Once in a great while, a series of investment themes will come together in a very satisfying way. 

In a previous letter, we had speculated about the investment of hedge funds in the energy market and whether that participation was driving oil prices artificially high.  In the last three months, two hedge funds hit the wall on bad bets in the natural gas market.  The second fund, with $9.2 billion dollars in assets reduced to $3.5 billion in a matter of weeks, was forced to sell off the rest of its energy portfolio at a discount, which caused the price of oil to fall from the low $70’s to the low $60’s in a week.  Oil briefly touched $59.50 last week before closing at $62.91 on Iranian saber rattling, compared to $61.04/barrel at the start of the year.  On the back of over-supply, gasoline prices are falling sharply compared to the summer, and natural gas prices are at the lowest levels since December 2002.  We have said that oil should trade in the mid-$50’s based on supply/demand conditions, and that range looks achievable by year end.

For over a year, we’ve underweighted energy stocks and overweighted tech.  That was completely the wrong position to hold right up until August when the oil stocks peaked and the technology stocks began to rally.

For the most part, our clients are trailing the market on the year, but the gap is closing rapidly as other investors roll out of energy and into growth stocks, primarily in technology.  Microsoft will release the Windows Vista operating system over the next 6 months, along with a new release of Office, which will drive revenue and earnings growth across PC oriented companies.  Meanwhile, earnings grow steadily in the Internet oriented sector.  Cisco, for example, has revenues 43% higher than in 2000, the height of the internet bubble.  Earnings are 108% higher, and Cisco’s current P/E is 26 versus over 100 in 2000, which represent a pretty good value given Cisco’s growth prospects.

For two and a half years, we’ve warned our clients to be very careful about real estate investments, and now that bubble appears to be bursting.  Sales volume is down dramatically, particularly in the most speculative markets such as Florida, Nevada and Arizona.  The year over year statistics indicate that prices fell 1.7% August to August, but anyone who is trying to sell a house these days would be thrilled to get last year’s price.  Robert Shiller of Yale University has compiled an index of house resale prices net of inflation over the last century, which was artfully rendered recently by the New York Times.