Arriba! Cinco de Mayo heralds big news for the S&P 500 this morning:

After a manic 36% bounce from its March lows, the S&P 500 has turned positive for the year. It’s now sitting on a whopping 0.4% gain, thank you very much.

But before you down the Cuervo Gold and shimmy onto the parquet for a hat dance… consider this:
The resurgence in S&P 500 is being driven by only three sectors: Consumer discretionary, materials and tech. See for yourself.

It’s hard to believe in “bull market” when two-thirds of the players are in the red.

We’re taking a closer look at tech, but for the time being — as if you need another reason to turn off CNBC — health care, utilities and consumer staples, the classic refuges for mainstream money managers, aren’t such good choices during this sucker’s rally.
“Buffett thinks his utilities and insurance businesses will do ‘quite well’ despite the recession,” says Chris Mayer, recapping Berkshire Hathaway’s annual shareholder meeting.

“Berkshire has its fingers in many different businesses, so Buffett has an eye into many parts of the economy. Buffett was mostly gloomy. Aside from utilities and insurance, he saw weakness in service and manufacturing and his other lines.

“Also interesting was a comment that he was looking more in the U.S. now than overseas. Last year, Buffett seemed to be devoting more energy abroad — I recall a trip to Germany, for instance. Now Buffett seems to find the U.S. situation more interesting.

“One other note: Buffett may not see much in manufacturing, but I’d say it is a wide spectrum. In Capital & Crisis, for instance, we own a few manufacturers in key areas of water, infrastructure and energy. They’ve turned in great results. But Buffett doesn’t see these, as they are too small for his radar screen. Too bad for him. Big advantage for us.”

In fact, Chris booked a 117% gain on just such a stock yesterday, in less than five months. Special Situations readers could have taken another 30% yesterday too, if they were following Chris’ advice. How did you do? If you’re not privy, become so here.
Stocks soared again yesterday, thanks mostly to another batch of “less awful” data. Traders started to rush in after construction spending and pending home sales data hit the tape at 10 o’clock. Both were way better than expected: Construction spending rose 0.3%, after a 1% drop in February, and pending home sales rose for the second straight month.

Of course, historically speaking, both measures are still in the dumps. But better to buy first and ask questions later… major indexes jumped 2.5-3%.
Markets are more timid today. The Dow is down about 20 points as we write — we suspect profit taking. And…
“Right now, the credit markets are broadcasting the following warning,” says Dan Amoss. “The equity of overleveraged REITs is at risk of elimination or permanent impairment. Yet the stocks of real estate investment trusts (REITs), which are popular among income-oriented retail investors, are still trading at high enough levels that discount a ‘garden-variety’ recession in commercial real estate.

“REITs were designed to invest in portfolios of rental properties, and generally pay no corporate income taxes if they distribute at least 90% of their profits as dividends to their shareholders.

“REITs thrive in an environment of steadily rising property values and rents. But in this ice age for commercial real estate, the REIT business model will cease to function properly; a REIT’s tax-free status doesn’t allow it to retain much excess capital during lean times. Since REITs pay out all their earnings, they cannot grow without taking on more debt. During the boom, a REIT strategy encompassing growth, leverage, and acquisitions was a virtuous cycle that led to juicy dividends and soaring stocks; in this bust, it’s morphed into a vicious cycle of dividend cuts, dilutive equity offerings, debt offerings at double-digit interest rates and bankruptcies.

“The REITs that levered up and grew too fast at the peak will go to zero in bankruptcy. Others could fall into the low single digits by year-end as the market anticipates that creditors will take title to many properties in 2009 and 2010. These developments would push the value of the REIT Index dramatically lower.”

Following that logic, Dan just handed his Strategic Short Report readers a short-REIT play with “200% profit potential.” Thanks to yesterday’s rally, it looks a whole lot juicier today… details here.
“I don’t know what in all honesty,” White House Press Secretary Robert Gibbs “government can do about it,” highlighting another industry ripe for short selling: flailing newspapers.

Of course, Gibbs assured us President Obama “believes there has to be a strong free press,” but it seems that any hope of a GM-sized bailout check from Uncle Sam was informally squashed yesterday. Alas, papers like The New York Times and McClatchy have borrowed just enough money to go out of business, but not enough to pose the all-so-critical “systemic risk” to the U.S. economy.

Only magnificent failure is rewarded in I.O.U.S.A.
Ten of the 19 banks undergoing government stress tests are going to have to raise capital… that’s the word from The Wall Street Journal this morning. Wells Fargo has now joined Citi and Bank of America on the unnofficial list of banks rumored to have been naughty.

No one will really know for sure until Thursday, when the government has promised to release results. But seriously, who’s cereberally challenged enough to believe this charade anyway?
The mighty greenback is looking knock-kneed and feeble as stocks soar. The dollar index dropped a full point, to 83.8, during yesterday’s rally. That’s a one-month low and nearly 6 points off its credit crisis high.

The dollar swing has given the euro a 2 cent shot in the arm, too. It’s up to $1.34 as we write. The pound followed suit, rising from $1.48 to $1.51 in less than 24 hours. Only the yen held pretty steady… around 98.
Gold likes it when the dollar sucks air. The spot price climbed $15 yesterday and another $10 this morning, bringing the current price up around $915 and ounce. Work it.
Oil has also been enjoying the stock rally, too. The light sweet stuff edged up higher again yesterday, this time to a 2009 high of $54.47 a barrel.
Quietly, gas has been inching back up to levels of concern. The national average price for a gallon of the cheap stuff is now solidly above two bucks… $2.07, to be exact.

