Welcome to the Blue Money Report

We tend to think with the herd when we look for these potentially dangerous swings. We want to believe that this is 1991 all over again. We want to ignore all of the things that have depressed the investing environment in exchange for the short term euphoria of participating in an upside move. But nothing has changed.

We are at war. But it has been a war of rhetoric for quite some time. Dropping bombs and advancing troops (may our prayers go with them) do not however signify anything but a further breakdown in the world business environment. George Patton has commented that you can't know your enemy until you meet them on the battle field. We can't as investors apply the same surgical strike tactics to our investments and expect any different results.

There are still some fundamentals that can not, and will not, be ignored. For instance, the recovery will not come among the Dow names. These folks are priced at about their worth before the rally began eight days ago. These companies have through the last three years, readjusted their thinking to become leaner, less risky making their value not worth the recent run-up. The broader market suffers from the same inflated P/E ratios that make most companies still a little too expensive.

The three most worrisome indicators remain intact, little changed by world events. The first comes from labor. In the coming week this figure is more than likely to add even more able bodies to the lines. These folks will not find employment anytime soon as business fails to see any hope on the horizon. In fact, that lack of interest in their own company's value is one of the more disturbing problems. Business execs are not seeing the value in their own company's stock price. If they were, the numbers of insider purchases would have systematically risen with the euphoria over the past couple of weeks or would have been the catalyst for the increase.

So unemployment will stay too high to warrant recovery and the business leaders are not as optimistic that their businesses will dramatically change over the near term, what else could have an adverse effect on the markets? The White House budget.

Number three on our list of downers for the economy continues to be President Bush's plan to continue with his "guns and butter" policy of cutting taxes, pushing the public debt to new levels. Taking advantage of the perverse charge that criticism equals lack of patriotism, the President's tax plan is sliding around the halls of Congress looking for approval while we sit and watch the events in Iraq unfold.

The Democrats believe that the budget is reckless while the Republicans acknowledge that any change in the basic plan would be embarrassing for the White House. This is not a reason to push a plan through that will do little for the economy, nothing for the American people as a whole, and even more dangerous, will leave us with the inability to maneuver through any recovery for the next several decades.

The President's plan will so seriously deplete future revenue that Social Security and Medicare, plans that are looking at underfunding to the combined tune of $10 trillion over the next 75 years, stand no chance at being fixed. Revenues, which help to build surpluses which, in turn could help to reinforce these programs, will all but disappear if those tax cuts move through unaltered. The Center on Budget and Policy Priorities recently estimated, using actuarial tables, that the tax plan will reduce revenue by $12-14 trillion.

Looking ahead in equities
When the recovery comes, it won't be in the large cap names. Instead, mid cap and small cap names will see the biggest upside in the coming months. The big names are still unwilling to risk anything on decisions that suggest they expand production in the face of diminished demand. So who will get the call? The companies that have the most to gain come from a smaller, less visible space. The upside risk is far too appealing to these companies and they will rise to the bait thrown to them by CEOs unwilling to take a chance.

Alan Greenspan suggested that the uncertainties were still a heavy weight on his committee, crippling their ability to see clearly what is in store for the economy. And investors react as if they had stolen the Fed's crystal ball, developed their skills at reading the numbers, and have divined the end of uncertainty is here.

Not so fast.

America remains in a less desirable position that previously thought. The Producer Price Index may be the first of the warning signs that we choose to ignore. Producers of goods found that energy costs were too high to warrant an increase in production as demand diminishes. The PPI is an important indicator of deflation. Prices tend to be discounted quicker at this level in the face of lack of demand making profits less likely. The CPI, another number just as easy to ignore, found that prices had increased last month about 3%. This is in part due to the run-up in the price of oil. So without worrying about prices, which producers find less than satisfactory but also are less likely to increase, and consumers, who are spending less on goods that they do not need, we are looking at a certainty. Nothing is changing as much as we would like.

But last week, oil prices fell. This should translate into better numbers moving forward, but don't count on it. Oil will find the best and most profitable range to take a breather. There was no less supply when the price went up to almost $40 a barrel and there is even less incentive to find it at the twenty dollar range. Demand and production, for that matter, remains constant.

So as the equity markets rally, the money normally hiding in fixed income jumped the fence and found stocks to their collective liking. The implied removal of equity gloom, much like reading tea leaves, is all in the interpretation. When folks invest in Treasuries, this is called a flight to quality. When these same investors reverse this stance as they did last week, is it because they see the quality in the downtrodden stock market as improved?

This week should tell all. I suspect that the traders that moved into equities last week saw the chance to build a base for their first quarter returns. It was noted that a good many of these investors came from cash poor mutual funds looking to prop up numbers from what was shaping up as a dismal quarter.

That doesn't mean the fixed income is that much better a place to reside. The bond market has been looking for a trading range, eliminating the bubble talk, for quite a few months now. Folks are looking for a flatter yield which usually come with an increase in short term rates.

An even more telling sign is the flight from mortgage backed securities. Interest rates on 30 year loans moved significantly higher making refinancing less attractive. Let me explain why this happens. Folks who invest in this space watch durations. These are simply the sensitivity of a fixed income investment to a change in interest rates. When durations get too long, there is an increase in the risk. According to the Salomon Smith Barney index, the duration on mortgage backed securities has lengthened considerably. Money removed from this market removes money from borrowers who are less likely to refinance at higher rates. Like dominoes falling slowly, these events trigger a good deal of economic worry that won't show up for quite some time.