Emulsification
Suppose for a minute that the old school thinking applies. That would mean the tax cut would be spent, dividend yielding stocks will outperform those that reinvest profits for growth and the lack of pricing power will be corrected with an uptick in inflation. That is a heady gamble for any CEO to take. Even more difficult for the company chiefs is the ability to garner enough support to rally behind this thinking.

Suppose for a minute, there is a new way of thinking about how the economy will react to the push the old schoolers have provided. The tax cut, as paltry as it will seem to many will be saved not spent. Inflation will have the desired effect on pricing but as this number moves upward, pressure on mortgages and refinances will slow the only part of the market that has shown any support for the economy during these difficult times.

Its no wonder they are just a little skittish about doing anything. If I was in their shoes, I would probably react the same way. But they may just be looking at something else and arriving at a similar conclusion.

In order for companies to grow which is the desired progress that leads to increased profits for shareholders, money must be raised to increase such things as research and development of new products, the purchase of equipment or even better, other viable companies with good business plans. The problem though is two fold.

Logically, the first question might be where to get the money. The second though is more troubling.

In the first much more minor problem, the CEO is faced with limited prospects. As the stock market moves up, even if that has been a more gentle slope recently, the value of the company increases and the debt ratio goes down. If these CEOs were to look to the bond market for help, what they would find is an swirling mass of confusion. More on that later. These folks have reached the limit on what they can do to sustain the false hopes they have been providing of late. Profits cannot continue to rise on the backs of layoffs or stock buy-backs. Sooner or later, you have to increase market share with soemthing they have produced rather than something they produced for far less.

The second question deals with the prospect of sustainability. Sure companies have gotten more lean, learning to fire on all pistons with much less capacity and employees while living an on-demand existence. But any company leader who is worth their mettle understands that this can not go on indefinitely. At this moment in time, the economy is exactly where it should be. In other words the stars are in perfect alignment to allow a recovery to begin. Without basing too much of their decision on the information available from the last tax cut, the quarter following such a move stood alone as improved. If that case carries forward, then we are likely to see the last half of this year improve. The question presents itself as "then what?".

Once they are committed to the belief that global competition is worth fighting, that prices will allow them to continue to grow without increasing the need to borrow heavily to keep up and they can do this for a long period of time, then and only then will we see things improve. But that commitment has yet to manifest itself.

Companies run a risk either way. Expand to grow and gamble that the economy will be better than anticipated in the first half of '04 or the reverse. Pulling the reigns even further in the name of discipline and the consumer may just take that as a sign that maybe they should do the same.

For those of you who do not cook, the title of the this little piece, "emulsification" refers to the suspension of tiny globules of one liquid inside another liquid, creating a mixture that would not normally happen. Spun at high speeds, the resulting mixture such as mayonnaise for example becomes a new entity in itself. The markets are beginning to look like just such a force is at work.

As I said earlier, the economy is ready and willing. All of the tiny little globules of positive economic information have been spun at a high speed creating a rich sauce whose property is far superior to its ingredients. But this mixture is fragile and can break down quickly if not handled properly.

The stock market has recently provided the right environment to break this mixture down. The effect has been similar to leaving the potato salad in the hot sun for too long. Stocks are grouped together in certain ways to provide investors the ability to see how one group might determine the mood of the whole. If one were to follow this logic, then the markets could be in for a world of hurt in the coming months from the financial members of the grouping. The rallies have of the past several quarters have been based on the strength of this sector. But the pressure on rising mortgage rates which effectively slow home purchases and refinances will be the one thing this group does not need.

I'll admit that the actual dollars that are poured back into the economy because of the home equity borrowing is still too fuzzy to determine. I can tell you thugh that the folks who are paid to predict these outcomes are not wholly excited by the prospects of this new development.

With the financials under pressure, the rest of the market's weakness might be easier to see. And if the pension funds begin to look elsewhere, namely the bond market, the increased sell side activity might prove to be all that this market needs to break down the mixture.

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