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January 24, 2006

Beware of Spells
by Ron Ellison

Several years ago the late Screamin' Jay Hawkins released a hit song called "I Put a Spell on You" that a designer jeans company recently used to market its product on television.

The point of the commercial was simple. The jeans were magical and any guy who donned a pair would instantly enjoy the ability to put a spell on attractive girls. Webster defines the word spell as "seemingly magical power or irresistible influence; charm, fascination."

Hawkins, who died in 2000 at age 70, was noted for his stage antics, often emerging from a coffin carrying a cigarette-smoking skull, singing his hit and reminding his audience that "smoking is bad for you, look at Henry."

Though not Webster's definition, a spell has also been defined as "a willingness to believe so powerful that it triumphs over contrary evidence." And when it comes to the world of Wall Street, investing and economics, it's this second definition that most interests us.

Many investors appear to be missionary-zeal convinced that the Federal Reserve has inflation under control. Yet gold recently hit a near 25-year high and commodity indexes in 2005 enjoyed their fourth consecutive year of double-digit gains as investors poured $6 billion into commodity-index funds. And the energy picture, though prices recently backed off recent highs, appears as muddled if not more so than ever given geopolitical turmoil and what at best can only be described as an unclear supply-demand equation.

At the beginning of 2005 nearly everyone was convinced, including the Great Omaha Sage, Warren Buffett, the dollar would falter severely, only to end the year on the upside. On the international scene few even among those most bullish expected the Japanese market to liftoff the way it did. And 2005 was another year in a string of years since the 2000 TMT crash that technology shares, like a vanquished former hero, were to triumphantly reappear, capturing invertors' hearts and putting some spiff back into their portfolios. Likewise, those who believed long-term Treasury bonds would face rough sailing in the high seas of rising interest rates and shorted them got fooled too. Ditto with consumers. As a famous retiring American general once noted: "Old soldiers never die. They just fade away." Consumers did neither in 2005. And ala O.J. Simpson people like Sir Alan and Ben Bernanke are still gazing skyward and mumbling "Thank you, thank you!" under their breaths.

Though it's still too early to tell, 2006 is also supposed to be the year of BCR, Big Cap Revenge, putting an end to the long, dominant small-cap performance. To date the Small Cap Russell 2000 is up nearly 5 percent while its large cap brethren continues to bring up the rear. Another current dyed-in-the-gray matter belief seems to be the economy has become less volatile; thus, investors can live with lower risk premiums. The bond market is a classic example. Such spell-casting thoughts give the impression that valuations as such can be much higher. According to this view, worrying about historically high p/e ratios is the hobgoblin of petty, just-don't-get-it minds.

Turn on the financial news any day of the week and you can catch some market Svengali citing technology as the place for rich rewards in 2006. And it may be, sooner or later, that is. Most of these people are card-carrying members of the fake-it-until-you-make-it crew. Predict something long enough and strong enough and it will eventually happen. A neighbor's pet aardvark one moonless night late last fall eloped to Las Vegas with another neighbor's prize armadillo. But the news hardly fazed anyone in the neighborhood because another neighbor with an Ouija board a couple of blocks over had been predicting it for five years. Recall too that Svengali was the evil hypnotist in the 1894 novel Trilby by George DuMaurier.

Most of these television sorts are financial talking heads. One guy, a so-called market strategist, was on so often and wrong for so long rumor has it his mother threatened to disown him. Most of these people put a spell on themselves. If all this has a familiar ring (as in new paradigm or just-in-time inventories, which by the way were around in the 1920s), you might be catching on to the spell-putting business.

A kiss may still be just a kiss and a sigh just a sigh, but you need to remember this: Be cautious. Do your homework or else they might put a spell on you and your portfolio.

Ron Ellison
Blasingham and Ellison Financial Group

Ron Ellison is a principal of Blasingham and Ellison Financial Group, a money management firm in Newport Beach, California, and can be reached at www.Befg1.com.

Copyright © 2005-2007 Ron Ellison

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