The new days: the boost of Ethanol

You don't need a crystal ball to see a ramp-up in government support for ethanol coming down the pike. Just look at who's in charge of next year's doozy of a farm bill.

The reauthorization of the massive 2002 bill is likely to dominate the next session of Congress, and it will have a whole section set aside just for energy.

Already, ethanol producers benefit from a constellation of government supports, including a tariff on imported ethanol, subsidies for growing corn and blending the fuel, crop insurance and a guaranteed market: The Energy Act of 2005 required refiners to ramp up ethanol use from 2.5 billion gallons last year to 7.5 billion gallons by 2012.

Now, the farm bill may lavish even more on the industry.

Turning the farm bill into a bonanza for ethanol and other biofuels is smart politics for the Democrats, who would be wise to court voters in red states if they want to hold onto Congress. It will also garner the support of Republican lawmakers from farm states and President George W. Bush, who seem equally glossy-eyed over biofuels.
But there will be brush-back from places that don't have a stake in ethanol, and this is where the refining industry will focus its influence.

A hike of the blending subsidy, currently set at 51 cents per gallon of ethanol, or any new support for ethanol producers would be fair game. Environmentalists, for one, are eager to see ethanol plants, which are powered on natural gas or coal, switch to renewables such as wind.

With the Iraq War and entitlements busting the budget, it seems far-fetched that such a windfall would go to an industry that has already gotten so much. But, as any ethanol booster will tell you, Wall Street's support of ethanol would dry up in a flash without all the government support.

So long ' Dollar '...

Americans may be spending their dollars with merry abandon as the Christmas shopping season begins this Black Friday, and that might be a good short-term strategy: the greenback slid on the foreign exchange markets after a Chinese central banker expressed fears about depreciation of the U.S. currency.

Underscoring the potential for U.S. inflation in a depreciating dollar, an ounce of gold cost $645.60, up from $630.80 on Thursday.

China has never revealed the exact composition of its foreign currency reserves, but market speculation suggests at least 70% is in dollars. With Chinese reserves having recently topped $1 trillion, a move away from the dollar could have significant implications.

For months China has been soaking up U.S. Treasury bonds, using dollars from its huge trade surplus with the United States. Some bankers have noted that East Asian investors not only face a currency depreciation risk from holding dollar-denominated assets but also falling interest rates on long-term bonds. There is some perhaps unintentional irony in that comment because China’s seemingly insatiable appetite for Treasuries seems to be a major cause of the falling interest rates.

Another cause is an expected slowdown in U.S. economic growth. Earlier this week, the United States cut its forecast for 2007 economic growth to 2.9%, down from an earlier forecast of 3.1%. (See “White House cuts economic growth forecast”) The yuan, whose fluctuations are restricted by the Chinese government, hit a record on Friday.

Standard & Poor's said in a research note that it expects the euro to reach $1.32 by the end of the year.

So long 'Dollar'... farewell...

White House cuts economic growth forecast

The U.S. economy should experience slower growth than originally anticipated for the remainder of the year and in 2007, the White House said Tuesday.

The President's Council of Economic Advisers projected that economic growth would be slower than forecasted last June, with real gross domestic product growing 3.1% for all of 2006 and 2.9% in 2007 before rebounding to a 3.1% gain in 2008.
The forecast said that the revisions reflect a weakening in the housing sector, but that other areas of the economy remain strong.

"The economic forecast clearly reflects the fact that the U.S. economy is moderating to more sustainable growth levels, firmer labor markets and steady inflation rates."

Treasury Secretary Henry Paulson.

On Monday, the Census Bureau reported that new housing starts slipped in October to their lowest level in over 6 years, while a reading on builder's confidence hit a 9-year low.

The government forecast, which will be used for the President's fiscal year 2008 budget, projects that the unemployment rate will be 4.6% during 2006 and 2007 and that employers would add an average of 129,000 jobs per month.
Last month, the unemployment rate slipped, hitting its lowest level in 5 years, according to the Labor Department, while employers added 92,000 jobs.

So if you think everything is going great, or in the other hand that the economy is slowly sinking, I suggest first you make a few reflections...

Do this thing reflect some sort of reaction related to midterm elections? Are this only independent situations with no relation between them? How are the Democrats going to contribute to the economy? What is finally going to happen?

A new slowdown for the U.S. economy

The U.S. economy has been battered by a bigger-than-expected slump in housing but will keep growing next year as consumers get relief from soaring energy costs.

That is the view of a panel of 50 top forecasters in a survey released Monday by the National Association for Business Economics (NABE).

