Fool On Today
Monday, April 27, 1998
by Jeff Fischer (

ALEXANDRIA, VA (April 27, 1998) -- The market was sharply lower after a Wall Street Journal article stated that the government's Federal Reserve officials have agreed, in principle, that an increase in the central bank's key lending rates is more likely than a decrease.

It's far from a revelation that an increase in the Fed funds rate is more likely than a decrease, though. Although the Fed has been interest-rate neutral recently, a decrease at this point would almost border on the bizarre. Interest rates are near a ten-year low and the economy is growing at a healthy pace. In fact, due to the strong economy inflation has been a chief concern over the past eighteen months, meaning that the Fed has been much more likely to increase rates in order to stave off the inflation monster than it has been to lower rates and risk bringing the monster to life.

So, it's not surprising that the Fed is inclined to raise rates rather than lower them, but the market's reaction to the news isn't surprising either.

Every time that inflation is mentioned in the same sentence with "rising interest rates," stocks tumble. Then, whenever the fear of inflation lifts, stocks rise. A Fool might ask why, and a simple explanation is in order.

First, stocks compete with interest-bearing investments. If the interest rate on the 30-year bond rises above a certain level, bonds become more attractive to investors than their equity counterparts. Next, stocks become less attractive during periods of rising interest rates because earnings growth is more likely to slow. Companies will borrow and invest less money for growth during these times, and consumers (and employees) also feel squeezed and are less confident to spend.

Imagine a doubled-edged sword that swings from side to side. The sword goes from bad, to bad again, but it should then settle in the middle at "good." Fools should avoid focusing on the "bad" times when the sword is swinging (this is when the stock market is most volatile), and instead focus on the "good" that eventually arises once the sword settles. An explanation of this:

1. Inflation is not good.

2. Rising interest rates are not good.


3. In many situations, you can't kill inflation without first raising interest rates. You need to take at least one "bad" to eventually get to the good. And usually the two bads go hand-in-hand. (The sword does a swing, another swing, and then rests...)

The Fed wants the economy to experience sustainable growth without undue inflation. This is the bliss that we've experienced for most of the decade. We've had a growing economy with low and even declining interest rates, which fuels further growth. But you can't let the growth get out of hand -- you can't let the fire spread too fast or it grows too high and out of control. Throw some water on the fire, experience the short-term darkness, but then expect things to continue to burn again at a sustainable pace. (Raising interest rates to fight inflation can remind a person of the old cliche: Short-term pain for long-term gain.)

As for the current situation:

Reportedly the Fed would consider raising rates because the economy is growing more quickly than expected even with the Asian crises. It was hoped that Asia's trouble would slow economic growth in the U.S., but if Asian woes don't get the job done, the Fed might take action to slow things down itself.

Right now, though, it's probably far too early for the Fed to take any decisive action. It's too soon to realize the impact that Asia might yet hold over the U.S. economy. In fact, as the Lunchtime News shared, certain parts of the market and the economy are actually pointing to lower inflation, not higher. So it's premature for the Fed to cry "Fire!" and come running with buckets, but as long as the fear exists that this will happen eventually, stocks will probably continue to be volatile. Of course, volatility is much easier to sail through if you're a long-term investor.

TODAY. The Fool Port lost 2.1%, slightly more than the S&P's 1.9% loss. The Nasdaq slid considerably more, down 2.6% -- though it's still up 16% for the year.

Today's big news came from (Nasdaq: AMZN), now the 3rd largest bookseller in the U.S., according to the company. Amazon announced first quarter sales of $87 million, a 32% increase over record fourth quarter holiday sales of $66 million. The company's run-rate (most recent quarter times four) calls for revenue of above $340 million this year. Amazon has trailing 12-month sales of $220 million, so the stock trades below 10 times sales.

Cumulative customer accounts grew 50% to 2.26 million, gross margins improved to 21% from 19% last quarter, and finally this was the first quarter in which the company had both an increase in sales and a decrease in the size of its loss. All good. But there's more.

Amazon is acquiring three leading Internet companies, including Bookpages (, one of the leading online book sellers in merry old England, and Telebook (, which is Germany's number-one online bookstore. Amazon is also acquiring the "Internet Movie Database" company (, which offers comprehensive movie and television information. (Once you have the eyes, you can make money simply by providing information, earning advertising revenue, transaction revenue, etc. But Amazon plans to offer a best-of-breed video store as well.)

