| Factoids from Business & Investment News
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The reduction in the available workers for hire and the gaping current account deficit -- two `safety valves' for the U.S. economy -- are reaching extremes. `These safety valves that have been supplying goods and services to meet the recent increments to purchasing power largely generated by capital gains cannot be expected to absorb an excess of demand over supply indefinitely,' Greenspan said. The Fed chairman reiterated a point that he made in his Jan. 13 speech to the Economic Club of New York. (It sounded flaky then and it sounds every flakier in rerun.) `Accelerating productivity entails a matching acceleration in the potential output of goods and services and a corresponding rise in real incomes available to purchase the new output,' he said. In other words, productivity growth boosts aggregate demand faster than it boosts aggregate supply. Wait a minute! For years, Greenspan has been waxing poetic about the increase in trend productivity growth, about the synergies among technologies that allowed the U.S. economy to expand at a stunning 4% rate without generating inflationary pressures. Now faster productivity growth is the villain? `The logic of Greenspan's position implies that the Fed's job would be easier if productivity growth were only, say, 1.5%,' says John Ryding, senior economist at Bear Stearns. `This is nonsense. Even in the bad economics textbooks, productivity is a good thing,' Ryding says. `Here's a guy who wants to get rates up and he's using whatever resources he can to dream up ways to justify it yet keep the pressure off himself,' says Paul DeRosa, partner in Mt. Lucas Asset Management. `It's a bit of a strain.' Most economists believe rapid growth in productivity -- output per hour of work -- has led to greater supply of goods and helps to explain why inflation has stayed so low. But Federal Reserve Chairman Alan Greenspan says productivity may now be fueling price pressures, by boosting demand.
The Case for Suppressing Inflation
The Case for Fueling Inflation
Mr. Greenspan argued that the exuberant stock market has turned on its head the assumption that faster growth in productivity was helping to restrain inflation. That is because higher expectations for productivity are leading to higher estimates for corporate earnings. That in turn is boosting "stock prices and the market value of assets held by households, creating additional purchasing power for which no additional goods or services have yet been produced," he said. Last year's third- to fourth-quarter 5% annualized advance by labor productivity and accompanying 1% shrinkage of unit labor costs were laudable. Not since early 1996 have these measures of the quality of economic growth posted such a strong performance. Mirroring the rapid expansion of productivity and drop in unit labor costs should be the acceleration of corporate earnings. Early 1996's very good news on productivity and unit labor costs was amid a sterling performance by profitability. For 1996's first quarter the US government's estimate of operating profits was up by 17.1% year-over-year which remains the steepest annual increase since 1995's first quarter. Early 1996's robust profitability promoted business expansion. In turn, the average monthly addition to nonfarm payrolls climbed up from 1995's 181,000 to 1996's 234,000. As the year-end unemployment rate dipped from 1995's 5.6% to 1996's 5.4%, the average annual increase of the hourly wage rose from the 2.9% of 1995's fourth-quarter to the 3.7% of 1996's fourth-quarter, at the same time, wage and salary income's yearly growth rate advanced from 5% to 6.5%. Dividing the 40 years ended 1999 into descending 10-year quartiles of real GDP growth reveals a very strong direct correlation between the growth rates of real GDP and of productivity. Real GDP growth averaged 5.9% in its top quartile, 4.2% in the second quartile, 3.1% in the third quartile, and 0.6% in its bottom quartile. The declension of real GDP growth by quartile was joined by a similar slide for the average annual rate of productivity growth. Productivity's 3.2% average annual increase for real GDP growth's the top quartile was followed by average annual increases of 2.4% for the second quartile, of 1.6% for the third quartile, and of 1% during real GDP's 10 worst years since 1959. [In a paragraph I shall paraphrase (and thus distort), Lonski implies that in this age of 'just-in-time' inventory