Tuesday, May 23, 2006


I have repeatedly pushed the idea that now is the time to get out of "little stocks", residential rental real estate and expense loaded mutual funds. The basic reason is that you do not need a mutual fund to buy big cap stocks and big stocks out perform small stocks in the second half of the business cycle. The same is basically true for technology stocks.

After a deep recession, there is more than enough capacity in most industries. The businesses in each industry can more than satisfy demand. The price of goods produced tends to fall during relative to general infation during this "slack time" all the way down to the break even price of the marginal producers. The pressure builds on all producers to cut costs; as the only way to make a profit is to lower costs.
NOW the WORM HAS TURNED! About half way through the cycle the world changes. Industry after industry discovers that they can raise prices because demand exceeds supply. The business that can make the most goods is now going to be the most profitable. How does a business make more goods? At first, it recalls laid off workers or expands work hours. However, more help only works for a while and the cost of that route increases as wages start to rise. At some point, the business realizes that it must spend on technology. This is the classic case of substituting capital for labor. Companies such as Oracle, have suffered for the past 6 years. There has been little need to buy expensive new software. How the worm does turn! Oracle has not been sitting in idle. With lots of software companies hurting from lack of business, Oracle has bought company after company after company. Oracle now "owns" market segments that it only entered after the down-turn. In several big markets where the company already had a presence, it is now the big dude on the block. The company is not without strong competitors but all of these providers are going to see much higher demand as this economy matures.
One should take the two ideas and combine them. That is; if one avoids small stocks (in general) and if one is willing to buy big caps and technology then why not add a big cap technology stock to your portfolio?