Dow Jones Industrial Average headed to 11,000

Posted by Shyam Moondra

In the past few days, the stock market has been very volatile, up 200 points one day and then down 200 points the next day. Some of this volatility may have been caused by the year-end window-dressing by mutual and hedge funds whose fiscal year ends in October. The market had gone up quite a bit since it bottomed out last March, so it was inevitable that some investors would want to take profits and short sellers would move in aggressively to create a downward momentum.

There are people who think that the market correction of the last few days may in fact be an exceptional buying opportunity for the long-term. Some of the stocks, that did exceedingly well since March, have been hammered down in recent days by as much as 25%. The bulls point out the following positive trends that suggest that the market is headed much higher:
· The recent quarterly earning reports exceeded analyst expectation by a wide margin. Most companies increased their guidance for the future.
· The latest GDP report showed that the economy grew at a faster rate than anticipated.
· The corporations have strong balance sheets, hoarding a lot of cash to support future capital investments.
· The corporations did a marvelous job in managing their cost structure during the recession and they have never been more lean and mean. That means their profit margins will expand rapidly as the economy recovers.
· The inventories are at historically low levels, suggesting that the industrial production may move into a higher gear (even if demand does not increase significantly), which means more jobs down the road. Recent industrial production report, showing better than expected increase, supports that belief.
· The stimulus spending was back loaded; as much as $585 billions worth of stimulus still remains to be spent through 2010.
· The Federal Reserve Board has indicated that money supply will remain bountiful and interest rates will remain low for the foreseeable future. Historically, liquidity and low interest rates have always favored the stock market in general and the financial sector in particular.
· Weak dollar has enhanced competitiveness of multi-national corporations that will garner a bigger market share as the global economy recovers. Weak dollar is also helping to reduce the trade deficit.
· Recent labor force reductions have considerably improved productivity that will expand the profit margins of the corporations in the near future.
· Since the capacity utilization remains low and demand is still weak, inflation is not going to be a problem in the foreseeable future. This gives the Fed some flexibility to keep interest rates low at least until the second-half of 2010.
· Recent housing reports suggest that the housing market has bottomed out, as indicated by the recent increases in home sales and home prices.
· The consumers have done a much better job in controlling their spending and saving more during this recession than any other recession in the past. This bodes well for the economy because as soon as the economy picks up some speed, the consumers will be ready to start spending freely again.
· The stocks are by no means over-valued with the average forward PE ratio in the low 10's. Recent merger and acquisition activity and share buyback announcements (e.g., by IBM) affirm that equity valuations are very attractive.

The bears have their own reasons for being pessimistic for the near-term. They cite the following trends that make them cautious:
· The stock market has gone up over 50% since March, making it the largest up move in a short period ever. It should be kept in mind though that the market went down too much in March because of the fear that some of the biggest financial institutions could go bankrupt, causing a systemic breakdown of the entire financial sector. However, that never happened and we are past that possibility now. One could argue that the market should not have gone down so much in the first place, and, therefore, it's misleading to keep harping on the 50% appreciation. Had market not gone down as much as it did because of sheer panic, the resulting appreciation would have been quite modest and considered normal in the aftermath of a severe recession.
· The unemployment rate will remain high at least through 2011, making it a jobless recovery. High unemployment rate will keep consumer spending in check. Since consumer spending fuels two-third of the economy, we may not see a quick recovery from recession any time soon. The counter argument would be that, while it's true that the lagging employment indicator would be slow to recover, the consumers are not going to wait for full recovery before they start spending again. All they are waiting for are the signs of a recovery-trend which will become obvious within the next six months, a lot earlier than 2011.
· Recent government spending (e.g., stimulus package and bailouts) has significantly added to the federal debt and budget deficit is widening. This will eventually lead to higher interest rates, choking off the economic recovery. We should, however, note that as the recovery takes hold, treasury revenues will increase and the budget deficit will eventually abate. Nevertheless, President Obama and the Congress would have to come up with a credible plan to address the issue of debt and budget deficit through a combination of spending cuts and tax increases for the wealthy individuals and corporations (shutting down off-shore tax havens and closing tax loop-holes).
· Weak dollar will lead to higher inflation because imports will become expensive which, in turn, will induce the domestic producers to increase their prices.
· The credit card losses and commercial real estate losses will keep the financial sector under pressure for the foreseeable future.