controlls, production follows demand. In the age of 'marketing', production preceded demand. And that changes things.] Productivity growth tends to be greater and unit labor costs tend to be lower as resources are used more intensively below the point of diminishing returns. In other words, productivity should grow briskly as the faster growth of demand allows for the realization of higher rates of capacity utilization. However, to the degree, gains in productivity are accompanied by a rising rate of industrial capacity utilization, inflation risks may climb higher. Nevertheless, technological advancements may curb the rise in inflation risks following from a higher rate of resource utilization. Perhaps inevitably, the costs of securing more output may take the form of an unwanted climb by price inflation at a high enough rate of resource utilization. During the 40 years-ended 1999, the average annual rates of growth were 3.5% for real GDP and 2.1% for labor productivity. Productivity's 2.6% average annual increase for 1996-1999 owed much to what was at times a below average rate of industrial capacity utilization and an above-trend 4.1% average annual growth rate for real GDP. To reduce economic growth by 1 percentage point in a hot stock market, the Fed would have to raise short and long-term interest rates 1.4 percentage points, believes William Dudley, chief economist at Goldman Sachs. Alternatively, a 20% decline in overall stock prices could accomplish the same slowdown in growth, Dudley said. He believes aggressive tightening by the Fed is more likely. A recent Federal Reserve Board study suggests that as share prices rise, long-term investors may actually save more to reap high retirement returns. Hence the rising stock market may actually induce less consumption by the new Investor Class. The Fed's new logic that productivity is inflationary shows the ad hoc, Rube Goldberg, incoherent nature of its thinking. Fed people choose and create economic paradigms to suit their purpose du jour. Greenspan's testimony implied that the central bank prefers real growth in a range of 3.5%, a substantial slowdown from the roughly 6% growth of the past two quarters. That's a 40-percent growth decline. 40 percent. Not mere fine-tuning, but a very sizable decline in growth. Is this necessary? Does growth really cause inflation? Does the Fed have the tools, or the information, to undertake such a precise and sensitively calibrated surgical incision? My answer is negative on all three counts. For generations central bankers have claimed they are all-powerful. But the results speak for themselves, and they speak poorly. After Mr. Greenspan's remarks, some Fed watchers said the odds of even more action were now higher. "We expect the Fed to tighten at the next two meetings ... and hope that will be enough," Merrill Lynch & Co. economist Bruce Steinberg wrote. "But the risk is that the Fed will end up tightening three or four more times this year." When Alan Greenspan speaks, the Old Economy trembles. But the new one thinks it is impervious to higher interest rates, and shrugs off warnings from the Federal Reserve chairman. The Nasdaq is up 69% since June 30, the date of the first of the Fed's four rate increases. The Dow is down about 4% since June 30. 'Greenspan seems dead-set on taking the punch bowl from the party,' said Thomas M. Galvin, chief equity strategist at Donaldson, Lufkin & Jenrette. 'The market is understanding that interest rates will continue to head higher.' Robert J. Barbera, the chief economist of Hoenig & Company, agreed. Mr. Greenspan, he said, 'is committed to ending, for a time, outsized gains for the equity market.' Greenspan warned that 'interest-sensitive spending has remained robust' and that the Fed 'will have to stay alert for signs that real interest rates have not yet risen enough.' 'Any time you see the word 'alert' from Alan Greenspan, watch out,' said David M. Jones, chief economist at bond firm Aubrey G. Lanston. Jones recalled that in January, the Fed chairman expressed confidence that economic imbalances were being corrected through rises in interest rates. But in Thursday's testimony, Greenspan pulled back from such expressions of confidence. He noted that stock market expectations had risen even higher, offsetting the medicinal effect that rising interest rates were supposed to have had. 'In this testimony, he's saying rates have gone up but we haven't seen that much effect. That implies that they've got to do more," Jones said.
