Past Commentaries
          
          Current Commentary, 
            Review and Outlook
            March 9th, 2001
          
          To My Clients, Friends & Observers:
          The Future Just 
            Ain’t What It Used To Be
          What is the optimal rate of economic 
            growth? It’s more than a rhetorical question. It’s one 
            that keeps economists employed. In the fourth quarter, the going estimate 
            for year 2001 GDP growth was 2 ½% to 3%, and we stated "upward revisions 
            would be a market catalyst" in our January commentary. Shortly thereafter 
            Mr. Greenspan projected growth of 2% to 2 ½%. Not the catalyst we 
            were hoping for.
          The inflation of the ‘70’s 
            made a deep and lasting impression on American economic thought and 
            politics. We will bear the costs of that decade for generations. Having 
            learned by 1980 how to fight inflation (thank you Messrs. Friedman 
            and Volker) the Fed continues the task today, inflation-fighting being 
            one of Mr. Greenspan’s most noted themes. One of our themes 
            of the last several years has been that inflation is not dead – 
            it’s alive and well in the financial markets. Mr. Greenspan 
            didn’t cut rates the end of February, disappointing many. And 
            while the street waits for the March meeting and hopes for a half-point 
            cut, let me make the case against that scenario, with regrets. 
          First, money supply has boomed, particularly 
            since January. M2 and M3 increased 7% and 9.5% respectively in year 
            2000. For the thirteen weeks ended February 26th M1 increased 1%, 
            M2 increased 8.5%, and M3 increased 10.7%, all at seasonably adjusted 
            annual rates. The Fed is providing some stimulus to a slowing economy 
            with doses of liquidity and cheaper money. However, the slowing economy 
            isn’t going to get inflationary doses of both and Mr. G is not 
            going to roll over because the stock market is working out its own 
            inflation. Look for a quarter point cut at the next Fed meeting.
          Second, oil prices remain over $28 
            a barrel (Nymex spot crude). OPEC announced last week their agenda 
            for the March 16 meeting. Among other items, if oil prices drop below 
            $23 a barrel they will propose cutting production by one million barrels 
            a day. That suggests to me that there is at least a possibility of 
            $23 oil, and a willingness to support it there. I would welcome $23 
            oil and so would the markets.
          Consumer sentiment and, finally, investor 
            psychology, has begun to turn negative if not deflationary. Cash is 
            king. The economy is de-leveraging. Money market assets, which increased 
            over one billion in January, total $2.03 trillion. Eventually 
            some of that is going to find its way back into other investments 
            when discounts improve to the point that a risk premium is 
            restored. That could be a while.
          We are suffering the results of over-capitalization, 
            which brings us back to economics, the dismal science. In a broad 
            generality, technology companies have become vastly overbuilt, over 
            inventoried, over-capacitied, over-acquired-or-acquiring beyond rationalization, 
            and over-confident, all the result of having to utilize all this capital. 
            The growth was capital, not market, driven. We’ve noted in prior 
            commentary that technology takes time to be assimilated and that many 
            technologies, even though they be superior, are never used. The new 
            frontiers in communications, networking, telephony, and optical transmission 
            are still out there. They’ve just been pushed back a couple 
            of years until all the aforementioned overages are corrected. Supply 
            exceeds demand. Net accumulations have turned to net distributions. 
            Prices fall. 
          Just about a year ago I ran into my 
            good friend Steve, who is a talented and very successful stockbroker. 
            At the time I had just finished reviewing a raft of tech companies 
            which had breathtaking run-ups from the first of the year. Mentioned 
            to Steve that if Cisco, which was trading at $75 and a P/E over 200, 
            increased earnings 50% a year for five years, it was trading at a 
            P/E of 34 on earnings expectations five years away. Cisco had not 
            generated a 50% increase in earnings for the last three years. "Denny," 
            Steve said, "You don’t do it that way. You don’t use existing 
            earnings. Analysts use this years expected earnings to get 
            a more realistic P/E." Oh. Don’t use real, use expected 
            to get more real. What an epiphany! That would have put Cisco’s 
            "more realistic" P/E at, oh, maybe 150 to 180, depending on your favorite 
            analyst’s expectations. I cordially thanked my friend for the 
            education and refutation but added that the damage was done as we’d 
            already started liquidating Cisco, among others. I walked away humming 
            an old Led Zeppelin tune: What Is and What Will Never Be. 
          Money to Burn, Part One
          It is well worth considering some 
            current events in the world’s fifth largest economy, California. 
            Two of the state’s largest power companies are facing bankruptcy. 
            To briefly recap: the state government deregulated wholesale power 
            prices while at the same time capping retail prices. If any further 
            explanation of the problem is necessary please find the nearest link 
            out of here or push the back button on your browser.
          If you’re still reading, consider 
            the solution, which isn’t much brighter than the problem. California 
            has long been on the cutting edge of creative financing. When I lived 
            there in the mid- 1970’s I was impressed with the pricey new 
            automobiles my friends drove, easily acquired with a de miminus 
            credit check and a seven year lease. 
          If the November elections didn’t 
            give us enough of a civics lesson about the efficiency of government 
            in carrying out complicated functions like accurately counting votes, 
            California’s creative financing of energy consumption should. 
            
