Review and Outlook
October 5th, 2000
To My Clients,
Friends & Observers:
Mark Twain said, "A man who does not
read great books has no advantage over the man who cannot read them."
One of the great books is The Power Elite, written by C. Wright
Mills in 1956. It should be required reading for every scholar, as
much as Macchiavelli's The Prince. Mills was a Columbia University
professor, regarded as an iconoclast by his fellow faculty. His book
is a compelling argument that America is not as democratic as it seems.
It dissects the American social strata and the influence of the military,
corporate and political elite. The book is a masterwork of perspicuity
and critical thinking, as timely today as 40 years ago.
While I don’t spend much professional
time on political and social analysis it is important to be critically
aware of current events and the economic changes wrought by military,
corporate or political influence. The current desperation of the power
elite fairly jumps out of the newspapers and television screens in
bas relief to the relatively mundane events that are cautiously reported
by the (corporate) media oligopoly. Power is the universal currency,
readily convertible to cash. Follow the money to find the pattern.
Some recent floats in the passing parade fail to dissipate from memory.
With four months left in his term,
our president goes to Lagos, Nigeria to deliver a sermon on aids prevention
and fifty million dollars. How much of that fifty million will actually
go to aids prevention in a shining democratic light like Nigeria is
speculation. It is probably more significant that Nigeria is an OPEC
nation, second only to Libya in oil and gas reserves on the African
continent. There is a quid pro quo here somewhere.
Our local congressman has a political
fund-raising gala in Washington, attended with our president and Massachusetts’
senior senator. The congressman raises $250,000 for his campaign.
While providing full and flattering coverage of our popular political
celebrity, not one local TV or radio station mentions that he is
Then again, this is Massachusetts,
where our sitting governor was elected with over $800,000 of pre-existing,
personal credit card debt.
Millionaire candidates that say absolutely
anything that anyone wants to hear to garner votes lead us to either
of two conclusions: if they actually believe what they’re saying
they are dangerous and frightening; if they don’t believe what
they’re saying they are unbearable cynics and liars. If this
is a pathology, it illustrates the greater appeal of power over money.
Our justice department is demonstrably,
politically motivated. Apart from stonewalling against investigations
of corruption and security breaches there is no principled rationale
for anti-trust enforcement or lack thereof. The media industry has
never been more consolidated. So too for the pulp and paper industry.
The company that initiated anti-trust action against Microsoft is
now part of the AOL/Time Warner empire (Netscape).
Soft money corporate contributions
to the political parties have never been higher and there is no end
in sight. In Iran they call it baksheesh. Here we call it lobbying.
Taxes as a percentage of GDP have
never been higher and this in a protracted period of unprecedented
economic growth. And yet the clamor against tax cuts is positively
shrill. Every economic transaction has a tax, or 3 or 4, associated
with it. Apart from income taxes, an additional 15% of income goes
to Social Security/FICA taxes, which is immediately spent from the
general fund by a ridiculously inefficient bureaucracy. There is no
"trust fund" until funded.
Our acclaimed Fed chairman has inverted
the yield curve, a recessionary action. The Fed is charged with regulating
money supply and providing a monetary climate in the best interests
of the economy. His remarks most attended to are those regarding his
concerns about the (disintermediary) stock market, something over
which he has neither rightful control nor authority. He has raised
interest rates 6 times, further strengthening an already strong dollar.
Oil prices have tripled. Oil prices
and interest rates move in the same direction.
The Financial Accounting Standards
Board (FASB) will complete in the first quarter of 2001 its elimination
of "pooling of interests" accounting in business mergers and acquisitions.
There is legislation pending in congress against this FASB amendment.
The composition and the work of the FASB is essentially political.
Eliminating pooling of interests will have a dampening effect on m&a
activity and force significant changes in EPS reporting.
Unless you subscribed to international
news services, as we do, or watched the BBC on PBS, you would not
have been aware in early September that over 80% of gas stations in
France had no gasoline, a result of public insurrection over
gasoline taxation that has since spread across Europe. I shudder to
imagine such a situation in the USA. Astonishing that this was not
even reported by our media for weeks.
The European Union is experiencing
problems with its newly-minted currency, the Euro, which has not held
its value as well as had been hoped. Whoops! Wonderful time to shop
in Europe if one could find the time. The Euro will prevail, at some
Party lines and ideologies are immaterial.
The power elite is never voided. As much as nature abhors a vacuum,
part of human nature is relentlessly dominant and political. Technology
and the world economy are changing faster than governments’
ability to regulate. The political aristocracy is struggling to keep
up. Information and travel without leaving a desktop have empowered
millions as never before. At the same time the internet has become
the greatest spying mechanism a government could ever dream of. It’s
no wonder that security and privacy mechanisms are not yet mandated
despite the plethora of devices available.
Political power is like hydraulic
pressure, neither good nor evil, just there, to be used for either.
While we were optimistic at the beginning
of the year we have been saying right along that the probability for
such a long string of 20% index gains continuing was low. We stated
in our March 3rd commentary that the NASDAQ was at an unrealistic
valuation and that old economy stocks had more potential to outperform
new economy stocks in the near term. The NASDAQ is down 32% and the
S&P 500 is down 7.5% from their respective highs.
Realistically, the "exuberance" would
have to be "irrational" to sustain the all-time highs in the indexes
at the end of March. Six Fed hikes, an inverted yield curve, and $35
oil has to take its toll. My hopes for $25 oil by year-end are dashed
going into heating oil season with very little new production as yet.
Perhaps by spring we will see some price relief and a Fed rate cut
Our attention is directed to companies
that are assimilating new technologies rather than producing technology.
New technologies and variations continue to proliferate and the impact
on earnings has forced a cold reassessment of many of our best performing
equities. Two examples: Cisco Systems, which we liquidated by half
in March and completely by mid-June; and EMC, the same procedure.
Both are examples of excessive valuations
and unrealistic earnings expectations, as well as an inflection point
in the quality of earnings. They also presented opportunities for
unexpectedly large capital gains with little likelihood of continued
growth in value. Further, both these companies that we sold were no
longer the companies we had bought. Both are besieged by other technologies
in an industry nobody can predict accurately. Both are morphing into
software companies. And both are excellent, well-managed companies
that we may choose to own again.
New equity portfolios that we are
building are 35% in cash, have a P/E of 23, and a dividend yield of
1.7% compared to the S&P 500 which is 27.25 and 1.1% respectively.
The P/E of the S&P 500 has dropped from 36 two years ago to 26
two weeks ago. The P/E is creeping back up as weaker earnings are
reported. It will stabilize as prices fall.
We bid a fond farewell to the great
J.P. Morgan & Co. which is being acquired by Chase Manhattan for
stock. We do not choose to own Chase and have taken the proceeds from
JPM and deployed them in Morgan Stanley Dean Witter (MWD), one of
the last great, as yet unacquired, jewels in the investment banking,
financial services industry. Phil Purcell, the chairman of MWD, is
a genius and has built a powerhouse of a money machine. The company
has an eight- year history of dividend increases. Earnings and income
exhibit high quality growth and despite the recent earnings warning
we believe the company is priced at a reasonable discount.