Where to Invest

If you're into investing these days, you have to be very careful.

The world is awash with liquidity, which has driven up lots of asset prices, from housing to bonds. While stocks have come down somewhat, they still trade at a slightly elevated historical price-to-earnings ratio.

There are lots of places to make money, you just have to look a little harder these days.

To start with, here are my high-level thoughts on the state of the market, and where I'm focusing my research.

1. Housing. No way. Don't touch it with a 10-foot pole. Housing is way over-extended, and is already starting to come down a little. http://www.benengebreth.org/housingtracker/ Housing prices depend a lot on interest rates, and interest rates are still going up. Until it is clear we are at the top of an interest rate cycle, I'd stay away from investment properties, REIT and other housing investments.

2. Bonds. Stay short-term and high quality. While there are some really nice high-yield bonds out there (I'll cover this later), the Fed is still raising rates. It is unclear exactly where long-term rates are going, but in my humble opinion, I think inflation is not only underreported, but underestimated going forward. Europe and Japan are talking about raising rates, so we could be in for a cycle of rising interest rates. Stay in short-term, high quality bonds and wait until it's clear interest rates are topping out. Only then will it be profitable to extend to longer term maturities.

3. Stocks. There are a few good plays out there. Price-to-earnings ratios are still a little high, but even so one can almost always find some real values in any environment. My personal favorites right now are:

UNAM - $9.49 - a small insurance company that trades just above book value and under 9 times P/E. They got into new lines of business in the late 1990's and lost lots of money. They got out of those businesses around 2000 to focus on their well-understood and profitable California P&C business, but the market is still treating them as if they had the bad businesses. A good value.

GLGC - $4.02 - also trading just above book value, this pharma research and services company is finally getting its two core business to be profitable, and getting into a 3rd, very exciting business. They are very undervalued on a metrics-basis, because the market doubts their ability to get profitable. I think the market is wrong, plus, I think the downside is minimum give their quality assets and high levels of cash.

4. Beware the Fed. I think the Fed is going to pump money into the system via the Repo markets, even as they raise interest rates. This should keep everything humming along, and we may see a holiday rally as is typical of this time of year. Looking into 2006, things are a little more scary, as increased liquidity and strong global growth may continue to generate inflation and force the Fed to continue to increase interest rates. A key metric to watch in the coming weeks will be if Oil stays above $55. The long-term trend in Oil is up, but if it breaks below $55, it will have pushed through it's downside support line. This could signal inflation is not as bad as I have been thinking. If Oil does stay above $55, however, and begins to rally, it could spell bad news for inflation and interest rates in 2006.

That's all for now!