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.