Although compared to the average price this time last year — $3.61 — who’s complaining?
A bankruptcy judge OKed Chrysler’s request to tap a $4.5 billion government loan yesterday, even though holders of their senior secured debt have yet to be repaid.

Investors and funds are filing motions left and right to stop the transfer of any assets to Chrysler… at least until the company ponies up $6.9 billion in assets to cover their debt obligations.

We doubt those “evil Wall Streeters” will get their way, but… oy… this thing is already a mess.

“The gurus in Washington say that the Chrysler bankruptcy is prepackaged,” writes Byron King. “And it’s going to be fast and easy. Yeah, right. Beware hubris. Like the previous administration thought that the Iraq war was going to be fast and easy.

“I used to practice bankruptcy law. Is there a courtroom anywhere in this land that’s big enough to hold all the players in a Chrysler bankruptcy? It’s the first ‘big’ automobile bankruptcy in the U.S. since Studebaker in 1933. There’s no recipe book for doing this.

“The judge in the case might just have to book Madison Square Garden to have enough space for all the participants. And everyone is entitled to their day in court. Considering the tens of billions of dollars in play, I expect we’ll see many days in court, up to and including the U.S. Supreme Court. That should take only a few years.”

But at least you’ll be able to drive one of these afterward:

The Fiat 500: Not Currently Available Near You

“After researching, over the past 10 years, the different venues of alt energy,” writes a reader, “I have invested what I can in geothermal. There is no other source that runs 24/7, has zero ecology damage and zero carbon footprint, is available virtually under every rock and is economically less expensive than any other source. We don’t have to wait for the sun, wind or enough uranium to be mined. Oh! We don’t have to figure out how to bury the byproduct in somebody else’s backyard (NISEBY).

“It is such a no-brainer that considering any other way must mean that there are serious politics involved. Maybe the wrong people will make the money. The difference in costs could go to solving the problems raised in I.O.U.S.A. Do you suppose that Big Oil would find it a problem if the grid were run on geo? It can be done.”

The 5: We suppose they’d be annoyed, but as an investor, why choose one or the other? Byron’s Energy & Scarcity Investor has strong plays in both oil and geothermal… check it out, here.
“So what if Byron King is right,” writes a reader, “that China now controls the ‘rare earth metals’ that are integral to the manufacture of guided ballistic missiles (and all the other knickknacks that we don’t really need — and some we probably do).

“I’d rather have the Chinese control them than the delusional, slobbering cowboys in our military. Maybe they’ll do something with these metals other than design weapons whose purpose is the wholesale slaughter of human beings. Besides, what are they going to do with them? Eat them? Of course not. They’ll sell them on the world market at market price and we can go on happily making new bombs, which, it seems, is the only thing we are really good at.”

The 5: Heh. You have a good point there.
“Hey, 5,” writes the last, “thanks for the ‘tip o’ the mug’ to Red Emma’s. In this day of lunatics and liars, Red Emma’s gives us a break, helps keeps us grounded. Not enough of that around these days.”

The 5: Best coffee (and transgender anarchist poetry selection) in Baltimore.

Source: Market Comeback, Sector to Short, Berkshire Meeting, Investing in Swine Flu and More!

The moment diesel fuel crested $3/gallon trucking simply could not compete. This trend will only accelerate now that diesel prices have passed the $4 mark.

It’s no shock that mega-investors like Buffett and Soros are reinventing themselves as modern-day rail barons. You should, too:

• Buy CSX (CSX: NYSE)
• Sell Con-Way Frt. (CNW: NYSE)

Adam Lass

Senior Editor, WaveStrength Options Weekly

***Black’s $15 Million “Magic Number” Could Hand Early Investors 135%

Join Wall Street’s top traders and grab a 135% winner guaranteed… but you must get in by June 31, 2008…

Click here for enrollment information.

Source: Trucking Dies & Railroads Fly When Diesel Fuel Crests $3.00

The release of the U.S. Federal Reserve’s minutes from the April 29 and 30 meeting of the Federal Open Market Committee (FOMC) included several “pronouncements,” none of which you’re hearing from the mainstream press and all of which we here at Money Morning told you were coming months ago.

Four things to think about:

1. The Fed’s doom and gloom forecast of 0.3% to 1.2% gross domestic product (GDP) growth represent the FOMC’s views from over a month ago. Since then, we’ve had a meager round of data showing that a recovery may be building and that there is, in fact, growth. First-quarter GDP was revised upward to 0.9%. And while that might not be as high as some would like to see, it’s still growth… and right on schedule for a possible late-2008/early-2009 pickup.

2. Investors who are looking to the Fed for guidance are driving with their rearview mirrors. The Fed’s data is almost always delayed more than the markets, which means that the smart money has most decidedly and almost certainly priced in the Fed’s “news” months ago. Smart investors have already been taking positions. In fact, that’s what they have been doing since the March 17 lows. They’re also waiting with baited breath for further deterioration in the Fed’s next comments as a result of higher oil prices in recent days… so they can buy in at even better levels.

3. All inflationary measures are rising and have been for over a year now… despite the fact that the Fed has apparently only just recently noticed inflation is rising faster than it would like. And it explains why commodities, some consumer durables and other traditional hiding places continue to defy all odds and rise despite record high valuations like oil, for example.

