Pi In The Sky

“Hey,” said my assistant Addison yesterday, “that’s just what we do.”

He was referring to the movie “Pi,” wherein the lead character decides that he can best discover the mysteries of the human heart in the movement of stock prices. He believes our amalgamated hopes, ambitions, work, emotions and fantasies can be tracked on a chart of stock price movements.

But the trouble with collective thinking, a point I have been making to the point of tiresomeness, no doubt – is that it creates a phony, shallow, slogan-driven view of the world, which ignores the complexity of real life.

Herd thinking can elect a president. It can launch a war. It can make a movie popular. And it can lead entire generations to abandon two millennia of experience and take the world into a ‘dark night’ that lasts 7 decades.

But it is not a good way to invest.

The tragic hero of “Pi” believes he can find a mathematical constant – like pi, or the Fibonacci sequence, or the golden constant – that will unlock the Deep Truth of the human heart.

But our goal here at the Daily Reckoning is much more modest. Just show us an episode of madness so extreme that even we can’t miss it.

The two biggest sensations in the investment world today are U.S. stocks (especially the Big Techs)… and the U.S. dollar.

The Techs seem to have already peaked out… and are working their way down. The dollar, though, is about 2 cents (against the euro) above where I thought it had peaked out back in March. Unless the ultimate peak happened yesterday – the great reckoning for the greenback still lies ahead.

The madness of dollar strength reveals itself soberly, even tediously, in macro-economic analysis and statistical deconstruction. But the madness of the techs is more entertaining..

Alan Abelson recently cited the case of a tech company called SpeechWorks. It is a tiny company with total sales of only $14 million last year. And yet, thanks to the power of collective thinking its market cap has been amplified to about $2 billion. What makes a small company worth that kind of money?

Well, it’s in the speech recognition business, which as Abelson puts it, “has always been a hot button for the racier element in the Street.”

In order to justify the stock price, the company would have to turn up the volume sales by approximately 14,200%. Maybe it will. But only if and when it does will the stock be worth what it is selling for today. Until then, it needs to be discounted for all the many things that might go wrong – competition, technical failure, management problems, a general breakdown in the stock market, nuclear war, global warming…the list is quite long.

Or, take the example of the 2nd biggest company in the world. In terms of market cap, that title currently falls heavily on the shoulders of the Cisco Kids. The current issue of Grant’s reveals, that when it comes to reporting income and earnings, the Cisco Kids follow the beat of their own drummer. While Cisco says its diluted earnings per share for the last year, ending July 31, 2000, came in at 53 cents, following the more traditional beat of the GAAP rules yields only 36 cents. By Cisco’s count, earnings also grew by 47% in the 12-mo. period, but GAAP gives a more modest figure of only about half that amount – 24%.

Cisco is not some dodgy company in a Brooklyn loft. It has a market cap of nearly half a trillion dollars. Yet it is priced, by investors, as though it were a fast- growing upstart with a patent on sugar. The current p/e, Addison tells me, is 169.

But Cisco is a popular sensation. Apparently, few people actually look at the numbers. If they did, they’d discover what Grants found: ROE has declined from 33% in 1996 to 10% in 2000. Operating margins have been cut in half.

And even if they do look at the numbers…and connect the dots…they still might not be able to believe the evidence of their own senses. They must wait for confirmation from the collective unconscious.

Meanwhile, the Wall Street Journal told the story of a very young man who made a more than a quarter of a million dollars in the stock market. Jonathan Lebed of Cedar Grove, NJ, learned how to pump and dump stocks at the age of 14. Trading through his father’s account, he bought shares in a thinly-traded company…then placed hypey notes on Internet bulletin boards. He sold the shares within 24 hours – to the slouch brains who believed his hype.

Confronted by the SEC, Jonathan copped a plea – saying that he did nothing wrong, but would not do it any more.

Your correspondent…oozing thoughts…

Bill Bonner

Paris, France September 22, 2000

P.S. The search for ‘Pi’ drives the hero of the movie mad.

