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Pastimes : DOW 36000 - Glassman and Hassett -- Ignore unavailable to you. Want to Upgrade?

To: Clouseau who wrote (12)	9/12/1999 5:11:00 PM
From: Sid Turtlman	Read Replies (1) \| Respond to of 42

Dave: There are many industries that have not been hot in the stock market, and therefore haven't attracted excessive amounts of capital. That doesn't mean that one will make lots of money being long the stocks in that area, for two reasons: 1) Maybe the reason that the industries' stocks weren't hot is that there isn't any fundamental growth in demand there, despite the strong economy, and 2) When the upward spiral of the last several years (high stock prices->ease of raising capital->huge corporate nest eggs->massive purchases and hiring->multiplier effect->strong demand and profits at the beneficiaries of this spending by well financed companies and their employees->high stock prices, etc.) starts to unwind and work in reverse, then plenty of industries that haven't been hot, haven't raised a lot of capital, haven't expanded capacity, could STILL find themselves in an overcapacity situation, not because supply has gotten too big, but because demand has shrunk too much. While I have my bear hat on, I'll add another factor that has helped the spiral go up, and will quite symmetrically help it go down: the trend in most corporate cost structures away from variable costs toward fixed costs. The whole computer revolution in business has been about replacing humans with computers - they are cheaper and more productive, allowing a business to expand output at a rate way above its growth in employment. That has allowed profits as a percentage of sales to reach such high levels. Unfortunately, this creates a negative leverage effect on corporate profits, whenever demand declines. In the old days, when business got slow, a company could lay off lots of employees, because most of them were there to produce product, and it could also lay off deadwood in management, of which there was always plenty. But businesses have been much better in the last decade about not taking on unneeded employees, so they have lost all flexibility of response when demand does turn down. Lay off deadwood? There isn't any, or at least not many. What else can they do when business gets slow - lay off the computers? I don't think so. So I think the surprising development that will happen in the next recession, whenever it may begin, is how the widespread adoption of relatively fixed cost structures will cause a highly leveraged drop in profit margins on modest drops in sales. That in turn will cause companies to stop hiring and spending, which will weaken the economy further. Fortunately, the spiral doesn't go down forever, any more than it can go up forever. At some point enough weak companies have been knocked out of business that the surviving competitors can start to make a decent living, and then the cycle starts up again. We'll know we are there when Glassman and Hassett get lots of publicity for their logically consistent theory demonstrating why the DJIA must go to 3600.