4. The Fed isn’t running the show and never has, despite what the media and most people seem to think. And “nowhere,” as legendary investor Jim Rogers pointed out when I talked with him recently at his home in Singapore, “does the Federal Reserve Act say the Fed is supposed to bailout Wall Street.” Which means that uninformed investors may be reading something into the Fed’s actions that the Fed itself isn’t charged with.

Federal Defense

Now here’s what to do:

First, when the markets get sideways and uncertain, it’s important to realize that having the proper portfolio structure will save the day – regardless of who’s at the helm (big money) and who might think he’s at the helm (Fed Chairman Ben S. Bernanke),

And by “structure,” we don’t mean individual stocks or allocation. Instead, what you need is an assemblage of stocks concentrated on the trends of the time, such as energy and inflation, for example.

Traditional diversification, while better than nothing, is just a proxy for having no clue about how to select smart investments. It’s like rearranging the deck chairs on the Titanic. It might look pretty, but it doesn’t work when the entire market goes down at once, as so many investors found out between 2000 and 2002 and again recently.

Structure, on the other hand, is a deliberate attempt to manage risk. That’s why famous investors like Berkshire Hathaway Inc. (BRK.A, BRK.B) Chairman Warren Buffett, George Soros, John Templeton and Jim Rogers concentrate their risks, rather than just spread their money around willy-nilly. [Editor’s note: Click here to find out how you can obtain a free copy of Jim Rogers’ new best seller, "A Bull in China."]

Not only do certain sectors bounce faster but they also fall less. And those same sectors can kick off huge income as they go, which means that investors who “buy” into this argument are ahead of the game far sooner than those who don’t.

Second, pay particular attention to unstoppable global trends. Then place money squarely in front of where they meet. This is not rocket science. For instance, the world’s electrical systems are antiquated or nonexistent, which means they need to be updated and simply built in the first place to meet demand. Which is why there’s an estimated $16 trillion behind the trend.

Other “unstoppable trends” include the emergence of China, inflation, energy, and even war, which, in a sad testimony to our times, is a growth industry.

Third, think like a plumber. A little water in the wrong part of your house can do a lot of damage, so it’s important not to let it get out of control in the first place. We’re not referring to micromanaging a longer-term portfolio here, but unless you’re a day trader or even a swing trader, there’s no reason to be constantly tweaking your portfolio in search of smaller profits when it’s the bigger picture that matters.

Source: Four Things to Ponder and Three Ways to Act When it Comes to the Fed

Today is a holiday in Britain and America. But here at The Daily Reckoning, we are on the job – because there are things that need to be reckoned with.

Before we get down to serious reckoning, however, we give you a look at the news from the end of last week.

On Friday, the Dow fell another 145 points. Oil stuck around $132 and the dollar at $1.57 per euro. Gold rose to $925.

Remember when you could buy an ounce of gold for less than $100? We do. Remember when you could buy a gallon of gas for 25 cents? We do. What is Memorial Day for…but for remembering?

First, let us pause for a moment of silence, in honor of our ancestors, our veterans and our war dead. Like Pericles, we recognize that we have a big debt to the generations that went before us — their sacrifices have helped made us what we are…and made the country what it is. They saved. They invented. They built. What we see around us is mostly the result of their hard work…and many years of saving. If our ancestors had used up everything they produced, there would have been nothing left behind. But they didn’t. They left us their inventions and their constructions. They left us money, too. In the post-WWI period up until the mid-‘1980s, America was the world’s biggest creditor. More people owed more money to Americans than to any other nation. Public finances were occasionally stretched – such as during WWII itself – but from the founding of the republic almost until the Reagan years, each federal administration generally tried to leave the government cash till in about the same state it found it.

But in the space of a single generation, that huge legacy of capital and custom has been squandered. Now, the United States is the world’s greatest debtor – by a huge margin. Every year, it spends approximately 6% more than it earns. Its leaders have abandoned the virtuous practices of their ancestors. They no longer even pay them the homage of hypocrisy; they don’t even pretend to balance the budget, and the latest tally reported in these reckonings put the total unfunded liability at $61 trillion. This has effectively bankrupted the average family. It also turns every new baby in the U.S.A. into a major debtor – with more than $100,000 worth of unpaid bills –on the day he is born.

So we have a lot to remember this Memorial Day, and a lot to reckon with.

Warren Buffett was born in 1930. He must remember what the United States was like when it was still growing and genuinely prosperous.

“I’m fond of 1929,” said he a few months ago. “I was conceived that year and have always had an agreeable feeling towards the crash.”

Now, the richest man in the world, Buffett has come to Europe looking for better investments.

In an interview for Der Speigel, the Sage of the Plains said the United States was already in a recession and that it would be “deeper and longer than people think.”

He was in Madrid over the weekend, so we picked up a copy of El Pais to see what else he was saying.

When will growth in the U.S. economy pick up, the Spanish paper wanted to know?

“I have no idea,” Buffett replied.

When will the financial markets stabilize?” El Pais persisted.

“No idea about that either.”

So you see, Buffett could write for The Daily Reckoning; he would fit right in. Go ahead; ask us a question. We’ll give you the same answer Buffett gives:

We have no idea. But we do have opinions.

And in our opinion, George Soros is probably right when he says:

“The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years. However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.”

