Endless Summer

What can you do? Over the summer I have subjected you to a series of letters reflecting on our inability to predict the future.

We read a quote from Nobel-prize winning economist, Friedrich Hayek, explaining how progress was not steady, not linear…and not even the result of a specific design. Instead, it proceeds by trial and error and consists chiefly in discovering what doesn’t work.

We heard from philosophers – such as Kierkegaard, who believed that progress was the result of unforeseeable jerks that pointed people in an unexpected direction.

We saw how WWI was triggered by an accident (Archduke Ferdinand’s driver took a wrong turn)…how an error by a German general (von Kluck) cost the Germans a quick, decisive victory…and how poor judgment (at least that is how it looks 86 years later) by Britain and America jerked the world into a long, dark night…a dead-end of war, Marxism, Nazism, holocaust and assorted miseries… that lasted for 7 decades!

We’ve seen how technology accumulates – little by little, discarding failures, pushing aside even the breakthroughs…to make room for new breakthroughs.

And we’ve noted how the human limbic system reacts emotionally, and episodically, to whatever external stimulus it confronts. Humans get charged up for war – full of ‘war fever’, which excites them to acts of bellicosity and self-sacrifice. And then, they are demoralized and depressed – so fed up that they turn away, not just from the war itself, but from the whole culture that created the war – its art, literature, architecture and codes of conduct. That is the history of the 20th century.

We’ve also looked at the way fads, fashions, and popular sensations develop. Harry Potter, Pokemon, running shoes, bare-headedness, and Big Tech stocks – all share many of the same symptoms…like infectious viruses, they grow quietly and pass, almost undetected, from person to person – sometimes for many years. Then, suddenly, they flare up…and everyone has to have one.

It is a world of sin and sorrow…of jerks, surprises, illusions…with a future that is always unknowable and a present that is almost impossible to understand. Even our own powers of logic and reason often lead us astray – rationalizing, persuasively, what we want to believe rather than what we should believe.

What can you do in such a world?

Since I am in a philosophic mood, I offer a philosophic tip: push ahead. In business, in romance, in passions and pastimes – simply go forward, do your best. Recognize that you will probably not end up where you expected to go…but who knows? Maybe you will end up somewhere better.

But while you are pushing, try to remember the first rule of all human interaction: reciprocity. Push others as you would like to be pushed.

I mention this merely to introduce my investment theme. There are rules to investing, too. Basic, simple – though, often hard to follow – rules.

Recognizing the boom and bust character of the human personality, you can expect investment prices to follow a similar pattern. Occasionally, you will also see certain investments become popular sensations.

You can make money buying investments before they become popular sensations, but it is very difficult to make money after they have run up. And it is almost impossible to tell what will become the next sensation.

Also, try to invest in the things you understand. Otherwise, you will find it hard to know when things are solid investments – and when they are merely the products of hype and wishful thinking.

And since you can’t predict the future, all you can do is to buy investments that are priced at levels where they are not likely to go much lower…and which you wouldn’t mind owning even if they didn’t go much higher.

This is a very modest goal. But it comes with the hidden wish that a very cheap stock will not be very cheap forever. Every dog has his day, as they say. You just want to be sure that you do not buy it on that day…but before.

I’ll give you an example from a recent issue of Grants.“Finmeccanica,” says Jim Grant, “is Italy’s high-tech crown jewel.” It has interests in energy, transportation, and many of the old- economy sectors. Among other things, it makes weapons – competitively. I cannot un-fog the future any better than Harry Potter’s Professor Trelawny but I do not think weapons are going completely out of style.

Compared to other weapons’ producers, Finmeccanica is preposterously cheap. Lockheed Martin and Northrup Grumman, for example, sell for a bit less than one times sales. The Italian arms maker, by contrast, sells for only 0.05% of sales.

