Imperfect Information

“Has the Sage of Omaha lost his marbles?” asks the headline of an article in the “Financial Times.”

Julian Robertson, Stanley Druckenmiller…

He that did ride so high doth lie so low. And now, for probably the first time in his career, Warren Buffett is taking flak.

As long as he was making investors 28% per year, he was revered as an investment god. Or at least a demigod…an important lesser deity, perhaps — one who could turn Coca-Cola’s fizzy water into gold.

But in the last couple of years, the Oracle of Omaha has seemed more human and less godlike. Gods do not regress to the mean.

At last weekend’s Berkshire Hathaway shareholders meeting, which used to be conducted like a Midwestern investors’ Bacchanalia, Buffett was hassled by an ungrateful investor:

“Why don’t you invest 10% in tech stocks so we’ll be able to recover some of Bershire’s losses?” he asked.

“Oh,” replied Warren, “we’ve got an expert here. Why don’t you [to the audience] let him handle your investments?”

“In the course of defending his worst-ever annual returns to investors,” charges Tim Jackson, manager of an Internet venture capital fund and guest editorialist for the “Financial Times,” “Buffett trashed the Internet with all the wit he has become famous for. But he made some more serious observations, too.”

It was the serious observations that made Mr. Jackson question Buffett’s sanity.

“For society, the Internet’s a wonderful thing, but for capitalists, it’s probably a net negative,” Buffett said, adding that “the ability to compare prices on the Internet was driving margins down and diminishing the value of U.S. businesses.”

Mr. Jackson, needless to say, sees it differently. For him, the Internet merely continues “the process of replacing labour with capital that began with the Industrial Revolution in the UK in the 18th century…”

People can now order directly over the Internet, which he says, might be likened [if you had an imagination with the stretch of a bungee cord] “to the spinning machine that Richard Arkwright patented in 1769, which spelt doom to the people who spun thread by hand in their homes.”

The spinning machine spelt doom to the hand-spinners because it allowed people to make more yarn faster and cheaper. The demand for thread was never in doubt. It was merely a matter of efficiency, capital investment and profit margins. How this is analogous to the Internet sector I do not know. You might just as well compare a 3- meter artichoke to a Big Mac.

Peter Huber attacks the issue from a different angle in a recent “Forbes.” He maintains that the enthusiasm for tech stocks is a “rational exuberance,” unlike Japan’s bubble economy of the late `80s.

Japan’s “confidence was misplaced,” he says. “The [corporate] shoguns failed to stay ahead of the rapid evolution of trade and technology in the 1990s.”

Japan’s stock market collapsed. Investors in Japan, Inc. are only half as rich today as they were more than a decade ago.

But this should be of no concern to American investors, Huber argues:

Unlike Japan, “We have millions of new microprocessors, millions of new kilometers of fiber-optic glass and a vast new infrastructure of wireless communications. The U.S. installed based of PCs has doubled since 1995. The Intel microprocessor inside most of the PCs: eightfold (in logic gates) and fivefold to tenfold (in speed) since 1989. Lines of code in Windows NT: up almost fivefold since 1993. Commercial cell sites: up fourfold since 1995. Traffic on the Internet: rising tenfold every year or two.”

Are you impressed? I know I am. Hardly a day goes by that I don’t wish I had more lines of code. Or maybe a few more logic gates to keep the absurdities out.

Jackson explains why all this hard-, soft- and just-right ware is so important:

“When the old companies fail to respond to the Internet, they lose market share; once its adoption becomes universal, the industry as a whole sees lower margins because all customers can easily find the best deal. This is a move towards `perfect information’ — the assumption made by economists in describing the behaviour of businesses and consumers, which used to look absurd.”

Of course, every person capable of walking upright is responding to the Internet. As they do, some investments will prove fruitful and others will not.

Buffett’s point is that the Internet, like the telephone, confers no special advantage that can be predicted and protected. That is, he has no way of knowing which of the players in the Internet world (and they are all players in the Internet world now) will be made more durably profitable as a result.

Like the telephone, the Internet may be a great thing for society. As Huber writes, “the technology, and ever- improving ability to put it to productive use, will continue driving real gains in living standards.”

Maybe, but that doesn’t mean that it is good for capitalists. Since the Internet facilitates competition, Buffett points out, it is likely that profit margins will be squeezed throughout the business world. Investors, generally, are likely to be harmed.

