Designing the Stock Market Roller Coaster By Allen Tye
  What a ride January has been for the equity markets. For sheer thrills, the exchanges could have sold tickets allowing investors to experience the vertigo of market participation. Many investors, in fact, feel as if they HAVE been charged admission fees, as both equity and fixed income markets roiled in turbulent angst.
The first week in January investors watched in discomfort as the Dow Jones suffered a precipitous 4.3% drop. Over the next two weeks the mood shifted, and the Dow manifested the traditional "January Effect" by rising 5.1%. But a gut-wrenching fall struck with a vengeance, driving the markets into a calamitous nosedive that saw the Dow drop 7.1% and the S&P 500 6.5% over the next 10 days.
  Is this market volatility a reflection of the true instability of the U.S. economy? Probably not. The problem is not that the underlying economy is changing that rapidly, but rather that the economy has been so consistent in its' strength for such an extended period of time. Traditional textbook economics predict that markets of this strength and magnitude either burn themselves out or are extinguished in a rising tide of inflationary pressures. Interestingly, neither has happened. Consider: In 1984, the Federal Funds rate and the unemployment rate were both just over 8%. Today the Fed Funds rate is 5.3%, but unemployment has continued to fall to 4.1%. And during that stretch, consumer prices as defined by the CPI have fallen to a surprisingly low 2.7%.
  It is a tug of war between a myriad of economic inputs. The budget surplus is exploding, and investors are happy. The trade deficit becomes bigger, and we fret. Economic growth rates increase, fanning fears about an inflationary resurgence. But those same growth rates increase corporate earnings, suggesting that corporate America has never been stronger. We are experiencing a dizzying assortment of economic indicators that, within the framework of traditional applied economic theory, are unsustainable, yet defiantly continue to be sustained. And investors and analysts are torn between the realization that things really are different this go-round and the trepidation of jettisoning eight comfortable decades of economic theory and practice.
  The market salve for investors looking past these short-term choppy seas - the Dramamine of the new economics - is the emerging dynamics of this new economic ether. Whether companies are selling software, music, video or - in the very near future Ð electronic books, communications and anything else that can be digitized, all are going to an Internet distribution model. In a sense, they will all be selling the same ubiquitous product: Light. Encoded digital photons which are not only freely distributed, but are also freely replenished. Coded bits that, when copied and sold to consumers, never leave the inventory shelves. A vast array of product that can meet any consumer demand at ever declining prices because the product supply for all practical purposes is infinite.
  This is the key metric to the new economic framework. Unlimited supply has fractured the traditional link between demand and supply in most aspects of the digital environment. This remarkable de-coupling - never before experienced on such a broad scale - implies that economic growth will not definitionally spawn inflation and supply shortages that were characteristic of every previous business cycle. In short, we can have consistently faster growth, lower unemployment, better standards of living and broader participation in the miracle of capitalism than has ever been previously possible.
  We are seeing the fortunate and unique convergence of democracy, technology and trade. And while the market is spasmodically adjusting to this convergence, the long-term implications are for a very rewarding ride indeed. DBJ Back (Allen Tye is portfolio manager at Vector Money Management in Jackson, MS)