01 Feb 2002 From Gutenberg to Google
As we pointed out last week, the ‘January Effect’ never materialized. Typically, January’s market volume is among the highest of the year as 401-K’s and corporate retirement plans receive their largest contributions. In addition, investors come back to the markets in January to replace stock they sold for tax-losses at the end of the prior year. The scarcity of enthusiastic buyers and a general malaise among investors weighed heavily on last month’s markets. The S&P 500 declined 1.5%, the Dow declined .91%, and the NASDAQ fell by .82%. The S&P 600, the index of small companies managed a gain of just less than 1%. During the five Januarys prior this one, funds flowing into equity mutual funds averaged 8.8 billion dollars in the first two weeks. The first two weeks of this January saw the exit of $4.7 billion from equity mutual funds, according to TrimTabs, a fund tracking service.
It seems that abnormality has become normality during the past year. We have experienced events that seem unprecedented in history, and in some respects, they are. Information and news on any subject is available almost instantly to anyone with the means to access it anywhere in the world. Communications tools and computers have become ubiquitous, making information available instantly. Millions of Americans and others throughout the world viewed, in real-time, the catastrophic and horrible sights that took place on September 11th, while simultaneously hearing the stories of victims and witnesses by means of cellular communications and the Internet. It will undoubtedly be years before psychologists and anthropologists can measure or explain the impact those events had on our national and individual psyche and the behavior that resulted.
In the late 90’s we became mesmerized by the belief that the information economy and the equity markets that fueled it were unstoppable. But in the end, gravity and valuation proved more powerful forces than hype and promise. Investor confidence and stock prices tumbled. The speed at which our economy went from boom to bust caught almost all by surprise, including the Federal Reserve, compelling them to drop interest rates faster in 2001 than they have any time in history. President Bush, who was elected, not by a popular vote, but by the Electoral College, and who was said to have no mandate as a result, now boasts job approval ratings above 80% because of his handling of the war on terror. But with instant information and feedback on the perception of that information, his ratings could fall just as quickly.
The bankruptcy of Enron, the largest in U.S. history, has infected both markets and politics with a cancer of uncertainty and distrust. Political opponents, the General Accounting Office, the media, and citizens are wondering if Enron management’s dealings with White House policymakers influence the administration’s Energy Policy. (At issue is the theme of utility deregulation. In my view the Republican philosophy of deregulation is, not surprisingly in line with that of Enron’s objectives, but there are not enough facts out yet to form a fair opinion one way or the other.) Investors wonder how many companies beyond Enron, Kmart, Anadarko, and Tyco might have misstated their earnings under the not-so-watchful eyes of their not-so-independent accountants and auditors. And finally, equities markets have declined for a second straight year, something that hasn’t happened since the 70’s.
It’s understandable that investors are retreating in fear. There is great uncertainty in the world right now, on many fronts. It seems that major and unprecedented news events drub us daily, with amazing regularity. The mammoth and rapid flow of information, misinformation, and rumors amplify the markets’ volatility. The mountains of cash on the sidelines cause volatility too. Last November, following the good news of potential recovery on the service side of the economy, previously sidelined investors rushed to get into stocks, fearing that they might be left behind. In their panic, investors bid up prices quickly; maybe too high given the increasing likelihood of a slower economic recovery.
Still, in the face of all this ‘newness’ and uncertainty it is comforting to remember that familiar verse in Ecclesiastes: “What has been is what will be, and what has been done is what will be done, there is nothing new under the sun.” Indeed Americans have experienced events of similar or greater magnitude throughout our history. We have had booms of the size and disruptiveness equal to or greater than the Internet boom. Gerry Jackson of The New Australian noted the following last July:
“Investment in the capital structure of about 6.4% a year caused manufacturing productivity per worker to rise by 43% while prices remained relatively stable. By 1929 America was producing virtually as many cars as in 1953, the sale of electrical products tripled, spending on radios rose from about $10.7 million dollars in 1920 to more than $411 million by 1929, a prolonged building boom provided millions of Americans with their first house. That the period was marked by rapidly rising consumption was not disputed.”