`How comfortable is cash?' says Steve Leuthold, chairman of the investment research firm Leuthold Group. `Well, consider that in a mere 10 days following the 1987 crash, net redemptions amounted to 4.5% of equity mutual fund assets.' Simple math suggests that if fund investors redeem more than the amount of reserves in the funds, fund managers will have to sell stocks to meet the redemptions. As recently as autumn 1990, when stocks tumbled in advance of the Gulf War, ICI data showed cash reserves as high as 12.9%. They've been in a steady decline since, eventually coming at yearend 1999 to their lowest level since they stood at 4.2% in December 1972 -- just before a two-year bear market. Bill Gross, acclaimed manager at Pacific Investment Management, recently offered another slant on stock managers' motivation: By pumping money into the financial system when stocks ran into trouble in 1987 and again in 1998, Greenspan `has demonstrated to investors that he will, when required, lower interest rates and provide liquidity to support the stock markets,' Gross said in a recent commentary. Gross argues that that has led stock managers to conclude there is `a floor below which stocks cannot fall.' Though nobody knows where that floor might be, he says, `the mere fact of a floor anywhere close to existing levels emboldens stock investors to buy more and more since they can make a lot but lose only a little.' If Gross's floor does exist, stock-fund managers would have almost a fiduciary obligation to keep their cash reserves low. Otherwise, they'd be passing up an offer too good to refuse.
`Investors say they've been piling out of the Anglo-Saxon markets of the US and the UK where central banks are raising rates to curb economic growth,' said Trevor Greetham, an investment strategist at Merrill who compiled the monthly survey. `The European Central Bank, by contrast, isn't trying to slow growth but instead take the heat out of the upturn.' Fund managers are holding more cash today than they were at the start of December when the average investor had 4.7% of assets in cash, the lowest in at least two years. Today, the average is closer to 5.6%, Greetham said.
Howard Penney, small-cap analyst at Morgan Stanley Dean Witter, said earnings growth expectations this year for the Russell 2000 stocks stood at 37.5%, more than double the 16.7% expected from the S&P 500. At the same time, price-to-earnings ratios of many smaller companies are below those of their larger brethren. By Penney's reckoning, the Russell 2000 trades at roughly 19 times what its companies should earn this year. The S&P trades at 24 times this year's earnings. 'Small caps are doing better for a simple, fundamental and honest reason -- they are a much better value,' said Byron Wien, chief US investment strategist at Morgan Stanley Dean Witter. 'The market is still overwhelmed by the appeal of technology,' Wien said. 'But for those who have said enough is enough, the small caps hold a lot of allure.' Three small-cap sectors look especially appealing, based on analysts' expectations for earnings growth. Energy, basic material and transportation companies have growth rates comparable to those of technology stocks but carry much cheaper prices. Thus far, small-capitalization companies' earnings for Q4-99 'have been robust,' says Steven DeSanctis, Prudential's small-stock analyst. The universe of small stocks that Prudential tracks shows profit growth of 25.8% for the quarter versus year-earlier results, beating analysts' estimates by about 4.3 percentage points, on average. If the trend continues among companies still to report results, it will mark the first quarter in nearly three years in which small-cap earnings growth exceeded 20%. Among small-cap tech companies, fourth-quarter profits were up 78.4%, on average, Prudential figures show. That means they beat analysts' estimates by nearly 13 percentage points. Other sectors in the small-cap universe in which many companies are exceeding Wall Street expectations include business and consumer services, and health care. Two fund managers we surveyed think [small cap] momentum stocks [in biotechnology and Internet-infrastructure] will surge further precisely because they're so hot now. Richard Gould, who co-manages the Rockland Growth Fund, says small-cap stocks tend toward "big runs" after they reach record highs, as investors feel more satisfied and less anxious. 'A record high is the least risky time to buy the index,' says this small-cap proselyte, 'because a lot of the selling dries up.' David Kovacs, a portfolio manager at Turner Investment Partners, agrees. He expects to see small-cap stocks 'going higher at least until mid-April.' After April, he says, investors will have plowed their tax refunds into the markets and may start taking profits. The success of small stocks also figures to feed on itself, notes Frank Russell's Lawson, because five years of under-performing the S&P 500 has left small caps with plenty of headroom. This favors growth stocks over bargains, he says. Russell 2000 growth stocks have gained about 13% this year, while value stocks have nudged up just 1%.
The odds vs. popular categories have been even better. Unpopular categories have topped the popular ones over the next three years more than 80% of the time. Investing doesn't get much closer to a sure thing than that. This year, our strategy means buying from the Latin American, precious-metals and convertibles categories. Buy one fund from each category. Staking everything on just one unpopular category can be risky. Limit your bets. Resist the urge to put more than 5% -- or at most 10% -- of your portfolio into unpopular categories.