The Internet is merely a communication device. It increases the speed and perhaps the convenience of spreading information about — good information, bad information and information graffiti. It does not improve the quality of information. In fact, the Internet might degrade the quality of information, generally, as it has degraded the quality of investment analysis.

The idea of “perfect information” on the Internet is an absurdity. Even the logic gates of Silicon Valley couldn’t keep it out.

Until tomorrow…

Bill Bonner

Paris, France May 2, 2000

*** “People do not perceive it to be a bear market,” said an analyst at Prime Charter Ltd. No, they sure don’t. The Dow is down 5.96% for the year. The Nasdaq is down 2.73%. Not enough to deter bullish sentiment.

*** Barron’s polled money managers and found them very bullish. Not only with clients’ money — but also with their own; 73% of their personal money is invested in equities.

*** So the money managers made money yesterday — as both the Dow and the Nasdaq rose. Whether they put their faith (and money) in the Old Economy or the New one…the effect was about the same.

*** The Dow rose 77 points. Not enough to make a money manager rich…but at least it was the right direction. The Nasdaq did even better — rising 97 points, or 2.5%.

*** The markets are bouncing around…apparently waiting for something to happen. But there were nearly twice as many rising stocks on the NYSE yesterday as declining ones. And more than twice as many stocks hitting new highs as new lows. Is this significant? I don’t know. The A/D ratio led the market down for two years. Could it be reversing now? We’ll see…

*** Long T-bonds fell $4 per $1,000 of face value yesterday. Yields rose to almost 6%. Even the euro rose – – to 91.54 cents.

*** “Sky-high returns are almost never sustainable,” wrote Mark Hulbert in the “Hulbert Financial Digest” in March. Mark studied the returns of newsletter advisors and mutual funds. He discovered that the “top ranked returns all cluster around the 25% annualized level,” which he regards as a “practical maximum.” Mark further notes that portfolios that exceed 25% per year in any given year tend to regress to the mean quickly. Among the investment advisors whose portfolios he tracks, those that performed the best in one year — with a spectacular gain averaging 141% — usually lost money in the following year.

*** Mark also sheds light on the way the market averages deceive investors into believing that stocks are rising more than they really are. Over the last five years, the Dow has risen at 22% per year, while the Nasdaq has soared at an annual rate of more than 40%. But in both benchmarks, stocks are weighted by capitalization. The bigger the company, the more weight given to the stock price. In a momentum market, this exaggerates the effect of the market leaders — such as MSFT, CSCO and GE. In the Dow, for example, GE is given 8 times as much influence as Philip Morris.

*** A truer gage of the market is provided, Mark believes, by the Value Line Geometric and Arithmetic averages. Combining the two shows a growth rate of 11.3% which, says Mark, “is my best guesstimate of how the average U.S. stock has performed over the last five years.”

*** By the way, the top performer for the last 15 years has been a service called MPT Review (Modern Portfolio Theory…related to the Efficient Market Hypothesis I wrote about last week). It has gained an average of 30% per year since 1984.

*** The Paris stock exchange announced a plan to trade wine futures.

*** William Fleckenstein of SiliconInvestor.com provided a good example of oversized corporate compensation. Jill Barad, former CEO of Mattel, makers of the Barbie doll, left the company with $37 million worth of severance, plus a $700,000 per year pension for as long as she lives. Still not satisfied, Fleckenstein notes that she wanted the art in her office, a car and free medical care.

*** Here’s a disturbing bit of news. Thanks to subsidies from the European Union, farmers in Spain are growing artichokes three meters high. They’re to be used for fuel in a new power plant.

*** The weather was so pretty out in the country. I was not eager to come back into town. And the kids and I were having fun working on the house. We’re trying to get it ready for a group of International Living subscribers coming at the end of June. http://www.agora-inc.com/daily2 Sophia, 17, is becoming a pretty good housepainter.

*** Meanwhile, while I’m on the family news, Jules was joined by an exchange student from Britain. The boy was supposed to stay with a French family, but there weren’t enough boys at Jules’ school, so the poor boy had to stay with us. He must have been relieved, though. He didn’t seem to speak a word of French. “Has the Sage of Omaha lost his marbles?” asks the
headline of an article in the “Financial Times.”

Julian Robertson, Stanley Druckenmiller…

He that did ride so high doth lie so low. And now, for
probably the first time in his career, Warren Buffett is
taking flak.

