Year: 2002

I don’t know. But I think so. Or if not an out and out bubble – this is not Japan in 1990, after all – a serious bulge.

But first . . . did you see David Brudnoy’s informative column in Saturday’s Boston Herald on the Pledge of Allegiance? If you don’t know its history, it’s well worth a click.

Also, hats off to President Bush for his forceful comments about Wall Street crime – accounting scandals, insider trading and the like. Never mind that Vice President Cheney seems very possibly to have profited from much the same sort of thing when he was at Halliburton, and that the President’s own insider sale of Harken Oil stock – much larger than Martha Stewart’s sale of ImClone – would seem to be an even more serious matter for review, given that he was on the company’s board of directors and audit committee at the time. (But he was also the President’s son, and the S.E.C. chose not to pursue it.) Click here if you need a refresher.

At the same time as the President was calling for full and fair disclosure to company shareholders, the White House continued to fight the non-partisan General Accounting Office’s request for disclosure of who the White House Energy Task Force met with while formulating national energy policy. After 300 days of White House intransigence, the GAO, for the first time in its history, sued the executive branch for access to requested information. That was more than four months ago, and still no info. Is it possible there is something here the Bush administration doesn’t want the public to know?

But I’m supposed to be writing about the real estate bubble. Why do I keep avoiding that?

Could it be that – like everyone else who owns real estate – I hope to avoid reality? That I hope prices have reached a permanently high plateau? That I, too, hope prices will remain firm here, or rise?

Let me be quick with two major caveats. First, I am no real estate expert. Second, there are all kinds of real estate – raw land, farm land, homes, condos, office towers, warehouses, hotels, retail space, industrial parks and more – in all kinds of places – rural, urban, suburban; North, South, East, West, Mid-West; slum, plum, and in between. For all I know, many of them are dirt-cheap.

But I’ve been watching prices in New York and Miami for a long time, and hearing a thing or two about prices elsewhere, and I worry that in some places, we’re in for rough sledding.

One final push to tackle this subject tomorrow.

The first thing to say is: I don’t know. Obviously. (Friday, I had one of my gloomy market assessments that at least one of you has learned to take as a contrary indicator – whenever I do one of those, the market bounces, at least temporarily.)

No, wait: the first thing to say is: See ‘My Big Fat Greek Wedding.’ It’s a romantic comedy not quite as good as ‘Moonstruck’ – what ever could be? – but in very much that wonderful mold.

And the next thing to say is that I had my second-ever root canal last week. Piece of cake. Didn’t even need even one of the pain pills they gave me for afterward.

This reminded me of the column I wrote almost precisely five years ago on the occasion of my first root canal. I reprint it here because (a) you have teeth, too (well, most of you) and (b) hindsight is fun . . . and it sort of leads back to the point.

June, 11, 1997

Gee, it’s great to be alive. You’re thinking that’s because the market is 7500 on the Dow, give or take, and — like the odometer that finally turns all its little dials to 00000.0 when you go those last 170 yards beyond 99,999.9 . . . delicious . . . the market is going to 0,000 just as the calendar is going to ,000 — it’s all coming together, in other words, neat and well organized, like the strands of a complicated plot.

But no, this is not what has me excited, although it certainly is fun to see one’s net worth inching up almost every day. Likewise, I’m happy to see the crime rate, welfare rolls and unemployment rates coming down, the AIDS virus yielding to science, the days getting longer and longer (if it keeps up this way through Thanksgiving, we’ll have nothing but sunlight), cigarette advertising under attack, decimal stock-market pricing on its way (it will shave transaction costs) — all that.

But the immediate cause of my good cheer is my root canal. I have wonderful news. It turns out — in the hands of a really good endodontist, anyway — root canals are just no big deal. All my life I have dreaded the possibility that one day I might need one. But having managed to avoid it until last week, I lucked out. I skipped the century or so when it was a procedure just this side of agony. Technology saved me, and just in time.

Seriously: this is one fewer thing for you to worry about. If you ever need one, take the time to find someone who specializes in root canals and then figure it will be only a little less convenient and comfortable than going for a haircut.

