"Nature gave men two ends - one to sit on and one to think with. Ever since then man's success or failure has been dependent on the one he used most" George R. Kirkpatrick

It's been full four weeks since I decided it was time to go long the market. At the time being bullish was quite unpopular, as fear was still ruling the market and thus it was a relatively easy call for me that in hindsight seem to have been precisely on target. However, situation today is different- for the first time in quite a while, when people ask me whether I am now bullish or bearish, I say that I am not yet sure...

And there are a number of reasons why. On one hand my skeptical mind simply refuses to comprehend how one could expect the economy to hold up well in a face of so many challenges? Residential construction is virtually at stand still, commercial construction is showing signs of severe strain. Banks are struggling to repair their balance sheets and are so risk averse now, that in some cases they refuse lending without tangible collateral to even some of their best clients. Retailers and restaurants seem to be struggling with a strong headwind of rapidly rising costs and slowing consumer spending.

Even formerly "recession proof" healthcare industry (excluding biotech for now) seems to have caught on a deadly decease of rapidly rising costs combined with decreasing revenues driven by massive simultaneous top drug patent expiration and decreasing population of people who can actually paid for provided services (hence insured). The list can go on pretty much forever, with virtually every industry in the US Economy, except probably agriculture and oil & gas, experiencing severe turbulence. And let me tell you something, I am a great believer of a concept that without healthy and well functioning credit market, all the other sectors of the economy are bound to slow down (read Jon Markman's most recent article on the banking sector)

However, here is the flip side of the coin. Federal Reserve has embarked on the most aggressive rate cut series in recent history. And while I personally believe that these moves will come back to haunt us in the years to come due to the spiraling out of control inflation expectations, one can not underestimate the impact this monetary stimulus is making in the short term. It is pretty astounding, but even though earnings of the all companies that reported so far (about 30% of firms) are down 20% year over year (according to WSJ's market data center) , if we exclude the negative impact from financial sector ($36B y-o-y shortfall so far), earnings have actually increased slightly!?.

And while the strength in basic materials and oil and gas sector earnings could be easily explained by what's looks increasingly looks like another bubble in the making, actual earnings in the technology, telecom and industrial sectors have been coming in handsomely above the last year's level. Technology sector's earnings are running 9% above last year, telecom-48% and industrial- 3%. Considering all the headwinds- these numbers are quite startling.

It increasingly looks like the weak dollar and higher oil prices are actually starting to make a tangible positive impact on competitiveness on several sectors of the US economy that seem to have been written off a while ago like "good-old" manufacturing. Yes, you did not misread what I just said- positive impact. Now let me explain what I mean.

About a week or so ago I had an opportunity to spend a few hours talking to the CEO of a small manufacturing company based in the Southeastern United States. Just like many other businesses around the country they have been hurt badly during the recent years because outsourcing. The lost business first to Mexico and most recently to China...What's more, he gave me a concrete example of one large contract lost to China several years ago. They initially quoted this piece of business at $1.60 a pound with a cost of goods of roughly $1.20. In contrast, their Chinese competitor quoted it at $.60 a pound, and even with shipping to the final destination in the US the final cost was only $.90. So you get the picture- it was not even really a contest- all of the business was gone within months- case closed...

Now fast forward to today and the picture is quite different- Chinese labor salaries have been increasing in healthy double digits for the last several years, currency has been steadily gaining on the dollar at the pace of 7-10% a year and finally - yes here is where the high oil prices come in play- transportation costs have simply spun out of control...So let's get back to the same little company in Tennessee- the same order that was once lost because of the almost a 80% difference in costs- has not only closed the gap dramatically because of the rising salaries and rising currency, but when transportation costs were added back- this gap became virtually nonexistent- it is now only about 5-10%...

This cost advantage is now is simply not sufficient to justify all the risks related to outsourcing to China. What's more, after you make adjustments for the increased inventory levels required to support the multi-week shipping cycles, and account for unpredictable shipping costs, the outsourcing case becomes even murkier. You get the picture...

Now, I am in no way trying to say that all the manufacturing is going to come back to the US, as most of the manufacturing done in China today, has a labor content that is a lot higher than the example I just mentioned. What's more- I am pretty sure most of the jobs lost are never coming back- period. But don't forget- manufacturing leads the business cycle- usually losing millions of job in a normal recession. But this time around, at least for now, the tide of heavy manufacturing job losses seems to be turning the other way. What's more we can reasonably expect that many of the European and Japanese manufactures will actually continue to expand their capacity in the US which means potentially adding net new jobs over the long haul.

And the same can be also said about the technology jobs- Indian IT salaries have been increasing dramatically and in combination with higher inflation you can expect the slowing tide of IT outsourcing to again cushion the US economy.

Now here is the punchline- assuming the job market keeps holds as it has so far - the initial recession might be a bit milder than market is currently expecting. Yes, once again I said the initial one :), I think that Fed will have start raising rates again before 2008 is over and we will be into another cycle of pain once that occurs, but for now- my mood is still quite neutral as opposed to the bearish one...

Please feel free send me e-mails at skepticalcapitalist@gmail.com