The NABE panel predicted that the overall economy, as measured by the gross domestic product, would expand by 2.5% in 2007.

That is down slightly from the previous survey in September which forecast that the U.S. economy would grow by 2.7% next year. The expectations for 2006 were also marked down with GDP growth now put at 3.3% instead of 3.4% forecast in the previous survey.

A bigger-than-anticipated slump in housing was the primary reason for the reductions.

The Federal Reserve engineered the current economic slowdown with a 2-year campaign to push interest rates up. The Fed's goal was to achieve a soft landing in which economic growth slowed enough to reduce inflation without bringing on a recession.

The slower growth will have an impact on the job market, unemployment rate could rise from an expected average for all this year of 4.7% to 4.9% in 2007.

The forecasters, however, said the fall in inflation pressures will mean that the Fed will not feel the need to raise interest rates further. They predicted that the federal funds rate, the interest that banks charge each other, will remain at the current 5.25% for an extended period. After raising rates at 17 consecutive meetings, the Fed has kept rates unchanged since August.

The NABE panel said the central bank's next move would likely be to cut rates, once inflation pressures retreat further. The forecasters saw 2 quarter-point rate cuts occurring in the second half of next year.

Can a market rise too fast?

On the face of it, this question would appear to be absurd. Who could possibly object to making more money rather than less?

But a number of the editors of the investment newsletters I follow nevertheless are worried about the pace of the market's recent advance. They argue that, historically, the market has tended to fall more sharply whenever the pace of its previous ascent was too steep - and is therefore dangerously unsustainable.

The metaphors these advisers use to describe such situations are instructive. Some draw an analogy to an airplane that tries to rise too quickly. An airplane in such a situation will eventually stall out and then plunge, of course, and the advisers employing this metaphor worry that the stock market today is vulnerable to just such a scary decline. Technicians often refer to the ever-steepening slope of such an ascent as a parabolic rise.
And in recent days, a growing number of investment advisers have begun to describe the stock market's advance in these terms.

Adding to the sense of danger, furthermore, are parallels between the market's recent advance and the strength it exhibited in the months prior to the bursting of the Internet bubble in early 2000. The Standard & Poor's 500 index gained more than 2% in each of the last three months, and before this past July, the last time this happened was in 1999.

It turns out that it is not as rare a phenomenon as you might think to have three months in a row of gains greater than 2%. In fact, such strength has been exhibited more than 5% of the time over the last century - about once every 20 months, on average.

The bottom line? When it comes to reasons why the stock market might soon decline, there no doubt are many other things one can worry about these days. But the pace of the market's recent advance is not one of them.

Dollar on path for a crisis

A lack of words can speak a lot louder than the words themselves.

The currency market can be very frustrating for traders, because it doesn't always follow a clear fundamental logic. It can rise and fall in unison with bond yields, but also with bond prices; it can fall on a widening trade deficit, but it can also rise if that deficit is expected to lead to increased pressure on politicians to act.

It can also fall when the U.S. says, and when it doesn't say, it has a strong dollar policy.

The dollar is moving toward a crossroads. The U.S. Dollar Index, which tracks the buck against a handful of the world's major currencies, has been consolidating along an uptrend line that began in December 2004, but also along a downtrend that started in November 2005.

Given that the trendlines are on path to intersect, the dollar will be breaking out soon. Technically speaking, it looks very likely that the direction will be to the downside.

With China and other countries freely talking of plans to diversify their foreign exchange reserves, which have been predominantly comprised of U.S. dollars, the FX hordes now have a fundamental excuse to push for a breakdown.

That would certainly run counter to the U.S.'s stated "strong dollar" policy at a time when a weak currency is certainly not necessary. If new Treasury Secretary Henry Paulson, Jr. doesn't want to deal with another currency crisis, like his ex-Goldman Sachs predecessor did more than a decade ago, he should realize that it takes more than a few unspoken words to turn a $3 trillion-a-day foreign exchange market.

Dow's high doesn't impress everyone...

The post-election stock market may have closed at a multiyear high Wednesday, but not everyone is impressed. The ones that have bearish reputation, should be ready to extend diplomatic recognition to a new bull market.

Much as you could like or dislike election's results, I think/hope that in this instance that this new flat world that produces massive transparency is producing a fine balance when this country can have a system in which the needs of the customer, employee, and shareholder can all benefit.

The U.S. still has a super bullish relative valuation of the stock market trying (and succeeding) to keep the trend of the market moving upward. At the same time, monetary conditions are wavering from extremely bearish to only very bearish.

