Economy and Manufacturing & Technology and Technology

BULLS & BEARS: Are ingredients in place for a market 'melt-up'?

January 22, 2007

A couple of years ago, I quoted legendary market analyst John Mendelson, who predicted the "mother of all short squeezes," causing a market "melt-up."

So far, nobody would say we've experienced anything resembling a melt-up.

In the two years since Mendelson's report, I haven't seen the words "melt-up" used. That is, until the last couple of weeks, when I saw it twice.

In early January, Barron's columnist Michael Santoli was describing the state of the market. He said valuations by historic measures are "middling," and the recent bull run has been "unspectacular by historic standards." Corporate earnings, however, "have been heroic" and the "buyout game" is still being played with global "copious liquidity."

All of these indicate to him that the "ingredients of a market melt-up are in place."

The second mention is in a new book written by the founders of the Hong Kong-based research firm GaveKal.

In the book "Our Brave New World," GaveKal disputes the doomsayers who see America's trade deficit, low savings, overspending and outsourcing as a scourge. In fact, GaveKal views pessimistic and foreboding predictions on the U.S. economy as "poppycock."

And because these guys are French and British, they can say the word "poppycock" with straight faces.

They believe the global economy is on the verge of a decades-long deflationary boom that will lift America and much of the emerging world to unprecedented prosperity.

GaveKal asserts that, these days, "things are indeed different."

Its studies show the old boom-and-bust economies of yesteryear have become much less volatile in the last half century.

Economic peaks and valleys worldwide have flattened since the 1950s.

The reason behind the smoother growth is what GaveKal calls the "platform company," which has been gaining traction, especially in the United States, Britain and Sweden.

A platform company may invent, patent and design a gizmo, then have it manufactured by another company's factories.

The platform company's suppliers may be here, or, in recent years, companies have (here comes a dirty word) outsourced gizmo-building to an Asian company.

Platform companies reduce their risk by farming out manufacturing, which is the most cyclical part of their business.

If sales slow down, a platform company like Black and Decker just cuts orders for drills from its Chinese manufacturing company.

The Chinese manufacturer is the one risking inventory write-offs, worker layoffs and idle plants.

The platform company profits from the high-margin knowledge, patents and technology, whereas the foreign manufacturer settles for the low-margin and volatile operation.

GaveKal argues this is why buyouts are so popular. Today, a private equity firm can borrow at 6 percent and earn a 9-percent return on the average American company, which is a 50-percent return on capital.

"That alone argues for a melt-up in U.S. stock prices," they claim.

There's that melt-up word again. I like the sound of it, and that ain't no poppycock.



Gilreath is co-owner of Indianapolis-based Sheaff Brock Investment Advisors, money management firm. Views expressed are his own. He can be reached at 705-5700 or daveg@sheaffbrock.com.
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