He goes on to say that the boom of 1896-1903 was even greater than the 20’s in terms of physical production, if not in financial folly. That boom witnessed the rapid expansion of and over-investment in America’s railroads. Read Gerry’s fascinating article entitled “The US economy: a lesson from the twenties?” in the Articles section of our new website.
Through this country’s history, investors have survived the financial difficulties that follow periods of excessive capital investment and we have weathered the trials of war and social unrest. Since World War II, there have been nine bear markets. Full recovery from market losses followed, on average, 17 months after the market troughs. If we remove the 64-month recovery required following the bear market of the mid 70’s, the average financial bear-market recovery falls to 11 months.
I do not suggest that recovery from these depths will occur so quickly, but it is important to remember that we do have precedents for today’s conditions and they do offer us a guide to what outcomes are likely. The technological forces that propelled the longest expansion in US history throughout the 90’s are largely intact. Yes the computer and the Internet bring new opportunities not witnessed in history, but the locomotive, electricity, the telegraph, radio, the telephone, and television were all just as important forces on the economies of their day. The excitement and disruption they caused were similar in scope to those caused by today’s technology. The critical difference is information, its speed, its availability, and its quantity. In 1815, Count Rothschild was able to learn of Napoleon’s defeat at Waterloo long before anyone else in England knew by his famed use of the carrier pigeon. His advance knowledge allowed him to make critical decisions and investments that made his enormous banking fortune possible.
Today, information on virtually any subject is available instantly. News from any corner of the globe can be witnessed in real-time. Analysis and opinions are available in moments. Remember that the information explosion, particularly in the investment world, is a relatively recent phenomenon. In years past, brokers and bankers carefully guarded investment information. That information could be converted to revenues in the form of stock commissions or investment banking fees. The broker with the best relationship with a company could get the best information and convert it to profit. Just last year, the Securities Exchange Commission required all public companies to make all substantive announcements available to as broad an audience as possible. That represented a marked divergence from tradition, whereby, a select few analysts were chosen to hear the company’s results and forecasts in closed meetings or conference calls. Those with the early information could, like Rothschild, capitalize on it. Information is money.
Now, of course, much more information is available almost universally. Accounting issues aside, much of today’s information is raw. Un-interpreted or analyzed, today’s financial information often has a sensational effect on the markets. In a bear market the strategy is to shoot first and ask questions later. Rumors and misinformation carry more punch in the marketplace, creating more volatility. The analysts filter did have the effect of smoothing the information flow, filtering out the superfluous or sensational and providing an informed opinion (for what it was worth). It will take time for investors learn how to better deal with the immense amount of information that is available. Indeed there is a fast-growing industry devoted to helping companies and investors manage the mountains of data they create and accumulate. Companies like Google, a top Internet search engine, Siebel Systems, developer of customer management software, and Cognos, provider of business intelligence software, are providing tools as vital to the success of business as human and financial capital – information capital.
William Blake said “The road of excess leads to the palace of wisdom.” It is our great hope that we grow wiser with each day’s lesson. The signs are in front of us and they are generally positive. Parts of the economy are getting better. Unemployment, just released, did not go up as badly as was feared and gross domestic product actually managed an increase of .2% in the fourth quarter. The investment excesses are largely gone and the market’s volatility has receded. Since early last year, we’ve tempered our expectations of a quick and vibrant recovery in the broad market averages because valuations remain high in some of the indexes volume leaders. So, if the broad averages are expected to go sideways for a while, what’s the best strategy? We intend to focus on the industries that should do quite well in the expected business climate ahead. We believe that individual stocks can do well in this environment, even if the broad averages grind for a while. We will remain focused on management integrity, stock valuation, cash flow, and financial strength. The industries we like best are those that create productivity enhancing services or tools and those that help their customers manage and store information – the heart of any business. We also look for companies that utilize the tools just mentioned to improve their productivity and to exceed that of their competition. Finally, we like the healthcare industry and think it represents exceptional return possibilities in the years ahead.
The Week’s Economic Data:
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Errata:
Our last Brief contained a misstatement due to the omission of a couple of important words. It should have read “January has accurately predicted the direction of the following year’s markets for 48 of the past 51 years, for a 94% accuracy rate.” Please excuse the error.
