Investment Outlook

February 2000

As we embark upon the year 4697, the Chinese Lunar Year of the Dragon, we find the US economy forging ahead full speed, celebrating 107 months of uninterrupted expansion. As the monthly economic numbers continue to flash green, the background of strong job creation and benign inflation continues to support ever higher stock valuations even as most indices hit all time highs.

Things look pretty good…..and yet, concerns linger in the minds of investors. The recent few months of market action show a distinct movement away from the heretofore solid blue-chip stocks, towards some of the lesser known names found in the Nasdaq and Russell indices. What does this mean? For years, market pundits have decried the lack of depth of the overall market’s advance during the nineties. The common refrain was that the advance was too narrow to be sustainable and that for the market to become truly bullish, you would need to see a broadening out of participation in the smaller cap stocks. Lo and behold, during the past few months, the Nasdaq and Russell indices have handily outperformed the Dow and S&P. In fact, the Russell index recently broke out through a peak last made in the summer of 1998. The run-up in January was accompanied by heavy volume indicating renewed interest in the small cap sector.

As Martha Stewart would say, this is a good thing. This is the process of market forces at work. Over the past few years we have witnessed nothing less than an explosion of new companies capitalizing on communications and process technologies. The success of the early pioneers in these new technologies such as American Online, Amazon, Microsoft, Cisco etc. has allowed the next generation of technology firms to be built on top of them. Now we have Ariba, Commerce One, Broadcom creating and dominating markets which didn’t even exist two or three years ago. A company such as Yahoo, which was revolutionary at the outset is in danger of losing their cachet if they don’t adjust to the change in technology which is occurring now. Essentially, they were (are) a yellow pages selling banner spaces for revenue. The new generation of XML search engine technology is going to surpass Yahoo’s HTML based format. Another pioneering firm, EBAY, has spawned a host of companies with every conceivable type of auction and bid format.

The creation and success of these firms lies not only in the advance of technology, but as importantly, in the ability of the financial system to accommodate technology’s pace. In a column in the Wall Street Journal, Schlesinger opined that it was the de-regulation of the financial sector in the ‘eighties which was largely responsible for the growth in the economy we see today. From that time on, traditional banking products and systems were replaced by dynamic financial products and services created by new financial intermediaries. The evolution and growth of derivative instruments, asset-backed securities and venture capital helped small to medium sized companies grow by financing which was market driven. Today’s economy is very much a tribute to the market system. With the proliferation of new processes, efficiency has gone up while costs have gone down. As a result, there is a significant increase in participation by retail as well as institutional and business interests in the capital markets ensuring liquidity and transparency.

So now what? Well we wouldn’t go out and dump all of our IBM or GE, but we expect that the place to be is in the smaller cap stocks we referred to earlier. It appears the Russell is just getting underway and that this next stage of the market, although speculative will yield some pretty impressive returns. Now if we can only figure out which ones…………