Recycling Petrodollars

Much of the rise in asset values in the past couple of years has been due to the massive flow of petrodollars into such assets as bonds, stocks, real estate, commodities and precious metals. While this may be good over the short run for holders of such assets, the long-term is more problematic. In a recent Barron's publication the governor of the Bank of England, Mervyn King was quoted as saying, "It is questionable whether such behavior can persist. At some point the ratio of asset prices to the prices of goods and services will revert to more normal levels. That could come about in one of two ways: either the prices for goods and services rise to catch up with asset prices as the increased money leads to higher inflation, or asset prices fall back as markets reassess the appropriate level of risk premia."

Barron's comments that the "prospects of a rate cut are growing more remote. The futures market is predicting only about a 50% chance of a quarter point cut in September; it had thought one was likely by spring." The article goes on to say that, "while observers and central bankers have come to recognize the impact of the massive petrodollar flows on the financial markets . . . the world as a whole cannot become wealthier if oil exporters do . . . Siphoning billions from strapped oil consumers to oil producers who have no other use for the money but to funnel it into the financial markets may benefit those markets, but not the economy as a whole."

In addition to the continued massive liquidity from oil producers markets have benefited from large pools of savings in emerging market resource countries and low interest rates in places such as Japan. Additionally, supply has been crimped in the US by private equity deals, corporate stock buy-backs and a fairly tepid domestic new issue calendar. Some of this is driven by such things as Sar-box and its regulatory reach. In the face of this, many observers have commented on the possibility of a melt-up in financial assets similar to what occurred in 1987, a year which saw an incredible rise in the first 9 months of the year only to followed by the collapse in October. It remains a possibility despite an overbought market over the short-term.

Strategy Update: We rolled out a new strategy recently: Focused 13D. This strategy actively purchases stocks that are the subject of SEC required 13D filings or other sources that indicate shares are under significant accumulation by knowledgeable investors. Presumably, it would be a beneficiary of continued private equity deal demand. We currently hold 22 stocks in the strategy, including yesterday's takeover announcement, Triad Hospitals. As can be seen in the graph, performance has been stellar, up +14% in the 2+ months since the end of November. We are an SEC Registered Investment Advisor. Visit our website for more information on our Strategies management program.