Arithmetic Of Desire
“Desire and necessity” said my friend Michel at lunch yesterday, “have no clear boundaries. People only really need a few calories per day…and a little heat when it is cold. Everything beyond that is want, not need.”
Needs follow wants, like my daughter following me into a department store. I wanted to take her shopping, but soon discovered that she needed a new jacket for summer, and a dress for the wedding, and a pair of shoes to go with the dress, and a purse to go with the shoes…and of course, a new hat to go with the shoes.
A man wants to buy a bigger house in a better neighborhood. Then, his wife informs him that they need new furniture, and a new washing machine, and someone to tend the garden.
Wants end up being more expensive than you expect. The needs trailing behind them expand proportionately.
This is why (I will come to the point right away) desire needs to be controlled. That is what interest rates, ticking meters, investment strategies and marriages do for you.
“Without discipline,” wrote Mark Hulbert in his AAII Journal article, “we are all too likely to dump a strategy at the wrong time – and then compound the problem by jumping on the bandwagon of a winning strategy just at the time it is about to lose its “hot hand.”‘
So it was the Stanley Druckenmiller, George Soros’ partner decided that he had to abandon the value-oriented strategy that had served the team so well for so long. In the 1999s, value investing looked like a loser. Value investors were dinosaurs, hopelessly retrograde in their thinking, and as out of style as a Nehru jacket.
I have already recounted Mr. Druckenmiller’s cautionary tale. Mr. Druckenmiller did not like being out of style. He wanted to be ahead of the curve, not behind it. Then, following the TNT (techs, nets, and telecoms) bandwagon, he walked right over the edge of a cliff in April.
One of the most popular bandwagons of stock market history is the remarkable case of the Cisco Kids. This too, is a story already told in these letters.
“The Industrial Age is over. The Computer Age is over. The Internet Revolution is five years old in the U.S. and just beginning in Europe, Asia, China and Japan (wherever they are, ed.),” thus writes another veteran of the newsletter investment advisory business, Donald Rowe.
Rowe, editor of the Wall Street Digest and a man who once liked gold but now likes capital letters, believes that “the Wireless Revolution is just beginning in the U.S., but will spread rapidly to the rest of the world. Selling Cisco to purchase GM is backward thinking. Cisco is the bluest of the blue chip Internet stocks, a company you should own and hold for at least five years or more. I see Cisco’s revenues increasing 30% a year for the next five years because of the worldwide wireless/telecommunications boom.”
The 30% per year figure is the result of analysts’ guesswork. But even if it were right, what would be a reasonable price for the company? You don’t even need a calculator to figure it out. A municipal bond will bring you, say, 6% per year. You would expect to do at least as well with Cisco, wouldn’t you?
Currently, even if all Cisco’s earnings were paid out, you’d get less than 1% per year. But hey, it’s growing fast. By the fifth year, says Stephen Koffler of First Union Securities, Cisco’s revenues will be triple what they are today. So, in year 5 – assuming earnings kept pace — you’d get, well, less than 3%.
The meter is ticking. It makes no sense to own the stock – unless you could buy it at 80% discount. Every year you hold it, you lose money – unless there is some bigger fool willing to pay an even daffier price for it.
But the argument against Cisco is not merely a matter of arithmetic. It’s a matter of desire.
People will pay a lot of money for something they really want. And what they really seem to want right now is to feel that they are a part of this great new world…and that they won’t Miss Out or be Left Behind in the march into the Next Millenium.
Owning Cisco stock satisfies the desire, even if it is very unlikely that it will make an investor any money.
But there’s an arithmetic of desire too. People will pay a premium for something they really want to own. A classic Corvette…a fine bottle of Taitinger champagne…a Rolex watch…a Harley-Davidson motorcycle. If you can control the brand, you can enjoy a generous profit margin for many years. Cisco has no way of controlling the “hot stock” brand.
Who wants a Cisco? What is a Cisco anyway? I don’t think I’ve actually ever seen one. And who could pick one out of a pile of trash – even if their life depended on it?
I don’t know about you, but I’ve never seen anyone with “Cisco” tattooed on his arm. Nor has anyone ever taken me into his garage to show me the new Cisco he just bought. No one is proud to own a Cisco product – just the stock.
That’s because Cisco products, whatever they are, are not “want” products…they’re “need” products. They’re commodities: the useful, anonymous nuts and bolts of the digital age. But I don’t recall anyone making a fortune producing nuts and bolts in the industrial age?
Cisco has competition. And the very attractiveness of Cisco and its stock price will draw other competitors. And some of them will do whatever Cisco does, but better, faster, and cheaper. People will substitute other devices for those of Cisco. Price competition will be devastating. Whatever margin Cisco enjoys today will become smaller. People will not need Cisco’s products.
Finally, owning Cisco stock will no longer be cool either. It will be the mark, not of someone who is on the cutting edge of the New Economy, but someone who is being cut down by it – someone who is unaware that Cisco’s time has come and gone…someone who sticks to old ideas long after they have been discredited…someone who has no vision…and no money.
For the moment, Cisco is a hot stock that investors want to own. But like so many passing desires, buying Cisco at today’s price may prove harmful in the long run.