As long as he was making investors 28% per year, he was
revered as an investment god. Or at least a demigod…an
important lesser deity, perhaps — one who could turn
Coca-Cola’s fizzy water into gold.

But in the last couple of years, the Oracle of Omaha has
seemed more human and less godlike. Gods do not regress
to the mean.

At last weekend’s Berkshire Hathaway shareholders
meeting, which used to be conducted like a Midwestern
investors’ Bacchanalia, Buffett was hassled by an
ungrateful investor:

“Why don’t you invest 10% in tech stocks so we’ll be able
to recover some of Bershire’s losses?” he asked.

“Oh,” replied Warren, “we’ve got an expert here. Why
don’t you [to the audience] let him handle your
investments?”

“In the course of defending his worst-ever annual returns
to investors,” charges Tim Jackson, manager of an
Internet venture capital fund and guest editorialist for
the “Financial Times,” “Buffett trashed the Internet with
all the wit he has become famous for. But he made some
more serious observations, too.”

It was the serious observations that made Mr. Jackson
question Buffett’s sanity.

“For society, the Internet’s a wonderful thing, but for
capitalists, it’s probably a net negative,” Buffett said,
adding that “the ability to compare prices on the
Internet was driving margins down and diminishing the
value of U.S. businesses.”

Mr. Jackson, needless to say, sees it differently. For
him, the Internet merely continues “the process of
replacing labour with capital that began with the
Industrial Revolution in the UK in the 18th century…”

People can now order directly over the Internet, which he
says, might be likened [if you had an imagination with
the stretch of a bungee cord] “to the spinning machine
that Richard Arkwright patented in 1769, which spelt doom
to the people who spun thread by hand in their homes.”

The spinning machine spelt doom to the hand-spinners
because it allowed people to make more yarn faster and
cheaper. The demand for thread was never in doubt. It was
merely a matter of efficiency, capital investment and
profit margins. How this is analogous to the Internet
sector I do not know. You might just as well compare a 3-
meter artichoke to a Big Mac.

Peter Huber attacks the issue from a different angle in a
recent “Forbes.” He maintains that the enthusiasm for
tech stocks is a “rational exuberance,” unlike Japan’s
bubble economy of the late `80s.

Japan’s “confidence was misplaced,” he says. “The
[corporate] shoguns failed to stay ahead of the rapid
evolution of trade and technology in the 1990s.”

Japan’s stock market collapsed. Investors in Japan, Inc.
are only half as rich today as they were more than a
decade ago.

But this should be of no concern to American investors,
Huber argues:

Unlike Japan, “We have millions of new microprocessors,
millions of new kilometers of fiber-optic glass and a
vast new infrastructure of wireless communications. The
U.S. installed based of PCs has doubled since 1995. The
Intel microprocessor inside most of the PCs: eightfold
(in logic gates) and fivefold to tenfold (in speed) since
1989. Lines of code in Windows NT: up almost fivefold
since 1993. Commercial cell sites: up fourfold since
1995. Traffic on the Internet: rising tenfold every year
or two.”

Are you impressed? I know I am. Hardly a day goes by that
I don’t wish I had more lines of code. Or maybe a few
more logic gates to keep the absurdities out.

Jackson explains why all this hard-, soft- and just-right
ware is so important:

“When the old companies fail to respond to the Internet,
they lose market share; once its adoption becomes
universal, the industry as a whole sees lower margins
because all customers can easily find the best deal.
This is a move towards `perfect information’ — the
assumption made by economists in describing the behaviour
of businesses and consumers, which used to look absurd.”

Of course, every person capable of walking upright is
responding to the Internet. As they do, some investments
will prove fruitful and others will not.

Buffett’s point is that the Internet, like the telephone,
confers no special advantage that can be predicted and
protected. That is, he has no way of knowing which of the
players in the Internet world (and they are all players
in the Internet world now) will be made more durably
profitable as a result.

Like the telephone, the Internet may be a great thing for
society. As Huber writes, “the technology, and ever-
improving ability to put it to productive use, will
continue driving real gains in living standards.”

Maybe, but that doesn’t mean that it is good for
capitalists. Since the Internet facilitates competition,
Buffett points out, it is likely that profit margins will
be squeezed throughout the business world. Investors,
generally, are likely to be harmed.