*** Yes, it was a super-boom that Soros describes. And it coincided with your author’s life. He was born at the beginning of it. He has now reached what he thinks is the end of it. That financial super-boom also probably marked America’s great peak – when everything went so well for so long that politicians and central bankers all wanted to claim credit for it.

But the tippy top of the peak also coincided with a number of trends and events that made it possible. Among the most important was a low oil price. Back in the ‘70s, the price of oil went to $30 – and shocked the world. It stayed around that level for 5 years, long enough to convince people that it was permanent. Consumers – especially in Europe – learned to live with less energy. Oil companies spent fortunes to produce more. And then the price plummeted back to $10…and world enjoyed a great boom.

That boom seems to be over, it drowned in the rising tide of the oil price. The black goo has gone up $50 a barrel since last September. The world’s consumers and producers should simply take the price clue with good grace – cutting back consumption and looking for new supplies, just as they did in the ‘70s.

That is what is happening. The oil companies are spending four times as much on exploration as they did eight years ago. And consumers are being forced to cut back too. But it is not all that is happening. Central banks are fighting the correction with everything they have – and all they have is cheap money.

As you know, the combination of higher fuel prices…and lower housing prices…is squeezing America’s family. Comes news at the end of last week that the typical house in California is down 32% from a year ago. The state also has the second highest foreclosure rate in the nation, with one out of every 204 houses going back to lenders.

The other thing putting pressure on U.S. family budgets is the price of food. For the 15 years, up to 2007, food prices rose only 2.5% per year. This was the “Great Moderation” that central banks felt so proud of. But in the last 12 months, food prices are said to be up 4%.

Luckily for our feckless leaders, it is easier than ever to rob the citizens of their savings, too. In the modern world, the “emperor” doesn’t have to bother employing an army of coin clippers. The government simply credits its account at the Treasury with as many digital dollars as it needs. Counterfeiting has never been easier.

But… a funny thing happened along the way to a complete breakdown of the world’s monetary regime. The old-fashioned parts of the system – circulating coins – have begun to reveal the fraud. A penny, which isn’t even copper anymore (it’s 97.5% zinc and 2.5% copper), costs 1.26 cents to make. And a nickel, which isn’t really nickel either (it’s 75% copper and 25% nickel), costs 7.7 cents.

Copper and nickel prices have tripled since 2003, and zinc has doubled. One congressman estimated minting the coins at these high prices cost taxpayers $100 million last year.

Like pennies and nickels, gold coins rise in cost as our government debases its currency. They’re a noncorrelated asset (meaning they don’t follow the value of the stock market). And from time to time, rare gold coins will make you a tremendous amount of money – they’ve done pretty well since 2003 when we began recommending them. Click here to access our report on our favorite gold coins to buy now.

The downturn in the economy means huge profits for pawnshops. And it’s not just gas-station attendants and waitresses fueling the growth.

A Philadelphia pawnshop reported making more loans to upper-middle class citizens and businesses. One local, high-end jewelry shop pawned $150,000 of inventory just to make payroll. Investors are pawning gold and diamonds to cover margin calls on stocks. And a Grammy-nominated Philadelphia musician pawned 30 guitars, worth $170,000, to cover mortgage payments on properties he bought during the real estate boom.

Sean Goldsmith attended Berkshire Hathaway’s annual shareholders meeting. Here’s what he heard…

Buffett thinks small investors shouldn’t buy Berkshire Hathaway stock. He thinks he’ll be lucky to grow the business 8% to 10% in the future (versus 22% a year in the past).

Due to Berkshire’s size, it’s difficult to find companies large enough to make a difference in the bottom line. Buffett estimated a company would have to be $50 billion or larger to generate a reasonable return, and outperformance is difficult when investing in a universe that small. Buffett said if a small investor is willing to look at thousands of companies, he’d find more attractive businesses than Berkshire.

While naifs blame the oil companies for rising prices and demand the counterfeiters in Washington do something about it, we’re willing to bet Washington is no better at ginning up oil supplies than it is at running a balanced budget.

As such, regardless of what Congress says, oil prices are very likely to keep rising. Readers of the S&A Oil Report are doing a pretty good job riding the bull. They’re up 176% on Brazilian oil giant Petrobras (PBR); 61% on Transocean (RIG), the world’s largest offshore driller; 60% on Chevron (CVX); and 96% on Occidental Petroleum (OXY). And the huge gains won’t stop there. We’re in the midst of the biggest energy bull market of our lifetimes.

William Doyle was rich when he was earning $780,000 a year to head Potash Corp of Saskatchewan and held $7 million in stock options at the end of 2003. Then the agriculture boom hit, and fertilizer prices soared. Potash prices have gone from $100 a ton four years ago to more than $600 today, and some forecasts call for $1,000 by year’s end.

The company’s share price followed suit, quadrupling in the last 16 months. Now Doyle’s stock options are worth almost $600 million – a number never before seen by an executive of a Canadian public company.

The ag boom is making people very rich, and Tom Dyson found the best way to play it. His latest International Strategist recommendation is another potash mine. If we assign a forward P/E multiple of two to Tom’s pick, it’s worth $2 billion. Right now, the stock trades for just over $500 million.