Tomorrow I’ll get back to money. But aren’t you relieved? Soon, I’ve read, they may be zapping tooth decay without need of drilling. Ah, brave new world. It’s stuff like this that makes you think the market’s not so overpriced after all. (And talk like that that makes you think it is.)

Wait a second. You mean I thought it was overpriced at 7500 five years ago? And Alan Greenspan and Bob Rubin thought it was overpriced at 6500 six months before that?

Didn’t we/they know that the Dow was headed to nearly 12,000? And that the NASDAQ would triple?

Well, no, we did not. Bubbles tend to expand way beyond what any sane observer imagines they could, just as busts, all too often, let out far more air than most sane observers think they should. Historically, the stock market goes to extremes in both directions.

This is possible because people ignore value at both extremes.

I have a friend with almost all his assets tied up in AOL stock who promised me, when I begged him to diversify, that he would sell when it got back up to 50. It was then 44, down from a peak of 81. Yes, even at 44 it was selling at 100 times earnings, but no matter – surely it would go back to 50. At 39, he said, ’45 is the new 50.’ He would sell when it got back to 45. Couldn’t bear to sell at 39. ‘Sell!’ I begged him. ‘Diversify!’ And so it went, all the way down to 14 last week. If this is how you make financial decisions – through a sort of superstitious numerology, as if you were playing craps, rather than an assessment of value – you would be much better off not calling the shots yourself.

(At 14, I think AOL may be fairly priced here. I’m no expert. But I’d be surprised if it’s absurdly undervalued. So its bear market may or may not have ended.)

Joel Williams: ‘I am really disappointed to see stuff on your site about ‘value’ in the stock market. There is no such thing as value. There is only price. If you can show statistically that some of these alleged measures of value can be correlated with changes in price, then there may be some basis for using the term. But any causal effect is rather weak, so far as I can see. Consider Comstock Capital Value Fund (DRCVX), managed by Charles Minter, for example. In 1998, he decided that the market was ‘over-valued’ and began shorting stuff. By traditional measures, he may have been right, but so what? In the third quarter, he actually made some money, but thereafter, for the next 2 years since 10/9/1998, the fund tanked big time, losing about 50%. But he was firm in his belief, and the fund turned around. Since 10/9/2000 the fund the fund is up over 60%, but is still not back to its 10/9/1998 high, even with distributions reinvested. Was he ‘right’ in 1998? Who cares! The purpose of being long or short stuff is to make money, and he has failed miserably. The point is that Mr. Minter just ‘knew’ that the market was over valued, and eventually he was right – just like the stopped clock that is right once or twice a day (depending on whether it tells military time). Sure, he saw the ‘bubble,’ but failed to profit from it. Currently the fund is entirely short – Mr. Minter still thinks that things are ‘over-valued.’ I wonder what will happen next.’

☞ I wonder, too. And I agree with Joel, up to a point. Sure, the ultimate goal is not to be right, it’s to be rich. I’ve lost a lot of money being right, too. (Almost invariably, this happens when I’ve tried shorting overvalued stocks and find that, like Minter, I placed my bet too soon. Yes, many of them eventually collapse; but often it’s just too expensive or heart-stopping to watch them go ever higher before they do.) But sure there’s such a thing as value when it comes to buying a business enterprise (or a small share in one), even if it can be very difficult to assess. And I would argue that stock prices, while they may wildly overshoot ‘true value’ in both directions, tend over time to follow it. Like a drunk trying to walk a straight line. He may veer sharply this way and that – may even fall into the gutter before righting himself – yet in a general way he tends to stick to that line.

What is a company with no debt, no expenses to speak of, no operations, and $100 million worth of cash and real estate worth? I would argue: about $100 million.

If it’s divided into 10 million shares, you might reasonably pay $10 each. You’d feel foolish paying $12 and might get pretty excited at $6. Why? In both cases it’s because of value.