But what makes Finmeccanica especially interesting is its 22.4% interest in another company – a maker of electronic chips, in fact, Europe’s largest chipmaker. That 22.4% interest has a current market value of approximately $13 billion. But all of Finmeccanica – including aerospace, energy, weapons, transportation and information tech operations – has a market value of, well, a bit less than $13 billion. These other operations are not marginal. They are spectacular – bringing in more than $5 billion of revenue and $312 million in operating income last year even without the chipmaker.

So, in other words, this is a chance to buy a $5 billion company…and a profitable one…for, uhhh, less than zero.

There is no guarantee, of course, that its price won’t descend even further below zero in the months ahead. But Finmeccanica is no popular sensation. It is, in fact, an anti-popular sensation. Investors are embarrassed to admit they own it. Without being able to predict the future, we can nevertheless anticipate better times for this Italian company sometime before the earth cools.

Lynn Carpenter of The Fleet Street Letter, offers someother examples:

“Centex (CTX:nyse) A company with a five-year average earnings growth of 27% ought to be worth a P/E of 30. If it were a dot.com, it would go for a P/E of 200 or more. So why is Centex, the largest homebuilder in the United States, trading for a P/E of 7? Because the market just gets stupid every now and then. It’s going for 90 cents on the dollar when you look at its assets (P/B 0.9). Each share costs just one-third the annual sales per share. So, is it a dying company? Not with income growth of 23% this year (and a 10-year rate of 28% per year) and sales growth of 21.6%.”

And another Italian company:

“Industrie Natuzzi S.P.A. (NTZ:nyse) an Italian company that sells on the New York Stock Exchange as an ADR. This will give you some nice global diversification without wrestling with foreign brokers of currency exchanges. Natuzzi has come a long way from one carpenter looking for extra income. It is now an ultramodern, successful and self-reliant business. It pours its own foam, builds its own frames and tans over 90% of its own leather. The company employs 20,000 workers and makes 400 models of chairs, recliners, sofas, sofabeds and sectionals. Of these, over 200 are patented designs or patent pending.

“And by the way, you can get this great company now at a P/E of 7 and collect a nice 7.7% yield as well.”

Unless we are enjoying an endless summer…where good times remain forever…a modest investment approach might be to sell the Big Techs…and buy these underdogs.

Your correspondent… still trying to figure things out…

Bill Bonner

Ouzilly, France September 8, 2000

*** Yet another increase in oil yesterday. Up to $35.39. High oil prices are beginning to cause some slips and spills on Wall Street and elsewhere.

*** Dupont announced yesterday that its earnings would be hurt. Higher oil would cost the company about $1 billion, it said. Dupont shares lost 11% and dragged the Dow down 50 points.

*** William Fleckenstein, at SiliconInvestor.com, recalls that this is the not the first time Dupont has slipped up on oil: “Dupont bought Conoco at the top of the oil cycle in 1980 when oil was about the price it is today-on its way to $8. The company sold Conoco a couple of years ago when oil’s price was on its lows. So, here’s a company that has managed to shoot itself in the foot at two different inflection points and now is being squeezed by the very costs it sought to avoid when it bought Conoco in the first place.”

*** Other forms of energy are rising too. “The Internet Begins With Coal,” says a research study on electricity by physicist Mark Mills of the Greening Earth Society.

*** Dan Ferris reports: “Mills’ thesis is simple, having been previously stated right in the title of a report called ‘Coal: Cornerstone of America’s Competitive Advantage in World Markets.’ Mills shows once again in ‘The Internet Begins With Coal’ that U.S. GDP and electricity demand have tracked one another perfectly for over 20 years now. No coal, no electricity. No electricity, no economic growth. We are very much a coal- based economy.”

*** “Mills saw years ago,” Dan continues, “what the rest of us are only now beginning to understand: that our ongoing economic growth is tied directly to electricity usage, and that nearly 60% of our electricity comes from coal. Since GDP has been skyrocketing since 1995, so has electricity demand. Where electricity goes, coal will follow. The whole thing could lead you to riches, if you stick with it.” Dan’s stock recommendation – Consol – is up 17% since he picked it in June.

