| U.S. ECONOMIC BACKGROUND AND POLICYIn a | | | | the most advanced technologies and contributes |
| free market system, when demand exceeds | | | | to higher aggregate living standards, although |
| supply, prices rise and there is excess profit. So, | | | | income inequality remains high.Labor economists |
| new supply is created, until excess profit | | | | refer to the 35-54 age group as "prime-age" |
| disappears. In the U.S. over the past few years, | | | | workers, because it's the most productive group, |
| inflation accelerated, corporations had strong profit | | | | based on education, experience, and training. The |
| growth, and the economy expanded at above | | | | second most productive group is the 55-64 age |
| trend growth.Measures of inflation, e.g. the GDP | | | | group. The 80 million U.S. "Baby Boomers," born |
| Price Deflator, CPI, and PPI, show inflation has | | | | between 1946-64, are at their productive peaks. |
| accelerated over the past few years. The Federal | | | | However, the Baby Boom generation hasn't |
| Reserve (or Fed) uses several measures of | | | | saved enough to retire, and many lost much of |
| inflation. However, it's primary benchmark is the | | | | their wealth when the Nasdaq bubble burst in |
| Personal Consumption Expenditures Chain Price | | | | 2000, which postponed many plans for early |
| Index, which is a component of the GDP Chain | | | | retirements (the stock market crash was a |
| Price Deflator. U.S. inflation has generally risen | | | | "correcting mechanism" to keep future labor |
| from 1.5% in 2002 to 3.5% in 2005.The S&P 500 | | | | supply and demand in equilibrium). Recently, many |
| had a record 14 consecutive quarters of | | | | Baby-Boomers took advantage of the housing |
| double-digit earnings gains recently, and double-digit | | | | boom, including refinancing at lower rates to spend |
| earnings growth is expected to continue into next | | | | much of their housing gains to raise their living |
| year. Total U.S. corporate profits rose from 7% | | | | standards. Consequently, the Baby Boomers will |
| of GDP in 2001 to 11% of GDP in 2005. | | | | have to work harder and longer before |
| Consequently, the S&P 500 P/E fell from 45 in | | | | retirement, to maintain autonomous |
| early 2002, which was an all-time high, to 18 in | | | | consumption.The massive Creative Destruction |
| 2005.Over the past 10 quarters, U.S. real GDP | | | | process and the low saving rate of Baby |
| growth has averaged just over 4%, which is | | | | Boomers are two powerful forces that have |
| above the long-run trend rate of 2.8%. Real GDP | | | | increased productivity and will maintain high levels |
| growth for the most recent quarter was 4.1% | | | | of productivity over the next several years. |
| (annual rate). Many forecasted that real GDP | | | | Consequently, inflation may remain contained |
| growth would slow to just over 3% in 2005, and | | | | longer than expected. However, there are several |
| may current forecasts are predicting just over | | | | other significant forces that will influence inflation, |
| 3% real growth in 2006.The goal of the Fed is to | | | | including monetary & fiscal policies, the "output |
| preempt inflation, or deflation, to maintain price | | | | gap," capacity utilization, the unemployment rate |
| stability, because stable prices lead to stable | | | | (Phillips Curve, i.e. inverse relationship between |
| output and employment. Sustainable growth, | | | | unemployment and inflation, and NAIRU, i.e. the |
| where there's neither strain nor slack in the | | | | Non Accelerating Inflation Rate of Unemployment |
| economy, is optimal growth, which raises living | | | | estimated to be 5%), wage growth, commodity |
| standards at the fastest possible rate. Price | | | | prices, the U.S. dollar, the balance of payments, |
| stability tends to smooth-out the business | | | | and the yield curve.Much of the slack, created by |
| cycle.There are hundreds of major forces pushing | | | | the massive Creative-Destruction process of the |
| and pulling a dynamic economy, e.g. the U.S., and | | | | early 2000s, has been taken out of the economy, |
| the Fed must find the net effects of these | | | | although monetary policy remains stimulative and |
| forces, through their interrelationships and | | | | fiscal policy is expansionary. Consequently, the |
| interactions. Moreover, the Fed must work in the | | | | output gap, i.e. the difference between potential |
