Doing nothing is sometimes the best thing to do.
Over the last three years, doing nothing in the investment market was hard to beat. If you had just parked your money in CD’s you would have earned a couple of percent – with no risk. Had you left your money in gold, you would have made a 10% gain since April 30, 1999.
By comparison, the last three years of Nasdaq returns would have reduced $1,000 down to $470.
But doing nothing is often the hardest thing to do. Not merely because it runs counter to the instinct to “do something”…but also because the moment when doing nothing is most appropriate is the very same moment when doing something seems most rewarding.
Recall, briefly, those glory days – that belle undefinedpoque technologique at the end of the last century…that April 30th – exactly 3 years ago.
On that day, you could have bought a share of Worldcom stock for $54. Who could have imagined then that very same share would trade hands 3 years later for $2.35?
The world seemed so full of promise back then. Technology had triumphed over time and space. Democracy had beaten the pants off communism. And central bank management had finally conquered the business cycle. Or so it was widely believed. We lived in a new world, we thought… a world that would get better and better, faster and faster, forever and ever, amen. Who could do nothing in such a world?
“Employment costs stable, economy booms” is the headline story from the Wall Street Journal of April 30, 1999. Initial jobless claims were just 294,000 – 20,000 less than the last week. And consumer prices had risen just 1.5% in the last 12 months. “The benign U.S. inflation scenario,” reported the WSJ article, “…has helped the Federal Reserve resist the temptation to tighten monetary policy despite continued robust economic growth and a low unemployment rate that dipped in March to a 29-year low of 4.2%.”
With such ideal growing conditions, who would not want to put some seeds in the ground? And yet, an ambitious investor – moved by the desire to take advantage of the information revolution – who put $10,000 into Worldcom three years ago, would have just $500 today.
We recite these embarrassing facts, dear reader, not merely to reminisce about the past…but to make a guess about the future. People still believe in technology, but most have come to doubt that progress comes without fits and starts.
And they’ve noticed that the same technology that can be used to research cancer cures can also be used to plan an attack on a tall building. But on the subject of enlightened central banking and democracy, investors have few worries. That they may soon have more is the point of today’s letter.
Michael Saylor was telling the world, in 1999, that “information” was the key to the future. With the Internet and high speed communications, information could flow freely, “like water”, and irrigate even the driest and most barren patches of human life. Within the year, investors would value Saylor’s shtick to the tune of $333 per share of his company, MicroStrategy. Today you can buy the stock for $1.94.
Back then, everything seemed possible – surely now that information was flowing, it would just be a matter of time before researchers figured out how to cure cancer, arthritis, and one of your editor’s favorites – baldness. And who could doubt that with so much information at their fingertips, business executives could now manage their inventories and investments so much better that profits should rise from here to eternity?
And yes, profits did rise in the following year…and then promptly collapsed. Such a sharp decline in profitability had not been seen since the Great Depression. Investors would soon discover that not only had information failed to protect profits but also that the companies that had made the worst mistakes were those that were the most “plugged in” to the information economy – such as Ebbers’ Worldcom and Saylor’s MicroStrategy.
But it was not access to information that hurt the New Economy companies, it was access to something else – credit. Like water, credit flows down to the companies that promise the richest rates of return. A businessman, even one with a website, might have decided to sit out the late ’90s boom.
He might have said “no thank you” to the credit purveyors, done nothing and emerged with his balance sheet, his integrity and his business intact. But the arithmetic of a credit bubble is too persuasive for most people to resist.
You could borrow money at 8%…buy a company for $1 billion…and investors would mark up your company by $10 billion. And think what that would do for your options!
The more the credit flowed, the more indebted companies became – borrowing to buy more and more marginal assets and higher and higher prices. Then, when the market turned against them, they found themselves underwater, with more debt than assets.
And so, the tech sector fell apart and investors lost a lot of money. Now they have their doubts about technology, but they are more impressed by the economy than ever before.