That doesn't sound like a lot, but for those of us craving to be bullish, it sets our tentacles vibrating - urging us on to crave a little more. ... We are continuing to keep our 10% cash, erring on the side of caution by expecting "one more" correction.

The stock market, contrary to public perception, is rather indifferent to divided or unified governments. While stocks have returned an average of 11.81% during times of unified governments, the returns are only slightly different, 11.37%, during times of divided government.

The significance of a divided or unified government is, however, apparent in bond total returns. During times of unified government, long bonds return 2.18%. When the government is divided, thus ensuring some level of gridlock, bonds return 8.82%.

What should we do now????

Lame duck or dead duck?

Midterm elections have often been tame events in the U.S. Some have come and gone without the public taking much notice. Not this year.

Today's congressional elections have been the subject of intense campaigning and relentless media coverage. They have been fought on national rather than local themes, with Democrats focusing on the unpopular war in Iraq and Republicans stressing the need to maintain lower taxes and bolster national security.

Republican Party leader Ken Mehlman says the election "is a pivotal moment in the nation's history. I am confident we are going to keep our majority, but we ought to engage in a very serious discussion about how to do better after this election is over."

The stakes are high for Bush as he heads into the final two years of his presidency. His job-approval ratings are at about 40%, emboldening members of his own party to oppose him on issues from immigration to a Dubai company's efforts to take over the management of U.S. ports. A loss of one or both houses of Congress would weaken him further.

Should Democrats take control of the House or Senate, they would be able to hold investigations of the administration and issue subpoenas. And Bush would come under increasing pressure to make progress in Iraq or withdraw U.S. troops.

The Democrats face their own pressures. So many pollsters and pundits are predicting they will win the House that failing to do so might seriously rock the party's confidence and future.

The two political parties are at an all-time low in terms of their image, and Republicans are going to get punished more because they are in power. If somebody could adopt a different style that did not result in partisanship and paralysis, that would be wonderful. But I don't have a huge expectation that is going to happen.

The priority must be a new direction for the country. The only difference this election makes is whether Bush is a lame duck or a dead duck.

U.S. elections ahead & how Canada has plunge a lesson for U.S. investors

For all the pundits out there claiming that the U.S. midterm elections next week won't mean anything for the stock market, take a good look at the Canadian stock market plunge Wednesday.

Canada's S&P/TSX Index in Toronto fell 2.4%, its worst showing since early this summer, and some of its companies fell between 11% and 19% in a vicious bout of selling sparked by a government announcement that it will close a tax loophole on income trusts that had led to a surge in big companies converting to trust status to avoid taxes. The income trust sector of the market fell more than 10%.

Whether the Canadian government is right or wrong to close this loophole isn't the issue for U.S. investors, although many Canadian companies that trade in the U.S. also got hit. What's important is that the announcement came as a complete surprise to the market, despite a robust debate about the status of these securities. It shows that when governments want to, they can have an immediate and powerful effect on markets.

And that's the lesson investors should take to the polls here in the U.S. next week.

While we haven't had an incident like the income trust one in Canada, we certainly have seen examples of government action that has shaken markets. Just this summer, the government's effort to go after Internet gambling sites stunned the shares of those sites - foreign listed - as investors suddenly bailed out of a strategy they never thought would turn on them so quickly.

The stock option backdating investigations by the government, while mostly tied to tech companies, have also shown how otherwise rosy company stock stories can suddenly become nightmares when the regulators show their hands.

Indeed, the biggest example may be the 1987 stock market crash, 19 years ago this month. The Dow Jones Industrial Average fell 22% on Black Monday, in what would be the equivalent of some 2,600 points at today's Dow levels.

Who knows what might be making its way through Congress right now that could strike the markets in this way, or even in a positive way? Just the fact that it can happen is reason enough to pay close attention to the elections next week.

My own feeling is that the stock market surge in October is a signal that the market felt the Republicans will hang on to both the Senate and the House. That the market has turned around in the past four days may reflect an emerging consensus that the Democrats might just pull it off.

But there are plenty of pundits who feel exactly the opposite - that the rising market was forecasting a Democratic victory in the House and gridlock in Congress for the next 2 years. And that the turn in the past few days is the real signal that the Republicans will hold on.

Whoever comes out ahead on Tuesday will have 2 years to make a lot of progress, or cause a lot of trouble, depending how you look at the world. The only thing that's certain is that the markets will be looking, and when they see something they don't like, they will react without warning or mercy.