Portfolio manager’s Letter July 2000
It would be hard to identify the dumbest thing that I have heard on CNBC in the last year, but certainly one statement that comes close to the top of the list, is opinion that Tech stocks are immune to raising interest rates. This had to have been dreamed up by someone who was not alive in 1973, 1974. Yes, it is true that these companies do not depend on borrowed capital to the same extent that old economy companies do, but in a recession earnings go down and what happens to a momentum stock when their earnings growth turns negative. That’s right, their heads get cut off at the waist.
Today the market has many problems; Stock options are considered a free lunch, yet cheat shareholders out of hundreds of billions of dollars. Companies massage their earnings with accounting games. Many TV commentators think corporate earnings always increase. Enormous amounts of money are concentrated under the management of people whose primary concern is career risk. These managers expose their customers to enormous risk to further their career, they play a game they know to be insane, because they have discovered that money votes with its feet.
An article in the Wall Street Journal Monday quotes a poll of 55 economists. The consensus is that Alan Greenspan will engineer another soft landing. “I’m betting on the FED,” said economist Nicholas Perna. “Alan Greenspan is the master of the soft landing,” I hate to disagree with 55 economists, but my guess is that at this point a soft landing is neither possible nor desirable.
My preference as far as a recession is concerned, would be the sooner the better. No, I do not enjoy the pain and suffering any more than anyone else, It just seems to me that the economy would be a lot stronger in the long run if we can knock some of the Hubris out of the tech sector. Too many investors believe things that are not true. Buy and hold is the best investment philosophy, but there very few companies that qualify for this kind program and none of them are tech stocks.
It is my opinion that it is collective, chronic, Hubris that is at the bottom of all real market disasters, 1929 and 1974 in this country, and 1989 in Japan. The bottom line is, the sooner we have an economic correction, the less the long-term damage.
Economic reversals may be painful, but they are a sure cure for hubris. You can not deal with your problems if you do not know what they are, or as Warren Buffett says “you don’t know who is swimming naked till the tide goes out”.
We do not know where our the economic problems are, nor will we understand their magnitude, until there is economic correction. It is important to the economic health of the county that we identify and deal with these problems. The longer the good times roll the taller the hubris grows. More and more mistakes get built into the economy. Managers assume that demand for their product (service) will expand indefinitely into future at the same rate that it is growing now. We need find out how much of that demand is real vs. how much is just extrapolation of fantasy.
One of two things can happen from this point forward:
- FED action to date will trigger a slow down in the economy, and result a broad and deep correction in the new economy stocks as their earnings start weaken. Last month there was a strong recovery in the new economy stocks, and profit taking in old economy value stocks. As the market acknowledged only the good news (Interest rates have topped), but refused to see the bad (profit declines).
- The economy stays strong, and the market does not correct. In that event the Fed will be forced to resume its tightening in August, and further after the election.
Neither of these scenarios is good for the Market, but the first certainly less bad. The pain and suffering will be over sooner, and the overall damage will be less.
For the investor it is important to hold some cash, so you can benefit from lower prices, but it is even more important to hold stocks that will recover and eventually make new highs. Many high PE new economy stocks have already discounted the best possible eventual out come, an outcome that will come to pass for one, two; or maybe three of the several hundred grossly overvalued stocks. Holding on to any these stocks in this market is about the same as playing the lottery except you have a lot more to lose and not as much to gain.
The good news is that many real buy hold stocks are cheap now and getting cheaper every day.
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