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*** Poor Ms. Wu. She had already taken a big loss in tech stocks in South Korea and had demanded that the government ‘do something’ about it. But no sooner do things begin to brighten up then – whammo – another torpedo slams into the hull. Stocks in Seoul lost more than 7% in trading early today.

*** It was the same story all over Asia as the Autumn of Anxiety got off to a good start. Tokyo took a 3% hit. Hong Kong got whacked for a 2.46% loss.

*** The trigger for these losses was an announcement last night from the world’s biggest chipmaker – Intel. Apparently, the chips are not selling as well as expected. In trading in the after market, Intel shares fell 12 points.

*** Dell lost $4 in after-trading too. Dell was in the news earlier in the day, announcing that it was on-track for 30% earnings growth. I’ve been hammering the Big Techs for weeks now – since they, like second marriages, represent such an obvious triumph of hope over experience.

*** Almost all the techs are trapped by their own good fortune. Dell, trading at a p/e of 55 – is just too expensive for a company whose sales are rising at 30%. You’d have to sit on the stock for 5 years – with sales rising 30% per year…and the stock price steady – before earnings (to say nothing of actual dividends) would equal what you could get from a T-bond.

*** Even if you were the sort of financial masochist who might enjoy doing that – you’d most likely be disappointed. The bigger these companies get – the harder it is to continue growing. Dell was supposed to grow at 40% this year…which was revised down to 30%. Some analysts think the actual number will come in closer to 25%.

*** The whole tech sector is doomed. The Nasdaq 100, home of the Big Techs, is down 21% from its March 27 record high of 4704.

*** But wait, Abby Joseph Cohen says investors’ fears are “overdone.” Actually, investors are not yet fearful at all. They’re still extremely bullish. Money is still flowing into mutual funds. People are still buying the Big Techs – even at prices that are preposterous. They still think there are New Economy stocks that are “must own” investments. Fear hasn’t even begun.

*** Investors are just getting edgy. The Dow is down 7% for the year. Major stocks such as Intel and Microsoft are off 30% to 50%. People are beginning to wonder what is going on.

*** I’m wondering too – but I suspect that Mr. Bear, who began his work last year when the Dow and Nasdaq both peaked out, and then took a long summer vacation, is back on the job. The U.S. economy carries $12 trillion more in debt than was normal, relative to GDP, for the first 3 decades after WWII. My guess is that some people are getting uncomfortable under that burden.

*** Oil eased off yesterday – falling $1.24. Al Gore accused the big oil companies of price gouging and is proposing to open up the strategic oil reserve to make it easier for democratic voters to drive their SUVs and heat their homes. OPEC says oil production is in excess of demand.

*** And the dollar broke to the downside; the dollar index fell to 115 and the euro rose to more than 86 cents.

*** The Danes are scheduled to vote on joining the euro bloc next week. Chances are, they’ll vote no. If so, we could see another move down in the euro. But the bottom for the euro can’t be much further down.

*** The Dow, meanwhile, rose 77 points, but the gain was not very satisfying. 17 stocks fell for every 11 that went up. Almost 3 times as many hit new lows as hit new highs.

*** “The trade deficit is now running around $30 billion a month,” writes Ray Devoe, “compared with $36 billion for the entire year of 1992.” When will this affect the dollar? And what would the Federal Reserve do? Raise interest rates to protect the dollar? And… if the dollar weakened would foreign money stop flowing into American securities? Or, conceivably, start returning

home?” *** Yesterday, the Fed Beige Book was released. Bill King: “It contained a most dire warning – wage increases and higher material costs are widespread (inflation), and the high labor costs are a problem. Oil, wage inflation, and the euro spell earnings contraction. Bye-bye stocks.”

*** Also from King, speculating on why the rich got richer and the poor get poorer during the Clinton years: “Dems typically raise taxes to cover social spending, then paper over it with monetary promiscuity. The wealthy capitalize on the easy money via asset leveraging, whether its real estate, stocks, or whatever. The middle and lower class don’t have the same access to capital and leverage, so their incomes sag.”

*** What else? Well, in a bit of old news, Alec Baldwin has pledged to leave the country if Bush is elected. So, you see, a Bush victory wouldn’t be all bad.

The Daily Reckoning