* Investment Strategy -- A direct line to Gary Shilling's thinking on current and prospective investment opportunities.  In our September 2004 issue, Gary took a look at how the oil price spike might affect the economy.  In July 2004, he laid out the differences between real and perceived inflation.  In our August 2003 issue, he told why the new 15% federal tax on dividends and capital gains won’t be enough to make real after-tax stock returns cheap.

      * Looking Ahead -- Examines economic and financial developments and looks ahead to how they may affect our investment themes. 

       * Commentary -- Gary Shilling's often humorous, sometimes philosophical look at almost any topic.

FEBRUARY 2005
“2005 Investment Themes: Three 'Likelys' and Three 'Maybes'”:  We have developed six investment themes for 2005.  Three of them are likely and three are "maybes" this year, but none are widely believed.
The dollar is likely to rally, especially against the euro as excessive pessi-mism and speculation against the buck unwinds and as the superior strength and productivity of the U.S. economy is appreciated.
U.S. consumer deflationary expecta-tions have moved from autos, airfares and telecom to general merchandise, and are likely to spread further.
The Treasury yield curve is likely to flatten further as the Fed raises short rates, but bond yields will probably be flat to down.
Maybe the housing bubble will break, creating much anguish and a consumer saving spree that will devastate the many foreign countries that depend on U.S. consumers to buy their excess goods.
Maybe U.S. stocks will fall to new lows as earnings growth proves inadequate to meet expectations in an era of high P/Es and low dividend yields.
Maybe China will suffer a hard landing with negative implications for many other economies and commodities, especially if the U.S. is simultaneously soft.

“Do Foreign Central Banks Influence Treasury Yields?”: Recently, foreign central banks have been heavy purchasers of Treasurys and many believe that is why Treasury bond yields didn't rise last year.
Nevertheless, there is no statistical evidence that these purchases affect bond yields, even after the influences of the Fed funds rate, inflation and the federal deficit are taken into account.

JANUARY 2005
“A U.S.-Hong Kong Debate: Will There Be Deflation?  Will It Be Good? Bad? Or Is Inflation On The Horizon?”: Last month, Gary Shilling and Marc Faber exchanged views and opinions on the global economy and, specifically, debated whether deflation is on the horizon and, if so, whether it will be good or bad.
Drawing on their backgrounds as well as their particular vantage point of the world—Dr. Shilling from the U.S. and Dr. Faber from Asia—they engaged in a wide-ranging discussion that brings forth their knowledge of history, geopolitics and, obviously, economics. 

DECEMBER 2004
“Institutional Investing—To Look Forward, Look Backward”:  The length and strength of the 1982-2000 bull market convinced many that equities would soar forever and spawned many widely-held convictions.  Investors should buy and hold, not try to time the market.  Cash is trash.  Precise asset allocation, "pigeon hole" investing, is superior as is concentration on high-flying sectors.  Managers should be hired to invest fully in specific sectors and their sole goal is to beat their benchmarks.  Index funds beat active management.  Dividends are counterproductive, bonds are for wimps and management fees are too tiny relative to returns to matter.
Despite the bear market that followed, the bull's strength and the massive monetary and fiscal stimuli that sustained the early 2000s economy kept speculation alive.  The demise of that speculation, centered now on hedge funds, the carry trade and housing, and the deflation I foresee will eliminate those bull market-sired convictions.  So will much lower returns on stocks.  Investors will learn that this time, it isn't different.

“Semi-Annual Economic Outlook—What Will Sustain Growth?”:  Massive monetary and fiscal stimuli muted the 2001 recession and offset      9/11's drag while consumer spending also benefited from increased borrowing and reduced saving.  But new spurs to consumer incomes and spending are lacking, and replacements from business outlays haven't materialized.
High energy costs, monetary tightening, the vulnerability of the housing bubble and the morning after the presidential election will also subdue economic growth.  A likely recession in 2006 if not before will eventually reverse interest rate increases but slash profits.  Most foreign countries depend on exports to the U.S. for growth and will not benefit the American economy in coming quarters.

NOVEMBER 2004
“The Economics of Medical Services—Free Markets Would Slash Costs”:  The current American health care system encourages high and rising costs.  On the demand side, consumers want the best in medical care since their lives are at stake.  And their demand is almost limitless since governments and employers pay most of their medical bills.
On the supply side, heavy government involvement in health care almost guarantees inefficiency.  Since hospitals are run for the benefit of MDs, not patients, inefficiencies abound there as well.  And because consumers pay little of their drug costs, the FDA and drug companies have little incentive to constrain them.
If government and employee health care money were given to consumers to spend as their own, they would become much better medical care shoppers, and much government bureaucracy and health insurance administration and cost would be eliminated.  Hospital employment of physicians would slash inefficiencies and put patients first.  Price-sensitive consumers would also compress drug costs.  Competition is being introduced to medical care, but much more is needed, before the huge medical needs of the aging postwar babies materialize.

“Export Dependence”:  Asian countries are growing concerned because their export growth is waning.  At the same time, rising energy prices and other forces are cooling the U.S. economy and, thus, American demand for Asian exports.
This will become a significant problem since most of Asia's exports go, directly or indirectly, to the U.S.  And finding a big importer to replace the U.S. is probably one of the global economy's biggest long-run challenges.  China is trying to cool her white-hot economy, so she may not be a candidate.  Could it be Japan?

OCTOBER 2004
“Here Comes Deflation—Ready Or Not”: Few agree with our mild deflation long-term forecast, probably because they've only experienced inflation and mistakenly believe that prices are rising on everything they buy.  Still, inflation is fading and many powerful deflationary forces are hard at work, including the burst in productivity-soaked semiconductors, computers, the Internet, telecom, biotech and other new tech.  Restructuring, inflation-wary central banks, globalization and the likely shift of U.S. consumers from borrowing and spending to saving also promote deflation.
We foresee the good deflation of excess supply, as in the new tech-driven late 1800s and the 1920s, not the 1930s bad deflation of deficient demand.  Still, the transition to good deflation may be rough as excessive leverage in housing, the carry trade and other areas is rationalized.
Once good deflation is established, stocks should do well, but nothing like the exuberant late 1990s.  Risk-adjusted, Treasury bonds will be attractive competitors after a further substantial rally to 3% yields.

“9-11's Effects: As Significant As Past National Traumas?”:  It's been oft-stated the past three years that the events of 9/11 changed the country forever.  But how much of that change is actually systemic?  Will that date be as full of long-term ramifications as other national traumas from our history?
Some of the after-effects of the Civil War are still with us today.  World Wars I and II led to long-term changes around the world that are still being dealt with.  Even events such as JFK's assassination and the Watergate scandal set in motion a number of developments that, 10 and 20 years later, altered the country significantly.
Time will likely tell whether 9/11 has the major impact that we now ascribe to that tragic event.

SEPTEMBER 2004
“Crude Behavior”: Many worry that the recent leap in crude oil prices will "tax" the U.S. economy into sluggish growth, if not a recession, as did the previous five oil price spikes.
But energy use per dollar of GDP continues to fall due to greater efficiency and the rising service orientation of developed countries.  Also, in real terms, oil prices are well below previous peaks.  In addition, the energy that Americans buy from domestic producers is recycled within the U.S. economy.
Still, big oil imports mean that the price spike is a "tax" paid to foreign exporters of almost 1% of U.S. GDP, and few of those dollars return to buy U.S. goods and services.  Given the subdued American economy, Fed tightening and the likely hard landing in China, the oil price spike may well tip the scales toward a global recession.

“Is The Middle Class Disappearing?”:  The Kerry camp says that the American middle class is endangered and that the country is gravitating toward two classes, one rich and the other poor.  Recent statistics on real pay, middle income layoffs and excessive executive pay support them.
Still, the polarization of income is three decades running, and results largely from employment shifts from high-paid sectors like manufacturing and utilities to low-paid industries such as leisure and hospitality.  Meanwhile, those on top have the skills to thrive in today's global economy.
Still, there are also new depressants on middle class incomes, including soaring medical costs, rising debt service costs, longer unemployment duration, offshoring and the maturation of new tech.  Bush should worry that the Kerry camp may have found a vulnerable issue.