Your very disciplined correspondent, sticking with the program, day in and day out, no matter what…
Paris, France June 15, 2000
*** What, do they make up these numbers? I’m referring to the CPI, which came out yesterday. The market expected an increase in the core rate of inflation of 0.2% — and that’s what it got. But how?
*** “The BLS (Bureau of Labor Statistics) must have conducted the CPI survey in La La Land,” said an item on Bloomberg. “Fraudulent” is how Bill King describes the numbers.
*** BLS had natural gas rising 0.7% in May, and gasoline prices supposedly fell 3.5%. If they fell, only the BLS noticed. The Dept. of Energy said gasoline rose more than 10% in the same period. Gasoline prices are now at record levels. And natural gas futures rose 40% while the BLS has the gas itself up less than 1%.
*** Investors didn’t seem to know or care. Stocks rose and fell, higgely-piggely, with no destination in mind. The Dow ended the day up 66. The Nasdaq ended down 53.
*** But gold seemed to know where it was going. The yellow metal rose a stunning $6.10. August contracts closed above $290…which, if I recall correctly from yesterday, Harry Schultz said would be confirmation of a bull market.
*** And while gold got harder, the dollar got a little softer. Don’t be surprised if you see a lot more of this trend.
*** The dollar, you will remember, depends on the willingness of global investors to keep financing Americans’ spending spree, which has reached epic proportions. “On a net basis,” Alan Abelson reports in Barrons, “Europeans alone have bought over $33 billion worth of U.S. equities” so far this year. They only bought $46 billion in all of ’99.
*** Meanwhile, Americans keep pouring money into mutual funds. On a net basis, $154 billion has gone into the funds so far this year.
*** But even this flood of money cannot seem to raise the general level of stocks. The Dow is lower today than it was a year ago. The smart money is draining out the hose. Insiders are selling out – like Dr. Koop, the former surgeon general, who sold stock in his dot.com start up while it was still worth something.
*** Investors Business Daily’s index of mutual funds shows equity funds producing a return of only 3% this year. That is not going to be enough to feed the meter. Whether people are investing borrowed money, or savings, the market will have to do better than that…or the money will go elsewhere.
*** The meters of DrKoop.com and many of the other Internet companies are almost out of cash already. The companies are consolidating. Petstore.com was bought by Pets.com for $13.7 and Ebay bought Half.com for $374 million in stock. Advice to Half.com shareholders: sell the stock as soon as you can.
*** Defense stocks have been mentioned here – and in the Fleet Street Letter – as a contrarian opportunity. War may be out of style, but styles change. Bell bottoms and mini skirts seem to becoming back; maybe war will come back too. In any event, “after 14 years of defense-procurement budget cuts,” writes George Putnam III in the Turnaround Letter, “the U.S. is in its second year of defense-budget increases.” Putman mentions several of the companies we’ve talked about here: Raytheon, Litton, Northrop Grumman.
*** “[W]e’re in the first phase of a bear market that could be long, tedious, grinding and very painful,” says Richard Russell, interviewed in this week’s Barron’s. “Before it’s over, I believe we’ll see big pools of money moving out of stocks and into cash. I also believe we’ll see absolute slaughter in that dinosaur industry, mutual funds. There are now an absolutely ridiculous number of equity funds. In time they’ll be decimated, with literally hundreds of them closing down as investors bid them good-bye.”
*** But for now…there is a lot of optimism in the marketplace which will take a while to wear out. Al Gore is betting that this good feeling about the economy will last beyond the November election. He’s staking his election on his kinship with the Clinton administration’s economic record. But the Clinton regime can no more claim paternity of the economic performance of the last 8 years than Gore can claim to have fathered the Internet. A blood test would show that the current boom was sired by Reagan’s tax cuts and Volcker’s tight monetary policy, followed by “Easy Al” Greenspan’s loose policies…
Like a wilding in Central Park, Greenspan was assisted by a gang of fortuitous events – the collapse of Communism, the bear market and recession in Japan, the baby boomer’s need to finance their retirements and the rise of the Internet – which held off inflation and focused attention on the excitement of the New Economy. *** “If you are an extreme contrarian who likes astronomical dividend yields on extremely beaten down gold stocks,” Dan Ferris, editor of Real Asset Investor, writes… “here’s a stock that just paid a $1.25 dividend on May 30, 2000. The share price just before then was around $2.68. So you could have had yourself a nice, fat 45% dividend. Every $10,000 invested turned to $14,500 in the blink of an eye…They pay dividends semi-annually, not quarterly. But man, do they pay.”
“Throughout 1998, the stock traded for less than $2. That year, it paid $0.4166 in regular cash dividends — 20%. …And actually, shareholders in 1998 earned a lot more … Total dividend payments to shareholders of record in 1998 were $11.6163 per share. No typo, Bill. $11.6163 PER SHARE, a little under 600%. Ever heard of anything like that in your life?”
I had not. The company: Gold Fields of South Africa.
*** Yesterday, the Manhattan U.S. Attorneys made the biggest securities fraud bust in history… 120 people were hauled in. Members of five NY mob families were among the suspects. “They go where the money is,” said U.S. Attny Mary Jo White. Where is the money? Need you ask? As part of the overall scheme,” says a journalist on the AP wire “the Internet was… used to promote stocks and companies were falsely touted as Internet or ‘dot.com’ companies to induce investors…” who lost an estimated $50 million.