Pension funds have been a force in the U.S. economy for 50 years, growing from $14 billion invested in fixed-income securities in 1949 to a total of $7.4 trillion in stocks, bonds, real estate and venture capital--plus $2 trillion in insured annuities--in 1999. Pension funds today own more than 60% of most major U.S. companies and many smaller ones. For 20 years they have invested in venture capital and also have pushed U.S. corporate managers to think first of returns to shareholders. In Germany, the clamor of small investors for stock markets that give prompt service to their small accounts, as well as the number of German companies raising capital outside Germany, indicates a need for new approaches. Daimler-Benz, before it acquired Chrysler, listed its stock on the NYSExchange in 1995 because it wanted access to world capital markets. Now Siemens will do so next spring. Simply put, German companies can't escape world markets.
Contrary to assertions by some traders, the Treasury hasn't issued directly contradictory statements about future plans. But officials have made statements interpreted by investors to have somewhat different nuances. And absent concrete information about the next few years, they have seized on those statements to draw vastly different conclusions. At a news conference last week, Gary Gensler, undersecretary of the Treasury for domestic finance, talked of de-emphasizing the use of 30-year bonds, saying that "the focus will be more and more on that 10-year note." His remarks were treated in the markets as presaging a sharp cutback, and possibly the elimination, of the 30-year bond. Mr. Summers on Wednesday said, "I expect the Treasury to continue to use the entirety of the yield curve," which was read to suggest that 30-year bonds had more life than Mr. Gensler's remarks suggested. The ratio of bids to securities offered was a paltry 1.33, the lowest cover in 17 years. When it was time to tally the results, the Treasury had to accept bids from a low of 6.01% to a high of 6.34% to cover the size of the issue. The good news is that everyone owns them on the cheap: at a Dutch auction, all bidders are awarded securities at the high yield, no matter what their individual bid. The 10-year auction on Wednesday was poorly subscribed as well, with a 1.45 bid to cover ratio and an award at 6.54%, 7.5 basis points higher than the issue's price at the bidding deadline. Would it surprise you to learn that the biggest reduction in Treasury supply this year will be in the 1-5 year sector? The amount of marketable debt outstanding with a maturity of 1-5 years will fall by $200 billion in fiscal 2000, according to Christopher Low, chief economist at First Tennessee Capital Markets. Alas, there was no scrambling for the shrinking supply of five-year notes last week. Instead, folks tripped over one another to buy bonds before they vanished. If Treasury sticks to the schedule outlined last week and sells $15 billion of 30-year bonds and $7 billion of 30-year TIPS and buys back $30 billion of bonds, that comes to a net reduction of $8 billion, or 1.7%. The Treasury's intention to pay down $170 billion of debt in fiscal 2000 would amount to a 6% decline in the $2.8 trillion of publicly held marketable debt, according to Wrightson Associates chief economist Lou Crandall. `On a proportional basis, the decline is much bigger in the front end,' he says.
Why care? The professor notes that many companies today -- especially dot-coms -- promote the idea that capturing brand leadership now means they will maintain leadership for a very long time. But his research indicates that leading brands are more likely to fade away over several decades than to retain leadership. "So, investors may want to view the long-term prospects of today's leading companies much more cautiously," Prof. Golder says. Top brands with the most longevity were in food and beverage groups, while the most fleeting were clothing brands.
The four college professors who wrote "Can Investors Profit from the Prophets?" analyzed more than 360,000 analyst recommendations from about 270 brokerage firms for the 11-year period ending in December 1996. Following the analysts' favorable recommendations during this period resulted in gains that were more than 4% higher than an indexing strategy would have produced. At the same time, turnover was so high (because many analysts change their minds as often as they change their underwear) that it periodically passed the 400% mark. That means that to follow the recommendations of the analysts, you would have had to change your entire portfolio once every three months, and the resulting transaction costs would swallow that 4% edge the analysts gave you over the market.