“It survived a stock market slide and an outright crash in the tech and telecom sectors,” says an article in this week’s FORTUNE. “It survived a near-vertical drop in corporate profits. It survived the bankruptcies o Enron, Kmart and Global Crossing. It survived the destruction of the World Trade Center.”
What’s the secret? Enlightened central banking…and “flexibility.” “A greater responsiveness to economic and financial change,” says Henry Kaufman.
“Our economy is incredible,” adds Bruce Steinberg, chief economist at Merrill Lynch. “It shrugs off shocks; it grows and grows. It is the most flexible and dynamic economy in the world.”
“We can’t bank on global dominance forever,” explains FORTUNE. “We can’t assume politicians will always do the right thing. But if the U.S. economy is better than the rest of the world at rolling with the punches, and better at taking advantage of the opportunities that pop up, well, that’s what you’d call a sustainable advantage.”
Or a cyclical peak.
April 30, 2002 — Baltimore, Maryland
Poor Bernie Ebbers! Yes, once again, Bernie has had a really bad day. An analyst noticed that his company, Worldcom, is effectively insolvent: “The value of the enterprise is at or below the book value of its debt,” he wrote.
So Bernie, attacked on all sides, even in his own boardroom, decided to call it quits. The terms of his departure were not disclosed, but with the price of gold up, and Worldcom’s stock down 82% so far this year, Bernie is not likely to get much. Instead of a golden parachute, he might be bailing out with a lead ball of debt tied around his neck; he quit owing the company $366 million.
But that’s the problem with a credit boom – no less for the captains of industry than for the first mates, crew and stowaways. When the end comes, the assets, ambitions, and reputations deflate…but the debt is still there, bigger than ever.
Bernie borrowed heavily to buy telecom stocks – which looked for all the world as though they might be worth something. Consumers borrowed heavily to buy SUVs, home entertainment systems, and God-knows-what-else. None of it is worth very much now. But the credit card bills and the bond coupons still have to be paid. Worldcom, for example, has $3.4 billion in bonds maturing in the next 18 months. For many people, big and small, it’s getting harder and harder to make the payments. More below…
Eric, what else is new on the Street of Dreams?
Eric Fry in New York City…
– The Dow skidded another 91 points yesterday to 9,820, while the Nasdaq slumped 7 points to 1,657. But hold on a minute! Abbey Joseph Cohen is bullish…again, or still, depending upon how charitable one wishes to be.
– Yes, it’s true. No macroeconomic clouds ever manage to cast a shadow on Ms. Cohen’s sunny outlook. Collapsing corporate profits? No problem. Soaring corporate debt? Don’t worry about it. A record current account deficit? Put it out of your mind. In Cohen’s world, “Hakuna Matata” seems to be the operating philosophy. Then again, “no worries” pretty much sums up Cohen’s job description. If Goldman Sachs paid me several million dollars per year to sit in a corner office and think up silly reasons to buy stocks, I could probably do it too…at least for a year or two.
– The omni-bullish strategist reiterated her prediction that the S&P 500 would reach 1,300 by year’s end, a jump of more than 20% from current levels.
– She cites four macro tends that she hopes will drive share prices higher: “(1) indications that economic recovery is sustainable; (2) continued moderate core inflation, giving the Federal Reserve significant flexibility on monetary policy; (3) signs that improved demand is translating into enhanced profit margins; and (4) the end of dramatic accounting adjustments.”
– However, given that none of these hopeful trends is yet in evidence, Cohen might be better off to base her bullish prediction on just one hope: That stock prices go up…for any reason whatsoever.
– On a generally glum day for the market, Corning was one of the few stocks to buck the trend. Shares of the one-time fiber-optic darling gained more than 4% yesterday, thanks to being touted as a value play in the latest edition of Barron’s. Calling the stock a value play might be a bit of a stretch, but it is certainly less of an anti-value play than it used to be.