          The Sacramento solons who capped the 
            voters’ utility bills were not generous enough to cap their 
            taxes. So, because California utilities, specifically Edison International 
            and PG&E Corp., have run up $13 billion in debts for higher wholesale 
            power costs, the Department of Water Resources has borrowed $2.3 billion 
            from the general fund since January to buy power for the utilities. 
            Better if they had capped taxes and let consumers buy their own power 
            in a free and open market.
          Worse yet, though probably the only 
            recourse, are the steps being taken to remedy this arithmetic. The 
            state is attempting to secure $10 billion in "revenue" bonds to buy 
            power. They intend to use long-term bond capital to buy current energy. 
            We’re not talking infrastructure capital, we’re talking 
            light bills. Then again, in the "new economy," on the information 
            super-highway, perhaps energy is the highway. The bonds, according 
            to the state treasurer, will be priced to yield 5.45% on a twelve-year 
            maturity. By way of comparison, other twelve year, triple-A rated 
            California revenue paper currently yields about 4.25%. The official 
            statement for the offering should make for good reading. But even 
            without it, I can assure you, it would be far cheaper for the citizens 
            of California to buy their own power rather than pay the taxes to 
            have the government buy it for them. 
          Meanwhile, the rolling blackouts continue 
            and they are taking their toll on California GDP, which will effect 
            U.S. GDP. Elsewhere this winter, the bad weather in the midwest and 
            northeast is also taking a toll on productivity.
          What To Do Now
          Many investors are shell-shocked, 
            static, numbed by the numbers, afraid. Many investors have been wooed 
            by hypothetical illustrations that project long-term returns, straight-line, 
            based on the "historical average" return of the equity indexes. These 
            illustrations do not address the probabilities of actually achieving 
            these projected returns. A Monte Carlo simulation is necessary for 
            that. Many investors are seeing for the first time what one bad year 
            can do to their average returns. Many are wondering how many years 
            might be needed to recover and how many years they can afford to wait. 
            And most people have a downside limit, a minimum portfolio valuation 
            they can live with.
          The prevailing advice for the investing 
            public seems to be "sit tight, stay the course, it’ll come back." 
            And the broader market will come back. What investors should be doing 
            now is positioning themselves for the next move up. There are times 
            to do nothing. Now is not one of them, however late it may be. Every 
            security should be examined. There are still opportunities to raise 
            cash for repositioning. Mutual fund owners should look at the securities 
            in their funds. Many if not most funds are guilty to some degree of 
            "style creep." What was stated in the glossy brochure does not reflect 
            what’s in the fund. In recent months I’ve examined utilities 
            funds (that you’d expect to be rather conservative) that are 
            overweighted in telcom tech stocks. I’ve reviewed funds that 
            are represented as having conservative, long-term, buy-and-hold strategies 
            whose average annual turnover is 30% to 40%. How long-term is that?
          Get cash flow. Investors can take 
            losses and carry them forward as needed against taxes, while earning 
            a positive return from fixed income securities. When the bull market 
            returns, as it will, they can participate again, in fairly priced 
            companies that survived the bear. One does nothing here at the cost 
            of time, opportunity and further risk. And doing nothing now will 
            not change the damage that has already occurred. If not now, when?
          Investors have to refocus on real 
            economic growth and get back to rational expectations for returns 
            better than the inflation rate and get paid an appropriate risk premium. 
            Sooner or later, they always do.
          Finally, Brae Head performance figures 
            are posted to the website. I am pleased to announce that Brae Head, 
            which I started in August 1997, has significantly outperformed the 
            S&P 500 Index for each of the last three years.
          Best regards,
           
          
          