Meanwhile, Potash Corp trades for 43 times earnings (a tad rich, perhaps?). When you buy Tom’s stock, you get an energy, timber, and metals business for free. To learn more about International Strategist and receive Tom’s latest pick, click here…

Good investing,

Porter Stansberry and Dan Ferris

The Sunday Times’ advice appears to have fallen on deaf ears. The following day, Monday, oil hit $120. Another record. Rebel attacks in Nigeria disrupted production and renewed Turkish action against Kurdish insurgents in Northern Iraq were given as reasons why. They combined to push West Texas Intermediate sweet light crude to $120.36. Brent Crude hit a peak too – $118.58. Nigeria and Iraq combined accounted for 5.5% of global production in 2006 according to BP. Where would the price go we wonder if Saudi – accounting for 13% – announced peak oil?

As it is Goldman Sachs weigh in with another oil price forecast this morning. It suggests the Sunday Times is at best a little early on their call. We could see $150-200 oil in the next two years they calculate as supply plays tortoise to the hare that is demand. Shell CFO Peter Voser reiterated last week they see a market that is well supplied but still think prices will rise from here. Morgan Stanley analyst Hussein Allidina reminds us:

“The global oil market currently has very little margin for error with spare capacity constrained.”

Brazil may have found an offshore “elephant” or two but the stuff is six miles below ground and requires a pushing of the technology frontier to develop. Whether that proves economically viable remains to be seen.

Predicting the peak and the duration of the up cycle in oil prices this time around remains a tricky one admit Goldman Sachs. As we’ve noted before, Jim Rogers is less shy on the broad subject of commodities in general. Expect the commodity bull to run to 2014 or beyond he says (adding he’ll shout when it’s time to get out!). And the key driver is the industrialisation of the developing world: first and foremost, China. And there consumption continues to rise in spite of the relentless rise of crude – up 25% this year alone. In China’s case its thirst comes with the added kicker of inventory stockpiling ahead of the Olympics.

So it doesn’t look like the strengthening headwinds of oil prices (or commodity prices generally) are going away any time soon. And that hurts everyone – from the car driving commuter at the micro level all the way up to UK plc. Ernst & Young’s Item Club reckon a $150 oil price could cut growth to nearer 1% or less next year and push up inflation. At $200 we could see 6% inflation by 2010 they warn. Mervyn King will be an experienced letter writer (to the Chancellor) should that day come to pass.

So while the eye of the credit market storm looks to have passed, commodity prices continue to agitate and could yet sink even the modest economic growth projections of the industrialised world.

Warren Buffett told the 31,000 faithful at the Berkshire Hathaway annual shareholder jamboree that the worst has passed for Wall St but not the man in the street. Those with mortgages that is. There’s a lot more pain to come for US mortgage holders predicts capitalism’s nearest thing to a rock star.

Berkshire Hathaway actually took a 64% earnings hit in the first quarter from derivative losses but with a $40bn war chest it’s a good time to be a value investor with an eye for a bargain. He’s shopping in Europe too and is rumoured to be adding to his insurance empire by buying RBS’s insurance business. Elsewhere, US private equity firm Apollo wants a piece of battered UK house builder Barratt. And another private equity house, Blackrock, is buying $15bn worth of subprime mortgage debt from UBS.

Another home builder, Bovis might find interest from value investors too, following a profits warning today. Buyer reservations collapsed 70% since it released year end results on March 10. The shares at 457.75p are down 2.8% today as at 12.30pm. From a 52-week high of 1,160p and against a tangible book value of 562p/share according to the caveated calculations of ADVFN.

With European bourses showing up red today and the FTSE100 down 44, last week’s optimism is starting to wilt under the pressure.

Regards,

Rob Mackrill
The Daily Reckoning

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Oil is up because people think the United States will avoid a recession. “Oil tops $120 a barrel as U.S. optimism rises,” says a headline in the Financial Times . And many think the Hillary/McCain summer gas tax holiday concept may be implemented – which would encourage people to use more gasoline!

John…Hillary…good thinking. Get people out on the road…using more fuel. Great idea. Even Thomas L. Friedman can see what vote-pandering imbeciles you are (more below…). Need we say more?

But say more we will…because, on page 1 of the Financial Times is a photo of a mob in Africa… What has stirred them to riot? The latest election result? Someone dissing their religion? No, high food prices!

It is the worst of times for people with big appetites and little money. Many of them will go hungry. And an empty belly is a dangerous thing. First, people develop a “lean and hungry look.” Then, they stab you in back.

Ah yes…predictably…inevitably…the world’s intellectuals, economists, yahoos, and pandering politicians are having trouble following the trail. They ought to look down at their feet. They would see the breadcrumbs…from the door of the Fed’s headquarters in New York…through the deep woods of subprime and leveraged derivatives…and right up the hill of soaring commodity and gold prices. That’s right…the Fed is trying to keep the money and credit moving. But it is going where it wasn’t supposed to go – into commodities, food, oil and gold. Still, the experts can’t see it. Instead, they read the polls, watch the TV, and come to the wrong conclusion. What is the cause of the rise in food prices, they ask? Speculators!

Another lead story today: “India targets food futures.” India imagines that food prices are being driven up by greedy hedge fund managers. It is considering a “blanket ban on food futures trading,” says the FT .

Why not? Nothing is too absurd or too counterproductive to escape the notice of the world improvers. Just look at John McCain’s big idea – a “league of democracies.” More about that coming up soon too… For now, let’s stick with the financial news…

The big story seems to be the idea that, as our chief financial researcher in London, Theo Casey, put it: “doom and gloom has been overplayed.”

