Just as a doctor checks the pulse of patients to determine their health, investors need to check
the pulse of the business and economic cycles to determine the best method and the best time
to put money to work. Of course, we all watch the passing of time — living life to the fullest
— for there is a life cycle too. Investing also requires knowing the pulse rate of cycles. Are
there boom and bust cycles, or is the economy just a juggernaut of strength, ably mending
itself through relentless fortitude and perseverance. Is the heart of the economy — manufacturing,
services, large or small industry-affected more severely than the outlying industries? Is
the Internet an infection or a catalyst for embryonic growth? Where are we in the energy
cycle, such that we can predict the location of highest profitability, whether it be upstream,
midstream or downstream in the production process? These are good questions to be asking
now because there is ample evidence that the U.S., and possibly the world economy, is bottoming.
Moreover, there is new evidence that a recovery is in the works.
One of the more closely watched indicators of future prosperity is the Index of Leading
Economic Indicators (or LEI). In a recent report for May, the LEI rose 0.5 percent, the second
straight monthly rise, and the largest such rise since December 1999. This indicator is
also compiled for the world, and indeed, for the first time in May, the world leading indicator
index rose 0.2 percent, the first such upturn since March 2000. Combined with other
indicators, there is mounting evidence for a recovery six months ahead. For example, rates
have decreased to 7.11 percent on a 30-year fixed-rate mortgage, which, in turn, drives housing
starts and existing homes sales upward. Consumer confidence rose again in June. Auto
and truck sales are stable. And, of course, the Federal Reserve lowered short-term rates
another 25 basis points, making for a six-in-six (6 rate declines in 6 months) interest rate
reduction, one of the fastest adjustments in the history of the Fed.
Analysis of market conditions after interest rate cuts shows that markets recover strongly six
months into the future. Salomon Smith Barney, did a study showing a 14 percent gain by the
S&P 500 12 months after six rate cuts. The Nasdaq Composite gained 28 percent. In a second
study of past rate cuts amid a profits recession, the results also are positive (5-16 percent)
for the market three months later. Nonetheless, we may face a very strong manufacturing
decline in the United States and abroad. Hurt by too much inventory (supply), manufacturers
have to adjust accordingly with a slowdown in production and layoffs. The extent of this
oversupply is impressive: in April, the inventory-to-sales ratio hit a 33-month high.
According to Credit Suisse First Boston, "manufacturing sector productivity has…declined in
Q1 2001 at the fastest quarterly rate in over a decade" (U.S. Economic Digest, 6/25/01).
This cycle of manufacturing productivity suggests that when inventory adjustments have run
their course, there will be a recovery in manufacturing output. Currently the outlook for
improved inventories is 3Q 2001, which is just around the corner.
Indeed, the economic cycle looks depressed at the moment, as does the business cycle. The
year 2001 is definitely a year of disappointing profits to the extent that a profits recession is
now set in stone. The S&P 500 is forecasted by First Call to post –6 percent returns for the
year but 19 percent positive returns for 2002. When cycles are down, it is time to look ahead.
This is the time to set in place the seeds of growth, much as you plant a garden in early summer
to watch it grow to harvest in the fall and winter. Rate cuts and tax cuts set the policy
standard for recovery. Once inventories ratchet down, a new era of productivity should ensue,
and markets should return to profitability. Advisably, keep your hand on the pulse of cycles.
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Investment Professionals 
