Thursday, June 19, 2008

Slamming the Door on the Enron Loophole

The US Congress is on a rampage. And the oil speculators (who have inflated the price of oil by anywhere between 30 to $50 a barrel) are on the run. Perhaps the most extreme proposal by a legislator or regulator to reign in energy speculation comes from Senator Joe Lieberman. Consider his comments of yesterday:

"We are not, as some continue to argue, witnessing the ebb and flow of natural market forces at work. We are instead seeing excessive market speculation at work and that is why our government must step in with new laws to protect our economy and our consumers,"

With yesterday’s override of President Bush’s veto of the Farm Bill, the first of many steps taken and to be taken to put a serious crimp in energy speculation are well underway. And with each new effort to tamp down on unlimited and undisclosed oil futures’ positions, be it closing key aspects of the Enron Loophole as in the Farm Bill* or the proposals to close the “London Loophole”, or the Lieberman effort to “prohibit private and public pension funds with more than $500 million in assets from investing in agricultural and energy commodities traded on a U.S. futures exchange, foreign exchange or over the counter”, the debate over whether the high price of oil is due strictly to supply and demand in the real economy versus supply and demand of speculators will soon be resolved.

Investment Strategy Implications

I believe the catalyst for higher stock prices this summer will be a sustained and possibly sharp drop in the price of oil for all the reasons (and then some) noted above. With valuation at reasonable levels and professional investor pessimism as high as the recent Merrill Lynch survey states, room for higher equity prices appears more than justified.

Moreover, from both a fundamental and technical analysis perspective, it is hard to understand how stocks will head lower when Mid Cap and Small Cap Growth issues (IJK and IJT, respectively)** are outperforming the broad market and, in the process, signaling that 2Q08 earnings (which are not so inflated as 4Q08 numbers are) are likely to be more than acceptable. Strength in second and third tier issues is usually not the precondition for lower prices.

Beta bets plus a tilt toward growth appears to be advisable. For the truly adventuresome, Consumer Discretionary (XLY), Double Long Financials (UYG), and the Broker/Dealers (IAI) should react positively to any summer rally.

*However, not enough according to Michael Greenberger (see blog posting below re The Enron Loophole), as the process by which the CFTC can act requires too many steps.
**See above chart. Click on image to enlarge.

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