A New Week

Last week in Barron’s Mike Hogan noted that the politicians are finally getting around to considering natural gas as a cleaner burning fuel, suitable to large auto and truck fleets, that might be capable of actually making a dent in our foreign oil dependency sometime this side of the next quarter century. Most energy alternatives are so far out in the development stage that they provide little near-term impact. It would be nice if we could develop the solar and other renewable options, but few barrels of oil will be left on the shores of Saudi Arabia, at least during the next decade, if we limit ourselves to clean green options.

Natural gas, though, is cost effective and available and, with just a little technological sprucing up, could drastically reduce our dependence on areas of the globe which tend not to raise their hands when volunteers for the USA fan club are solicited (unless, of course, the term “citizenship” is dangled as an incentive).

Harry Reid and Obama’s Chief of Staff, Rahm Emanuel, are among those pushing for a political initiative favoring natural gas. How it was left out of the hundreds of pages of middle-of-the-night negotiating for the Cap and Trade bill, is a great question. The Colorado delegation might want to spin up an answer for the next election cycle. For Western Colorado, natural gas stocks, and our current portfolio, however, it’s a plus.

Natural gas and crude oil are diverging in an unprecedented way. Natural gas prices are setting new lows, making this clean substitute for crude ever more cost effective. It reduces the value of reserves, which is a negative for the gas exploration stocks, but it creates an ever greater incentive to lean toward gas as a clean fuel for the future.

I was less enthusiastic when I checked the recent money supply statistics in the tiny print of the Market Laboratory section of the paper. Excess reserves, which is money held in the banking system instead of being available to business and consumer borrowers, rose again – back up to nearly $800 billion. Thus, the money which came screaming out of the stock market, last Fall, and now sits earning practically nothing in certificates of deposit, is not yet finding its way back out into the real economy.

Were it not for the credit crunch, credit-worthy borrowers would abound. As it stands, since no money is going into the real economy and therefore attempts by the Federal Reserve to stimulate the economy using monetary policy isn’t stimulating anything, almost any loan looks like a mistake waiting to happen. It’s a classic “Catch 22,” but without the biting humor that Joseph Heller wrote into his characters.

Finally, money flows into equity funds went negative last week. The last six weeks have been good to stocks, and positive flows into the market helped explain the surge. In many sectors, valuations look stretched. I can find insurance stocks and healthcare stocks whose earnings prospects remains strong, but whose stock prices are a lot lower than a year ago. For the broad market, though, earnings power has fallen at least as much as the stock market itself. We’re rotating into some new sectors, but if the same guy who was telling you to “sell” in March is now telling you to throw caution to the wind and “buy” today, it’s probably time to upgrade your choice of market pundits. Risk is always at least partly a function of price, and today’s market is 50% more risky than when the market that was causing us all to sweat bullets last March.

Clearly the economy is stabilizing, as we said it would. It’s not clear that it’s getting ready to shift into high gear. Or even that it will be able to sustain the momentum it’s got. It’s in low gear, crawling forward through difficult terrain, and valuations ought to reflect this reality.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

Go to Investments main page.