Since the drama of Bear Stearns, no other major financial firm has failed. Quick action by the Fed and other central banks seems to have saved the world.

“Has the worst of the financial crisis passed?” asked Le Monde yesterday.

“Yes,” said the world’s richest man over the weekend. Warren Buffett told his shareholders that the “worst of the credit crisis on Wall Street is over.”

Maybe he’s right. But let’s look at the numbers. In 2006, alone, nearly $7 trillion of new debt was issued worldwide. Maybe double that amount in the entire five-year period – 2002-2007. So far, says Bloomberg, since the beginning of 2007, less than $200 billion has been written off. You can do the math yourself, but Fred Y. Jones guesses that total losses so far probably don’t exceed 1% of the debt sold in the last 5 years.

So far, so good, in other words. This is the best of times. The Fed has cut rates 7 times. And it now takes on its balance sheet – as collateral for loans – the very credits that are likely to go bad…credit card debt, student debt, and even car loans. It has only 200 basis points left, before it gets to zero, and there are approximately $10 trillion (just guessing) worth of credits that still could go bad. If just 5% of them went bust…the loss would be $500 billion. Maybe the doom and gloom is underplayed. Moving bad debt from the people who deserve it to the Bank of All the Americans – the Fed – doesn’t turn the bad credits into good ones. It merely allows everyone to keep doing what they’ve been doing…that is, to keep pretending that everything is all right.

But everything isn’t all right. Far from it. And budding out in our brain is a little idea about why the situation can’t be fixed…and why a major breakdown may be on its way…more to come…about how democracy and modern, state-guided capitalism really work.

Interestingly, Buffett is famously pro-America. You bet against American business and you will go broke, he says. But over the last 10 years, betting against American business was the best thing you could do. The dollar sank…and foreign markets – particularly emerging markets – soared.

Buffett hasn’t missed the point. He paid $4 billion for an Israel-based metalworking company in 2006. And now he’s coming to Europe to scout for opportunities. He’ll no doubt want to stop by The Daily Reckoning headquarters in London for our advice.

Warren, look for the building with the golden balls. We’re waiting for you.

*** “He must have hired a new ghost-writer because this is actually good,” writes colleague Byron King. “On energy, Friedman is nailing it exactly.”

Thomas L. Friedman…writing in the New York Times :

“…If you are going to use tax policy to shape energy strategy then you want to raise taxes on the things you want to discourage – gasoline consumption and gas-guzzling cars – and you want to lower taxes on the things you want to encourage – new, renewable energy technologies. We are doing just the opposite.

“The McCain-Clinton gas holiday proposal is a perfect example of what energy expert Peter Schwartz of Global Business Network describes as the true American energy policy today: ‘Maximize demand, minimize supply and buy the rest from the people who hate us the most.’

“This is not an energy policy. This is money laundering: we borrow money from China and ship it to Saudi Arabia and take a little cut for ourselves as it goes through our gas tanks.”

*** Boris Johnson is the new mayor of London. He’s also the former editor of the British magazine, The Spectator , for which we occasionally contribute an article.

The papers are so full of claptrap and humbug this morning…we don’t know what to laugh at first.

There is Hillary’s proposal for a ‘Gas Tax Holiday,’ for example. The initiative is so absurd that even trained economists can see through it. Alice Rivlin, Bill Clinton’s former budget director said she was “appalled” at what “looked like pandering.” One hundred economists signed an open letter criticizing the proposal – pointing out the obvious, that it would increase driving and divert money now going to the U.S. government to the governments of Arab oil exporters.

Obama has an advantage; Paul Volcker is advising him. So, we can expect a little better. But little better is what we get. Obama proposes a cut in the payroll tax (which finances Social Security) – up to $1,000 – to help families “offset the cost not only of gas, but of food.”

As we have said many times, we never met a tax cut we didn’t like. But what troubles us is: where are the cuts on the other side of the ledger? If Social Security has less money, how will it keep up with baby boomer retirements?

The weekend press tells us that people are beginning to worry about whether they’ll be able to retire at all. The middle class counted on rising house prices. But now house prices are going down. What are they going to do?

They’re going to start saving, is the answer. “Consumers to the sidelines,” says a Wall Street Journal headline. “Americans cutting back for Mothers’ Day,” says a headline in the Los Angeles Times.

You will recall why stocks were certain to go to the moon, dear reader. It was “Dow 36,000″ for sure – because the baby boomers had to put money in stocks so they could retire. When that mirage disappeared, they turned to residential real estate. People figured that they could buy an extra house at the beach. They would enjoy it on weekends and holidays…and then, when the time came to retire…they could sell the main house and live off the proceeds. That strategy too was fine – as long as prices were rising.

And now the boomers find them themselves with no easy way to finance their golden years. (They should have bought gold when we first suggested it!) What can they do? They have to resort to the old-fashioned, tried and true method – thrift and savings.

Here, we will spell it out:

You take the total amount of income, after tax. Then, you subtract the total amount you spend. If the result is a positive number, at least you are headed in the right direction. If it is a negative number, we suggest you apply for a job in government…maybe with the Council of Economic Advisors or the Congressional Budget Office. Besides, the federal retirement system is the most generous one around – outside of Wall Street.

