BIG PICTURE MID MARCH 2005

Three of the authors I try to read regularly, Ken Fisher, Ed Yardeni and Harry Dent have all compared the cycle of the 2000's to the cycle of the 1990's. Every investment cycle is different from every other investment cycle, but history does indeed repeat itself.

The prime rate is a good example. The prime rate charged by banks was below the treasury bond rate from October of 2001 until November of 2004 and from July of 1991 until November of 1994. In the 1995, the Fed Funds Rate continued to rise for 3 months after the crossover. The increase in the discount rate in 1994-95 was just right. Rates went from 3 to 5.25% and the stock market went up the next three years.

Another "event" in 1995 was that the real earnings yield of the S&P 500 approached the real yield on the ten year government bond. The next couple of years was a period of rising rates but company earnings went up about as fast as bond yields increased. I think a lot of investors, including "pros" often get the relationship wrong. Shouldn't one expect interest rates to go up if companies are making a lot of money and are therefore buying and building to expand their businesses?

A month or two ago, earnings yields actually went above bond yields! By this measure, stocks are cheaper now than they were at the start of the 1995 boom. The last time real earnings yields went above Bond yields was in July of 1982. A number of stocks doubled within 9 months.

There are many other similarities between the 1990's and the 2000's. Productivity held down inflation. The employment cost index went down in the face of increasing heath care costs. Personally consumption slowed mid decade. The leading economic indicators declined. Investors were confused. Money supply was on the rise and after a long hiatus commercial paper was in demand again. Businesses started spending money.

Much has been made of high consumer debt but in fact, consumers have paid down debt for two years. It is a high number but remember that it is business that drives an economic expansion. The signs of expansion are all around us. Industrial metals are in demand. Raw commodity prices are approaching the levels of the mid to late 1990's. Long bond rates have recently gone up; not enough to kill the recovery but enough to take off the "edge".

The job market was slow to gain traction in the 1990's and slower still in the 2000's. However, US exports have steepened their climb; good jobs ahead!

The big expenditure businesses are preparing to make is the touch screen computer terminal. This terminal is starting to show up at restaurants, banks, service stations, ticket booths, and airline check-in stations. These "machines" will soon be every where. It will become natural for one to punch in a food or beverage order at the gas pump, pay for it and pick it up after the pumping is done. The new bank ATM will allow one to "drag" a payment from a checking account to a credit card account or a deposit to a savings or checking account. There will be no need to try to understand the lady at the drive-in window. If you want tomato and no onion, you will select right from the screen.

Businesses are finding that they sell more by letting the customer enter his order. The customer feels less pressure to respond quickly. He takes more time to select exactly what he wants. The cost to the business is low because the employee who used to take the order can now spend his time helping to fill the order.

The late 1990's were driven partly by the y2k rush to upgrade computers. The business spending in the second half of this decade may not be as strong. On the other hand, there are productive new technologies available and as soon as it is clear that the labor market is going to tighten, businesses will speed the pace of investing in those technologies.

The Big Bull Boom Bubble Bust is still playing its way through. Investors should recognize that stocks will be the investment to perform well in the second half of the first decade of the 21st century.