Amazon is leveraging off its existing customer base, to put it simply, while acquiring even more customers in other countries and markets.

The company shared that these acquisitions will mean more expenses going forward, of course, especially in the beginning. As for the purchase: All three acquisitions will be accounted for with a $55 million charge to Amazon, coming from stock and cash. Amazon anticipates issuing 540,000 shares of stock as a result, diluting the current shares outstanding by 2.3%. We'll happily accept that sort of dilution for these three acquisitions. We love owning this company with all of the various long-term possibilities going forward. Amazon is also ramping up for the launch of its music store.

By the way, the company announced a 2-for-1 stock split, which will happen around June 1.

Friday's Column. Finally, Friday's column generated over two-hundred email responses, most of which I've been able to at least quickly read. I'll be responding over the next few days.

Surprising to me, about 9 out of 10 emails were in agreement with Friday's column, a column that I had expected to produce maybe a 50/50 response. Most of the emails were thoughtful, well considered, and interesting. I hope to share some of them here, including, of course, the "critical" emails.

Mainly, Friday's column was asking questions. Why not give more? And why not now? But most importantly, as one Fool wrote in, "Giving isn't a question of money, it's a state of mind. Once you have the right state of mind, the other follows in whatever form."

Foolishly poetic, and it isn't even the Holiday season.

Fool on.

--Jeff Fischer

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Stock Change Bid ---------------- AMZN -2 3/16 82.69 AOL -1 13/16 72.88 T -1 11/16 60.50 DD -1 11/16 72.81 DJT - 1/8 8.25 XON + 13/16 74.31 INVX - 11/16 25.56 IP -1 3/4 51.31 IOM - 7/16 8.19 KLAC -1 7/16 41.25 LU -1 5/8 71.88 COMS - 1/2 33.50 TDFX + 3/8 26.75 SPY -2 3/32 108.72
Day Month Year History FOOL -2.12% 4.87% 17.72% 295.08% S&P: -1.93% -1.38% 11.96% 137.03% NASDAQ: -2.60% -0.84% 15.92% 152.76% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 72.88 1904.02% 5/17/95 1960 Iomega Cor 1.28 8.19 539.44% 10/1/96 84 LucentTech 23.81 71.88 201.89% 9/9/97 290 38.22 82.69 116.34% 8/12/96 130 AT&T 39.58 60.50 52.86% 2/20/98 215 DuPont 59.83 72.81 21.69% 2/20/98 200 Exxon 64.09 74.31 15.95% 1/8/98 115 S&P Depos. 95.91 108.72 13.36% 2/20/98 270 Int'l Pape 47.69 51.31 7.59% 1/8/98 425 3Dfx 25.67 26.75 4.22% 4/30/97 -1170*Trump* 8.47 8.25 2.58% 8/24/95 130 KLA-Tencor 44.71 41.25 -7.74% 6/26/97 325 Innovex 27.71 25.56 -7.75% 8/13/96 250 3Com Corp. 46.86 33.50 -28.52% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 51741.25 $49159.38 5/17/95 1960 Iomega Cor 2509.60 16047.50 $13537.90 9/9/97 290 11084.24 23979.38 $12895.14 10/1/96 84 LucentTech 1999.88 6037.50 $4037.62 2/20/98 215 DuPont 12864.25 15654.69 $2790.44 8/12/96 130 AT&T 5145.11 7865.00 $2719.89 2/20/98 200 Exxon 12818.00 14862.50 $2044.50 1/8/98 115 S&P Depos. 11029.25 12502.66 $1473.41 2/20/98 270 Int'l Pape 12876.75 13854.38 $977.63 1/8/98 425 3Dfx 10908.63 11368.75 $460.13 4/30/97 -1170*Trump* -9908.50 -9652.50 $256.00 8/24/95 130 KLA-Tencor 5812.49 5362.50 -$449.99 6/26/97 325 Innovex 9005.62 8307.81 -$697.81 8/13/96 250 3Com Corp. 11715.99 8375.00 -$3340.99 CASH $11233.54 TOTAL $197539.95

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