Yes, dear faithful reader…the economy is getting a nip on the derriere. The consumers who spent what they didn’t have are now forced to save the little they do have. Result: the consumer economy is slowing down. The bubble has sprung a leak…and the feds desperately try to keep pumping it up. (More below…)

But forget the math…forget the ledgers…there’s an election to be won…and faint humbug n’er won fair voter. No, the way to win is to go all out…tell the biggest lie possible…promise the moon…and pretend to be something you are completely and emphatically not.

George W. Bush, for example – son of a CIA Chief, Vice President and then U.S. president, educated at Andover, Yale and Harvard, from one of America’s richest, most elite New England families – passed himself off as a straight-talking yahoo in a cowboy hat. Now, both Obama and Hillary are trying to pretend that they feel the working classes’ pain. Hillary appeals to the redneck instinct for toughness; she will “obliterate” Iran if it lays a hand on Israel, she says.

(Why the yahoos from Kentucky should care what goes on between Israel and Iran has never been fully clarified…but in the final days of imperial grandeur no sparrow can fall anywhere in the world without setting off sensors in the Pentagon…and eliciting a rapid response from the military/industrial/political complex!)

Obama, meanwhile, can pretend to be a man of the people too. He drinks beer, when the occasion calls for it… and shoots hoops with the locals. Of course, neither politician would probably give the blue collar workers the time of day were it not for the fact the yahoos are likely to vote tomorrow.

Yes, dear reader, tomorrow is now the big day…the showdown between the two democratic candidates. If Obama wins big…he can say goodbye to Hillary. If the Clintons win big, they could still win the nomination…and probably, the election. At least, that’s what the pundits say…

And so we see how democracy really works…by flimflam and bamboozle.

*** We have set up shop in a café near Auteuil in Paris…copy of the International Herald Tribune in hand…and someone’s wifi connection at our fingertips. It is a delightful spring morning in Paris…the chestnut trees are in flower…birds sing, the sun shines, and beautiful women amble along the sidewalk.

We had a café crème and a croissant…and then, we were enjoying the view so much, we ordered another. The waiter brought a check – the damage was just $15, very reasonable, under the circumstances.

The relevant circumstance is that the price of food is soaring everywhere. The grains are selling near record prices…and so is oil. This is no laughing matter. Food is a relatively minor part of our own family budget; the rising prices are only a nuisance. But a news report from Reuters tells us that 20% of Asians live on less than a dollar a day. Many are farmers with their own local supplies of cheap food. But more and more of them live in cities and pay global prices for their daily bread.

Rising food prices are producing famine-like conditions for many of these poor people. For others, they are wiping out years of financial progress, creating what Reuters calls a “Poverty Time Bomb.”

But that party is over. And in all probability, bank stocks will remain poor investments over the next five years and beyond.

In the next few years, I see a host of formidable challenges facing the badly bruised financial services industry. This includes new government regulation, losing the traditional investment banking deal-flow and far less lucrative leveraged loan portfolios. All these factors are conspiring to make financial services stocks a dull investment proposition.

The Financial Sector – Flying High Until Last July

The Easy Money is History

Most banks have been operating as casinos for years…that is until last July. Suddenly the sub-prime crisis imploded credit markets.

Sub-prime’s collateral damage will revolutionize the way banks do business going forward. In all likelihood, some of the most profitable revenue streams on Wall Street will disappear, mostly those tied to CDOs or collateralized debt obligations and other illiquid and hard-to-price synthetic securities. Worse, government regulators are bound to reshape the way investment banks mark these illiquid securities. In some cases, I can see banks even forbidding to trade the more exotic and leveraged securities that risk trashing the financial system.

In a nutshell, the investment banking business model is about to change. For shareholders, this implies far less profits as traditional sources of revenues are streamlined or liquidated altogether in 2008 and beyond.

The Fed, Bear Stearns and Systemic Failure

In order to avert a probable run on U.S. and many international prime brokers in March, the Federal Reserve orchestrated a US$39 billion dollar bailout for Bear Stearns. This event marked what many pundits called the “end of the sub-prime crisis” because the Bernanke Fed unofficially guaranteed all major U.S. financial institutions would remain solvent.

The implications of this watershed event are enormous. The Bear Stearns saga shows with brutal clarity that modern financial markets are even more tightly interwoven than before. That leaves regulated institutions even more exposed to each other’s risks. The next U.S. administration will spearhead a global effort to legislate and superimpose a watchdog on the financial services industry as the threat of systemic collapse is addressed through policy initiatives. More rules or restrictions won’t be bullish for bank and investing banking revenues.

The bottom line for the banks and their shareholders is not inspiring.

Greater financial market regulation, especially as it pertains to credit risk, will reduce long-term earnings for most investment banks worldwide. Even with Wall Street’s uncanny ability to create new models to maximize profits, government regulation and a new set of restrictions will likely dilute the innovative financial product development.

Increasingly, the government will scrutinize dealers and market-makers to isolate where systemic risks threaten the global financial system. And I can see the government destructively harsh on Wall Street.

Buffett Correctly Predicts Shareholder Dilution

In an interview with the National Post in Toronto, Canada, earlier this year, Warren Buffett of Berkshire Hathaway urged his audience to avoid most bank stocks in the future. Buffett stated that although some banks might be fair long-term investments, other sectors of the market offer far superior returns.

Buffett correctly predicted a wave of rights offerings. In other words, banks diluted their own banking shares by issuing a rash of new, public shares to finance bulging losses. Five months after his speech in Toronto, Buffett’s prediction came true. Today, many U.S. and European banks have already announced new rights offerings this year to shore-up depleted capital ratios.