Now take the same company and assume that, independent of the cash and real estate, it also has a business that makes forklifts. That business throws off $20 million a year in profit – $2 a share – and, in your estimation, is no more likely to grow than to shrink, but should be able to keep up with inflation. Now what’s it worth? You have the $10 or so in assets, but also a magic wallet that fills up with $2 each year – real dollars not diminished by inflation.

Would anyone pay $150 for a share in that company? To get a paltry $2 a year in profits? And to own, in addition, $10 a share worth of real estate and cash?

It makes no sense when, with the same $15,000 that you might have paid for 100 shares at $150 a share, you could pre-pay a portion of your 6.5% mortgage. With the stock, you’d have your theoretical $200 share in annual profits (100 shares earning $2 each). With the mortgage pre-payment, you’d be saving $975. So why buy the stock?

But what if the stock were selling for $7 instead of $150? Then, wouldn’t you grab it?

The exact same company, but two very propositions – one terrible, one great – depending on where the stock is.

The problem, of course, is that – even when the accounting is honest – it’s difficult or impossible to know what a company will earn in the future (or even, in most cases, the true value of its assets and the true weight of its liabilities and contingent liabilities). So ascertaining value is not easy. But that doesn’t mean it doesn’t matter.

As Ben Graham wrote (thanks John Hook for reminding me of this), ‘value will out.’ Maybe not today or tomorrow. But, almost invariably, an overvalued stock will eventually fall and an undervalued stock will eventually rise.

The values are a lot better today than they were a couple of years ago. They may get better still.

Tomorrow: Is There a Real Estate Bubble?

John Mahoney: ‘When the media said the party would go on forever, it was time to sell. But this recent headline in USA Today – Stocks Drop, No Bottom in Sight – makes me think it’s about time to get back in.’

☞ It may be. But first you have to be sure stocks have gone well below their intrinsic value before we would be at or near a classic bottom. Are most companies selling for unreasonably low prices relative to their assets and earning potential? Some would question this.

You’ll know it’s the bottom – or at least a good time to buy even if stocks drop further before bouncing back – if you can say with the same sense of wonder that you said it at the top: ‘Can you believe these prices? They bear no relation to value! They are INSANE!’

Or if you can say, as I concluded many of my pieces in the 1974-1982 period . . . ‘If the world doesn’t end – and it usually doesn’t – this has got to be a great time to buy stocks. (And if it does end, what difference does it make?)’

In large part because interest rates were high, many companies were selling at under 10 times earnings. I hope interest rates never go up again, but I’m not sure we can assume that they won’t.

Maybe this bear market will end before prices seem insanely low. I hope so! But usually, bear markets go to extremes of undervaluation just as bull markets go to extremes of overvaluation.

We’re getting there. We may still have a way to go.

If you own country or region mutual funds, click here. The ‘jockey’ is even heavier than we thought. (Thanks to Roy Gilbert for bringing this link to our attention.)

#

So you have the great bulk of your stock-market-money in index funds – the smart way for most people to invest in the stock market – but, in keeping with the notion I’ve suggested from time to time, you have a little of your money in a few speculative stocks . . . for three reasons. First, it keeps your blood going, just as a lottery ticket might. You are not made of stone, after all. You are descended from warriors! You fly through the heavens like Mercury, racing to Zeus with the news! Your middle name is adrenaline! All right, calm down. Second, if one of your little speculations hits big (and you have held it a year and a day), you can sell it for a lightly taxed capital gain, or use it to fund the next few years’ charitable giving. (Set up an account at the Vanguard Charitable Endowment Fund or Fidelity’s or Schwab’s.) Third, if one of the stocks tanks (as at least one surely will), you use the loss to offset up to $3,000 of ordinary income a year.

Speculative stocks are going to rise and fall far more dramatically than index funds. They will give you the sharp gains and losses that can help you minimize taxes. Index funds will give you the good long-term performance that will keep your stock-market performance well ahead of that of most of your friends and neighbors – even as you spend less time and worry doing it.

But which speculations?