AUGUST 2004
“The Fed's Effect on the Economy, Stocks and Bonds”:  The initial sluggishness of the economic recovery and fears of deflation induced the Fed to delay raising interest rates until June, when the expansion was 31 months old.  Delays at least this long occurred in three other post-World War II business upswings.  Conversely, the Fed tightened as soon as one month into earlier recoveries.
In past cases, Treasury bond yields continued to rise even after the Fed delayed tightening.  Still, with the current transparency of intended Fed actions, yields this time rose more than they ever have before the Fed acted.  And, the end of earlier massive fiscal and monetary stimuli and likely slowing of economic growth may well turn inflation fears back to deflation concerns.  Treasury bond yields may have already peaked, especially if a post-election year recession unfolds.
Stock gains tend to be small after Fed tightening commences, and sometimes equities peak before the central bank moves.  In view of the current expensiveness of stocks, this may be one of those times.  In fact, the stock advance that topped early this year may prove to be a rally in the bear market that started in early 2000.

“The Great Disconnect”:  The economy and corporate profits are strong but stocks are limp.  This disconnect probably measures investor expectations of rising interest rates and much slower earnings advances while stocks are already expensive
This dichotomy also reflects the disconnect between the economic and financial worlds that started with irrational exuberance over stocks in the late 1990s and shifted, after massive Fed ease, to residential real estate and "borrow short-invest long" speculation.
History says the two worlds will reunite, but the longer Washington staves it off, the more violent it may well be.

JULY 2004
“Inflation: Perceptions vs. Reality”:  Inflation has replaced employment as investors' primary economic concern.  The Fed, however, is less worried and intends to raise short-term interest rates at a gradual pace.
Unlike the Fed, most Americans didn't see a deflation threat last year and, indeed, mistrusted the data that showed core CPI inflation close to zero and falling producer prices.  Most are biased by lifetimes of inflation and recent price hikes in frequently-purchased items like gasoline and milk.  They forget the price drops on big, infrequently-bought goods such as computers and vehicles.  In fact, the CPI continues to overstate inflation.  
The current inflation rise will probably prove to be one more uptick within the disinflationary trend since 1981.  Indeed, with softer U.S. economic growth likely in coming quarters and a hard landing in China, renewed concern over deflation may soon replace inflation fears.  Then the Fed will switch from raising to cutting interest rates.

“Car Crazy?”:  Since 9/11, big incentives have been needed to sell cars in the U.S., but may still be required after concerns over terrorism, high gasoline prices and other negatives are history.  Longer-lasting vehicles and market saturation will limit future sales growth.
This is bad news for domestic producers, with their continuing labor cost disadvantage to imports and transplants.  Market share losses and strains on profits should persist.

JUNE 2004
“Semi-Annual Outlook: The Deflating Speculative Balloon”:  Fed-induced low short-term interest rates and a steep yield curve spawned immense speculation in recent years.  Many hedge funds and others borrowed short term here and abroad to finance Treasury bonds, commodities, currencies, emerging country stocks and bonds and junk bonds with gay abandon.  The massive extent of this speculation is being revealed by huge market volatilities as these trades are unwound in the face of anticipated Fed rate hikes.
The two big questions are, first, have interest rates risen so fast that some major financial institutions have been seriously hurt and will drag others down with them?  And second, will the real economy, especially the vulnerable housing sector, be significantly damaged?
Even without either of these major crises, U.S. economic growth is likely to slow later this year and may enter a recession in 2005, especially if China's attempt to cool her red-hot economy results in a hard landing, as is likely.

MAY 2004
“Spotlight On Profits”: With the near universal predictions of rising interest rates, already high stock  P/Es are likely to decline.  And, dividend yields are too low to protect equity prices.  So, the bulls' case requires very rapid gains in profits.
Corporate earnings growth has been robust recently, much more so than indicated by the usual drivers.  Still, the consensus forecast of continuing rapid economic growth, higher inflation, robust employment and the resulting slower productivity growth, stronger labor costs and rising interest rates translate into S&P 500 operating earnings gains of only 4% year-over-year in future quarters.  This is far below Wall Street analysts' estimates of 16% growth and the 20% average of the last six quarters.
Interestingly, our forecast of slower economic growth, subdued prices, rapid productivity growth with continuing layoffs, modest labor cost increases and falling interest rates results in the same modest gains in profits.

“Will Job Growth Be Robust?”:  The unexpectedly large payroll increase for March, reported April 2, convinced most that rapid economic growth, renewed inflation and Fed tightening lie directly ahead.
But 70% of the gains were in retailing, health care and other sectors shielded from global competition, and they may be temporary spurts.  Also, most other components of the March labor market reports were weak.  Weekly hours fell, permanent job losses grew, the unemployment rate rose and those offered only part-time jobs leaped.
Furthermore, the growth in jobs is centered in low-paid areas like leisure and hospitality while high-paid jobs in manufacturing and IT disappear.  Earlier lackluster labor markets may not be ancient history.

APRIL 2004
“Interest Rates—Up Or Down?”:  The conviction is almost universal among economists, Wall Street wizards and investors that the next major move in interest rates is up.  Withdrawals from bond mutual funds, the widespread shorting of Treasurys, big corporate bond issues and statements from Fed officials bear witness to this belief.
Most look for continuing rapid economic growth and the return of significant inflation to boost interest rates.  Still, the rally in Treasury bonds since last August and the steepness of the yield curve is very frustrating to bond investors who have remained on the sidelines in cash with its negative real returns.
In contrast, we see a weaker economy later this year and next, with weak labor markets dominating, and we continue to forecast mild deflation in the long run.  We also expect foreigners, especially central banks, to continue to recycle dollars into Treasurys to restrain their currencies and promote exports.  A subdued economy may induce the Fed to cut short rates further before they move to our long-run 2% forecast.  Deflation will push Treasury bond yields to our long-held target of 3%.

“The Housing Bubble”:  Conventional, site-built housing has benefited in recent years from declining and low mortgage rates.  Many see its nemesis in the spike in interest rates they forecast.
We believe that the next major move in rates is down, but still see trouble for housing from overly generous lending terms.  To keep the bubble expanding, Washington is moving downpayments for low-income buyers from 3% to zero.  Private lenders are pushing interest-only loans and loans that exceed house values.
The bubble is insidiously self-feeding as more liberal financing terms spur higher prices that require even more liberal terms to keep first-time homebuyers viable.  Look for the bubble's ultimate collapse to slash house prices and destroy much homeowner wealth.

MARCH 2004
“Profitable Unemployment?”:  The average time between jobs has been much higher in relation to the unemploy-ment rate since the early 1990s than earlier.  It's due to excess worldwide capacity and the resulting lack of busi-ness pricing power, which spawns permanent, not just cyclical job cuts, as well as job exports.  People who enter retraining and move to different occu-pations take longer to become re-employed, especially now that white as well as blue collar jobs are being permanently axed.
It doesn't appear that lush unemployment benefits encourage laid-off workers to conduct job searches only leisurely.  Washington does extend unemployment benefits, but only temporarily and after unemployment leaps.  

“The Kondratieff Wave—Dead or Alive?”:  The 1970s interest in the Kondratieff Wave evaporated when the final "depression" phase failed to materialize in the 1980s.  Still, high inflation stretched the plateau phase from the usual 10 to 25 years, but didn't alter its structure.  Indeed, the 1990s twinned the 1920s.
The “depression” phase likely started with the financial collapses in Asia and Russia in 1997-98, and will be the usual 15 years of working out past excesses.  The tech stock collapse and super-abundant capacity are typical as are protectionism, new regulation and impotent monetary policy.
Look for the good deflation of productivity-driven excess supply after a rough transition, falling real estate prices, aggressive fiscal policy, 4% to 5% real Treasury bond yields and 7% real total stock returns.

FEBRUARY 2004
“A Limp String”:  The Fed's easy credit policy in recent years has spurred mortgage borrowing, but little else.  Other bank lending demand is so weak that the Fed hasn't needed to create more bank reserves to keep short-term interest rates low, despite the recent strength in economic activity.
With weak inventory investment, subdued plant and equipment spending, huge free cash flow and pressure to clean up their balance sheets, businesses are retiring, not increasing, their bank borrowing.
The net result: the money supply has been falling since last summer, and the Fed can't do much more to revive it.  For the monetarists who see money as THE driver of the economy, this is scary.  For the rest, it's worth watching.  Money isn't the only driver, but it does matter.

“Pressure on Investment Fees and Commissions”:  Led by New York Attorney General Eliot Spitzer, regulators are squeezing mutual fund fees, which have risen in the last two decades despite the supposed economies of scale from the leap in fund assets.  Furthermore, 12b-1 fees that pay for marketing and for distribution are being scrutinized, especially for funds closed to new investors.
The real sleeper is commissions on securities transactions.  Fund share-holders are largely unaware that they pay for more than execution, with the excess used to buy research, computers and administration and to pay brokers who promote the funds.
Pressures to shrink mutual fund fees and commissions may well intensify the likely consolidation of the mutual fund industry.  Non-brokerage house independent research could largely be eliminated.

