1992. In 2005, his total compensation, including options, amounted to $150 million. KB Home said backdating benefited Karatz to the tune of $13 million, which he will repay. Compared to his total compensation over the years, this is chump change. It won't make a dent in his bank account. Of course, by the time the SEC gets through with him, he may end up paying a whole lot more.

Karatz isn't the only one leaving the company. Richard Hirst, chief legal officer, and Gary Ray, head of Human Resources, are also leaving. But Ray is the only one being fired. Karatz and Hirst were allowed to resign. It seems they cooperated in the company's internal investigation while Ray refused.

Backdating is gearing up to be the next big corporate scandal. Karatz is the biggest name to fall so far, but it looks like there will be plenty more coming up in the near future.

The Middle East is not the Soviet Union

Having written recently that the economy favors the Republicans in the mid-term elections, I suddenly find myself having to defend that point of view. After all, the Republicans got trounced. However, those who read my writings carefully know that I also said the economy would not be the deciding factor in the elections. That burden fell on the war in Iraq. Most voters seem satisfied with economic conditions at the moment, but they are fed up with the Bush administration's bungling of the war. Even though the Democrats don't have a coherent plan, voters obviously felt it was time for a change.

I suspected Donald Rumsfeld might be forced to step down if the Democrats won, but I never would have guessed it would have happened so quickly. The stock market was down for the day until Rumsfeld's resignation was announced. Suddenly the market rallied and closed up for the day. If that isn't adding insult to injury, I don't know what is.

President Bush nominated Robert Gates to replace Rumsfeld. Knowing how paranoid people can be in certain parts of the world, Bush should have stressed that this Gates is from the CIA, not Microsoft.

Like Condoleezza Rice, Gates has a lot of expertise in matters relating to the former Soviet Union. That's all well and good, but isn't it time we stacked our government with some Middle East experts?

Money Matters

I traveled to Bala Cynwyd, PA yesterday to do an interview with Money Matters, a Comcast program on investing that airs on certain stations in the Philadelphia area. The co-hosts were David Ebner of Merrill Lynch and Tami Fratis of Phoenician Ventures.

We talked about the weakening housing market, slowing GDP growth, inflationary pressures, etc. They also asked me to explain the investment strategies behind the Forbes Growth Investor and Special Situation Survey investment newsletters.

In the "small-world" department, Money Matters is produced by Richard Whitfield, my cross country coach at Lower Merion High School in Ardmore, PA. It was great seeing Rich again and finding out that we are dong similar things.

The video should be available in a few weeks on the Internet. You can check it out at Money Matters.

Interview with American Superconductor's Greg Yurek

Today I interviewed Greg Yurek, the founder and CEO of American Superconductor (AMSC). In the interest of full disclosure, I have owned this stock for several years.

This company went public 14 years ago to commercialize superconducting technologies. Finally, after all these years, its largest business segment is profitable. But the company is still spending heavily on R&D so it won't be profitable on a company-wide basis for quite some time.

However, there are a couple of exciting projects. AMSC has a contract to develop superconducting motors for the U.S. Navy. These superconducting ship propulsion systems have several advantages over conventional motors including smaller size and weight. AMSC is also installing superconducting cables in a project for Long Island Power Authority.

This MoneyMasters interview will be available for viewing on Nov. 23.

BELM is a Close Out, Not a Sell

Yesterday, I dropped Bell Microproducts (BELM) from the Special Situation Survey recommended list. I didn't drop it because I think it is overvalued. In fact, I think the stock should be selling for $8-10 per share. I dropped it because it had been on our list for 28 months. We typically keep stocks on our list for no more than two years.

Yet I'm shocked at the reaction. The stock fell as much as 12% soon after our close out. I'm sure much of this is coming from swing traders who buy or sell a large number of shares in reaction to any news that comes out. News of our close out even made it onto the Yahoo message boards.

A Special Situation Survey close out is not necessarily a sell recommendation. In fact, I still believe BELM is an undervalued stock. I've owned it myself for several years and haven't sold any shares. I suspect this stock will be bouncing back rather quickly.

Wal-Mart's Results Augur Poorly for Holiday Sales

The National Retail Federation defines holiday sales as sales that take place in November and December. In 2005, holiday sales were up 6.1% to $435.6 billion. The NRF is forecasting a more subdued 5% gain in 2006 to $457.4 billion.

Yet even this forecast may be too optimistic. Wal-Mart, the nation's largest retailer, announced today that same-store sales in October were up only 0.5% year-over-year. If stores affected by last year's hurricanes are excluded, growth was 1.7%. Wal-Mart is seeing particular softness in women's apparel. What's worse, Wal-Mart is projecting no growth in U.S. same-store sales for November.

Ironically, just a few days ago investors cheered when Wal-Mart said it will slow capital spending in future periods. The stock rallied a couple of dollars per share in response. But that just turned out to be a selling opportunity. Wal-Mart has already given back those gains.

Some of Wal-Mart's losses may be going to Target, but that stock is selling off, too. So are other retailers such as Gap, Abercrombie & Fitch, and AnnTaylor, which also reported disappointing sales figures today.

The NRF's 5% growth forecast for the holiday season may be a bit too optimistic. Don't be surprised if it is revised downward in the near future.

Economy Still Favors Republicans

I got a call from Fox News yesterday asking if I thought the state of the economy plays in favor of the Republicans or the Democrats. As I write in the current issue of the Forbes Growth Investor, which was released today, I believe the Republicans still have the upper hand on the economy. Unfortunately for the Republicans, the economy will not play a big role in the mid-term elections. Polls indicate that voters are more concerned about Iraq.

Although the trends are not favorable, for the most part the economy is doing well. GDP growth is slowing, but it's still healthy. Companies are laying off workers, but the unemployment rate is low. Inflation is rising, but it's relatively tame.

One thing to keep in mind, however, is that the economy was doing well during the Clinton administration, too. But when it began to slow toward the tail end of that era, Republicans started warning that the economy was headed into recession. Democrats scoffed at the notion, yet the Republicans turned out to be correct. Today, the tables are turned. The Republicans are the ones in power with a good but slowing economy. So far, I still think the chances of recession are remote. However, the probability keeps rising. Energy and housing will play key roles.

Meanwhile, corporations keep reporting outstanding profits. Standard & Poor's Howard Silverblatt who tracks the numbers is my next guest on MoneyMasters. This video will be available for viewing Thursday morning at 6:00 am.