Here are three I own, hoping they might be a lot higher in two or three years . . . but recognizing they might well tank: our old friend BOREF, which makes amazing claims on its website, trading back under $4 a share (valuing the whole thing at $20 million); CSPLF, a natural gas producer in Canada, also under $4; BMRN, a pharmaceutical company trading just above $4. All three could be zero three years from now. With luck, one might be higher.

But remember: you have no business being in the market at all if you still have any high-interest debt or lack a substantial rainy day fund. The stock market is only for your long-term money.

And remember: many stocks that seem cheap now, down 90% or more from their highs, will just fade away . . . while others, that may actually be cheap, are likely to fall further anyway, for two reasons. First, the mood has shifted. Where two years ago bad news was ignored and stocks were climbing irrationally higher regardless of value (‘value schmalue’) as everyone wanted to get in on the game, today fear has begun to overtake greed, as people lose stomach for the game and just want to get out, regardless of value. Second, there is likely to be a lot of tax-loss selling as the year wears on, and it will be concentrated most heavily on the stocks that have shown the largest percentage losses.

Until we get to the end of Dick Davis‘s 35 tips, I don’t have to declare an Andy Day – I can declare a Dick Day:

Item 23: Predisposition Toward Failure

Human nature makes us ill-equipped to achieve success in the market. Fear and greed are powerful, deep-seated emotions and work against us. They can be harnessed but only with great discipline. I’m not saying we are predestined to fail. Only that by temperament most of us are predisposed toward making the wrong moves. Contrarians make a living from this human fallibility. Some investors, by a complete lack of discipline, are born losers in the stock market. Every time they buy something, it goes down and every time they sell something, it goes up. If you know someone who is consistently wrong, you can do the exact opposite of what he does and be consistently right.

Item 24: Avoid Big Losses

Taking losses in the stock market isn’t a probability, it’s a certainty; it’s an integral part of the investment process. Yet, there is a strong reluctance on the part of the investor to take a loss. It is much easier to hold on in hopes that a stock will come back than it is to close the door on that possibility and deal with the pain and embarrassment of having made a bad investment. Psychologists dealing with stock market behavior tell us that investors consider the loss of $1 twice as painful as the pleasure received from a $1 gain. However, you can keep losses moderate by using stop loss protection. In fact, you can be wrong more often than right and still come out a winner. (The baseball player who fails to get a hit 7 out of 10 times, in other words a 300 hitter, is considered a star and is paid millions.) What’s not acceptable is taking a big loss. When buying, enter a stop-loss order or make one mentally, giving yourself plenty of room on the downside. If you’re stopped out, at least you won’t be wiped out. Sometimes the stock will go back up, but more times than not, you’ll be right. Right or wrong, the key point is you protected yourself against a risk you could ill afford. It comes down to preservation of capital. A big loss is a crippler. You can’t play the game if you lose your chips. Unless of course, you’re super wealthy. Last year, Paul Allen, who founded Microsoft with Bill Gates, lost $1 1/2 billion in RCN, a telecommunications company. Bear markets make smart money a lot less smart. Of course, Allen’s nest egg includes some $9 billion worth of Microsoft stock.

Andy Long: ‘Would Robert, a ‘CPA who specializes in international tax issues,’ really have us believe that Stanley is moving its headquarters because it likes the weather? Technically, he’s correct, Stanley will still owe taxes on all US operations. As a practical matter, though, I predict that Stanley’s US operations will suddenly become MUCH less profitable while its overseas operations will become MUCH more profitable. This will be done through transfer payments and overhead allocations. There are some [flaws in] corporate taxation; but let’s be honest about what corporations [that pretend to move to Bermuda] are trying to accomplish.’

Toby Gottfried: ‘In your November 16 column a correspondent advocated buying the Smith Barney Aggressive Growth Fund based on its track record, which you pointed out might not continue. Today, in item #2 of this article, I read that the respected manager of this fund made a big play on Tyco (and other poor choices) which sent the fund to ‘an ugly 27.9% year-to-date loss, worse than 96% of its category rivals.”