JANUARY 2004
“Long Term Outlook--Still Deflationary”: Most believe that a surge in inflation is imminent.  They look at recent strong economic growth and normal inflation harbingers such as the gold price spike.  We disagree and continue to foresee mild deflation of 1% to 2% in the years ahead.
Despite 9/11, defense spending should continue well below Cold War levels, total saving will grow faster than investment, and central banks will be impotent in resisting deflation.  Restructuring persists globally and new tech, despite stock market embarrassments in the recent past, will continue to drive productivity and excess supply.  Globalization with persist in turning worldwide excess capacity into deflation, and the shift by U.S. consumers from borrowing and spending to saving will put downward pressure on prices internationally.
Deflation will persist until the next major shooting war, and will be the good kind, spawned by excess supply, not the bad deflation of deficient demand.  Still, the transition to it may be rough since few are prepared, and a financial crisis that could turn good deflation to bad is possible.
In mild, good deflation, stocks will be attractive but much less so than in the late 1990s bubble.  High-quality bonds, risk-adjusted, will be equally interesting.

We also look at how China’s current attempts to cool her overheating economy could implode with worldwide ramifications.

And we also take a look at how Asia's attempts to lessen its dependence on exports to the U.S. are failing.

DECEMBER 2003
“U.S. Quarterly Economic Outlook: Will Recent Strength Persist?”: U.S. economic growth, especially in the robust third quarter, has relied on consumer spending and housing.  These sectors have in turn been driven by tax cuts, falling mortgage rates and the military spending bulge during the Iraq hot war phase.  These stimuli, however, are running out.  Optimists hope that business spending on inventories and capital equipment will seamlessly take over and continue rapid economic growth, but negative pricing power and excess capacity say otherwise.
The lack of stimuli will unmask the weakness in consumer incomes resulting from continuing layoffs, the only route to cost control and profits growth when selling prices are falling.  Combined with consumers' newfound zeal to save, this suggests economic weakness next year and a breaking of the housing bubble.  In that climate, stocks are vulnerable but Treasurys will benefit, especially as a soft economy resurrects the specter of deflation.

“Sidebar—Capacity Utilization: How It's Measured”

“The 2003 Tax Cuts: They're All Over”: The 2003 tax cut package had a big impact on third quarter consumer spending as the $400 Child Tax Credit checks went to Wal-Mart, pronto.  But that's all folks!
The rest of the individual tax cuts went largely to higher-income taxpayers since they pay the vast majority of taxes.  They're also the big savers, so the income from tax reductions this year and next as well as the big refunds next April will be predominantly saved.  Business tax rate reductions are unlikely to spawn capital spending, given ongoing excess capacity.

NOVEMBER 2003
“Productivity and Profits”:  Recent robust profits growth, aside from the ending of big writeoffs, has been driven by leaping productivity.  This in turn is the result of vigorous layoffs and job exports more than longer run factors like new tech, labor training and restructuring.  In a climate where pricing power is absent and volume growth tepid, cost-cutting, especially labor costs, is the only route to profits improvement.  Without robust productivity, profits in recent quarters would have fallen as the effects of higher labor costs and falling selling prices offset the impact of rising sales volume.
Tax cuts, low mortgage rates and other stimuli that have been spurring consumer spending and housing strength are fading at a time when consumer saving rates are rising.  If business investment seamlessly supercedes these government stimuli as the economic driver, double-digit corporate profits growth may well continue and support current high stock prices.
But if a business spending surge is lacking, as we expect, then continuing layoffs may well precipitate weakness in consumer spending and housing.  This climate would be detrimental but not disastrous for profits.  Layoffs would probably keep productivity growth ahead of muted labor cost increases, but falling selling prices and volume would harm earnings.  Present stock prices do not suggest that shareholders are prepared for this scenario.

OCTOBER 2003
“Is "The Bond Rally of a Lifetime" Over?”:  The leap in Treasury bond yields from mid-June to mid-August—along with the conviction that the Fed, fearing deflation, is hell-bent on recreating inflation—has convinced many that the two-decade-long rally in Treasurys is over.  We disagree.
Deflation remains the odds-on bet regardless of monetary and fiscal policy attempts to stop it.  This will be clear to fixed-income investors if our forecast of a 2004 recession pans out.  Tax cuts, low mortgage rates and the leap in defense spending have sustained the economy in the face of robust global deflationary forces and the morning after the 1990s bubble.  But these stimuli are about over, and high layoffs continue.  So consumer retrenchment and housing weakness are likely to subdue the economy.
This will force investors to recognize the strength and pervasiveness of deflation and, in the process, push Treasury bond yields to our long-held target of 3%.

“Protectionism Is Flourishing”: The  recent breakdown in trade talks and the G-7 pressure on Japan and China to boost their exchange rates points to an increasingly protectionist world, not surprising when layoffs are continuing and jobs are scarce.
The U.S. is limiting immigration and subsidizing numerous sectors; Europe, pleading health and safety, has severely limited imports of certain U.S. agri-cultural products while subsidizing its own farmers; and Japan restricts rice imports to protect its own.
Meanwhile, China and Japan gave a flat "no" to the G-7's demands.  And the poor countries want the rich to stop subsidizing farm exports with no quid pro quo.
Unless America pushes free trade vigorously, protectionism may become serious enough to precipitate a global financial crisis.  That could lead to a 1930s-style dose of bad deflation caused by deficient demand.

SEPTEMBER 2003
“U.S. Quarterly Economic Outlook—Will U.S. Growth Rise Or Fall?”:  U.S. economic growth in the second quarter reflected earlier federal tax cuts, the low interest rate inducements to housing activity and cash-out mortgage refinancing, and a huge leap in military spending spurred by the Iraq war.  These forces will probably propel the economy in the second half.  Beyond that, the optimists expect a renewed surge in capital spending and robust inventory-building along with continuing strength in consumer spending and housing as the delayed effects of earlier stimuli surface.
We disagree.  Economic growth has been sluggish for almost three years because the flip side of the late 1990s stock market bubble and economic boom has largely offset aggressive monetary and fiscal measures.  Furthermore, increasing global deflationary forces weigh heavily on American business as do mountains of excess capacity.  In this environment, meaningful revival of capital spending and inventory-building are unlikely anytime soon.
The effects of monetary and fiscal stimuli will soon be exhausted, shifting the spotlight back to layoffs as the only way to preserve corporate profits when volume growth is lousy and pricing power is nonexistent.  The results will likely be renewed economic weakness next year as saving-bent consumers retrench.  Their retreat and the recent spike in interest rates will burst the housing bubble.
 
AUGUST 2003
“With 15% Taxes on Dividends and Capital Gains, Are Stocks Still Expensive?”:  Stocks remain very expensive with a sky-high P/E of 32 on the S&P 500 and a miserly dividend yield of 1.7%.  In the early 1960s, the last time inflation was as low as now, the P/E was 18 and the dividend yield was 3.1%.  Still, the new 15% federal tax rates on long-term capital gains and dividends might bridge the gaps.
Not so.  Dividend yields after not only 15% federal but also New York State taxes are lower than in the early 1960s.  This is also true after adjustment for inflation, Alternative Minimum Taxes and the growing share of stocks owned by nonprofits.  Also the new 15% tax rate doesn’t make realized capital gains after taxes and inflation any better than in the early 1960s.  And total returns, compared to Treasury bond yields, after taxes and inflation, are weaker than 40 years ago.
Furthermore, the consensus forecasts for stock appreciation and dividend yields are less attractive after the 15% tax rates and inflation than in the early 1960s.  Ironically, our deflation forecast is more auspicious.  One reason: Real gains from deflation have a zero tax rate.
 
“Bulls vs. Bears”:  The investment bulls need strong second-half economic growth to justify this year’s stock rally, and they expect it.  They foresee the long-delayed effects of massive fiscal and monetary stimuli to explode soon.
The bears, us included, note that what’s at work isn’t delays but deflation and the flip side of the stock and economic bubbles of the late 1990s.  Without big stimuli, the economy would be in deep doo-doo.

JULY 2003
“The Dollar—False Hopes For Further Weakness”:  The Administration seems to favor a weak dollar to discourage imports, encourage exports and thereby spur the lackluster economy.  The Fed wants a soft buck to insure adequate inflation.  But import and export prices reflect only a quarter of dollar fluctuation as traders take offsetting actions.  Much more important is economic growth.  A 1% rise in GDP hikes U.S. imports 2.9%.  The dollar, then, is much less important to deflation or inflation than we thought earlier.  In the short run, the dollar should revive as the U.S. is the best of a bad global lot.  Intermediate run, the buck should gain from America’s superior efficiency vs. other countries.  Long run, U.S. tech leadership will make America the center of worldwide action, to the dollar’s benefit.
 