*** European companies, meanwhile, are getting caught between rising oil and a falling euro. Oil rises in dollar terms – while the companies earn revenues in euros.

*** The euro bounced a tiny bit yesterday. It is still at record lows against the dollar. But it got some relief against the yen after Moody’s downgraded Japanese debt.

*** Japan runs the largest public deficits in the industrialized world – in an attempt to raise the animal spirits of the Japanese economy. Currently, public debt is at 130% of GDP.

*** In the U.S., meanwhile, public debt as a percent of GDP is falling. But private debt is rising. Last year, reports Dr. Kurt Richebacher, “the American credit machine produced $2.2 trillion in new credit.” Savings rates fell to their lowest point ever – 0.3% in February.

*** Yesterday was a bad day for the Old Economy, but a good day for the new one. Intel gained $1.40. Cisco was up a couple bucks. Sun Micro rose more than $6. These Big Techs are the popular sensation of the year 2000. They – like Pokemon and Harry Potter – are the result of what Robert Prechter calls a “mental contagion.” Prechter believes that fads and major market moves can be explained by “unconscious herding behavior” in which such mental contagions propagate, brain to brain, like infectious viruses.

*** Once something ‘catches on’ in the stock market, investors rush to it. This has the effect of increasing the price, which confirms the delusions of the trend- setters and attracts still more investors.

*** And more “…bad news for the West,” writes Gary North. “In the last 30 days, Col. Hugo Chavez – president and of Venezuela and disciple of Castro – made a personal tour of the Middle East, meeting with the heads of state in Saudi Arabia, Kuwait, Iran, and Iraq. Saddam Hussein personally drove him around Baghdad in his limo. After returning to Iran, he flew to Indonesia. What he got was assurance from the leaders that they will personally show up at the OPEC meeting this month [in Venezuela]. If they do, it will be a major show of force.” And could present a major problem for US oil supplies.

*** The summer vacation is over. But so far, there is little sign of Mr. Bear. Confidence is high – perhaps the highest levels ever. More stocks are advancing than falling back – 1506 to the upside yesterday, as opposed to 1302 moving downwards. There were 138 stocks hitting new highs; only 38 hit new lows.

*** More ordinary Americans are getting into stocks – via mutual funds. The number of households with mutual funds increased 4.5% so far this year. “US investors’ love affair with mutual funds is unlikely to end any time soon,” opines Reuters. But how do they know?

*** Only Internet stocks seemed to buck the trend on the Nasdaq yesterday. Internet retailers are out-of-style. They are yesterday’s fad, not today’s. Yahoo lost ground – so did Amazon and many others.

*** Reading the newspapers is depressing. There are occasional moments of unintentional hilarity…such as the report from Mattoon, IL, that a retired electrician named Clyde had conned more than 10,000 people all over the globe out of about $12 million by offering them a 50- to-1 return from a mutual fund investment. Investors were instructed to send cash – wrapped in tin foil!

*** But overall, the news is so boring that I have to remember to keep breathing as I read it. Especially, the campaign coverage – which is so banal, moronic and hollow that it is challenge to read it without nodding off.

*** Washington Post editor, David Ignatius, asks us “Whom Would You Trust Most” in a financial crisis. The English language has a lot of adjectives, Ignatius can find only one that seems to describe the Clinton team’s slick handling of the LTCM blow-up and Asian currency crisis: ‘prudent.’ So apparently apt is this word that he uses it more than once in a short piece, pushing aside the other modifiers that come to my mind – such as asinine, numbskull, dangerous, foolish, self-serving, cynical, short-sighted and lame-brained.

*** Was it really a “prudent rescue” as Ignatius says? Or just more air in a dangerously-inflated bubble? We will see. But, alas, perhaps not before the November elections.