The stock market always looks ahead and most economic indicators (GDP growth, corporate earnings, housing sales and prices, industrial production, etc.) point to economic recovery from the worst recession of our times. While the recovery may be erratic, its direction is not in dispute. Early this year, industrial production was declining which led to layoffs, which, in turn, led to lower consumer spending, and that led to lower corporate profits, thereby creating a downward spiral in which each economic calamity was feeding into the others. But now we are in the process of an upward spiral that will restore employment, corporate profits, and stock prices over time. While there are very few plausible hazards that could choke off the recovery, there are many more potential catalysts on the horizon that could in fact propel the stock markets to new yearly highs in the coming months. The Dow Jones Industrial Average at 11,000 before the end of 2009 is not a far fetched possibility. One thing unique about Americans is that they are driven by a sense of optimism and hope. They thrive in adverse conditions and turn calamity into opportunity.

Proposed health care bills will not reduce costs

Posted by Shyam Moondra


The health care bills passed by various committees in the Senate and House will cover many, if not all, of the 40 millions or so people who are presently uninsured, thanks to the subsidies provided by taxpayers' money at a cost of little less than $1 trillion over ten years. However, these bills will most likely increase the costs for those who presently do have the insurance coverage and/or the quality of health care will go down. All in all, none of the bills being currently considered by the Congress is satisfactory and the American people have a reason to worry about the future.

The following are the major weaknesses of the health care bills being considered and what needs to be done to improve them:

· The main problem is greed and profiteering among the service providers. We need to regulate insurance companies, hospitals, and drug companies as utilities. Health care is just as essential as electricity, gas, water, and telephone service. The state public health care commissions (structured in the same way as state public utility commissions are structured) should decide on the rates and profit margins of the health care providers. This approach will ensure that the health care costs remain under control.

· The final plan must have a non-profit government option to keep the competitive pressure on greedy health care providers. This option will provide an added protection if the other methods of cost reductions don't produce the desired results. Without this option, it does not seem fair to require people to buy mandatory insurance at inflated rates from the profit-hungry providers. This mandatory imposition on the public without a means to buy the insurance at a reasonable rate may even be unconstitutional.

· The inflated health care costs are partly due to exorbitant malpractice claims and huge malpractice insurance premiums hospitals and doctors have to pay that induce them to over-prescribe tests and treatments just to protect themselves. Without an effective tort reform, it's very unlikely that any of the proposed health care plans will result in lower health care costs.

· The current patent laws make it difficult for competing drug manufacturers to bring out inexpensive generics to the market place. The final health care plan should change the patent laws shortening the duration of exclusivity to enable generic offerings sooner. Also, the plan should allow re-importation of drugs from Canada and Mexico.

The best Afghanistan strategy: Give what Gen. McChrystal wants and then negotiate with the Taliban from strength

Posted by Shyam Moondra


The U.S. focus on Afghanistan began in 1993 after Al Qaeda operatives exploded a bomb in the underground garage of the World Trade Center in New York that killed six people and injured 1,042. The WTC attack was followed by the 1996 Khobar Towers bombing in Saudi Arabia and 1998 attack on the U.S. Embassy in Nairobi, Kenya that resulted in the murder of hundreds of people. In 1998, President Bill Clinton ordered cruise missile attacks on Al Qaeda training camps in Afghanistan. The Clinton administration demanded that Taliban, the rulers of Afghanistan at the time, expel Al Qaeda from Afghanistan but the Taliban refused. On September 11, 2001, Al Qaeda terrorists hijacked three commercial jetliners in the U.S. and crashed them into the twin towers of the WTC, the Pentagon, and the countryside of Pennsylvania, killing about 3,000 people. That attack led President George W. Bush to issue an order to invade Afghanistan, remove the Taliban from power, and install Hamid Karzai as the President of Afghanistan. Osama bin Laden, the head of Al Qaeda, escaped and is now believed to be hiding in the tribal area of Pakistan bordering with Afghanistan. Right after the removal of the Taliban from power, the U.S. efforts in Afghanistan were scaled down to support the war in Iraq. The vacuum created by the withdrawal of the American forces couldn't be filled by the corrupt and inept government under Karzai that led to the comeback of the Taliban. The Taliban now controls 80% of the country and they are on the offensive while the casualties of the NATO forces are mounting.