“Limiting Labor Costs”:  Pricing power among American businesses is weak and will be even more so in deflation.  So, stringent labor cost controls are essential.  Inflation will no longer erode overpaid staff back to the proper levels.  Instead, their real pay will rise in deflation.  Cutting pay rates is tough in the aftermath of the 1930s, but is occurring today.  Layoffs have become the postwar method of choice, but are brutal. 
Other strategies are being pursued, including replacing experienced but overpaid workers with cost-effective staff.

“What’s Keeping The Consumer Flush?”:   Despite layoffs, stock losses and a leaping saving rate, consumer spending has held up.  But the outlook is negative.  Income boosts from pay fringes and government wage rises are waning.  Federal tax cuts are being offset by state and local hikes.  Cash-outs from mortgage refinancings will end if consumer-led economic weakness bursts the housing bubble.

JUNE 2003
“Greenspan In Heaven”:  Fortunately, Federal Reserve Chairman Alan Greenspan is alive and well.  Still, it seemed interesting to send him off to the afterlife to debate the prospects of deflation and appropriate Fed policy with deceased former Fed Chairmen William McChesney Martin and Arthur Burns.  The alternative—to simply say that those two inflation fighters must be spinning in their graves after the Fed declared that the prospects of deflation are greater than inflation—seemed rather dull.
Some of what Chairman Greenspan is saying reflects his public statements on the risks of deflation and its probable results.  At the same time, much of what he says are our own views, and we hope you can tell which is which.  Chairmen Martin and Burns play the deflation skeptics and, we hope, accurately reflect those who don’t foresee deflation—no way, no how—despite the Fed’s new position.
We hope you find this piece more amusing than offensive, and at the same time a useful summary of the current debate over deflation, both pro and con, as well as a reminder of our views.  We thought it appropriate after the Fed’s extraordinary and dramatic switch from a half-century of combating inflation to resisting deflation.  In any event, the Fed’s new stance certainly gives credibility to our long-held deflation forecast that goes back to our two Deflation books published in 1998 and 1999.

MAY 2003
“The Corporate Profits Outlook: Hope vs. Realism”: Wall Street analysts persist in their rosy corporate earnings forecasts needed to substantiate still-high-priced stocks.  Forecasts of 10% or more long run profits growth are the norm.
But, over time, profits grow slower than the economy.  In the 1959-2002 years, GDP climbed 7.3% annually while S&P 500 reported profits rose 5.0%.  In the years ahead, we expect mild deflation and 1% annual increases in nominal GDP.  The consensus looks for about 2% inflation and 5% nominal economic gains.  Either way, 10% profits growth isn’t likely without some huge salutary force, like the unwinding of inflation in the 1980s and 1990s.
Our statistical model amply demonstrates the power of sales growth in propelling earnings but, like analysts’ forecasts, understates the drags that cut profits growth below sales gains in the long run.
 
“U.S. Quarterly Economic Outlook—Was Iraq Really The Problem?”:  With the Iraq war won, the economic optimists foresee a cloudless sky, hoping spent-out consumers can hold the economic fort until the cavalry of business capital spending rides to the rescue.
But huge excess capacity will delay any boom in plant and equipment and post-Iraq war indicators suggest that prewar problems remain. 

APRIL 2003
“The Chinese Tea Cup: Half Full Or Half Empty?”:  Many are dazzled with China’s rapid growth and mushrooming exports.  Fueled by cheap labor, she has become the world’s low-cost producer of many manufactured goods.  And she may continue in that role for decades as she employs her pool of urban and especially rural unemployed and underemployed that total close to 500 million.
But many were dazzled by Japan in the 1980s before her bubble economy broke.  China bulls may suffer a similar letdown.  In fact, Chinese economic growth in recent years may be vastly overstated to meet political goals.  More important, China needs rapid growth to accommodate the rural migration to cities, to keep urban unemployment in check, to clean up busted state banks and restructure government enterprises, and to fund social services.  Her reliance on rapid export growth and heavy deficit spending is probably unsustainable.  Domestic unrest and restructuring problems may disrupt the Chinese juggernaut.

“Do Crude Material Price Hikes Portend Inflation?”:  The recent spike in commodity prices, led by energy, is unlikely to pass through the system and create meaningful inflation.  Quite the reverse.  Historically, crude material price changes have had trivial effects on producer finished goods prices.  Unlike the inflationary 1970s, when crude oil and other raw material price hikes were passed on to customers with ease, today business and labor have little pricing power.  Global excess supply and looming deflation say that these conditions will persist and intensify.

MARCH 2003
“U.S. Quarterly Economic Outlook—Iraq at the Bat”:  Investors hope for a quick and successful Iraq war with few casualties—a rerun of the Gulf War.  But removing Saddam and rebuilding Iraq may be much more expensive and drawn out.  Also, stocks, despite their three-year fall, are twice as expensive as in the early 1990s.  And the terrorist threat was unknown back then, but is very real today.  Corporate malfeasance is also a current concern that didn’t exist in the early 1990s.
The economy today is also depressed by weak capital spending as low operating rates and rising vacancies discourage business outlays.
For consumers, the tax rebates and cuts are full absorbed and the President’s proposed further tax cuts are unlikely to spur stock prices, incomes and spending much, and will be more than offset by municipal tax increases and spending cuts.  Layoffs and wage restraint are squeezing private sector incomes.  Also constraining consumer spending is the unfolding saving spree.  Furthermore, subprime lending woes are resulting in tight lending standards for credit cards and mortgages as consumers backpedal on using these sources to fund spending.  On balance, we foresee a consumer-led recession in the first half of this year followed by moderate recovery.  Renewed recession will probably burst the housing bubble as low-income new and prospective homeowners lose their jobs.  On top of deflated stock prices, falling house prices may make recognition of deflation unavoidable.  With most foreign economies dead in the water, a U.S. downturn spells global recession.
 
“Home Again”:  In the late 1990s, soaring stocks and the roaring economy pushed personal income taxes well above the long-term average in relation to personal income.  That, as usual, led to tax cuts.  With the bear market and recession, however, the effective tax rate is back to its 12.5% long run average.

“Spend or Save?”:   On Jan. 7, President Bush introduced his “growth and jobs” package of tax cuts designed to spur spending.  Then  on Jan. 31, the Administration proposed three savings plans to encourage more saving.  Which do they want?

FEBRUARY 2003
“What The Long Bull Market Taught Us: 20 Follies”:   The now-defunct August 1982-March 2000 bull market sired many strategies and concepts that are now equally defunct.  Some were so ridiculous that you simply hope you never get sucked into believing anything that stupid again.  Others have clear lessons for future investments.  And some need to be emphasized because they are still believed, at least by die-hard bulls.  We analyze and try to learn from 20 of these great follies.
 
“Dividends Resumed”:  Investors want dividends to insure that corporate earnings and cash flow are real, and to help provide adequate total return on stocks, now that the days of huge appreciation are history.  So, the President’s proposal to eliminate investor taxes on dividends looks like a godsend. 
But since dividends are skewed toward higher-income investors, Democrats may curtail their tax exemption.  Also, many dividends are received by tax-free accounts.  More important, our earlier work shows that few industries pay or can easily pay meaningful dividends.  To rise to the 3% dividend yield that used to be the floor would entail an unlikely leap in the dividend payout ratio

“Challenges and Opportunities For Asset Management”:   Demand for investment and related services in the years ahead will be huge.  The long bear market has convinced many investors they can no longer do it themselves.  A saving spree is replacing two decades of borrowing and spending, especially among postwar babies who have saved little but are looking retirement in the teeth.  But at the same time, current investment fees and full service brokerage commissions will eat up the lion’s share of likely investment returns in future years.  Restructuring investment services costs to appropriate levels will probably be very difficult for many firms.  The airline and steel industries suggest that when big and wrenching changes are necessary, only new firms with new cultures are successful.

