Playing The 'Prelude To A Kiss' Market

1. SHORT-TERM MARKET FORECAST AND RANT O' THE WEEK: Playing The 'Prelude To A Kiss' Market

So what did we learn from Tuesday's little romp and Wednesday's five-year high in the Russell 2000 small caps and the Nasdaq?

Just exactly who is in charge of the stock market, of course.

Call it a prelude to a kiss — a glimpse at what the market will do in May or June when the Fed tells the world, "We're done."

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As I've said repeatedly during the last two years, if you ultimately think that there is ANYTHING more important to overall market prices than the Fed, you aren't paying attention.

We moved almost 200 points on the Dow with crude surpassing $70 a barrel — there goes the "oil prices are holding us back" story.

You have to get the following data into your cranium: Energy costs corporate America four percent of sales on average. Employment costs represent more than 70 percent of corporate overhead.


As a percentage of household income, energy costs consume a little less than 6 percent — during the 1980-1982 energy crisis that figure rose to 9.1 percent. A car costs about 40 cents a mile on average to run before you factor in gas — $3 a gallon fuel adds 15 cents per mile. At $2 a gallon, gasoline adds 10 cents a mile — an extra 5 cents a mile to run your vehicle is NOT an economy killer.

We don't have an energy crisis ... yet. We have to get to $5.20 a gallon gas (price adjusted for inflation) to slow oil demand down 12 to 13 percent, like we did from August 1980-1985. In today's dollars, that translates to $90 -- $110 a barrel oil.

Oil does not kill the latest economic expansion at $70 a barrel. However, inflationary unit labor costs can kill the expansion because if we see core unit labor costs soar above 3 percent (inflation adjusted), the Fed will take us to 5.5 to 6 percent rates. And THAT move kills the economy.

History is only helpful for your economic and market analysis if what you are analyzing is comparable fundamentally. Thankfully, today less than 8 percent of our workforce is paid wages that have automatic inflation pay raises baked in. In the late '70s to early '80s, more than 21 percent of the workforce had this inflationary incendiary device baked into their compensation.

It was the inflexible cost-of-living-allowance workforce that created systemic inflation in the early '80s, NOT energy prices. It is the incredibly flexible workforce (read: non-union) of 150 million people, 15 million or so low-skilled illegal immigrants and global sourcing that keeps unit labor cost inflation in check.

The relative restraint in unit labor costs has American companies recording the highest rate of gross profit margins in history. High rates of productivity building technology and knowledgeable management help, and available low-skilled labor (read: immigrants available for work regardless of their paperwork) also keep unit labor costs contained.


What does the Fed really see in the data? An economic expansion that has now slowed to a sustainable 3 percent-ish rate because of the following GDP headwinds:

· A rapid reduction in the rate of home building and home values — not a crash, but a stall — until earnings and building costs catch up to the 50 percent swoosh in home values in America overall (and the 100 percent swoosh on the coasts). The major source of new jobs (and higher wages) is no longer. The ballistic growth rate slowed to a sustainable growth curve.

· Much lower total dollars in home mortgage cash-outs, down from $600 billion in 2004 to more like $200 billion by 2007.

· Reasonably higher (but historically still low) adjustable-rate mortgages and home-equity lines.

· Average and below-average income households shifting a bigger percentage of their non-discretionary spending to energy (with $3 gas) and away from services or Wal-Mart (WMT).

· A reasonable rate of job creation and destruction that will add 120,000-150,000 new jobs per month, but NOT the 250,000 jobs that would be inflationary.

· Net net: 5 percent and done for the Fed, and Dow 12,000/ Nasdaq 2,500/S&P 500 1,400 by year-end.

· $60 oil for the rest of the year UNLESS we get whacked by a Category 5 hurricane in the U.S. energy belt.

· $7 natural gas with trading between $6.50 and $10.

· $600 per troy ounce gold going to $1,100 with supply withering and demand growing faster than supply.

· Internationally, higher demand and a lower dollar make up for at least 40 percent of the demand for U.S. goods and services.

· Iran noise gets noisier, but not ugly — for at least another 12-18 months. Nigeria gets worse, but mutually assured destruction fails to happen.

· Japan (the world's second-largest economy) continues to grow after 14 years of recession.

· China slows to 7.5 to 8 percent real growth as they race to the 2008 Beijing Olympics. India goes to eight percent-plus growth as economic reforms and privatization take hold.

In short, we'll see a worldwide expansion that creates higher demand for base metals and hydrocarbons, and higher capacity for inflation-killing production of goods. That's the message I want you to understand.

In a world where energy is four percent of corporate costs and labor makes up 70 percent, you can expand the economy nicely with higher energy or commodity costs if unit labor costs are controllable.

This is exactly where the world economy is today (minus France, Germany and other labor forces with out-of-control inflexibility).

How do you make money? By making sure you have ALL your equity bets in before the Fed is done.

Yes, I gave this advice at Nasdaq 2,000, 2,100, 2,200 and 2,300. But the point is it was right then — and it is right now.

The lagging U.S. stock market is about to catch up to its superior growth fundamentals vis-à-vis the rest of the world's markets.

You have about 80 days to make sure you are positioned for lift-off after the end of the Fed's rate hike campaign.

Days like Tuesday give you a taste — soon you will get a full gulp.


P.S. Higher oil and gas prices are going to hammer a lot of stocks before all is said and done, but there is an alternative play that will pay off big for investors. The Clean Energy Wave is building and getting ready to take off, and a little money in these stocks could add up to BIG profits.

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Tobin Smith is a ChangeWave Research editor and regular FNC business contributor.

Catch FOX News' "Cost of Freedom" Business Block, Saturdays beginning at 10 a.m. ET, for more with Tobin Smith and the entire FNC business team.