The world markets are looking good

We are sending a message of optimism about many markets. We are optimistic about Asian stocks in Indonesia, Korea, Malaysia, Singapore, and Thailand. We are also optimistic about commodity producing stocks in countries such as Canada, Australia, and Brazil. U.S. export companies including those in technology, shipping railroads, autos, food, medical, basic materials, and other U.S. sectors are also attractive. We continue to favor European export stocks in the same areas, and we believe that U.S. bank stocks continue to be attractive as a trade. We are bullish on commodities such as gold, oil, iron ore, coal, wheat, and soybeans.

Not bullish on bonds (and some currencies). We are bearish on bonds, and we are bearish on the Euro and the U.S. dollar over the longer term.

The dramatically expanding U.S. Federal Reserve balance sheet. Our friend, Larry Jeddeloh of The Institutional Strategist, in his Market Intelligence Report of April 14, 2010 brought an important point to our attention. He points out a large increase of $421 billion in the Federal Reserve’s balance sheet in the same week that the Greek Bailout took place.

The bailout for Greece was only $41 billion and the Fed balance sheet expanded by $421 billion in loans. What is going on? Obviously the Fed is lending a lot of money. Was some of it lent abroad? We do not know.

One other explanation is that the loans, the U.S. banks had kept off of their books in offshore SIV’s [Special Investment Vehicles] are coming back onto their banks’ books, and the Fed is lending against them to provide liquidity for U.S. banks. This brings us to a major question that all investors and U.S. taxpayers should consider. How did the accounting profession allow this SIV type of activity, where banks were allowed to keep liabilities off their U.S. books in the first place?

Fed takes on responsibility for foreign banks. It is public knowledge that during the 2008 crisis many non U.S. banks benefited from the U.S. taxpayer injection of capital into AIG. As a result of the injection, foreign banks collected at least $37 billion that was owed to them by AIG. In early 2009, the list of recipients of the AIG money was published in the news media, and Fed Chairman Bernanke admitted the same on “60 Minutes” in March 2009.

We agree with Larry Jeddeloh and many others who are irritated and concerned about this pattern of events. Clearly the U.S. has enough problems at home without taking responsibility for the bad management of foreign financial institutions.

AIG is currently trying to raise capital to repay the loan. We do not know if AIG will grow enough and sell sufficient assets to repay the entire sum.

Summary. We are enjoying the current market rally and we hold positions in the thematic areas mentioned in the first paragraph of our letter. We see the current juncture as being a period of low interest rates with rapidly growing corporate profits for the next several calendar quarters. In our opinion, this rally should continue until one or more of three events take place.

1. Stocks become over-valued. Based upon our historical analysis, stocks are currently fairly valued to under-valued.

2. Corporate profits begin to falter. In many of the industries we follow, this is not expected for at least a year.

3. Short term interest rates rise above the inflation rate. Raising interest rates while unemployment is high is an event which we do not think the politically sensitive Federal Reserve will have the nerve to implement.