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Mid-Week Analysis

We are again in the midst of an extraordinary week. It will be days and perhaps weeks before the resolution of one of the most unusual Presidential elections in history, creating only another facet of uncertainly for the marketplace. So far this week, the Dow has gained 1%, while the S&P500 has declined 1%. The Transports have gained 1% and the Morgan Stanley Consumer index 2%. The Utilities and the Morgan Stanley Cyclical index are unchanged. The broad market continues to trade relatively well, with the small cap Russell 2000 and the S&P400 Mid-cap index having declined only 1%. The financial stocks have been mixed, with the S&P Bank index unchanged and the Bloomberg Wall Street index declining 2%. After a strong rally, the technology stocks were hammered today. So far this week, the NASDAQ100 and Morgan Stanley High Tech indices have been hit for 8% and the Semiconductors pounded for 10%. The Street.com Internet index has declined 6% and the NASDAQ Telecommunications index 7%. The Biotech stocks have declined 4%.

Credit markets have been relatively quiet, with Treasury yields rising between one and three basis points. Mortgage-back yields have generally added three basis points and agency yields 4 basis points. The benchmark 10-year dollar swap spread has widened 3 basis points to 111. The dollar is generally strong, with the dollar index gaining about 1%. Unstable conditions continue in the emerging markets, with Argentina remaining on the edge of a financial crisis that would likely be contagious to other economies in the region.

We regularly write that we are living in a truly historic period. Yesterday's extraordinary election was further confirmation of this view. Undeniably, we are witnessing history in the making, with a confluence of powerful and interrelated political, cultural, financial and economic forces. Such an extraordinary situation breeds uncertainly and acute unpredictability, factors anything but conducive for the stability of the great stock market bubble. This is particularly the case with current underpinnings already so fragile, particularly in the faltering technology sector. It is certainly our view that the extraordinary political landscape is indicative of deepening social and cultural fissures that are poised to exacerbate the coming bear market.

First, there is no doubt that our country is the most divided it has been in ages. This was articulated clearly today by Washington Post columnist David S. Broder in his article titled Divided States of America. Quoting from the article: "It was as if two different nations went to vote yesterday - men vs. women, big cities vs. small towns, large states vs. small, splitting their votes between Republicans and Democrats so evenly that the government of their one country, the most powerful nation in the world, hung in the balance.

Politically, demographically and culturally as well, the United States of America looked anything but united on Election Day 2000. In a time of peace and prosperity, with political candidates and parties that presented sharply contrasting views on the role of government, the priorities in the budget and the best way to preserve Social Security and Medicare, the two nations agreed only to disagree. The divide went deeper than politics."

With our expectation of significant impending financial and economic troubles, it is quite ominous that society is today - despite unprecedented prosperity - incredibly polarized and, we would say, with deepening underlying frustration and bitterness. Unfortunately, faltering economic conditions will only exacerbate this situation. And while this "social mood" has been developing for some time, it has been easily ignored with a liquidity and speculation-driven stock market bubble. We don't believe the future market environment will so easily disregard a polarized society and political system going forward.

One of the maxims that developed over this long bull market can be stated as "the stock market loves Washington gridlock." With the political process "hand tied" by deep political animosities, as well as a highly partisan and equally divided government, Washington has been seen as utterly incapable of doing anything to derail the great American boom. Well, we have doubted this view, seeing it as little more than looking through hopelessly "rose-colored glasses" and boom-time wishful thinking. After all, it is only a matter of time until Washington gridlock proves highly detrimental in dealing with a critical issue or some type of a crisis. Sure, political gridlock may be, by accident, advantageous for periods of general tranquility, where bullish conditions prevail in the markets, and economy. Conversely, political impotence creates problematic uncertainty (and potential catastrophe) during crisis or other circumstances that call for decisive bipartisan action.

There is clear potential for this election to develop into a major political crisis. As Vice President Gore stated today, "this is an extraordinary moment for our democracy. We now need to resolve this election in a way that is fair." There are allegations of voting improprieties, including uncounted votes, double voting, as well as voter intimidation and other serious errors in the voting process. We have no idea if there is any validity of to these charges. Still, Vice President Gore further stated this afternoon that "what is at issue" is the "full faith and confidence" in the election process and the results. He also stated that there should be "no rush to judgment." This comes from the winner of the popular vote, and someone who can fight for his own political future while also invoking the "rule of law" and the "protection" of the individual rights of citizens. He and other democrats may even feel that they can make a strong case for "taking the high moral ground" and fighting this "to the end." These are clearly the circumstances for great destabilizing uncertainty.

Already, it has been reported that several voters in Florida have filed suits charging that their rights have been violated. Legions of attorneys are one their way to Florida and there is certainly the possibility that this gets tied up in local courts. Possible legal remedies at this point are uncertain, but there has been media speculation that there may be a call for a revote in Florida or that the Supreme Court may need to intervene. No doubt about it, this has potential for political "trench warfare" that could turn into a protracted legal battle. There is also the potential for the Electoral College process to be delayed or disrupted, and the issue looms of some electoral delegates not bound to follow the popular vote within their respective states. At the minimum, the end result will be only more animosity and electorate disenfranchisement. If the Florida results are upheld, these circumstances will likely weaken the initial Bush Presidency. Without victory in the popular vote and evenly split House and Senate, the new President will arrive in Washington without a clear mandate and a highly divided political environment. We cannot imagine a more disconcerting environment considering what we expect to be an unfolding financial and economic crisis.

Importantly, we think yesterday's election should be seen in the context of significant unfolding change in the general environment. The dimming of the public mood is almost palpable, and the ramifications for financial markets quite ominous. We are witnessing the subtle transformation of the greatest bull market in history into what we fully expect to be a historic bear market. It is a time of great flux and uncertainly, with profound social, political, and economic ramifications. We don't think it is coincidence that the technology sector (the epicenter of bullishness and excess during this cycle) was hammered today. As we said, times are changing. It is certainly our sense that the marketplace is coming to better appreciate the quagmire developing throughout the technology sector. With liquidity having evaporated in the junk bond market and bankers, investors and speculators alike fleeing the leveraged lending area, the critical lifeblood of the massive telecommunications build out is disappearing. The ramifications for the stock market and the soundness of the U.S. financial sector and economy are great. And while the current political situation may be resolved over the coming days and weeks, the bursting of the great technology bubble will be resolved over a period of years.

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