| future economy, because of lags in policy | | | | and actual output, has closed, capacity utilization |
| changes, using its several "crude" tools to control | | | | has increased, the economy is near full |
| the economy.The U.S. had 20 years of disinflation, | | | | employment, wage growth is slow (although |
| from the early 1980s to the early 2000s. In 2002, | | | | income growth is stronger), high commodity |
| the FOMC (policy-setting committee of the Fed) | | | | prices reflect economic strain in foreign |
| lowered the Fed Funds Rate to below 2%, and in | | | | economies, particuarly in Asia, a weaker U.S. dollar |
| 2003, lowered it to 1%. Over the past 18 months, | | | | has spurred export growth, although import |
| the FOMC has raised the Fed Funds Rate 25 basis | | | | growth has been stronger, to keep the balance of |
| points at each meeting to 4.25%. Currently, | | | | payments balanced, and the flattening yield curve |
| financial markets are expecting the tightening | | | | indicates economic growth will |
| cycle to end in early 2006, when the Fed Funds | | | | slow.CONCLUSIONThe Fed typically "overshoots" |
| Rate reaches 4.5% to 5.0%.Although, the FOMC | | | | preempting inflation, because once inflation is out |
| has tightened the money supply, raising the Fed | | | | of control, massive amounts of liquidity must be |
| Funds Rate from 1% to 4.25% over the past 18 | | | | drained out of the commercial banking system, |
| months, monetary policy remains accommodative. | | | | which often eventually results in a recession. So, |
| However, recently, the FOMC stated monetary | | | | the Fed will overtighten rather than risk falling too |
| policy is near neutral, i.e. a stance that neither | | | | far behind the inflation curve. Consequently, the |
| stimulates nor slows the economy, and implied a | | | | Fed may continue to tighten beyond a neutral |
| "restrictive stance," of further tightening, to slow | | | | stance, and adopt a restrictive stance for some |
| the economy to a sustainable rate.POWERFUL | | | | time. However, the Fed may pause in early 2006, |
| FORCES INFLUENCING THE U.S. | | | | when the Fed Funds Rate reaches 5%, after |
| ECONOMY"Information Age" firms accumulated | | | | tightening 400 basis points over 16 consecutive |
| economic inputs, e.g. labor, capital, raw materials, | | | | FOMC meetings, since its campaign of |
| energy, etc., throughout the 1980s and 1990s, | | | | "jawboning," to keep inflation expectations low, |
| and became increasingly wasteful utilizing those | | | | along with actual tightening have been effective. |
| inputs. Eventually, financial markets withdrew | | | | Nevertheless, future economic data will decide if |
| massive amounts of investment from those firms | | | | or when the tightening cycle will continue.Arthur |
| in 2000 to 2002 causing a quick and massive | | | | Albert Eckart is the founder and owner of |
| "Creative Destruction" process in the "Information | | | | PeakTrader. Arthur has worked for commercial |
| Revolution." Consequently, Information Age firms | | | | banks, e.g. Wells Fargo, Banc One, and First |
| became more efficient, producing more with less, | | | | Commerce Technologies, during the 1980s and |
| and surviving firms became more price | | | | 1990s. He has also worked for Janus Funds from |
| competitive, while improving their financial | | | | 1999-00. Arthur Eckart has a BA & MA in |
| conditions.Therefore, massive amounts of | | | | Economics from the University of Colorado. He |
| resources were "freed-up," in 2000 to 2002, and | | | | has worked on options portfolio optimization since |
| shifted into emerging industries. These inputs | | | | 1998.Mr Eckart has developed a comprehensive |
| continue to flow into emerging firms, while older | | | | trading methodology using economics, portfolio |
| industries in the Agricultural-Industrial-Information | | | | optimization, and technical analysis to maximize |
| Revolutions continue to become more productive. | | | | return and minimize risk at the same time and |
| Consequently, the U.S. economy has become | | | | over time. This methodology has resulted in |
| more diversified, which stabilizes the economy and | | | | excellent returns with low risk over the past four |
| helps smooth-out the business cycle. Moreover, | | | | years. |
| the economic flexibility of the U.S. helps create | | | | |