15 Mar 2002 ‘Beware the Ides of March’

Good Friday morning to you. If you get carried away by foreboding terms, today is rich with them. The all-familiar warning to Julius Caesar in Shakespeare’s play ‘beware the Ides’ has traversed the ages with a sense of foreboding. But the day itself was no more foreboding than any other day in Caesar or in Shakespeare’s time. The term ‘Ides’ comes from the earliest Roman calendar, according to Borgna Brunner of Infoplease.com. The Roman calendar organized its months around three days, each of which served as a reference point for counting the other days. Kalends was the first day of the month, Nones, the fifth or the seventh day, depending on the month, and Ides was the 15th day in March, May, July, and October and the 13th in the other months. Another phrase of forbiddance heard every so often is ‘Triple Witching Friday’. The term refers to the final hour of trading before equity options, index options, and index futures contracts expire. Because of contract schedules, a triple witching hour occurs four times a year, each time marking heavier than usual trading and greater volatility. Now that hocus-pocus is out of the way, let’s deal with some real information. The week’s numbers were more mixed than last week, but on balance, a continued recovery remains likely. Retail sales were considerably weaker than expected, but the data are preliminary. Given the seeming disparity with the other evidence, such as high unit vehicle sales and favorable chain store data, it is reasonable to expect that these numbers will be revised higher in months to come.

The Business Inventories flashed both a caution and a green light yesterday.  Upon release the market declined initially.  Since July of last year the trend had been for declining inventories and most expected the trend to continue.  But later in the day the thinking reversed when the build was taken as a positive sign that business managers felt strongly enough in the economic recovery to begin adding to their inventories in support of the expected increasing demand.  The best news of the week just came out moments ago as the University of Michigan announced its confidence indicator.  The reading of 95 represents both an increase over expectations of 93 and over February’s reading of 90.7.  The widely followed indicator of consumer confidence had declined in both January and February, so the latest increase is a very positive sign that the consumer remains confident and expects to continue spending in this economy.

What has become clearer in the last couple of weeks is that the recovery will likely be slower than in previous cycles.  There are some restraints on this economic recovery not experienced in previous, more typical recoveries.  Consumer spending never really slumped, so the traditional stimulus measures (lower interest rates and taxes) will not have their usual elastic effect.  Instead, both consumers and corporations have dramatically higher debt loads than usual.  This increased leverage will dampen the strength of the eventual recovery.  But, on the plus side, the higher debt load suggests the Federal Reserve will maintain favorable interest rates longer than they might otherwise to avoid a credit crunch.

We are seeing signs of recovery in the industrial or ‘old’ economy.  This trend bodes well for the entire economy.  As the industrials beef up for expected increases in their business, they hire and invest in capital equipment and in technology.  The best performing stocks of late have been the industrials (we own Caterpillar, Flextronics, and Celestica) as investors bet on recovery.  But, as the stocks rise, doubters say they are rising too fast in light of a slow recovery, or even the possibility of a ‘double dip’ (slide back into recession).  It looks like the bear talk will accompany this recovery longer than usual, requiring patience, but a more orderly market will result.  Our focus is on the companies that should do well in a slow-recovery environment, but are not too richly priced.  They include, selected healthcare companies, industrials, selected consumer cyclicals, shipping, providers of outsourced business functions, and limited technology, mostly high quality software and consulting services.

Last week’s Brief focused on the continued importance and influence of technology in our economy.  Hopefully, you have noted that our technology influence on the Quality and Growth models has declined substantially over the past several months.  But, they represent substantial value and should do quite well when technology spending improves.  Interestingly, old economy companies are the best customers of technology suppliers, representing a full 80% of technology spending.  As industry ramps up its investment to support their improving business outlook, technology stocks should do very well.

As we wrap up I want to share a fascinating study we found this week.  Tom Galvin of Credit Suisse First Boston used the chart on the next page, prepared by Michael Cox of the Dallas Fed, to show how much acceptance cycles of new technology have compressed in the last few years.  This ‘picture’ of spaghetti strings graphically illustrates just how much change we have digested in a very short period of time.  It makes it easier to understand how we could get so caught up in the promise of the ‘Information Age’ and subject to all the hype that ensued.

There is a wealth of fascinating information in this graph, but I will just make a few observations.  The vertical y-axis denotes the percentage of American homes that own a particular product.  The horizontal x-axis denotes the number of years since invention of each product.

You can see that the telephone, the automobile, and air travel, took between 65 to 80 years to reach 50% of American households after their invention.  Their more gradual slope than the lines to their left denote a more gradual rate of acceptance.  The radio, television, VCR, and microwave all have relatively steep slopes, indicating rapid acceptance once they started, but you can also see that it took between 20 to 30 years for them to become available after invention.

Here’s the best part.  Look to the far left of the graph.  The cell phone and the PC reached a quarter of US households in their first 11 to 12 years since invention – that’s 15 to 20 years faster than radio and television, and 55 years faster than the telephone and automobile.  And if there was any doubt about the profound influence of the Internet.  It holds the record for the fastest adoption.  It should be noted that the ‘Internet’ was invented more than a decade ago by our government, and military (Al Gore notwithstanding) to share research.  The World Wide Web was an outshoot of the Internet essentially made possible by Marc Andreessen, an undergraduate student working at the National Center for Supercomputing Applications (NCSA), who developed a graphical browser in 1994 that was the precursor to Netscape.

The market is dictating patience and restraint and we will comply.  But to ignore the message given by the purple, pink, and green lines on the graph (Internet, PC, and cell phones) would also be foolish.  Information is the ‘New Economy’ – it is real, it has not been wiped out with the ‘bubble’ implosion.  Investment opportunities for the future are as exciting as they have ever been in history.