JANUARY 2003
“Long Term Forecast: A Deflationary Decade”:   In the next decade, deflation will likely be the dominant force. The deflationary forces first discussed in our 1998 Deflation book and in its 1999 sequel are hard at work, although some of them in unexpected ways. The return to federal deficits suggests inflation and rising interest rates to some, but will be easily offset in the years ahead by slack corporate borrowing and big consumer saving.  The Fed and other central banks are moving from fighting inflation to battling deflation, and plan to flood the banks with money, if necessary.  Still, as we see in deflationary Japan, that money will probably be impotent as lenders fear to lend and borrowers concentrate on reducing, not expanding, debt.  Bereft of stock appreciation, older people plan to work longer, adding to the supply of goods and services—another deflationary force.
New tech will increasingly dominate the economy, despite investor disappointments.  The reaction to corporate shenanigans and excesses in the 1990s suggests a movement away from deregulation and its deflationary effects.  Nevertheless, unless a Great Depression develops, the cosmic need for scapegoats is not likely to reverse the global trend toward deregulation and the lower prices and other benefits its spawns.  The strong dollar and its deflationary connotations also seem in jeopardy, but U.S. dominance in productivity-enhancing new tech, coupled with structural inefficiencies in Europe and Japan, suggest that recent disenchantment with the buck is transitory.  We continue to foresee the good deflation of new tech-spawned, productivity-driven excess supply, not the bad deflation of deficient demand.  Still, the transition to it will be rough, especially for consumers and businesses that never expected it and have far too much debt for a climate of declining prices.

AUGUST 2002
"Where's The Bottom?": To reach a final bear market bottom, stocks normally need to be cheap and investors sworn off of equities.  Although the Nasdaq, S&P 500 and Dow Jones indices have fallen to within our November 2000 bottom target ranges, stocks are still expensive and investors haven't reached the puke point.  Even if the bottom has been reached, big selling by disgruntled shareholders may continue, and a rapid revival of stocks is unlikely.  Equity losses and disillusionment over corporate hanky panky make a second recessionary dip likely.  Beyond that, modest economic growth will subdue stock performance, a far cry from the huge 1982-2000 raging bull.  It may take 10 to 20 years to regain the 2000 stock peaks.

"The Depressed Dollar": Against the euro and the yen, the dollar has been weak recently as foreign investors desert U.S. markets.  Still, on a trade-weighted basis, the buck has fallen little as Latin American currencies nosedive and the yuan remains dollar-linked.  Furthermore, American problems will spread abroad as the likely second U.S. recessionary dip spreads globally via a reduction in the American imports on which the rest of the world depends.  Also, the economic and political structural problems on the Continent remain as does the cultural rigidity of Japan and instability in South America.  And, U.S. leadership in productivity-driving new tech, always the hallmark of the globe's leading economy, is assured for years.

"The Protection Threat": We're forecasting the good deflation of excess supply, but global protectionism could turn it into the bad deflation of deficient demand, as in the 1930s.  Weak economies and rising unemployment are promoting worldwide attempts at increasing exports and retarding imports.  Most disquieting is Washington's leadership in this area as it hikes steel import tariffs, increases farm subsidies and backs away from the strong dollar policy.

"Commentary": Bribery--Do It Right!
 

JULY 2002
"The Housing Bubble": Housing has benefited from falling mortgage rates, easy affordability, accommodative lenders and disdain for stocks and low-interest returns.  Now it has taken on self-feeding, bubble dimensions that will sooner or later collapse.  We don't foresee rising mortgage rates that would burst the bubble, and overbuilding isn't a problem, at least so far.  But falling house prices will be lethal to the residential boom and are part of the deflation we forecast.  The spur to declining prices is likely to be a consumer retrenchment-led second dip in the recession, spawned by the continuing bear market in stocks.  Rising unemployment will devastate recent first-time home buyers with little home equity or other assets.  The lenders will withdraw and the bad news will ripple up the housing chain, depressing house prices at all levels.

"The Economics of Women's Lib-Suspicions Confirmed": In1989, we said that equal pay for men and women and women's choice of working or not are incompatible.  Without commensurate rises in value added, hikes in women's compensation would come at the expense of men's purchasing power.  Then many men could no longer support non-working wives and children, forcing their spouses into the labor market.  In the ensuing 13 years, the pay gap between men and women has narrowed, in part due to better-educated, better-trained women and job market shifts in their favor, but also due to political and social pressures.  As predicted, men's wages relative to the bare bones poverty level have been squeezed.  The trend toward early male retirement has halted as many men decide they must work longer.  The pay gap between men and women is probably through closing, but the narrowing so far appears to have forced many mothers from their homes to the workforce.

"Commentary": Character
 

JUNE 2002
"Pension Profits Become Corporate Costs": Corporations can’t effectively take money out of overfunded defined benefit pension funds, but they can and do count fund net income as profits, the reverse of corporate contributions to the plans which reduce corporate earnings. 
The calculations involved are complicated but explained here in layman’s language. And they are important in an era when many companies have pumped their pension fund wells dry of overfunding, producing considerable but low-quality profits in the process. 
From here on, the record growth in pension assets will drop significantly as reduced assumptions for long-term asset growth and recent stock losses enter the calculations. And lower interest rates will boost present value liabilities. So, bookkeeping hikes to profits will turn to book and cash flow subtractions. Some firms will terminate their defined benefit plans in favor of defined contribution funds like 401(k)s, and the rest may re-emphasize bonds over stocks. 

"Sleepers, Wake": In recent months, Americans have truly awoken from the pipe dreams of the 1990s, when everything seemed to go right. Now they look back and realize that the soaring stock market and booming economy of the latter part of the decade lulled them to sleep while a myriad of improprieties flourished. 
Current nonstop revelations of phony profits, overstated revenues, silly mergers, excessive CEO pay and crooked brokers reveal that investors and the watchdogs slept through it all. 
The similarities with the excesses of the 1920s suggest that cleaning up the residue of the 1990s may take longer than most expect. The economy and financial markets may be in a Kondratieff Wave depression, not a 1930s-style collapse but a prolonged era of sluggishness.

"Commentary": No Free Lunch 
 

MAY 2002 
"Elusive Earnings": Investors’ eyes are on corporate earnings, since many stocks are still at nosebleed valuations. The consensus forecast for inflation and interest rates is consistent with an S&P 500 P/E of 15, about half the recent P/E on operating earnings and one-third the multiple on after-tax reported earnings. So, operating earnings would need to double to bring stocks in line, even if equity prices go nowhere in the meanwhile. Our analysis indicates that an unrealistic leap in corporate sales volume is required to produce this earnings explosion over the next two years, even if selling prices are strong and productivity growth offsets labor cost increases. A 27% fall in the S&P 500 to our long-held target of 764 would help push the P/E down, but inconsistently rapid sales growth would still be required. 

"Sidebar: More On Dividends": Our April 2002 report on returning to more meaningful dividend yields has caused quite a stir as investors learn that getting back to a previously minimum dividend yield would take an extraordinary combination of dramatically higher payout ratios, lousy stock performance and exploding earnings. 
Skeptics note that stock buybacks also return money to stockholders, but including them leaves recent dividend yields still below 2%. And few stockholders benefit. Furthermore, many companies bought back their stock at much higher prices, hardly a help to shareholders. In addition, buybacks to fund employee options have transferred corporate value to employees from stockholders. 

"The First Quarter—An Inventory Bounce; Now What?": Stock investors gave a Bronx cheer to the first quarter GDP report, and for good reason. Over half the growth came from the unwinding of inventory liquidation, and no encore is visible. Housing and consumer spending never retrenched in the recession and have been supported by temporary spurs. Look for a muted recovery, or a double dip recession if consumers pull back. 

"Commentary": A Deflating Ego 
 

APRIL 2002 
"The Return to Meaningful Dividend Yields: It’s Hard to Get There From Here": In the post-Enron/Andersen, post-stock market bubble world, investors will demand dividends to insure that reported earnings are real and a big portion of total stock returns. A 3% average dividend yield used to be the floor and may again be, but is more than twice the recent 1.4%. 
At current P/Es, a 3% yield requires a 75% dividend payout ratio, far higher than in the postwar era, since the dividend yield times the P/E equals the payout ratio. Alternatively, the P/E could be driven down by flat stock prices and normal earnings growth for 8 long years, or by unrealistic earnings leaps for many years, but neither alternative is likely. The transition to higher payout ratios will be difficult, so industries that already pay meaningful dividends and can expand payout ratios are favored. Not so for many consumer-related industries and others with low dividend yields and slow earnings growth prospects. 

"Japan: Is It The Culture, Stupid?": Hope springs eternal that Japan will finally emerge from her long deflationary depression, and the recent jump in the Nikkei stock index is no exception. But the cleanup of bad bank loans and other needed reforms are still in the future. So Japan can only grow the old-fashioned way, through exports. But that will require a renewed U.S. consumer spending spree, which we doubt. 

"U.S. Economic Recovery?": Recent economic strength tells the bulls that the recession is history and strong growth lies ahead. But growth beyond that, generated by the ending of inventory liquidation, requires a spending pickup in other sectors. Housing and consumer spending are the logical candidates, but neither retrenched to prepare for renewed rapid expansion, making both vulnerable. We foresee a sluggish recovery at best and a still strong likelihood of a consumer retrenchment-led Phase II of the recession. 

