Question: How many central bankers does it take to screw in a light bulb?
Answer: One. Greenspan holds the bulb and the world revolves around him….

Economic issues took center stage during the turn of the twentieth century. As a technology revolution swept the nation, millions of Americans jumped into the stock market to get a piece of the action, and Greenspan became a touchstone. Even if it was unclear exactly what the Fed did - or perhaps precisely because of that - he captured the popular imagination. Here was this enigmatic man who seemed to hold the fate of the nation's economy in his hands. As a consequence, Greenspan managed to achieve a level of acclaim never before bestowed on a Fed chairman and probably never to be bestowed again.

Greenspan, The Man Behind Money - Justin Martin

It's a safe bet that far fewer newborns in the U.S. this year will be named "Chad" now that the bizarre Florida election recount has punched its way into America's permanent, political annals. And chad-phobia was not the only fallout from the presidential election marathon, with its final, litigation-lined gauntlet before the women and men in black. A large number of public and private sector economic soothsayers may have become so obsessed with the daily fortunes of Messrs. Bush and Gore that they took their eyes off their economic crystal balls. These gnomes seem to have been caught offguard by the suddenness with which the economy has turned south. But there is no mistaking the economic sluggishness that is now sharing equal billing with the continuing political tussles. In the election aftermath, economic headlines have chronicled a steady drumbeat of decidedly gloomy news. Plummeting stock prices in the U.S. and around the globe have signaled a bleak outlook for profits and employment. Investment analysts have been scurrying to adjust their corporate revenue and earnings expectations downward. The talk of a "new paradigm" and "this time it's different" finally has given way to debate over whether the domestic economy will have a soft or hard landing.

Through all of this, the Clinton administration and the Federal Reserve Board have shown perhaps the most disconcerting behavior. With straight faces, Clinton's spokesmen claimed that everything was fine and there would be no recession. Ditto from the Fed for some time - but then they cut interest rates between scheduled FOMC meetings, belated recognition that the wheels started coming off of the boom some time ago. One should expect a rosy spin from politicians, but chief economists should be careful to read the correct tea leaves. One wonders where the Fed has been over the last several months. Had Greenspan and company been out talking with auto salesman, retail clerks, real estate agents, exporters, factory workers, gas station attendants, stockbrokers, disillusioned and demoralized dot-comers, personal computer salesmen, and the folks at recently bankrupt Montgomery Ward, they would have realized that interest rates have been too high for too long. Rather than "irrational exuberance," arcane economic statistics, dubious government figures, and non-existent inflation and a speculative stock market that was defused last Spring and Summer, the Fed's own irrational analysis and fears should have been central to their musings. People who watch CNBC from time to time, and those who watch it too much (you know who you are), are familiar with how talking heads ridicule stock analysts who miss the signals and downgrade a company's stock only after the company reports a major earnings shortfall. CNBC pans to a shot of penguins (i.e., analysts) diving into frigid Antarctica waters, one after the other. We have been waiting for a caricature of the tuxedoed Federal Reserve Board diving from the top of a BankAmerica building into the wintry economic mire.

Many observers enthuse that the Fed's first rate drop in January 2001 portends several more this year, but this will not be an immediate cure because the salutary economic effects of an easier monetary policy will not be felt for several months. When the economic future is uncertain, consumers and businesspeople do not, and often cannot, turn on a dime and easily reverse decisions to cut back on spending, production, investment, and hiring. Thus, the downturn in consumer spending and corporate profits heralded by declining stock prices probably will continue for at least one or two more quarters. If the economy is cooling, should investors bail out? We believe an opposite course is better.

Millennium Mayhem

Before looking at a glass that's half full, let's examine the half that was emptied last year. The build-up was ominous. In late 1999, a Y2K-fearful Fed created an excess money supply. Through the first quarter of 2000, this excess fueled euphoric markets and a speculative buying mania. Then investors became disheartened and panicky, and they began throwing out the babies with the bath water. Capital-loss tax selling by the mutual funds in October and by individuals through December exacerbated the fall. Additional selling pressure arose from mutual fund redemptions, especially among aggressive tech equity funds, and from margin calls.

Nearly all major equity indices around the globe declined. The S&P 500 had its first decline since 1994 and its worst since 1977. The Dow Jones Industrial Average, which had not declined since 1990, recorded its most severe drop since 1981. The most stunning reversal occurred on the Nasdaq Composite. From its peak of 5049 on March 10, the Nasdaq declined 51% to its closing low of 2471 on December 31. This decline is the index's worst since the Nasdaq's inception in 1971 and the worst decline in any major U.S. market index since 1931, a year in which the Dow declined 53% and the S&P 500 fell 47%. The accompanying tables illustrate last year's savage losses to both investors and the market's former leading workhorses.