Gen. Stanley McChrystal, the commander of nearly 60,000 U.S. troops in Afghanistan, believes that he would need at least 40,000 more troops to stop the Taliban from taking over the country. His proposed strategy combines the military actions with the rebuilding efforts to win over the support of the general population. These requests are coming at a time when the U.S. government can least afford to increase the war spending because of the balooning budget deficit.

First, let us look at the players in the Afghanistan conflict:
· The Taliban (from the Arabic word for student, “taleb") are fundamentalist Sunni Muslims, mostly from Afghanistan’s Pashtun tribes. The Taliban dominates large swaths of Afghanistan and a large part of Pakistan’s Federally Administered Tribal Areas. They scorn democracy and consider any secular or pluralistic political process as an offense against Islam. The Taliban’s version of Islamic law, or Sharia, is deviant from prevailing interpretations of Islamic law and practice. They have been fighting foreigners for centuries – modern armies of Britain and Russia couldn't win there. They are tenacious, they know the terrain, and they can fight with limited resources. The history tells us that Afghanistan can't be governed without their support.

· Al Qaeda is a militant Islamic terrorist movement that is run by Osama bin Laden. It started out as an organized populist effort to dethrone the Saudi royal family. The Taliban, a quasi-political movement within Afghanistan, gave Al Qaeda shelter in Afghanistan, where Al Qaeda trained for and planned terrorist acts around the world, mostly against the western countries and Saudi Arabia. The two movements had similar outlooks except that the Taliban's terror activities were inflicted mostly on its own citizens.

· President Hamid Karzai, by most reports, is a corrupt and inept politician, who may be involved in drug trafficking and who is believed to have stolen money from the international aid funds. Karzai is accused of winning the recent presidential election fraudulently and he is not very popular among the people of Afghanistan, especially outside Kabul. Unfortunately, the U.S. is in a bind because constitutionally Karzai is the only person the U.S. can deal with. If the U.S. exit strategy is to stabilize Afghanistan before leaving, Karzai is hardly a part of the solution.

The U.S. conflict with the Taliban did not begin because of any ideological differences, although the U.S. strongly opposes Taliban's treatment of women and their application of extreme medieval Sahira laws. The main U.S. complaint against the Taliban is that they provided a safe haven to Al Qaeda that continues to plan terrorist attacks against the U.S. and its allies even today.

The current situation on the ground favors the Taliban. Given that they are gaining strength, the U.S. cannot just walk away, as some Democrats are suggesting. A total withdrawal of the U.S. forces would amount to conceding defeat, which will have negative policy consequences elsewhere in the world, especially with respect to the Middle East, North Korea, and Iran. The U.S. will lose credibility and moral standing if they just pack and leave; the people of Afghanistan will suffer immensely. Besides, Osama bin Laden has not been captured yet, so if NATO pulls out, Al Qaeda will move back into Afghanistan. Therefore, withdrawing from Afghanistan is strategically a bad idea. At the same time, given the history of Afghanistan and Taliban, it's a wishful thinking that NATO could eventually win militarily. A negotiated settlement with the Taliban may be the only viable end-game. However, any negotiation with the Taliban at this juncture, when the U.S. position is relatively weak, is not advisable.

Given the way things stand today, it makes sense to go along with the McChrystal approach and send more troops to Afghanistan. After a year or so, assuming NATO is able to get the upper hand, we could then initiate negotiations with the Taliban and make a deal that incorporates the following terms:
· Change their certain attitudes – such as role of women in the society, education of women, respect for individual liberties, democracy, etc.
· Eliminate opium farms and stop drug trafficking.
· Help find Osama bin Laden and eliminate Al Qaeda.
. Do not support the Pakistani Taliban and destabiliize Pakistan. Cooperate with Pakistan to root out Al Qaeda.
· In return, the western countries and other oil-rich countries would offer financial aid – not in the form of cash but in the form of contracts to American and European companies to build roads/bridges, hospitals, schools, water treatment facilities, power stations and electricity grid, and democratic institutions (don't give cash because most of it will end up in the pockets of the Taliban rulers). The objective must be to make a difference in the lives of the people of Afghanistan.