Let's start off with a very appropriate quote from Warren Buffet that fits today's financial markets quite well and is worth remembering: "Over the short term the markets are like voting machines but over the long term they behave more like a weighing machine." Now what we think he means is that the short view is driven by emotions such as current news and world events while the longer term is focused on the big picture and how it impacts the economics of both the U.S. and the world. For example, Ivan has stopped oil production in the Gulf and there is fighting in Iraq and we will run out of oil by next week and therefore buy a lot of oil today at any price. Long term the financial markets would look at the big picture and focus on how this would play out in the context of economics both domestic and worldwide. So, the short term hedge traders are betting that oil will spike above $50 per barrel while the longer term fundamentalists argue that increased production by OPEC should be sufficient enough to bring prices back down.

Regardless of how we interpret recent events, the fact is that oil is trading in the $50 per barrel range and is having significant impact on our financial markets. We will grant you that after hurricane Ivan and Jeanne halted Gulf oil production, coupled with ongoing terrorist threats, it makes sense that the hedge funds are doubling their positions but remember that their trades are momentum driven and not based on sound long term prospects for cheaper oil prices. Enough about oil.

The Fed hiked the funds rate for the third time since June at its September 21 FOMC meeting, lifting the rate to 1.75%. In making its announcement, they noted that an increase in economic growth and recent easing of inflation were in line with expectations and confirmed that the economy had emerged from a sluggish summer. The remarks were pretty much like their previous statements and our take is that we are likely to see several more rate hikes into early 2005. Despite the disruptive impact of the hurricanes, we believe the economy will continue to grow in the 3%-5% range for the next few quarters with inflation remaining subdued.

U.S. GDP grew at a 3.3% annual rate in the second quarter, exceeding expectations, and many of the quoted experts were caught completely off-guard. A quicker pace of inventory building and a smaller trade gap contributed to the better than expected increase. However, consumer spending is still doing well, business spending is strong, and the federal government spending is off the charts. While there will likely be some indigestion from higher energy prices, the overall prospects for an improving economy remain intact.

The question being asked most often: are bond yields too low and are stock prices too high? We are of the opinion that bond yields are too low and need to be higher. But given the fact that the hedge funds are still short the 10-year, and must painfully cover these positions soon, we could experience lower yields from current levels. Until supply pressure returns, we will not have a sharp sell-off in bonds. Stocks are a bit more tricky but we argue that until the shorts are cleaned up, stocks will trade in a tight range. With NYSE short sales up to 7.75 billion and the NASDAQ at 5.1 billion, it is easy to see where the rub lies. We do know that no one rings a bell when markets make a bottom or top. With this said, we do believe that bond yields will rise modestly from current levels in the fourth quarter and the stock market will do much better.

Remember, there is a lot of cash in money market accounts, a lot of shorts in both stocks and bonds, and a lot of shorts in dollars. And, an economy that is starting to pick up speed again. So in sum, there are major forces in play right here that could send us to much higher stock prices which we feel will have a very positive effect on adding to a robust economy. Lower stock prices put us in a funk and they can lead us out of one too.