☞ Well, it’s so much easier to pick a good fund in hindsight than prospectively – unless you choose index funds. Then it’s easy, because index funds are ‘guaranteed’ to outperform 80% or 90% of their peers over the long run (even more if you’re investing in a taxable account). That said, of course, if the market drops by 50%, so in all likelihood will your index fund (by 50.2%, actually, allowing for the expense ratio). But most other mutual funds would drop even more.

PILL SPLITTING

It is crazy that a 25-year-old man of steel like me – this is how I think of myself, even if it’s not how my knees think of me – would be suggesting a tip like this, but you won’t be 25 forever, either (and you may have grandparents), so listen up. Part I: Lipitor really works. For all I know it will kill me some other way (see the archives for October 12 and October 15 for reader warnings), but my cholesterol plummeted so sharply after the first month’s daily minimal 10 milligram dosage – from 253 to 144 – that . . . Part II: I began ‘pill splitting’ even more aggressively. I had begun buying the 40mg Lipitor tablets and cutting them in quarters, because even at Drugstore.com a year’s supply of the 10s would come to $678, versus just $269 buying the 40s and eating them in quarters. But now, armed with the results, I began nibbling the 40s rather than cutting them, hoping to make each last for about 6 days instead of 4. This is good because Lipitor tastes pretty rotten -adding to my sense that I am doing something worthy – and because if Lipitor is bad for me, as some of the MDs in the crowd have suggested (and I am increasingly coming to believe), I am taking even less of it. And because I have now cut my cost even further, to about $180. My latest test score: 145. I’m excited to be rated now in the lowest risk category for heart disease, but even more excited to be saving $500 a year.

THE REAL ESTATE BUBBLE

In many parts of the country (Manhattan, for one, curiously, in the wake of 9/11), we’re in one. More thoughts on this soon.

Less Antman: ‘Juanita Albro summarized my points in a manner that could be misinterpreted, and that is exactly what Bob Kirkland then did. I’d appreciate a clarification, or at least a link to the page Juanita was ‘quoting’ in her message. The whole page was clearly designed for someone with over $1,000,000 in assets, and hardly suggested someone give away virtually everything to heirs during their lifetime. The focus was on using the $11,000 per year annual exclusion, as this excerpt shows: ‘Start giving now – Take advantage of the annual $11,000 exclusion (in 2002) and unlimited exclusion for medical and tuition payments. And make your will out to charity, so your kids have a rooting interest for you to live as long as possible!”

Robert: ‘I’m a CPA who specializes in international tax issues. Companies like Stanley Works will not avoid U.S. income on all their earnings. Just monies earned outside U.S. borders. The reason companies are doing this move to Bermuda is that our tax system makes it very difficult to avoid economic double taxation on foreign earnings. Most of our trading partners have a territorial tax system that exempts income earned overseas. We have a worldwide tax system that taxes all income of a U.S. corporation no matter where it is earned. Stanley Works will still owe U.S. income tax on all of its U.S. earnings. I think you have overstated the amount of tax avoidance from moving to Bermuda. I think the current system of taxation needs to be changed. The corporate income tax is not a huge source of revenue for the Treasury – only about 10% or so. Let’s get rid of it. I believe that most of the corporate tax is passed on to the consumer any way. I think the migration to Bermuda is not such a great thing, but neither is the mess of a corporate tax system that we now have.”

Steve: ‘Brian Annis wrote: ‘Those who support the estate tax are in the moral class of ambulance chasers and grave robbers; or perhaps lower.’ I’m curious – into what moral class would he place those who support tax breaks for the fabulously wealthy while simultaneously claiming we can’t afford to address the educational, health, or housing needs of our less fortunate citizens?’

Debra: ‘One of your readers said US citizens are subject to US Federal tax on income worldwide. Not exactly accurate. I’ve lived abroad for seven years. Individuals are allowed a $76,000 foreign earned income exclusion. We don’t have to pay taxes on the first 76 grand (I only wish I made more). This is for citizens who are bona fide foreign residents. The US is one of the only countries that has this arrangement.’