– In December of 2000, Grant’s Investor (now Apogee Research) produced a very negative examination of Corning. Alan Abelson quoted extensively from that story in the December 22, 2002 issue of Barron’s. Corning shares collapsed shortly thereafter.
– Last Friday, Apogee Research published a follow-up to its original Corning story. The research firm wrote: “Corning Inc. (GLW) is much closer to bottom than when we first wrote about it 16 months ago – 90% closer, to be exact.
– That’s how much the share price has lost in the ensuing collapse of the fiber-optic business. Our initial skepticism drew slings and arrows from GLW fans, but our gloomy predictions proved all too prescient. Now, amid heavy losses and a cash hemorrhage, the storied industrial giant looks like just another New Economy has-been. No one expects Corning to disappear – in fact, it may well thrive…eventually. [But] with so little of the share price left to lose, now is the time to close out short positions.”
– AAA-rated American companies are dropping like fly balls around Mets outfielder Roger Cedeno. Last week Bristol Meyers fell from the ranks of AAA credits.
– “The downgrade of Bristol-Myers Squibb means 50 companies have lost the elite rank since 1979,” the Financial Times reports. “leaving only eight AAA-rated companies left in the US: General Electric, UPS, AIG, ExxonMobil, Johnson & Johnson, Berkshire Hathaway, Pfizer and Merck. In 1990, there were 27 companies that held the top credit rating, while in 1979 there were 58.”
– At the other end of the credit spectrum, defaults are soaring. “In the first quarter of 2002,” Moody’s calculates, “47 issuers defaulted on a total of $34 billion in bonds – the most severe quarter for defaults on record in terms of dollar volume.”
– Reversing this worrisome trend will not be easy. Rebounding profit growth is a necessary prerequisite and that is not happening just yet, no matter how many times Abby Joseph Cohen predicts it.
– In the meantime, maybe Moody’s could cut corporate America a little slack. Maybe the rating agency could “grade on the curve” by awarding a AAA rating to the top 50 companies, no matter what.
– Another way to attack the problem would be to tie executive option awards to a company’s credit rating instead of its share price. What a different world that would create!
– Overnight, pro-forma earnings and stock buy-backs would follow the dodo bird into extinction. At the same time, executives would begin obsessing about mundane items like debt coverage ratios, free cash flow and tangible book value. When that day arrives Abby Joseph Cohen might have a legitimate reason to be bullish.
Back in Baltimore..
*** “Market’s Long Affair with Dollar Hits Rocks,” says a headline from yesterday’s news. The U.S. absorbs 10% of the entire world’s savings – just to finance its current account deficit.
*** But after 3 years with no rise in U.S. stocks – and, recently, better return from foreign markets – the smart money, and the overseas money, is beginning to back away from U.S. dollar assets. Last week, the 10 largest cap stocks on Wall Street hit a new low for the year. These are the big stocks that foreigners typically buy.
*** “Figures deepen doubts about U.S. economic recovery,” says a Financial Times headline. Consumer confidence fell more than expected last month. Credit card late payments rose to a 5-year high. And nominal sales growth is at its lowest level in 40 years. Are American consumers finally getting a little weak in the knees – after carrying the weight of the entire world economy for so many years? Note – savings rose to 2.1% last month.
*** Back in America, the level of casual rudeness in unexpected places is shocking.
*** I asked for a glass of wine in the American Airlines Admiral’s Club lounge at JFK.
*** “What color…” barked the woman behind the counter – with no trace of a smile, or the slightest social grace.
*** “Pardon me,” I asked. I figured she was referring to the color of the wine, but I didn’t know how to answer…I was struck dumb by her coarse manner…
*** “What color?” she repeated the question as if she were interrogating a prisoner of war.
*** “Uh…red,” I took a guess. “But with a deep burgundy hue…”
*** “Look, we got white and we got red, which do you want? Five dollars.”
*** Of course, you run into surly people everywhere. But in France, we’re still like Chevy Chase in “European Vacation” – too dumb to notice and too enchanted to care.