For the record, Buffett does own stakes in U.S. Bancorp (NYSE-USB) and Wells Fargo (NYSE-WFC). The former is probably the cleanest of all U.S. large-cap banks with no sub-prime exposure.

U.S. banks have already issued more than US$26 billion worth of preferred stock in 2008 to bolster their balance-sheets. Merrill Lynch this week announced a US$4 billion offering while Citigroup has issued billions in preferred securities since late 2007.

To date, global banks have lost over US$200 billion dollars with Switzerland’s Union Bank of Switzerland (NYSE-UBS) responsible for almost 20% of that total. The International Monetary Fund or IMF has pegged total losses tied to sub-prime and other credit losses to peak at roughly US$1 trillion. That suggests banks still have a stash of cash to write-down over the next several years.

Dead-Cat Bounce or Market Bottom?

From their lows in mid-March following the near-demise of Bear Stearns, U.S. bank stocks have gained 14%. Now investors are starting to bargain hunt amid the credit wreckage.

To be sure, some banks are probably worthy investments at these levels assuming write-downs have peaked and their respective dividends won’t be reduced or cut entirely. But for most of the financial sector, more pain lies ahead as other segments of the credit markets and real estate come undone.

MAXJet, Eos and Silverjet set up as specialist business class operators. MAXjet began in 2003 and went bust in 2007. Eos, the name of a Greek god of the dawn, set up in 2004 and went bust last Sunday. In Greek mythology, Eos opened the gates of heaven every day. Sadly, its modern day equivalent just passed through them.

The UK’s AIM-listed Silverjet is the last one standing. For how long we wonder? It began operations in 2006 and Air crew website Cabin Managers strikes a cautious note. It is warning against applying for work there until the “financial picture improves”. Two proxies presumably serve to monitor the situation. The oil price and the share price. Oil is $117 and the shares, from a high of over £2 last March, now trade at 14.5p.

It’s shopping time for the world’s most celebrated investor and it certainly isn’t airlines. Indeed, a capitalist present at the inaugural flight of the Wright brothers would have shot them out of the sky, Warren Buffett once quipped.

But for the world’s greatest investor prices have come down, and it’s the moment to be greedy when others are fearful… especially when you’re sitting on a $40bn cash pile.

Buffett likes simple businesses he can understand. He likes globally recognised brands with staying power and significant ‘economic moats’ too. And he certainly didn’t become the business world’s equivalent of Croesus without recognising a good price when he sees one. Mars and Wrigley have ticked all the right boxes

Buffett has chipped in $4.4bn to Mars’s (think Mars bars, Snickers, Twix, M&M and more) efforts to buy chewing gum maker Wrigleys (think Spearmint, Jiucyfruit, Orbit, Hubba Bubba and more).

Mars is offering $23bn all told. Buffett will secure a 19% stake in Wrigley for a “discounted” $2.1bn reports The Times today. The combined Mars/Wrigley group will overtake Cadbury’s to become the largest sweet maker in the world with over 14% of the market from $27bn sales.

The spotlight now falls on the prospect of consolidation for other Charlies running chocolate factories. The UK’s Cadbury Schweppes is shortly to be demerged into chocolate business London-listed Cadbury plc and US-listed soft drinks maker Dr Pepper Snapple. Speculation is increasing that a deal between the newly demerged Cadbury and Hershey could finally happen following talks that came to nothing last year. Interesting to note that, from a quick scan of the numbers, Wrigley managed to make almost three times Hersheys’ net income last year on sales only 8% higher.

So in Mr Market’s eyes Hershey is worth slightly more than a third of Wrigley, yet in 2005 and 2006, we find the a rather different comparative performance. Hershey’s sales exceeded Wrigleys, and in 2006 it made more money

The Times describes Warren Buffett as the world’s richest man, with a fortune of $62bn. Though he’s not the richest in terms of family wealth, according to the latest Sunday Times rich list last week-end. India’s Mukesh and Anil Ambani (who?) sit atop an $86bn petrochemicals fortune. Top of Britain’s rich list today is another Indian family – the Mittals, with an estimated £27.7bn fortune from steel. Ten years ago the Sainsbury family topped it with a £3.3bn retailing empire. In a decade or so no doubt we’ll gawping at the world’s first trillionaire. Or maybe less given the accelerated rate at which petrodollar wealth is being amassed.

And petrodollar wealth is showing up in state managed wealth too. The world’s Sovereign Wealth funds – in good part recycled petrodollars – could exceed the US economy (est. $13.8trn) in seven years time reports the Guardian. In 2007, their collective value rose 24% to $3.5trn from an estimated $0.5trn in 1990, according to the IMF. In fact, they have been growing at 24% a year for the past three years. Says Jan Randolph, head of sovereign risk at Global Insight:

“Armed with such large amounts of debt-free cash, sovereign wealth funds are the new financial power brokers, replacing the combined financial muscle of hedge funds and private equity, and usurping central banks as the international capital providers of last resort.”

So move aside Bernanke, Trichet, King and co and here comes the new muscle with a bulging wallet.

More than 20 countries have established SWFs says the International Monetary Fund, but they sound relaxed about their growth. In the greater scheme of things, $3.5trn isn’t such a huge sum when set against the estimated value of US securities at $50trn, or the global value of traded securities at $165trn.

Regards,

Rob Mackrill
The Daily Reckoning

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