PetSmart introduces "Shareables," snacks such as peanut-butter-filled pretzels, for consumption by both pets and their masters. The company says folks often share their food with pets even though it isn't necessarily good for the animals. So PetSmart makes snacks that are nutritionally correct for both. (WSJ 2-17) Net income of major U.S. companies surged 31% in the fourth quarter of 1999, according to Wall Street Journal statistics. Net profit from continuing operations, which excludes one-time accounting entries, grew 33%. The figures are based on 564 of the earliest reporting U.S. companies in the Dow Jones Global Indexes. First Call expects companies in the S&P 500 to post first-quarter earnings growth of 19% and second-quarter growth of 16%. With the Fed expected to embark on a series of interest-rate increases to brake the economy, the outlook for the second half of 2000 is more difficult. (WSJ 2-17) The number of Nasdaq stocks making new 52-week highs each day is starting to recede, while the number dropping to 52-week lows each day in rising, said Mike Hurley, technical analyst at E-Offering in San Francisco. Richard McCabe, technical analyst at Merrill Lynch in New York, expects the Nasdaq index to soon drop into a correction of about 20% that will last two to three months. Nasdaq daily trading volume now averages a record 160% of New York Stock Exchange volume. High figures like that have historically pointed to excessive speculation in risky stocks, McCabe said. That kind of activity often precedes sharp market downturns. Nevertheless, the Nasdaq trend that has most impressed the bulls recently is the difference in trading volume during rallies and declines. Market technicians like to see the index rise on days when trading volume is heavy. They also like to see any index declines accompanied by lighter trading volume. In general, that's what has occurred in recent weeks. (Walter Hamilton, LA Times 2-17) Overseas investors bought about $108 billion of U.S. equities in 1999, double the 1998 level and trouncing the previous record of $70 billion in 1997, the Securities Industry Assn. estimated. But demand for U.S. Treasury bonds slumped last year to a 25-year low, as foreign investors looked for higher returns from American equities and corporate bonds. Although many foreign stock markets were even hotter than the U.S. market last year, American investors were net sellers of foreign stocks, SIA said. Through November Americans sold a net $17.8 billion of foreign shares. (LA Times 2-16) Vanguard's founder John Bogle's laundry list of the many ways mutual fund returns are overstated: (1) Returns totally ignore sales charges; (2) Fund returns ignore increasing expense ratios; (3) They ignore risk factors between funds; (4)they minimize the impact of taxes; (5) There are statistical problems in multi-year comparisons; (6) They fail to account for hyperactive turnover and (7) They don't reveal gimmicks used by new funds. (Paul Farrell, CBS MarketWatch 2-16) Corporate income taxes represented only 10.1% of U.S. government receipts in fiscal 1999. That was down from 11% in 1998 and the third consecutive yearly decline, according to the president's budget. Back in 1966, corporate income taxes accounted for 23% of the total. (WSJ 2-16) The initial sales report is based on a small sample survey. In a period of strong growth, it makes intuitive sense that the inclusion of late-month sales, captured in the revisions one and two months out, will bias sales upward. That's why it's hard to get too excited about the 0.3% increase in January retail sales and 0.3% decline in non-auto sales, especially since November and December sales underwent huge upward revisions. (Caroline Baum, Bloomberg 2-16) The magic of capitalism is that over the long run, the average worker does capture most of the gains from productivity, either in terms of what he's directly paid, or in his other role as consumer, in the form of cheaper prices. For example, the fantastic gains in farm productivity, which have meant we've been able to produce ever more for ever less, have mainly benefited consumers. (Gene Epstein, Barrons 2-14) Senior Treasury staffers think that if government debt becomes extinct, dealers will merely turn their attention to agency and corporate securities or the interestrate swaps market for benchmarking and hedging purposes. Remember that before the Treasury began regularly selling 30year bonds in the mid-1970s, the bond benchmark was high-quality corporate debt, such as obligations of AT&T. Before that, in the late 19th century, it was high-grade railroad bonds that served as the standard. (William Pesek, Barrons 2-14) In one more instance of the old rules no longer applying -- for now -- last year it paid to stay away from companies that pursued aggressive buybacks. The 50 companies in the S&P 500 that