Taking A Hair Cut

“Bill,” a voice called to me as I was walking up Fifth Avenue yesterday. I was in the middle of a thick crowd and took a minute to connect the voice to a body. But then I saw an old friend.

The young man — who looks like Senator Patrick Moynihan, to whom he is related — now has a bit of gray in his hair. He wrote a book we published — a travel guide to London. But his writing inclinations were more literary than commercial. So he settled into one of those tiny, gritty apartments on the Lower East Side of Manhattan — so small that the bathtub was in the kitchen — determined to become a novelist.

A brief conversation, however, revealed that Michael had changed career paths. He had not, however, entirely abandoned the fiction genre: he had entered the fantasy world of Internet stocks. His company is called AlwaysonTV.com. He explained what they are doing — not much of which I understood.

Marc Faber tells the story of a company called CutCo, which operated hair care salons — 146 of them. The hair care business is not exactly a high growth industry. Sales had been going down and the stock had been delisted from the Nasdaq. But in August of last year, CutCo changed its name and its ways. It decided to give investors a hair cut — rather than paying clients. CutCo sold the hair salons for $3.6 million — and using its capital, and the expertise acquired from caring for people’s locks and coifs — became, are you ready for this, an incubator of high tech companies.

Investors must have thought that a team that couldn’t make a go of it in the hair care business would be a big success in the tech field. They had proven they couldn’t make profits — perhaps that was the key. The stock rose from under $1 to over $14.

All over the world, entrepreneurs have rushed to fill the demand for TNT stocks (techs, Nets and telecoms). In Australia and Vancouver, B.C., mining companies — which never found any appreciable precious metals and never made investors any appreciable money — reinvented themselves as dot-coms. Vengold in Australia, for example, saw its stock price rise 25-fold in the four months following its transformation.

“In Hong Kong,” writes Faber, “property developers have also set up Internet businesses.” Nothing is more tangible than digging in the dirt or building upon it. Nevertheless, investors seemed willing to believe that the skills of miners and developers could be effectively applied to the new high tech business world.

Novelists…geologists…builders — all have laid down the tools of their trades in order to supply the market what it really wants: stocks.

In this way, the market both fulfills investors’ demands — and crushes their expectations. Faber quotes Oskar Lange’s “On the Economic Theory of Socialism:”

“The system of free competition is rather a peculiar one. Its mechanism is one of fooling entrepreneurs. It requires the pursuit of maximum profit in order to function, but it destroys profits when they are pursued by a larger and larger number of people.”

The profits from entering the TNT sector were extraordinary. No wonder so many entrepreneurs sought to join the party. New businesses and new investment in the sector exploded. “Over the last two years,” writes Faber, “approximately $100 billion has been invested in Venture Capital funds in the United States alone. (Up until 1993, there was only one year, 1989, in which VC funds attracted more than $5 billion.)”

But as the number of entries increased, profits were destroyed. Too much competition forced profit levels down. This is the same thing that happens when any new investment boom get under way.

Again, from Faber: “Warren Buffett recently pointed out that between 1900 and 1908, 485 companies entered the auto business. But by the end of 1908, 262 company had to shut down.”

And by the end of the century…all but three of the auto companies were out of business, merged, bought out, or bankrupted. The odds of choosing the winning stock were slim. And even those few companies that did survive did not produce outsized profits for investors.

“In [Buffett’s] opinion, the key to investing was not in assessing how much a new industry was going to affect society,” writes Faber, “nor how much such an industry would grow; rather, successful investing involved `determining the competitive advantage of any given company and, above all, the durability of that advantage.'”

Perhaps needless to say, hair salon operators are not likely to have a durable advantage in the high tech era.

Unfortunately for my friend Michael, AlwaysonTV.com has not yet gone public. And with the shift in attitude towards new Internet companies, becoming a billionaire in an IPO is a little tougher today than it was, say, six months ago. What’s worse, dot-com companies are now expected to produce profits — or the venture capitalists don’t want to bother.

Recent declines in stock prices in the TNT sector have not yet produced panic, but they have caused an increase in the level of anxiety. People are starting to think.

What’s ahead? Stay tuned…

Bill Bonner

Paris, France May 26, 2000

P.S. That’s it for another week. I don’t feel a week wiser, but definitely a week older. And now I have to drive down to the country with a group of five of Maria’s giggling, squealing 14-year-old friends! Ooh la la…

Until Monday…

*** The market opened up — as it usually does (it takes a long time to break down optimism). But the rally lasted less than an hour. After that, “volume just completely stopped and the market swooned,” as one trader put it.