Was there a fundamental reason for the precipitous decline? One overriding drag has surfaced in recent months: You. Mr. and Mrs. Consumer, you were the problem.

A Strike Without Picket Signs

The U.S. experienced a robust stock market for many years, and growing corporate profits and wages have tempted America-led businesses and consumers to engage in a discretionary, multi-year binge of overspending and overproduction. SUVs, DVDs, PDAs, cell phones, first and second homes, PCs, IPOs, vacations, Christmas toys, and Internet joys - a virtual cornucopia of goodies was produced and consumed by consumers flush with jobs, cash, and, importantly, easy credit. In fact, consumers' buying binges increased consumer debt so that, by some measures, it moved the consumer saving rate lower than in the 1930s. On examining business and consumer gluttony and the real or misperceived imbalances in the economy, Mr. Greenspan began to squeeze the liquidity from the system; six interest rate increases stretched between June 1999 and June 2000.

With the Fed's credit tightening last year, withdrawal symptoms became tangible. Consumers began to retrench, still gadget- and doodad-rich but increasingly portfolio-poor. As retail sales slowed, so did employment growth. Layoffs were announced with increasing frequency. The rising prices of gasoline, heating oil, and natural gas acted almost like a massive tax increase that further drained the buying resources of businesses and individuals. Already weak last October and November, auto sales fell off the table in December. Domestic auto sales declined 14% to 18% among the Big Three domestic producers. During the peak Christmas selling season, Mr. Grinch bounced up on theater screens and also made extended appearances at the nation's retailers. Many retailers did not have extended holiday hours for lack of customer traffic. PC sales plummeted throughout the U.S. and Europe. Although holding up well, the average price of a house recently declined. Slowing house sales meant fewer purchases of appliances, carpets, and other furnishings. The National Association of Purchasing Managers signaled a continuing slowdown. Manufacturing job growth became almost nonexistent. Manufacturers began liquidating excess inventory due to slowing demand. The University of Michigan's Survey of Consumer Confidence continued to move south. Is it any wonder that businesses and individuals are now engaged in a purchasing strike?

The Ship's Sprung a Leak, But She Ain't Gonna Sink

Economic headlines in the daily news media are more negative than they have been for some time. They will probably get worse. Most likely the U.S. economy will not be revved up to fire on eight cylinders any time soon. In the last few years, too many investors, especially high-tech investors, became overly optimistic, threw caution to the wind in perhaps the most speculative stock market binge of the last century, and ignored basic, immutable facts about profitable stock market investing. One of these facts is that rising interest rates and tight money almost always lead to falling price-to-earnings ratios, which, in turn, are followed by slower earnings. Many of these investors now sit burned by the fires of their own greed and naiveté.

Another investment fact underscored by recent events: markets rarely stay fairly valued for extended periods of time. Markets move between levels of over-valuation to under-valuation, with these over or under levels reaching extreme magnitudes from time to time. In March 2000, many stocks and certain indices were at heights of extreme over-valuation. In recent months, a large number of stocks crashed to levels of gross under-valuation. Some stocks, especially in technology industries, remain too expensive in the unfolding economic environment and might undergo even more downward price adjustments. But a large number of stocks recently have reached levels that are more closely attuned with economic reality and the intrinsic worth of their underlying businesses.

True, with each passing week there are more economists who anticipate not just a soft economic landing, but possibly a severe one. Even so, the time for panic has passed. We are reminded of a play on Rudyard Kipling's famous line: If you can keep your head when everyone around you is losing theirs, then you don't understand the situation. Yet we feel certain that investors should consider important signs before they exit. The most notable sign: Alan Greenspan poised to ride to the rescue. He is the knight startled to action, shouting "Eureka," straddling his white horse named Recovery, and brandishing his shield emblazoned with the magical words "Easy Credit." Easier credit initially will lead to rising price-to-earnings ratios and eventually to an improving economy and rising earnings. It will become a cycle in reverse. Just as stocks tend to decline as earnings peak, they typically begin to rise as earnings continue to fall. We believe that, within the next several quarters, stocks will begin to anticipate the inevitable recovery, spurred by an easy monetary policy.

Of course it would be foolhardy to blindly plunge back into stocks, especially stocks that seemingly appear inexpensive solely due to their recent dramatic price declines. To abandon an orderly, fundamentals-based investment approach simply because the prospect of easier credit is in store would be to expect a return to the lunacy of the recent past. The markets will improve, but they will not fly to the moon and not all investors will be along for the ride.