bought back the biggest percentage of their outstanding shares in 1999, only eight beat the S&P and 33 of the 50 showed negative returns. The weak results have continued into 2000. One of the trends these days is for companies to announce weak results and simultaneously trumpet a big buyback in the hope that the repurchases will soften the blow. That strategy, however, generally doesn't work. (Barrons 2-14) Sam DeRosa-Farag, global high-yield strategist at Donaldson, Lufkin & Jenrette, calculates the average high-yield bond fund has 4.2% of its assets in stocks, and another 4.2% in stock-like instruments, such as preferred stock and convertible bonds. He notes that such stakes are up considerably from 1992, when the typical high-yield-bond fund held about 1.5% of its assets in stocks, and just 2.75% in preferred stock and convertible bonds. (WSJ 2-14) From Goldman Sach's Abby Joseph Cohen: 'At 1,400, the S&P 500 is roughly at fair value. Our year-end 2000 target remains at 1,525. A fairly-valued market should generate returns that track corporate performance and do so with normal volatility. This may appear somewhat unkind after several years of above-average stock price gains and below-average volatility [and] may encourage notable portfolio rotation,' Cohen said in a note to clients. 'Technology companies in the S&P 500 are finally getting the respect they deserve for their favorable long-term growth prospects. For much of the past decade, they were grossly undervalued and our model portfolios recommended dramatic overweighting relative to the index. This is no longer the case,' Cohen added. (CBS MarketWatch 2-14) Confused by such terms as "red herring" and "dead-cat bounce?" Pay a visit to InvestorWords, which provides more than 5,000 definitions and claims to be the most comprehensive financial glossary either online or off. The investor-tools area of Investorama has a glossary of hundreds of financial terms. Quicken.com's quick and well-organized glossary provides straightforward definitions of financial terms, including brief descriptions of laws. (WSJ 2-13) There are no statistics on the incidence of last-minute billing, but consumers increasingly are complaining that their credit card companies are making them late [thus generateing late fees] on purpose. Card issuers are legally required to mail bills at least two weeks before they are due and to process payments immediately upon receipt. But consumer advocates say that in some cases, companies may be sending bills at the last possible moment and then processing those payments slowly after they're received in an indirect attempt to drive up fee revenue. Those who have billing problems that they can't resolve with their credit card companies may want to call the comptroller of the currency at its toll-free number - 800-613-6743. (Kathy Kristof, LA Times 2-13) Right now, the S&P 500's biggest members make up a larger portion of the index than at any time since the early 1970s, when the so-called Nifty 50 stocks dominated the market. Today's top-10 stocks, led by Microsoft, Intel, GE and Cisco, account for nearly a quarter of the index's value. Last year, the 10 biggest companies in the index returned 38.8% on average, compared with just 4.4% for the bottom 200 companies, according to the Leuthold Group, a stock-market research firm. And if you removed all the tech stocks from the S&P 500, its return would have fallen to 3.1% last year from 21%. (Ken Brown, WSJ 2-11) The P/E gap between the headiest tech names and the also-rans is perhaps as wide as it has ever been, analysts say. Legg Mason strategist Richard Cripps noted this week that although the top 50 S&P 500 stocks are trading at an average P/E of 75 based on most recent 12 months' earnings per share, the average P/E of 1,800 stocks tracked by Value Line is just 14.5. The overall S&P P/E, at about 29, thus is grossly inflated by the index's tech stocks. (Thomas Mulligan, LA Times 2-11) This is how I read the message from the underperformance of the Dow Jones relative to the Nasdaq. A hundred basis points' tighter Fed is having a much greater impact on the old economy. That means the cyclical economy, which is vastly more interest-rate-sensitive than is the new technology economy. Thirty-eight percent of the Nasdaq 100 companies have no long-term debt. In the S&P 500, less than 1% of firms can make that claim, according to Investor's Business Daily. (Lawrence Kudlow, CNBS 2-11) The Greeting Card Association in Washington says teachers get the most Valentine's Day cards. (WSJ 2-10) The number of new restaurants opened in the U.S. last year barely budged from a year earlier, while overall sales rose 6% to $269 billion, says NPD Group Inc., a marketing-information outfit. (WSJ 2-10)
From Business Week's glossary of chocolate terms 2-11
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