"Commentary": "Big Company Rewards and Risks" 
 

MARCH 2002 
"Productivity’s Progress": Productivity has grown rapidly in the recession so far as business slashed payrolls faster than output fell. But history suggests that further big staff cuts will be tough if consumer retrenchment continues the downturn. Productivity will also suffer from post-9/11 inefficiencies and post-Enron excess regulation. 
Still, the recession will end and the 9/11 and Enron blows to efficiencies are likely to be one-shot affairs. So, the prospects remain bright for new tech-driven long run productivity growth. 

"The Deleveraging of America": The fading federal surplus and looming deficit suggest to some that renewed Treasury demand for credit on top of private demand will push up interest rates. 
But rates fell in the 1990s when federal deleveraging was swamped by consumer and business borrowing, due to falling inflation and foreign zeal to invest here. 
In the years ahead, a consumer saving spree, and corporate deleveraging, will, in the aftermath of the late 1990s bubble and Enron, replace the faltering federal surplus, and then some. Add in mild deflation and the direction of interest rates remains down. 

"Commentary": "Enron—Ethics?" 
 

FEBRUARY 2002 
"The Bear, 9/11 and, Now, Enron": The Enron debacle won’t be the last—look for other firms to be unmasked as engaging in questionable accounting practices, something that was not an uncommon occurrence in the exuberant 1990s. The result of all the financial skullduggery will likely be more—and unnecessary—government regulation, for one. Corporate managements will substantially reduce their financial leverage. Investors will also be seeking conservative and disciplined accounting by public companies along with a renewed emphasis on meaningful dividends. 

"The Fourth Quarter—A Pause Between Recession Phases": The slight growth in real GDP in the fourth quarter of 2001 tells most that the recession is over. But we see it as a normal mid-recession uptick to be followed by a consumer retrench-ment-led renewed downturn. With low consumer saving and high debts as well as expensive stocks, any recovery from here would be weak. 

"The Future of American Beekeeping—Protectionism or Productivity?": Rapid productivity growth fueled the success of American farming, but not in beekeeping for 127 years. So, the industry is labor intensive and vulnerable to imports from low labor cost lands. Beekeepers have opted for protectionism, but productivity growth is a much better solution. 

"Commentary": "Summer Soldiers and Sunshine Patriots?" 
 

JANUARY 2002 
"2001 Long Term Forecast: Looming Deflation": We’ve long held that deflation would commence with the next recession. The downturn is here and deflation looms as our 14 deflationary forces are all now operating. The few others in our camp fear the bad deflation of deficient demand, as in the 1930s and in Japan today. We look for the good deflation of new tech-driven excess supply, as in the late 1800s and in the 1920s. The transition to good deflation, however, will look bad to the many who planned on indefinite inflation. 
"Investment Strategy: Big Changes Lie Ahead": Pension fund consultants who advocated lots of stocks, few bonds and no cash as well as the pigeon hole approach to stock allocation and benchmark goals are joining discredited Wall Street analysts. Emphasis will shift to positive returns, more portfolio manager discretion and market timing. Bloodied individual investors, especially postwar babies, will seek more professional management, but much lower portfolio returns than in the 1990s will compress fees. 
Investors will demand solid earnings growth and much higher dividends, which will account for half the 6% return on stocks in deflation. Treasury bonds yielding 3% will be competitive with stocks, risk-adjusted. Real estate investment will be difficult as property prices fall in deflation. 

"Commentary": "Corporate Altruism" 
 

DECEMBER 2001 
"The Third Quarter—In Between Recession Phases": The U.S. economy is now officially in recession, but the questions remain, how long? how deep? what effects on the rest of the world? on consumers and business? on inflation? on security markets? 
It’s an odd recession. Phase I, which began early in the year, has been dominated by new tech excess capacity and excess inventories as well as falling exports as foreign economies atrophy. Phase II commenced even before the terrorist attacks as consumers succumbed to destroyed real stock wealth and leaping layoffs. 
The long bear market and impact of the terrorist attacks have rung down the curtain on the irrationally-exuberant 1990s. So, the recession will deepen, stretch well into 2002 and be followed by a sluggish recovery as consumers stop borrowing and embark on a long-run saving spree. The frustrated Fed is pushing on a string, and anti-recessionary fiscal stimulus will, as usual, come too late. 
As U.S. consumers retrench and shun imports as well as domestic products, already weak foreign economies will falter. In this environment, the prelude to secular deflation, stocks are still vulnerable but Treasury bonds remain attractive. 

"Commentary": "Academic Economists Catch Up—Finally" 
 

NOVEMBER 2001 
"What’s Essential?": The U.S. is entering a new era that, unlike the late 1990s’ exuberance, will be dominated by consumer caution with an emphasis on saving, and spending on a newly-defined schedule of essentials. The years ahead will also be marked by mild deflation and subdued economic growth and stock performance. Many heretofore essentials will be reclassified as discretionary. Recent spending patterns are giving hints of what lies ahead. 

"When Will The Bear Hibernate?": When will this bear market be over? We’re waiting for two things to happen before we’re convinced that a final and convincing bottom has been reached. First, investors need to reach the puke point, where they disgorge their last stocks—at any price. Second, stocks need to become much cheaper. Many began the bear market at such lofty levels that they’re still expensive by historical standards. 
"How Have We Done?": We took a look at the long and short themes and portfolio allocations we’ve recommended during the height of the bull market in 1998 and 1999 and in the bear market ever since. Our consistent caution paid off handsomely. 

"Commentary": "Talking Isn’t Always The Best Alternative" 
 

OCTOBER 2001
"Recession, For Sure": The American economy was already in recession before the terrorist attacks on Sept. 11; those strikes magnified the contractionary forces already at work.  Consumers—long the last bulwark against an economic downturn—have finally succumbed.  Consumer confidence, slipping before the attacks, was just as weak afterward.  Housing, another final pillar of economic strength, has also begun to lose much of its previous vigor.  The negative effects of the terrorist attacks are spreading through the economy, as ailing airlines cut flights and announce layoffs, tourism suffers, car makers try anything to boost sales and retailers brace for a cruel holiday shopping season.

"Home Sick": Unlike past downturns, housing this year remained vibrant well after much of the economy headed south.  Further consumer retrenchment should ensure a weak housing market, and despite recent declines in their stocks, we’re selling conventional home builders.

"Commentary: Uncertainty"
 

SEPTEMBER 2001
"Analysts-damerung": The recent spate of legal actions by investors against Wall Street analysts—combined with other factors such as the SEC’s Reg. FD—are bound to have a profound and lasting impact on analysis who, for years, have really been promoting investment banking clients.  In the wake of a number of Wall Street polyannas being exposed as shills for corporate finance, investors are sure to look at analysts’ reports with a sharper eye.

"Fee Generators Aren’t Safe": If the stock market continues to remain subdued, financial services firms that are dependent on asset management and other fees are likely to be just as negatively impacted as those institutions that rely on commissions and trading profits.

"California Energy Crisis: The Politicians Repeat History": California’s energy crisis is not a unique occurrence.  In fact, it’s a case of history repeating itself, as politicans, unwilling to rely on free markets, seek short-term solutions instead of addressing long-term problems.

"Commentary: Productivity Applied"
 

AUGUST 2001
"Pushing On A String": The Fed’s rate-slashing campaign may not revive the economy soon.  History shows that past Fed rate-raising efforts have usually resulted in recessions.  Furthermore, recessions probably end not because of Fed ease but because inventory liquidation and other depressing forces run their course.  After all, recessions occurred—and ended—long before there was a Fed.

"What Moves Foreign Trade?": The dollar’s strength of late has hurt profits from abroad as they translate into fewer dollars.  But it’s doubtful that a weaker dollar would retard imports or boost exports.  Ditto for other major currencies and countries.  Trade depends mainly on economic growth—and that’s slowing around the world.

"The 2nd Quarter—On the Brink": The tug of war between the spenders and the retrenchers was won—barely—by the spenders in the second quarter, resulting in GDP growth of 0.7%.  Consumers are still spending, but at a slowing rate; once they decide to throw in the towel, the U.S. economy will slide into a recession that will last into next year and spread globally.
 

JULY 2001
"Manufactured Housing and Apartment REITs": Conventional housing—a great investment in the inflationary postwar period—will not be such a sure thing in the mild deflation that lies ahead, especially as consumers retrench and save more and become less enamored of bigger and bigger houses.  We think much of the future demand for housing in the years ahead will be filled by manufactured homes and rental apartments as Americans separate their investments from their abodes.  They’re not as costly as traditional housing, which will be important in the leaner economic times that lie ahead.

