Tight Collars And Tight Margins, Reprise
No time to write a letter today. So, Addison is going to select one of the “Greatest Hits of 1999.” And I’ll be on a boat tomorrow morning. You will hear from me as soon as we get to our digs in Donegal. Friday. Stay tuned.
Until then, your roving correspondent…on the road again…
(“Tight Collars and Tight Margins” first ran exactly one year ago today: July 26th, 1999. In this episode Bill and his family are traveling on The Scotia Prince – a ferry between Portland, Maine and Yarmouth Nova, Scotia. Today… July 26th, 2000, as you’ve just learned, Bill and his family are traveling on a ferry between Cherbourg, France and Waterford, Ireland. The symmetry is stunning. Enjoy, Addison)
TIGHT COLLARS AND TIGHT MARGINS
The Orioles stadium in Baltimore is decorated with baseball photos from a much earlier era. Looking at the photos, you will see that the bleachers are much more modest than Camden Yard today. But the most striking difference is what is in the bleachers – the fans.
The players look pretty much like those of today, but the fans are entirely different. They are all male, which might be expected. But they are wearing coats, ties and hats. Fans today no longer wear ties. Or coats. Or straw hats. They wear shorts and tee shirts. This attire is almost de rigueur among sports fans and vacationers. The passengers aboard the Scotia Prince, the ferry between Portland, Maine, and Nova Scotia wore little else.
Psychological studies show that clothes really do make the man. Or, perhaps they just help the man on the make. Women were asked to select men, from photos, whom they found attractive. They almost invariably chose the guys who were well-dressed… even when the same guys were displayed in more casual attire. I don’t know if a study has confirmed this – but I’ll bet the advantage increases as people age. Real clothes cover paunches, bulges and blemishes. As America gets fatter and grayer, it has more to hide.
So why the unflattering dress codes?
I considered that question as I waited for the Scotia Prince to dock at Yarmouth. The baseball photos were taken, I guessed, in about 1920. This was only a couple of years after the Great War. At the time America entered the war, a French soldier at the front lines had a life expectancy of just 21 days. It was only a couple of years after the Spanish flu epidemic. Thought the statistic seems unreliable today, the virus is believed to have been responsible for the deaths of one out of every ten citizens in cities such as Baltimore and Philadelphia.
The people on deck did not seem prepared for any sort of adversity – except perhaps famine. They were big… and soft. And very gray, too. Perfect targets for a bug…or a bear.
Michael Rothschild’s book, Bionomics, presents an analysis of a beehive as though it were a profit-making business. What you see quickly is that bees operate on a thin margin. If the weather is bad… or another hive moves into the territory… the hive won’t make it. It doesn’t take a lot of adversity, in other words, to turn a profit to a loss… and ultimately to cause bankruptcy. Nature is unforgiving.
Those men who watched the Orioles game in 1920 were much more conscious of nature’s thin margins. This was before the days of penicillin. And novacaine – painless dentistry was still in the future then… as it still is today. Human life was a more marginal proposition than it is today. Investments were more marginal, too. When you put your money into stocks, you took an enormous risk. Periodic panics produced unequivocal bankruptcies. Alan Greenspan wasn’t even born yet. And the first loop of the safety net had not yet been stitched. So people girded themselves up as best they could – morally, financially, and sartorially. They fastened themselves in with strict codes of conduct and stiff collars. They bought life insurance and saved gold coins. Rectitude and prudence were defenses against adversity.
They were up tight.
Here in Nova Scotia, they stacked wood. A few cords of wood are insurance against the long, cold winter. Wood is real money in the bank. It is honey in the hive. It is a margin of safety. Nova Scotia has been in a slump since 1920. Maybe that’s why they still stack wood.
Nature abhors a vacuum. She also abhors high profit margins. Wherever they exist, she brings in a competitor… or a new technology… or some form of adversity. Americans today are enjoying some of the loosest margins in history. They fear almost no enemy…human or bacterial. They see no danger and no purpose to be served by self-restriction. No tight collars, in other words. No tight budgets either. No matter how nice things are today, they believe, they will only get better.
I hope they are right.
But no matter how right they are, they won’t be right enough to save America’s tech stocks and big Dow stocks. They are priced for a world with a very bright future. But it’s a future that cannot exist. The prices on leading stocks imply that they will become very profitable at some point in the future… and then the future will stop dead in its tracks to allow these companies to benefit from their hoped-for margins. How else can you make sense of drkoop.com or dozens of others? (…dozens of others that got crushed this spring…Addison) Their business model calls for them to invest millions in order to buy a chare of a market that does not yet exist. If things go very well… this market will come into being and the former surgeon general will then sell things at a profit. What things?
