Investing Daily

For every modern market collapse, a new bubble has emerged to take its place. This isn’t how things should work in an efficient market, but the fact is that’s been the trend.

A look at the history of the US markets reveals a long-term bubble-and-trouble process. The events that led to the last major credit market collapse, in 1989, are a good starting point.

Federal authorities deregulated thrifts and savings and loans (S&L) to prop up the housing market in the 1980s. S&Ls were allowed to be more flexible with reserves and investments beyond their core mission of taking in deposits and making and holding home mortgages.

The result was a reckoning not too dissimilar from the current banking mess. The workout resulted in the formation of the Resolution Trust Corporation (RTC), which would eventually seize more than 700 thrifts and sell off their loans and other assets.

The collapse of the housing and credit bubble in 1989 brought with it a recession. Market losses of 10-plus percent, though not as calamitous as what we’re suffering now, were shortly erased as the next bubble began to make its way into the market.

The Federal Reserve not only flooded the economy with cash but also worked to ease reserve and margin restrictions for stocks and bonds. This heavy lifting by the US central bank set the stage for the next bubble in equity markets from 1995 through 1999. Subsequent gains would eventually dwarf market losses caused by the credit bubble’s collapse.

The dot-com bubble burst when investors began to seriously question company valuations and revenues as well as money conditions. And higher interest rates began to kill off even viable start-up companies.

This burst bubble amounted to a loss of a third of the value of the S&P 500 and sent the US into recession again. But Uncle Sam was at the ready, primed to pump the next bubble.

And this time it was almost a rinse and repeat of the ’80s-era real estate bubble. Not only was money eased by the Fed but capital requirements on banks and brokerages were significantly relaxed.

These actions attracted what money remained in the wake of the dot-com collapse into housing at an even greater intensity than during the ’80s real estate rush. We all know how that’s played out: House prices have dropped 20 percent. And with defaults and foreclosures expected to continue rising, a bottom is still a ways off.

While real estate was imploding, the Fed, along with the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC), was already aiding a commodities bubble.

The game plan was to ease rules concerning non-exchange trades in commodities, helping to move more cash to commodities or to tracking indexes, creating a huge build up in the markets for real goods. From 2006 to 2007, a broad measure of commodities rose by 49 percent; it’s since given back 42 percent after that bubble, too, collapsed.

The credit market has been mauled, stocks have been slaughtered and commodities have been cooked.

But already underway—the mother of all bubbles—is Uncle Sam’s plan to get things going again.

Uncle Sam Inc.

Following the burst of each of the bubbles of the past three decades, politicos, fearing retribution by voters or succumbing to lobbyists, have not simply cleaned up market messes but have actually set up ensuing bubbles.

Government’s role in the economy has expanded dramatically during the past 30 years. The graph “Leviathan” reveals that, at just the federal level, spending has soared by 550 percent, more than double the rate of inflation. And the expansion will accelerate in 2009.

If we were to tell you about a company that’s grown 550 percent—through recessions and bubbles—and is forecast to grow even more in coming years, you’d be crazy not to want to own a piece. And that’s exactly what you need to do now.

Uncle Sam might not be publicly listed, but its subsidiaries are.

Uncle Sam Inc. has five core divisions: banking, defense, health care, energy and infrastructure. The graph “Bubble Up” details how much new spending each division will see in the official 2009 budget.

Each is about as close to a sure thing in terms of cash flows as you can get in the market. But the work comes in figuring out which companies will get their capital from the capitol.

Bank on It

Let’s start with the most visible bubble in the making, banks.

The major response to the bursting of the credit and market bubbles is the Troubled Asset Relief Program (TARP). TARP authorizes the US Treasury to spend taxpayer funds on pretty much anything that might resuscitate the economy and markets.

Hundreds of billions of dollars have been allocated to buy troubled loans and other assets from banks. That was the plan. But as it’s been put to work after Congress authorized it, the Treasury has begun to buy ownership interests, not assets, in banks as well as insurance companies and other financials.

In just the past few weeks, 25 banks around the nation have become partially owned by Uncle Sam Inc. through direct investment in preferred shares. And that’s after the government added two of the nation’s biggest mortgage lenders—Freddie Mac and Fannie Mae—to its portfolio.

And there’s more to follow. Under the auspices of the Fed, Uncle Sam has entered the lending business, making loans not just to member banks but directly to non-financial corporations via a new commercial paper facility.

The impact of this will be huge. There will be a stream of further consolidation directed by Uncle Sam, resulting in big gains for banks. We will therefore start doing what Uncle Sam is doing: buying preferred shares issued by solid banks. One of our favorites is St. Louis-based First Banks.

A solid, family-owned operation that’s always shunned risk, the bank bought up all of its common stock and now only issues a preferred. That’s fine by us; First Banks 8.15 Percent Preferred (NYSE: FBS A) offers a yield of more than 12 percent.

First Banks 8.15 Percent Preferred, a new Growth Portfolio Cash Cow, is a buy under 18.

Best Offense Is Defense

One of the steadiest of businesses is supplying Uncle Sam’s military. Spending never goes down. And with a large capital budget, profitability will only increase.

We’ve been handicapping the best prospects over the past few months, most recently in the Oct. 8 article “Big Defense Equals Safe Profits.” General Dynamics (NYSE: GD) is one of the big dogs that will be around for a long time to come. We’re ready to add General Dynamics to the Growth Portfolio as a new buy under 68.

Health and Wealth

The transformation of the health care industry is still getting underway. Uncle Sam already spends as much and will soon spend more on it than on defense.

The Federal Health Benefits Plan (FEHBP) is one of the key models for health care benefit managers to cash in on providing broader coverage for more Americans.

One of the leaders in the market for providing healthcare coverage is UnitedHealth (NYSE: UNH), which should be in line to get a bigger chunk of public and private business. Buy UnitedHealth under 25.

Energy and Infrastructure

The last two divisions of Uncle Sam Inc focus on increasing alternative energy and fixing and expanding key bits of our transportation and essential services infrastructure.

We’ve been focused on these two areas for years and now see that the cash is coming, less so from the private sector than from the government.

In energy, efforts to expand nuclear power are ramping up. Deals have already been cut with one of the leaders in power plant equipment and construction, Areva (OTC: ARVCF).

The company is a partner with old favorite Siemens and has current and pending contracts right now from Uncle Sam. Buy new Growth Portfolio Nibbler Areva under 550.

There are plenty of key companies that will get the call from Uncle Sam to repair all facets of our deteriorating infrastructure, but one stands out for us, Shaw Group (NYSE: SGR). With divisions spanning most of our key national needs, it’s set for Uncle Sam’s cash to flow. Buy new Growth Track Nibbler Shaw Group under 20.

Neil George is editor of Personal Finance.