"Bonds Are Beautiful": It may comes as a surprise to some investors that bonds—the least sexy type of investment—have been a great investment recently.
 

JUNE 2001
"Watch The Consumer":  Although three economic areas—inventories, equipment and software spending, and exports—remain weak, they’re offset by continued, albeit weaker-than-before, growth in consumer spending.  We continue to feel, however, that the huge loss in stock appreciation, in addition to mounting layoffs, will soon reverse the spending boom of the recent past, leading to consumer retrenchment, lower corporate profits, more job losses and a recession that will last into next year.  Meanwhile, the employment picture—an important determinant of consumer spending—continues to deteriorate.  The unemployment rate has risen this year, and manufacturing employment has suffered greatly.  Creeping weakness in service sector employment spells real trouble for the economy.  Since services produce no inventories, weakness in orders, employment and output reflects weakness in final demand.

"Early Starters Finish Last": A recent trip to Portugal and Spain brought forth an awareness that, although these two nations led the way in the Age of Discovery, their dom-inance of the world stage in the 16th and 17th centuries didn’t last.  Their missteps 500 years ago provide lessons that today’s new tech entrepreneurs failed to heed.

"Commentary": Fatima—Religious Site or Commercial Show?
 

MAY 2001
"The First Quarter—Consumers Still Spend":  The 2% growth in first quarter GDP surprised us because everything seemed to point to a decline.  Consumer spending had slowed in the fourth quarter while plant and equipment spending had dropped.  Inventory building was high but had started to drop, so we figured massive liquidation was in sight.  The biggest reason for the positive first quarter growth numbers was that consumer spending continues to charge ahead.  Granted, it was fueled in some part by big rebates on new auto sales and the effects of lower interest rates on housing sales.  But, the truth is that stocks have still fallen significantly in the past year while layoffs continue to mount and consumer debt is still rising.  Because of these latter negative forces, we’re sticking with our forecast of a full-blown recession that will spread globally and probably last until next year.

"Our 15 Minutes In The Sun":  We’ve had our fair share of bad economic forecasts in the past, but in the last few years, we’ve made some good calls, especially those relating to the big decline in stocks, the bursting of the Internet bubble and the weakening economy.  We had also warned early on about the growing debt being incurred by consumers and the problems it would cause once stocks fell and capital appreciation dried up.  We also chose correctly when it came to investments that do well in market downturns, touting Treasury bonds and certain other stock sectors that out-perform a declining market.

"Commentary": Quantity Premiums
 

APRIL 2001
"The Next Shoe to Drop": Almost everyone hopes that Fed ease and a quick tax cut will revive stocks and the economy.  But Washington is unable to arrest the downside momentum.  Furthermore, profits disappointments are feeding the bear, and without a new bull market, revival in consumer spending and the economy is unlikely.  New and old tech business is already in the tank, with excess inventories and receding capital spending.  Consumers will probably follow as stock losses crimp the jet-set while spreading layoffs vs. earlier attrition flatten Joe Sixpack.  Big debts will depress consumers throughout the income spectrum.  The bear might hibernate till fall, and maul a lot more investors in the meanwhile.

"Global Recession in the Cards": The U.S. economic downturn will not be confined to our borders.  Instead, the recession is spreading overseas.  Most already-weak foreign economies are export-led and dependent on a vibrant American market for their goods.

"Consumer Confidence Predicts Little": Those optimists who saw the uptick in the latest consumer confidence numbers and figured they point to a renewal of consumer spending should think again.  History shows that consumer confidence is a lousy predictor of future economic trends.

"Commentary": Cab Control in New York and London
 

MARCH 2001
"Not Adding Up": A year ago, Internet and other high tech ads were ubiquitous.  When we examined a week’s worth of major news-papers in early 2000, we found that much of the advertising in those papers was Internet- and new tech-oriented.  Now, however, the story is a different one.  Thinner newspapers result from fewer ads—and much fewer ads from the formerly high-flying new tech sector.

"Economic Forecast—Recession": The argument continues between the few like us who believe the economy is already in a recession and the say-it-ain’t-so-Joe majority who hope for a brief landing.  But economic weakness is spreading beyond Old Economy manufacturing of vehicles and appliances.  Inventory excesses, once thought to be ancient history in an increasingly service-oriented economy, are now a growing problem in new tech industries.  With consumer confidence dropping sharply, layoffs increasing and stock prices—and appreciation— weakening, the case for a U.S. recession grows.

"The Late 1990s—Measuring The Era’s Exuberance": The last few years of the 1990s were so exuberant that putting that era in proper perspective today is difficult.  But, in an attempt to gain some focus on the recent bubble era, we need to place ourselves in about 2005, assume that normal long-term conditions are prevailing, and take a look back.

"Commentary": Smaller Barns or Bigger Spirits?
 

FEBRUARY 2001
"Forecasts Follow Facts": The Nasdaq has been the center of the action—good and bad—in recent years.  It’s where new tech blossomed.  It’s where the dot coms soared and then crashed.  And it’s where the real wealth was built that allowed consumers to spend freely as their saving rate plunged to less than zero.  It’s understandable, then, that investors are watching Nasdaq for clues to the economy’s future.  With the rally in stocks in January, including Nasdaq’s double digit gain, investors’ fear of a full-blown recession faded, replaced by the hope of a brief landing in which the economy struggles in the first half, but revives—on the back of a rally in tech stocks and the Fed’s credit easing—in the second half of the year.  We continue to foresee a drawn-out recession in 2001, however, because five forces continue pointing in that direction.  The earlier credit tightening has not yet been fully felt, while any fiscal stimulus out of Washington will be so delayed as to have little effect on the downturn.  Meanwhile, high fuel costs continue to sap purchasing power.  In addition, the economy now looks like it’s in the early stage of a recession, and stocks, while down from a year ago, continue to be overvalued.

"Commentary": You Can Go Home Again—In Your Memory
 

JANUARY 2001
2000 Long Term Forecast
"Part I - The Case For Recession And The Shape Of The Downturn": The bear market and the recession we’ve been forecasting are both now upon us.  Five recessionary forces are currently at work, and stocks in general were down—significantly, in many cases—last year.  Now that the slump has arrived, a major excess that will be corrected by the recession is high consumer debt and its flip side, negative saving out of current income.  Economic weakness in the U.S. will spread abroad as overseas economies dependent on         exports to the U.S. weaken as Americans curtail their spending on everything, including imports. 

"Part II - The Long Term Beyond The Recession": The most novel feature of the long run will be deflation of 1% to 2% annually.  This brand of deflation will be the good variety resulting from new tech productivity-driven excess supply, not the bad deflation of deficient demand, as was seen in the 1930s Depression.  But, after 60 years of inflation, mostly everyone is unprepared for a world of deflation.  Some investment areas will be more profitable than others.   Real estate will struggle in deflation, as will commodities.  On the other hand, bonds, especially Treasurys, will thrive in the deflationary climate. And the coming era of deflation will have effects on overseas economies as well.

"Commentary": Natural Athletes—Frustrating But Useful 
 

DECEMBER 2000 
"Debt Problems and the Shape of the Recession": Potential debt problems are surfacing even before the recession we foresee gets underway.  Corporate debt woes grow as junk bond problems spread and as start-ups turn to their suppliers for loans they’re unable to repay.  But the major debt excesses clearly lie among consumers.  Their debts have leaped while the saving rate has dropped to less than zero as they relied on stock appreciation.  Eventually, as the ongoing bear market in stocks and coming recession take hold, individuals will rethink their 20-year borrowing-and-spending spree and start saving.   Widespread consumer financial problems seem unlikely, but their newfound caution will lengthen the recession and dampen the recovery.  As consumers retrench, imports will suffer, dragging the rest of the world into decline. 

"How Durable Is the Federal Budget Surplus?": The large surpluses of recent years made spending the anticipated trillions of excess money a big campaign issue.  But what happens as stocks fall and the economy sinks into recession?  Soaring stock prices in recent years have accounted for virtually all of the surplus, and a deficit is likely as the recession unfolds.  Longer-run, chronic surpluses are possible but only if budget restraint again rules Washington. 