Focus on the Forest

The process of purging the excessive economic euphoria of the past few years has ended. The process of reliquification and recovery has begun. We anticipate that a Scrooge-like Federal Reserve will hurl no more bombs on investors, and instead render up care packages. And tax cuts are coming. When House Minority Leader Richard Gephardt signaled that even he was ready to sign for tax cuts, you can bet that they will become a done deal, although their final form remains unknown. One of the most important ways that Washington can improve the environment for investment and job creation is cutting the capital gains tax. Regardless of which tax measures finally are enacted, they will buttress the positive effects unleashed by lowered interest rates.

Besides anticipating these measures, investors should keep sight of the long-term positives fueling the bull market that was interrupted last year. These days technology comprises a significant and growing piece of the domestic and global economy. The information technology evolution is in a transition phase, merely slowing down before reaccelerating. The Internet and telecommunications revolutions are in their infancy; these industries will continue to grow rapidly for several years. Opportunistic businesses and individuals will continue their investment commitment to all aspects of information technology, with corollary benefits for investors. In addition, we believe that excess global capacity, lowered trade barriers and fierce international economic rivalry will lead to larger end-user markets, help keep inflation in check, and continue to spur technology-enhancing productivity.

We also believe that despite tax cuts and pork barrel spending, U.S. fiscal policy will continue to create budget surpluses in 2001. Tax cuts, particularly capital gains tax cuts, should fuel economic growth that will further increase tax receipts into government coffers. Supply-side economics does work. One of the big surprises of this year might be a surplus that is not shrinking, but growing.

In the year ahead, government regulatory policy likely will play a less punitive role than in the recent past, and also have less drag on the economy. It is hard to imagine the Bush Administration skewering the likes of Microsoft, or holding major mergers hostage to misguided concepts of fair competition in a world of energetic, domestic and global business. On the other hand, do not expect the prompt cancellation of the Byzantine maze of regulations that has been heaped on businesses and individuals by the feel-good, do-good politicians during the past four decades. In short, in 2001 and beyond, businesses and investors should have less to fear from government, and greater confidence that government will be, if not a confederate, certainly less of an obstacle to job and wealth creation, with greater tax revenues an inevitable by-product.

We expect the half-full glass of economic opportunity to become fuller in the months ahead. Investors should be looking over the proverbial valley of decline toward recovery. Stocks are down because, in some cases, they were ridiculously overpriced, or they already anticipated the economic morass through which we now struggle. The worst of this bear market is over. We now see the Federal Reserve as an ally of investors. Tax policy will benefit consumers, businesses, and investors. Technology will reassert its pervasive influence on economic activity. Increased global economic activity and a more rational environment for energy production and pricing will improve an economy unburdened by inflation.

We are sanguine about the future of equity investments in the US and many international markets. The opportunities for wealth enhancement are quite plentiful, and we foresee positive returns for a myriad of stocks. This is not to say that 2001 will be a year without difficulty and great market volatility, but the willingness of many disillusioned and in some cases, panicked stockholders to flee the market or throw in the towel presents opportunities to those who can keep their perspective and take a long view. Many of the speculative excesses in technology that were rampant in 1999 and early 2000 have been wrung out of the market. The Nasdaq declined 39 percent in 2000 after rising 86 percent in 1999, an increase without historical precedent. The overall market has been broadening of late - on the NYSE on January 5, 181 companies made new 52 week highs while only 12 made new lows. A small group of highly valued technology stocks is no longer driving the market indices higher. No longer do day traders rule the day. The fundamental analysis of "real companies" trading at reasonable valuations has come back to the fore, as it inevitably would. Such a market environment favors an active manager with a portfolio diversified beyond technology. We believe that, through this rough sea, investment decisions based on our Business Valuation Approach - with its emphasis on private market value, historical valuation, and growth at a reasonable price - proven in all parts of the economic cycle, will pay handsome dividends for our clients in the months and years to come.

We wish all our clients and friends a year that is blessed with the joy and love of friends and family - with some monetary rewards thrown in for good measure.

Roger E. King, CFA
Chairman and President

Other contributors to this issue:
Leah Friday, Ruth Laseski, Ryan McCleary, Jill Silver, and Marcey Whitney

Sources: Barrington Research Associates, Inc.; Bloomberg; Credit Suisse First Boston Corp.;
Salomon Smith Barney; Wall Street Journal