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March 19, 2010 – 1:03 pm

The interesting statistics this week were February’s inflation numbers. On the producer front it fell sharply mostly because of energy. The core rate rose only slightly. For consumers the rate fall matched that for producers. These numbers came out after the Fed meeting but the governors had the numbers in hand when they decided to leave interest rates at their current very low levels. Inflation is something that is on every investors’ and economists’ minds. The massive government spending and the ultra loose money have always translated into inflation in the past. Foreign governments that have overspent, printing money like confetti, have always dealt with hyper inflation. Here in the U.S. we have had our own history of runaway inflation. Loose money causes prices to rise in fundamental materials meaning commodities, and low interest rates usually result in excess borrowing and risk taking. These are real dangers and it is only because of the very deep recession we find ourselves in that we don’t see inflation, but at some point we are going to have to reverse this loose money policy. The timing is going to be very difficult.

On the jobs front I think we will actually see growth in jobs for March. We have had three weeks of falling jobless claims, but my reason for possible job growth is not because of an improving economy, though I do think that is happening, but rather a boost in employment will come from hiring a large amount of census workers. The estimate is that we need about one million of them, but of all these jobs are temporary.

In the headlines this week was the healthcare overhaul, if it can be called that, and the new bill proposed to change the way the government conducts oversight of our nation’s financial institutions, mostly the banks. These two major bits of legislation have and will act as a drag on our economy. Banks do not want to take much risk not knowing what the new law will require from them. They may need to improve liquidity and if they loan money out today they can not use that money to comply with the new rules. The issue is the unknown. Until Congress passes the legislation why would any bank take on any more risk? Add to this problem increasing foreclosures where banks have to set aside funds to deal with bad loans and you can see why they will not be a major part of this recovery at this point. Long term earnings for banks will be under pressure.

The foreclosure problem is the biggest danger our economy faces at this point. The rate will continue to increase for some time. The counterweights to this problem are the very low prices of property and the interest investors are showing to snap up these low prices. Low interest rates also help. However, do not expect a huge recovery in housing. There will be a recovery but it will be very slow. Because of this issue the recovery for the overall economy will be slow. Construction spending typically rebounds sharply coming out of a slowdown but not this time. It is interesting that we are not seeing much more deterioration in commercial property. It was assumed that problems in this area was going to be the next foot to drop for real estate with surging loan defaults, but we are not getting what was expected by all the experts. It helps that there is a lot of merger and acquisition activity with a very large mall owner buying out one of its very large competitors. This type of activity tends to push property values higher or at the very least keep them from falling. The banks, so far, are breathing a sigh of relief as a result.

Healthcare has been the focus of our President since he has been in office and it has taken up a lot of energy by our Congress. Since healthcare is a major part of our economy the uncertainty of the changes being wrought has caused that entire sector to stall. Change is always difficult and until health care providers and insurers know what is going to happen they will make no major moves; no mergers, no investment in capital spending and an overall pause in the sector. That will change once the law either passes or fails.

Yes, there remain major problems in our economy, but name any time where an economy was in recovery from a recession and I will show you major problems exiting that downturn. This one may be different in its depth and steps taken to fight it and, I will grant that there will be other problems because of the massive spending, but we are still in a recovery. One area of very positive influence on our economy that seems to get very little attention is the impact of Asian economic growth. China and India are at a pace that can only speed the U.S. recovery. In fact both countries are raising interest rates and tightening money supply to slow themselves down. They fear overheating. That would be a nice problem to have here, but at least don’t expect that for some time. We caused this world wide recession with our excess leverage so most of the heavy lifting to right our ship is up to us, but we do have help from our foreign traders.

At KPP we are fully invested but very soon we will take some profits. However, being invested is far smarter than exiting the market. There is just too much money on the sidelines that will act as fuel for higher stock prices. We see another correction coming but maybe after tax time, April 15th. We will need money to buy in to that correction when it comes so taking some profits off the table soon is prudent. Unless something dramatic happens that is unforeseen the market will continue to improve, but it will be a slow and bumpy ride.

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