"Commentary": Giving Doesn’t Just Mean Material Things 
 

NOVEMBER 2000 
"The Roles Of Stock Analysts Under Reg. FD ": The SEC recently issued Reg. FD (for Fair Disclosure), which requires public companies to make public market-moving data  simultaneously—not just to friendly analysts and big investors first before releasing it to everyone else.  Wall Street is crying "Foul!" and analysts are arguing that corporate managements will clam up rather than risk violating the new regulation.  In reality, many analysts have been so busy promoting corporate finance deals that they have spent little time on serious company analysis. The result, at least recently, is that rose colored glasses-wearing analysts have been blindsided by negative company news.   Reg. FD will likely divide analysts into two camps: those who continue working for corporate finance and those with little or no relationships with corporate managements. 

"Who Moves Stocks?": While investors in total can’t really move money in or out of the market, investor segments can.  Which sectors’ buying and selling patterns correlate better or worse with stock performance over the past several decades?  Winners include insurance companies, foreigners and state and local governments.  Losers include pension funds and households. 

"Commentary": New Tech vs. Old. 
 

OCTOBER 2000 
"The Menacing Yield Curve": The yield curve right now is inverted, meaning that short rates are above bond yields.  Many believe the reason the Treasury curve has been inverted lately is because of the Treasury’s announced intention to retire long-term obligations with the mounting federal budget surplus, thus creating a shortage.  The resulting scramble to buy them, the thinking goes, pushed up their prices and reduced their yields.  Still, keep in mind that inverted yield curves have preceded past recessions, so the return to a         positively-shaped curve would alleviate fears of a business decline and strengthen convictions that the Fed has once again pulled off a soft landing.  But there are a number of reasons why the current inversion strongly foretells a business downturn. 

"Morocco—A Lesson In Technology": A week in the Northern African country exposed us to a host of contrasts with America, especially the way goods are manufactured in the most interesting and eye-catching—but inefficient—ways. 

Commentary-"September—A Great Month": Here are a few reasons why the just-ended month may be my favorite of the year’s 12. 
 

SEPTEMBER 2000 
"Global Effects Of U.S. Economic Softness":  Whether forecasters realize it or not, their projections of continuing if not faster growth in Canada, Latin America, Asia and Europe depend heavily on an ongoing robust U.S. economy.  We have serious questions about this assumption.  It may be that the Federal Reserve has laid the groundwork for a business slowdown and a recession.  The U.S. economy now resembles an economy at a business peak: existing homes sales were down in July; bank loan officers continue to tighten lending standards; durable goods orders fell in July; the leading indicators index fell in July for the third month in a row; and, most importantly, inventories are increasing.  A U.S. recession would send shock waves throughout the world, where most countries are dependent on America—via exports—to generate their economic growth, as evidenced by the gigantic U.S. trade deficit.  Asia would be hit hard by a significant economic slowdown in the U.S., as would Mexico and Latin America.  Europe’s business cycle lags that of English-speaking countries by several years, which explains the still-accelerating economies across the Atlantic.  But growth there is export-led, and the Europeans would also be affected as American import cutbacks spread to the rest of the Americas and to Asia. 
 

JULY 2000
"Yuan Devaluation And Global Effects":  China will shortly enter the World Trade Organization, and many think that will strengthen her yuan currency, which may even be allowed to float freely.  We believe it will lead to a significant devaluation, with major implications internationally.  A country’s entry into the WTO is supposed to foster foreign investment, with outsiders allowed to enter more businesses and own larger shares of companies.  But it’s unlikely the Chinese authorities will give up their control over business or make the other changes necessary to attract foreign capital.
A floating of the yuan, in concert with its WTO entry, would have great effects on its Asian competitors and could lead to competitive devaluations not only in the region but also in other developing countries that compete with Asia in global markets.

"Third World Wars And Global Peace":  A glance at the newspaper these days reveals a number of wars and conflicts in the Third World.  Other than sympathy for the human suffering, are these fights cause for greater concern?  No.  It’s unlikely these conflicts will erupt into global warfare unless a Cold War-style superpower conflict arises.

Commentary-"General Grant and Marshal Kutusov: Great Economists?"
 

JUNE 2000
"Bear Market Buffers":  Investors who share our view that a major bear market is unfolding should initiate some changes in their portfolios.  Long-term Treasurys, we think, offer the next big investment play, although it’s still difficult to pinpoint when the rally in Treasurys will begin.  But history shows rallies normally start at about the same time the Fed moves from tightening credit to easing, although it may be underway already.

Meanwhile, the Fed continues raising short-term interest rates, and will continue to do so until slower economic growth is established.

Besides Treasurys, are there any industry groups that do well in recessionary bear markets?  Some of the groups that performed better than others in past stock declines may not be able to repeat that in the unfolding bear market.  Big brand companies, for example, are already suffering because brand loyalty has weakened in recent years; they may not do any better in a stock downturn.  Tobacco has usually been unaffected by bear markets or recessions, but given the anti-smoking assault in recent years, this industry may not provide a safe haven in the next downturn.

Ethical drugs, though, may offer refuge for investors in the next bear market.  The same may be true for electric utilities, but those companies that haven’t ventured too far into new tech area are the ones worth a look.

Commentary-"Is Education Still  The Route To Success?"
 

MAY 2000
"Has the Bear Emerged?":  Market volatility is usually extreme around market tops—and the recent stock market gyrations, among other factors, suggest that a bear market is beginning to take shape.  The S&P 500 index is down 1.1% so far this year, while the Dow Jones Industrial Average has declined 6.6%, and the Nasdaq is ahead only 1.7% after taking a clobbering in April.  And with some inflation indicators pointing upward, the Federal Reserve is sure to aggressively continue its interest rate-raising campaign, which will ultimately deal a severe death blow to the bull.

"The Coming Credit Card Crunch": Americans love to spend and love to use their credit cards and other borrowing means to finance their purchases.  Consumer credit is rising, while credit card delinquencies and individual bankruptcy filings are at high levels.  Furthermore, credit card issuers will suffer when stock losses end consumers’ 20-year borrowing binge and initiate a chronic saving spree.

Commentary-"Pigeon Problems—And Solutions": Some years ago, when my Dad wanted to eliminate a neighborhood pest, he assigned the task to me.
 

APRIL 2000
"Ebb Tide": Proctor & Gamble’s shocking earnings disappointment last month highlights the declining value of brand power in an era when few companies enjoy any pricing power.  If our deflation forecast unfolds, and as the Internet spreads product information, P&G and other producers of mature big brands will see their franchises eroded further.

"Ad Down": New Internet companies plow big gobs of their venture capital and IPO money into advertising as they attempt to build market share, brand image and investor identification.  This, along with the spur to advertising from the new tech stock market-led economic boom, has been a huge boon to radio and TV broadcasters, magazine and newspaper publishers, and ad agencies.  When Internet stocks collapse and their new money evaporates, all of these beneficiaries and their stockholders will suffer.

Commentary-"Walk or Work": A new children’s book, Henry Hikes to Fitchburg, shows the importance of taking time to smell the roses, but neglects the full benefits of paid work.
 

MARCH 2000
"Buy The Rumor, Sell The News?": New tech stocks continue to soar while old tech equities are languishing.  In the mild deflation we foresee, how will new tech stocks fare?  While new tech may drive the U.S. economy in the years ahead, not all new tech companies will necessarily survive.

"U.S. Stocks and the Fed": The Fed is squeezing in two ways: hiking short-term interest rates and withdrawing Y2K comfort money.  At the same time, most U.S. stocks have declined so far this year.  If free-spending consumers begin to retrench, all of these factors could add up to a recession starting later this year.

Commentary-"The Long (Unlaunched) Bond": Is a boat just a boat?  Or is it a hole in the water into which you pour money?
 

FEBRUARY 2000
"The Fed Continues to Tighten, But Bonds May Be A Buy": The Fed’s fourth rate increase in the past half-year was not really a surprise; in fact, to our eyes, it was completely on schedule.  The central bank continues to worry about inflation, its own reputation and a speculative sell-off in stocks.  We think they’ll keep hiking rates until a recession is in sight.

"Productivity Growth—The Key to So Many Things": Productivity growth is of the utmost importance to most important economic issues, be it the rate of sustainable growth, Fed policy, the potential performance of tech and non-tech stocks, or the dollar’s outlook.

Commentary-"Ridiculous Regulation": Here’s the story of how an airline’s departure was delayed for an hour—because one seat was missing its seat pocket.
 

JANUARY 2000
"Theory Follow Fact": How is a stock’s value measured these days?  Stocks were valued in relation to their dividends back in the old days.  Then, in the postwar period, a company’s earnings were a prime factor in setting its value.  But, now, the significance of earnings have faded, as witnessed by the billion dollar stock offerings by companies with not one cent of profit.

"Is The End Near?": With stock prices ridiculously high, we think the stock market is ripe for a major 40% to 50% correction.  Six factors suggest