*** By the close of business, the Dow and the Nasdaq were each down 2%. The Dow lost 211 points. The Nasdaq lost 65.

*** MSFT fell four points. And Costco went down eight.

*** The S&P Auto Index is down 8.7% from its peak of May 3, 2000. The Homebuilding Index, meanwhile, is 42% below its peak from July ’98. Autos and building, as Richard Russell keeps pointing out, are the two largest industries in the nation. It’s not a good sign when they are going down.

*** In fact, it’s a sign of an economic slowdown — not merely a stock market pullback. The fantasies of Internet and tech investors can evaporate with no direct harm to the rest of the world. But when the economy goes down — it’s another matter. Paychecks shrink. Spending declines. Businesses and individuals have a hard time making ends meet. When the ends can’t be brought together — they declare bankruptcy. Bills go unpaid. Accounts receivable weaken.

*** Bonds and oil both rose yesterday. Oil is at $30.51 — a record.

*** One industry that is bound to get hit hard by either a bear market or an economic slowdown is the mutual fund industry. A carmaker will keep on making cars — even if its stock declines. But a big decline in stocks will reverse the flow of money to the mutual fund industry. Instead of putting it in, people will take it out. Soon the funds will not be collecting enough in fees to pay their overhead. Many, many mutual funds will go out of business. As Richard Russell puts it — “we’ll see a slaughter in that dinosaur industry.” The average mutual fund went out of business in the bear market of `73-`74 in the United States, and in the bear market in Japan after 1989. Expect the average fund to disappear here, too.

*** Lynn Carpenter reports, “48 of the most productive countries in the world are cities.” Reports Lynn Carpenter. “And U.S. cities at that. Los Angeles alone has a bigger gross product than Argentina or Russia.” Despite obvious weaknesses in the markets, Lynn recommends you think twice before diversifying to smaller global economies.

*** According to the BBC, currently only six out of every thousand business plans get funded, and 40% of those fail within five years. One San Francisco man is trying to cash in. He has launched a business (startupfailures.com) to help online businesses that have failed lose even more money… by starting up again. He claims he is “more than qualified” to run the business because he has founded two companies that flopped and worked for a third that also went belly up.

*** “The days of high-flying stocks are over,” says a Forbes reporter. Of the 375 Net stocks monitored by research firm Digital Video Investments, 22% are below $5 as of May 23, compared to just 2% last January. “During the past few weeks, the slide of Net stocks has been driven less by selling than by lack of buyers. For example, on May 23 the total volume of Net stocks trading below $10 was just 50% of the average volume during the past 30 days.”

*** “Last night I was playing around with a few stock screens,” wrote Dan Denning, of the Fleet Street Letter. “Here’s what I ran: First I looked for the lowest P/E ratio on the Dow, of those companies, I wanted the highest market cap possible. From there, I filtered out for the highest dividend yield and highest net profit margins. Then I searched for net increases in insider and institutional buying. And finally, for the stock price having crossed above its 200-day moving average in the last quarter.

“Guess which stock was at the top of the list? RJR. With earnings of $23.77 per share and a current stock price of $25, it’s trading at just over one times earnings. But get this, it’s got a book value per share of $67! So it’s trading at a third of book value!! The net profit margin is 33% and it’s got a dividend yield of 12.3%.

“…phenomenal that it’s so cheap, considering they also own the largest foodmaker in the U.S. But it’s the smoke that gets in the eyes of most investors…”

*** And in Paris a small businessman, a boulanger perhaps, who had no prior stock market experience, invested 600,000FF in the Bourse, the French stock market. With the aid of remarkable leverage, and a remarkably addled banker, he then proceeded to lose 19 million FF. He is now asking the COB (French SEC) to sue the bank on whose recommendations he placed his bets.

*** In response to yesterday’s musings about my train ride to New York, a reader sent me a song about Baltimore.

*** “Terror is terror,” writes a black man in Zimbabwe, “no matter what color it is.” He points out that the struggle in Zimbabwe is not a matter of black and white. Eighteen people have been killed so far — three were white farmers, the rest were opponents of the Mugabe regime — all black.

*** He also points out that Mr. “Kill All The Whites” Hunzi, also known as “Hitler,” who has been leading the campaign to take the white farmers’ land, has hired a white lawyer to defend him against a corruption charge.

*** Well…after a series of trains, planes and automobiles, I made it back to the office in Paris. I finally figured out how to handle these transatlantic flights. Coming from Europe — work, take a nap, read a book. But coming from the United States to Europe — just sleep. Don’t eat. Don’t drink. Don’t watch the movie — just sleep.