Sunday evening, November 25, 2001

COMMENT: I hope you enjoyed your Thanksgiving. What a wonderful holiday. All
you have to do is give thanks and eat. We have much to be thankful for. The
war on terrorism is progressing better than had been widely expected. US
authorities are acting to foil new terrorist strikes at home. The
intelligence agencies of nations around the world are cooperating more in
the effort to attack the global network of terrorists. The new airline
security legislation should revive public confidence in flying again over
the next six to 12 months. US relations with Russia have improved greatly.
Freer trade is increasingly viewed as one of the best responses to
anti-globilization. China has joined the World Trade Organization. Russia
could be next. There is ample financial liquidity. Energy costs are low.
Interest rates are low too, and 0% financing has boosted auto sales. The
economic recession is likely to remain shallow and should end by next
spring. The profits recovery during the second half of 2002 should be
robust.

The bond market seems to share this assessment. Two weeks ago, I wrote "the
flood of liquidity is likely to revive the economy next year. This suggests
that the bond rally may be coming to an end. This is why I am raising my
stocks/bonds ratio." Since then, the 10-year bond yield is up an
extraordinary 80 basis points. Over this same two-week period, the Dow Jones
Industrials Average rose closer to 10000. In 1995, when the Dow crossed
5000, I predicted it would cross 10000 by 2000.  It did so on March 29,
1999. I didn't expect it would rise above 10000 two times again as it has
since then. Odds are the Dow will soon (this week) rise above 10000 yet
again for the fourth time

How much longer will the Dow remain flat around this level? It could be a
long time. After all, it did rise ten-fold from 1000 to 10000 from 1982
through 1999, following two decades of meandering in a flat trend between
500 and 1000. A long period of consolidation after the extraordinary gains
of the 1980s and 1990s is possible. The Dow's 200-day moving average has
been relatively flat between 10000 and 11000 since late 1999. The week
following the September 11 terrorist attacks, the Dow bottomed at 8235,
which was 2214 points, or 21%, below its 200-day moving average. That was
probably "the bottom." Bottoms are often made by panic selling during major
crises. The Dow was oversold and it quickly bounced back.

It is hard to see the Dow moving much higher soon since it is already
discounting a solid rebound in earnings next year with a reasonable
valuation of those earnings expectations. Since 1999, the 52-week consensus
expected forward earnings per share has hovered around $500 per share and
the forward P/E has hovered around 20. If both continue to do so through the
first half of 2002, as I expect, the Dow Jones Industrials will continue to
hover around 10000. By the end of next year, however, the Dow could retest
the record high set in early 2000 of about 11500. That would be a 15% return
from current levels.

The major risk is that consumer spending might weaken significantly in early
2002. Auto sales are bound to tumble as the stimulative impact of 0%
financing wears off. While the pace of layoffs may be slowing, it is
becoming harder to find a job because many firms have imposed hiring
freezes. Also, the coming bonus season will probably be the worst since the
early 1990s. Many job losers are losing high incomes and are unlikely to
find comparable-paying jobs soon. The good news for many of them is that
they are receiving large severance pay packages. This development may partly
explain the surprising resilience of consumer spending, as well as some of
the amazing surge in liquidity this year. MZM--which includes M1, savings
deposits, and money market mutual funds--is up $930 billion over the past 52
weeks, a record rate.

GOODWILL: The November 9 issue of EARNINGS WEEK examines the likely impact
on earnings of the elimination of goodwill amortization expense next year.
We come up with a $5 per share boost. Will the market treat the accounting
rule change as a technical adjustment with no impact on stock prices? In
other words, will a lower P/E offset the higher E? My hunch is that there
will be some bullish impact even though nothing real changes. (What does
reality have to do with stock valuation? Reality probably matters in the
long run., but perceptions certainly matter in the short run.)

MOVIES: "Harry Potter" was too long. It reminded me of "Star Wars" set in a
British boarding school for would-be wizards. It isn't my cup of tea. My
11-year-old son enjoyed it, but he isn't interested in seeing it again. I
predict that "Harry Potter II" will be much less successful. "The Man Who
Wasn't There," starring Billy Bob Thornton is the latest film noir classic
from the folks that made "Fargo." I enjoyed it. Billy Bob was perfect for
his role as a barber.

Dr Ed
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