Michael LeBoeuf: ‘A university creative writing class was asked to write a concise essay containing the following elements: 1. Religion, 2. Royalty, 3. Sex, 4. Mystery. The prize-winning essay read: ‘My God,’ said the Queen, ‘I’m pregnant. I wonder who did it?”

THE LEONA HELMSLEY PHILOSOPHY OF CORPORATE TAXATION

Headline in yesterday’s New York Times: G.O.P. Is Moving to Slow Action on Tax Loophole. The story begins: ‘Republican leaders in Congress are using procedural tactics like walking out of committee hearings to keep Congress from voting on measures to close the so-called Bermuda loophole in the federal tax code, measures that would almost certainly pass overwhelmingly if given the chance. The loophole allows big companies to pretend legally that they are based offshore (Bermuda has been the country of choice) and then filter profits through a third country (most often Barbados), avoiding American income taxes.’

To the Republicans – always sensitive to the plight of the rich – this is just good old fashioned Yankee ingenuity. ‘The Bush administration,’ the Times reports, ‘while saying in a Treasury Department report last month that the Bermuda deals should not be allowed, has called for further study, which may take several years.’

It is a grand time to be rich and powerful in America.

#

LET’S WRITE A NOVEL

Picking up the thread from yesterday, Michael Rutkaus contributes the second and, apparently, concluding chapter of The Longest Book Review Ever Written:

Chapter 2 – APPLY AGAIN IN 500 YEARS

Never seen or heard from again in THAT universe, anyway.

John was an emissary from Zeta Reticuli determining whether we were worthy to join the federation.

Unfortunately for us, this one rude passenger tipped the scales, and as John’s bodily information was reassembled at home he began his report: ‘Given several hundred more years Earth may be ready, however now the general level of human achievement has not reached acceptable status for including them in the Federation. Respectfully yours, John.’

[The End]

FLIPPING PENNIES IN NEVADA

Well, of course not all of Nevada is west of Los Angeles – but Reno and Carson City are. But thanks to the several of you who pointed this out. (And to Steven Rubin for reminding us that it is FARther west, not FURther west – further is reserved for abstract distances, not measurable ones, I believe.)

Also, there seems to be some doubt about that heads-heavy penny. Stephen Gilbert: ‘I saw a report on CNN or someplace like that of a study done by a European physicist (is this vague enough?) which involved spinning a coin which came up tails more than half the time. It was mentioned that this effect is only seen when the coin is spun, not flipped.’

John Seiffer: ‘I don’t know about the heads being heavier but I know that professors in probability class often give a homework assignment to toss a penny 100 times and record the results on a chart. I am shocked, SHOCKED, to learn that students often fill in the chart without actually doing the flipping. However, it turns out this is easy to detect. In an actual flipping of 100 times a run of 4 or 5 heads or 4 or 5 tails is to be expected once or twice. However, such a pattern often looks fake to a student who is actually faking it, so the professor suspects any chart where no such run is in evidence. The point? People often give meaning to patterns (in places like the stock market) where the explanation is actually randomness.’

DICK DAVIS #22

Item 22: The Insignificance Of News

The impact of news on a stock is grossly exaggerated. Much of the news is routine and mostly forgotten over time. The only news that has long term significance is news that represents basic, fundamental change. Such news occurs rarely and when it does, the basic change usually cannot be determined except in retrospect Almost all other news, regardless of its short term impact, is usually no more than a blip in the long term picture. In the majority of cases, after the initial reaction, the stock will resume the course it was on before the news was released. History tell us that if news is in conflict with the market’s, or a stock’s primary trend, it will cause a temporary detour at most. If news conforms with a stock’s primary direction, that news will be used to explain the move, but it would likely have happened anyway, sooner or later. Obviously, news on earnings, the economy, interest rates, inflation, etc. matters. It matters a lot. It shapes the long term direction of stocks and the market. But it is the totality of the news, when one news story, let’s say an earnings report, is confirmed or negated by the next news release and then the one after that, that we begin to get a trend with some possible long term significance. Almost no news story, in and by itself, requires immediate action by the long term investor.