The Internet is merely a communication device. It
increases the speed and perhaps the convenience of
spreading information about — good information, bad
information and information graffiti. It does not improve
the quality of information. In fact, the Internet might
degrade the quality of information, generally, as it has
degraded the quality of investment analysis.

The idea of “perfect information” on the Internet is an
absurdity. Even the logic gates of Silicon Valley
couldn’t keep it out.

Until tomorrow…

Bill Bonner
Paris, France
May 2, 2000

*** “People do not perceive it to be a bear market,” said
an analyst at Prime Charter Ltd. No, they sure don’t.
The Dow is down 5.96% for the year. The Nasdaq is down
2.73%. Not enough to deter bullish sentiment.

*** Barron’s polled money managers and found them very
bullish. Not only with clients’ money — but also with
their own; 73% of their personal money is invested in
equities.

*** So the money managers made money yesterday — as both
the Dow and the Nasdaq rose. Whether they put their faith
(and money) in the Old Economy or the New one…the
effect was about the same.

*** The Dow rose 77 points. Not enough to make a money
manager rich…but at least it was the right direction.
The Nasdaq did even better — rising 97 points, or 2.5%.

*** The markets are bouncing around…apparently waiting
for something to happen. But there were nearly twice as
many rising stocks on the NYSE yesterday as declining
ones. And more than twice as many stocks hitting new
highs as new lows. Is this significant? I don’t know. The
A/D ratio led the market down for two years. Could it be
reversing now? We’ll see…

*** Long T-bonds fell $4 per $1,000 of face value
yesterday. Yields rose to almost 6%. Even the euro rose –
– to 91.54 cents.

*** “Sky-high returns are almost never sustainable,”
wrote Mark Hulbert in the “Hulbert Financial Digest” in
March. Mark studied the returns of newsletter advisors
and mutual funds. He discovered that the “top ranked
returns all cluster around the 25% annualized level,”
which he regards as a “practical maximum.” Mark further
notes that portfolios that exceed 25% per year in any
given year tend to regress to the mean quickly. Among the
investment advisors whose portfolios he tracks, those
that performed the best in one year — with a spectacular
gain averaging 141% — usually lost money in the
following year.

*** Mark also sheds light on the way the market averages
deceive investors into believing that stocks are rising
more than they really are. Over the last five years, the
Dow has risen at 22% per year, while the Nasdaq has
soared at an annual rate of more than 40%. But in both
benchmarks, stocks are weighted by capitalization. The
bigger the company, the more weight given to the stock
price. In a momentum market, this exaggerates the effect
of the market leaders — such as MSFT, CSCO and GE. In
the Dow, for example, GE is given 8 times as much
influence as Philip Morris.

*** A truer gage of the market is provided, Mark
believes, by the Value Line Geometric and Arithmetic
averages. Combining the two shows a growth rate of 11.3%
which, says Mark, “is my best guesstimate of how the
average U.S. stock has performed over the last five
years.”

*** By the way, the top performer for the last 15 years
has been a service called MPT Review (Modern Portfolio
Theory…related to the Efficient Market Hypothesis I
wrote about last week). It has gained an average of 30%
per year since 1984.

*** The Paris stock exchange announced a plan to trade
wine futures.

*** William Fleckenstein of SiliconInvestor.com provided
a good example of oversized corporate compensation. Jill
Barad, former CEO of Mattel, makers of the Barbie doll,
left the company with $37 million worth of severance,
plus a $700,000 per year pension for as long as she
lives. Still not satisfied, Fleckenstein notes that she
wanted the art in her office, a car and free medical
care.

*** Here’s a disturbing bit of news. Thanks to subsidies
from the European Union, farmers in Spain are growing
artichokes three meters high. They’re to be used for fuel
in a new power plant.

*** The weather was so pretty out in the country. I was
not eager to come back into town. And the kids and I were
having fun working on the house. We’re trying to get it
ready for a group of International Living subscribers
coming at the end of June.
http://www.agora-inc.com/daily2 Sophia, 17, is becoming a
pretty good housepainter.

*** Meanwhile, while I’m on the family news, Jules was
joined by an exchange student from Britain. The boy was
supposed to stay with a French family, but there weren’t
enough boys at Jules’ school, so the poor boy had to stay
with us. He must have been relieved, though. He didn’t
seem to speak a word of French.