The 20th century was an exciting era. It began with Western Europe trying to recover from the Dark Ages with continuous battles throughout the continent and an average life expectancy of only 45 years. It ended in a period of peace and prosperity with most of the world's major industrial countries experiencing growing economies. We also had the rise and fall of communism, the growth of democracy and a technological revolution in airplanes, automobiles, biotechnology, communications, computers and the internet. In the U.S., our economy will reach its longest expansion on record in February, our bull market in stocks is the longest and strongest of the postwar period and the U.S. stock market at $17.4 trillion is half the world market of $35 trillion. The end of the Cold War marked the beginning of the "New Economy."  And, the spread of American capitalism and culture is comparable in scope to the spread of the Roman Empire.

The performance of the U.S. stock market in 1999 was most unusual. While the major averages were strong, the market experienced the biggest negative breadth divergence in its history and has continued longer than the 1928-29 divergence and just short of the longest 1971-73. For example, the median stock in the S&P 500 declined -1.3% and almost 70% of stocks listed on the NYSE declined last year. Also, while the NASDAQ gained +85% - the largest gain of any major index in the history of the U.S. stock market - the median stock gained only +1% and 48% declined. The unweighted Value Line Composite declined -1.4%. In fact, one third of all NASDAQ and NYSE stocks declined over 20% last year. This bizarre disparity developed because most of the major indices are market cap weighted. Only 25 large cap companies were responsible for the entire gain of the S&P 500 and approximately 100 companies accounted for almost the entire gain of all the market cap weighted indices. The spectacular gains in a few stocks camouflaged the market's overall weakness. In view of these developments, the key question today is what can we expect from the economy and stock market as we begin the millennium?

The U.S. economy remains in overdrive with powerful momentum and the Y2K bug became the "millennium shrug."  Over $300 billion was spent worldwide on this problem and the year 2000 conversion went smoothly. There were minor problems, but they have already been corrected. However, more problems are likely to surface in the months ahead, but they are not likely to cause any significant economic disruption. As a result, real GDP is likely to have another year of 3.5% - 4.0% growth with an overall increase of +8% in corporate profits accompanied by strong cash flow and a 30% increase in our Federal budget surplus to $160 billion. This year, the above average strength in consumer spending and housing is likely to moderate while our export growth and inventory rebuilding gradually strengthen. In addition, business equipment and software is likely to continue to be the strongest sector of our economy with another double-digit increase. Our foreign trade deficit will continue to increase and may reach $400 billion or 4.1% of GDP. This is a risk since we will need a growing inflow of capital to finance this deficit. Internationally, economic growth was stronger than expected last year and worldwide growth of over +3.0% is likely this year. In fact, we may have a truly global synchronized boom. Since the end of the Cold War, capitalism has flourished as more nations understand that trade and technology generate economic security, military security and prosperity.

Last year was the ninth year in a row of inflation under 3%. The Consumer Price Index (CPI) increased +2.7% in 1999 versus +1.6% in 1998. This increase was almost entirely represented by the sharp gain in oil prices which may decline somewhat in 2000. In reality, the core CPI - excluding energy and food- increased by only +1.9% versus +2.4% in 1998. More importantly, the CPI for goods - excluding energy, food and tobacco - declined -0.4% while consumer spending increased +5.5%. The employment cost index - benefits and wages - increased +3.4% last year while wages alone were up +3.5%. But, productivity is expected to be strong offsetting most of these gains. Looking ahead, any slowdown in consumer spending is likely to exert further downward pressure on prices. And, the amazing internet is continuing its deflationary impact. Inflation is still not a problem in our economy and the world inflation rate is still declining.

On the other hand, Mr. Greenspan and the Federal Reserve continue to believe that our economy is growing at an unsustainable rate especially in the fourth quarter with real GDP increasing +5.5%. Demand is exceeding supply and we are beginning to run out of workers. Over the past four years, real GDP grew 4% annually while productivity grew +2.6% per year and we added 12 million new workers. The unemployment rate experienced a steady decline during this period to a thirty year low of 4.1%. The big risk is that if our economy continues to grow at +4%, the unemployment rate will decline further putting upward pressure on wages and inflation as demand exceeds supply - unless productivity rises more. While the Fed increased rates three times last year, the economy continued its strong growth and consumer sentiment is at the highest level of its 32 year history. In addition, household debt reached $6.2 trillion - 68% of GDP and 96% of disposable income - new records! Since wages, material costs and household debt have been rising, we believe that the Fed is determined to curtail these pressures and "pre-empt" future inflation by moderating our economic growth and will raise rates on February 2, March 21, and again on May 16 unless consumer spending and job growth begin to moderate. We may also get an increase in capital and margin requirements because of rising debt levels and market speculation. Eventually, the Fed will slow down the economy. Hopefully, it will be a "soft landing."

We continue to believe that the investment outlook is favorable for the majority of stocks over the intermediate term. While the S&P 500 is selling at 24x this year's estimated earnings of $57 per share, many stocks have more reasonable valuations and appear attractive based upon the current level of inflation and interest rates. This is likely to be a transition year as investors rotate to more attractive valuations. But, the risks are high among those large cap and internet stocks that experienced unusual "parabolic" gains over the past two years in a "feeding frenzy."  For example, the 100 largest NASDAQ stocks increased +102% last year and are selling at 130x earnings while most of the companies in the speculative "internet bubble" do not make any money and sell at unbelievable valuations.

The demand supply picture continues to be favorable for equity investments because of rising cash flow and the continued annual net reduction in shares outstanding caused by mergers and stock buybacks despite IPO's of $69.2 billion last year - a record. The "urge to merge" and the recent acquisitions of Time Warner by America Online - the largest in history - is an example of this trend along with Glaxo/SmithKline, Monsanto/Pharmacia & Upjohn and Schwab/U.S. Trust. It is interesting to note that presidential election years are usually good for the stock market. For example, the S&P 500 increased 13 of 17 election years since 1932 and 11 of 13 since World War ll. But, we expect that the market will be characterized by increasing volatility in 2000. After all, this is the Chinese "Year of the Dragon" and the dragon is known to be combative, formidable, unpredictable and violent!

On the technical front, market breadth has been expanding, but sentiment indicators are deteriorating - growing enthusiasm with little concern for risk.  Eventually, we will experience a meaningful correction. But, this time, the majority of stocks are likely to perform much better than the major averages. This will strengthen the technical position of the overall market and set the tone for above average price gains for the majority of stocks over the next two years. This year, that great sucking sound will probably be money pouring out of high multiple and "air" stocks into quality reasonably priced growing companies.  This is likely to be a wild year - keep your seat belt fastened.   The "stealth bear market" of the last two years is likely to become a "stealth bull market" over the next two years.