But they have to sell millions of dollars worth and continue doing so for years in order to justify the stock price. So they better hope that evolution of technology and the marketplace halts right there, and the future ceases… like a photo of dead baseball fans.
Maybe it will. Maybe baseball fans will look the same in ten years from now. Maybe the 0’s will win the pennant every year, too. Maybe nature will give the bees a break. But don’t count on it.
Ouzilly, France…HOME OF MR. DESHAIS’S TOTALLY AWESOME VEGETABLE GARDEN
July 26, 2000
(On July 26, 1999 you would have paid 25 1/2 for drkoop.com… at yesterday’s close it was trading just below $2… Addison. More ‘Greatest Hits’ tomorrow.)
*** Today’s message will be mercifully short. I’ve got to get in the van with the family and drive to Cherbourg and get there in time to catch a ferry to Ireland. It’s vacation season and the roads are clogged with people pulling trailers – often people from Germany or Denmark. So, the drive is expected to take 7 hours. Then, the ferry ride is 17 hours. Why did I decide to do this?
*** Ah…it seemed like a good idea at the time. And now momentum carries us along. We’ve got tickets… reservations… gotta use ’em.
*** Momentum is carrying the stock market along too. Most of the action is meaningless. Up…down…up…down – who cares? The bear is at the beach. And it’s his market.
*** S&P futures rose at the opening yesterday – as they always seem to do…a sign of continued bullishness among the lumpen investoriat.
*** 1448 shares advanced. 1379 declined. 47 hit new highs. 52 hit new lows.
*** The Dow rose 14 points after Harry Potter Greenspan, the Wizard of the Federal Reserve, said nothing. The Nasdaq was even more grateful. It rose 48 points.
*** Consumer Confidence rose in July. And sales of new homes rose too – 2.8%. In this summer of love, both indexes are at their 2nd highest levels ever.
*** “I don’t want to talk about that” said the Fed chairman in his non-talk. Specifically, what he didn’t want to talk about was the controversy surrounding the productivity numbers. You and I, and other Daily Reckoning readers, know they are nonsense. Greenspan probably knows it too. But he doesn’t want to talk about it. How could he? It would mean admitting that all his “new era” talk was rubbish. *** Bill Fleckensteinhad an interesting comment today. Let’s assume that the doom and gloomers are wrong. That is, we’ll assume that there will be no crash nor major recession for another 10 years. Assume also that the P/E of the S&P will be roughly its average since 1926. And that earnings growth of S&P companies will be about average since 1970. And adjust the numbers for the average inflation level since 1960. Guess how much you can expect to make from your S&P stocks over the next decade? Zero.
*** Marc Faber mentions a similar calculation, done by David Krotok, for the Nasdaq. Assume that these companies can gow earnings at a compound rate of 20% per annum – a rate that is so high it has almost never been achieved. And assume that at the end of 10 years the Nasdaq P/E will be twice its earnings growth rate (one times growth is the more normal level). This takes Nasdaq’s current earnings of $25 billion to $155 billion – with a P/E of 40. Even under these fancifully generous conditions, the Nasdaq is still lower than its high for this year.
*** Another calculation by Krotok determined what would have to happen in the Nasdaq in order for it to produce the same return for investors over the next ten years as they could get from treasury bonds. Nasdaq stocks would have to bring in their 20% per year earnings growth each year – and sport a P/E in the year 2010 of 80…1000% higher than the average since 1970.
*** You may take from this that it is possible for the Nasdaq or the S&P to match the returns of treasury bonds – but it will take a miracle.
*** Tom Petrie, by way of Ray Devoe “reckons that a $30 a barrel translates into a $70 billion drag on the U.S. economy and interest rates….would have to rise to 7_-8% to exert a comparable braking impact.” Devoe speculates: “The obvious winners in this scenario are OPEC, of course, Fed Chairman Alan Greenspan and Governor Bush. Congress might possibly be considered to benefit since they did not have to tax $70 billion out of the economy to slow it down. But, since this is an election year for the Presidency, one-third of the Senate and all of the House – a tax of that magnitude would be virtually
impossible to become law.”*** The International Herald Tribune studied the results of mutual funds worldwide for the second quarter. The assessment: “No matter where they were domiciled, the best equity funds tended to target areas that had little or nothing to do with technology…such as real estate, energy and food.” The old economy, in other words, is the one delivering the profits – not the new one.