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March 27, 2000

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Subject:  Re: Good ole days
Author:  wolfeman

The "million-dollar question" for me is - will the baby boomers (individual investors) continue to pour $$$ into tech stocks (keep on investing?) or will the money managers decide the game is over? (get out quick!)? Let's discuss.

Jon:

OK. I'll give it a try. I have some notions that everybody can find something with which to disagree. I don't accept the concept of a "New Paradigm", but there are new factors in the mix that we have not seen before. Every time one finds a pattern in the market, it changes. Its mission is to confound us. No rule is inviolate. What works at one time will not work at another. That's why we cannot take the Wise seriously. No rule stands the test to time.

I was on the JNJ board and they frequently refer to the upcoming "Tech Wreck". As I'm a relatively newbie investor (3 years stocks - 15 years mutual funds) and have not really lived through a "whatever-it-has-been-in-the-past Wreck".

Of course the J&J board is awaiting the "Tech Wreck". They are in a sector that is not performing at present. Much of that can be discounted, though they will have their day in the sun. Now, if you listen to CNBC, we have a tech wreck every other month. It lasts about a week. I suspect the J&J folks are talking about the death of tech and the revitalization of drugs over the long term. Techs have always outperformed everything else, though their swings may be intense. Even those considered "cyclical". New products are always where stock prices grow fastest.

If you stay in the market there will come a day when you have your value cut in half and this would not be a serious setback or a "crash". It will be a normal fluctuation in market sentiment unrelated to background economics. NTAP deserves to be cut in half and probably will be. Many of us will still have beaten historical returns after this happens. This should be considered a non-event, depending on how long it takes to recover. In the '70s I had $8,000 dollars in the market for eight years and it remained unmoved for that period. I gave up and bought a Corvette with it. That investment did almost as well. I paid $5,700 for it new and sold it ten years and 150,000 miles later for $5,000. That doesn't sound like today, does it? This "new market" started in '85 and now constitutes the longest bull run in history.

Two things are key to maintaining hypervalue; interest rates and new cash infusion into the market. (Robust economic conditions also count, but they are manifest in the two previous metrics). We have resisted a serious fall due to new cash coming into the market. The interest rate hikes we have seen should have reduced the PE of expensive growth stocks, but we have had enough new dollars invested to keep it from happening. It will though. I watch the entry of new money to try and guess when the fall will come. It usually happens in late summer.

In reality this Fed policy has punished the value stocks and the traditional smokestack industries. They are the first to suffer from such hikes. New IT companies can get their money elsewhere. They can issue secondary offerings, trade their over inflated stock for real assets, or seek venture capitol. Consider the new AOL acquisition. They have essentially traded concept for real assets. A very smart long-term move if they can figure out what to do with a bunch of guys that wear ties to work.

The old rule, "Three rate hikes: sell. Three rate cuts: buy." Seems not to apply anymore, yet the concept is still valid. Stock prices are directly tied to interest rates. Greenspan is trying to find the level that will take the "exuberance" out while avoiding an economic disaster. It's a dangerous but necessary game. He is fighting a vicious cycle. The wealth effect caused by stock growth fuels spending that must lead to inflation. Inflation will knock the wind out of stock prices. So we have the enigma of growing stock value threatening the value of stocks. He will plod ahead in quarter point increments until the market is halted. He hopes a crash can be avoided (but he wouldn't mind one) and just usher in a period of rational advances, but it is not in the nature of equities to act in a stable manner. The best possible result will be that growth will be slowed until the high flyers grow into their prices. You may have noted that stocks with PEs from 500 to 1000 have been trending sideways (QCOM, JDSU, QLGC, etc). NTAP is there also. They won't be able to go much higher by themselves. The only way they will run again is if the market in general moves higher or they significantly outperform their historical returns, which is close to physically impossible. Doubling capacity is about as fast as an entity can grow, and this becomes more and more difficult as the size that must be multiplied increases.

In the late summer of '98 we were headed into a bottomless pit. On Oct. eighth Alan Greenspan came to the rescue with a rate cut. The market immediately reversed with a strong "V" bottom. He followed up with two more cuts and the market soared. It hasn't stopped since. I think it would behoove the Greenspan bashers to remember he was there for us when the times were bad. I think his hope was to take back those three cuts and return the market to sanity. It has not worked. Many are clamoring to cut margin rates or move in � point increments. Luckily Greenspan is opposed to these more sudden jolts. He wants investors to know where we are going. At some point this policy will work. The trouble is nobody knows where that level is, including Greenspan. We will not have another '29 type crash. Then the margin needed was only 10%. That is a far cry from the current 50%. Unprecedented growth in worker productivity is also having a big influence on the market. Since we have never seen such productivity growth, we don't know how to factor in its effect. You are correct that much of this growth in productivity is due to information technology. These will give us some insulation. I don't expect we shall see brokers jumping out of the Wall Street windows next time the market plunges.

However, the crash of '87 can be easily replicated. Portfolios were cut from 50 to 90 percent, depending on how conservative the investors were. Value investors suffered less, but if you held high flyers you would have had to have been ahead by 1000% to stay in positive territory. It took about three years to recover to the baseline. In my mind this is no disaster. It did not interrupt the bull run. It just meant the investor had to sit through three years to get his money back. This happened during prosperous times. I don't expect we can do worse than that today. We will call this the worst case scenario and I don't expect we shall see anything this serious.

One side of me says that I ought to "cash in" and wait for the end of the irrational exuberance (I'm about 95% invested in a seven-figure portfolio) and buy in after we hit bottom and start the rise again.

One never knows when the run will end. We can count on significant "dips" and "corrections" every year, but is that enough? Perhaps the decision is best done stock by stock. Ideally, a PE should be equal to the growth rate. In today's communication build out it is probably safe to consider double that number a safe and reasonable price. This puts NTAP at a fair value in the 200 PE range. Once the PE is four times the growth rate, it probably makes sense to take some profits and find another up-and-coming issue. I've not done so because I just can't find a better company unless it carries a comparable value to NTAP. The trouble is, this market could still run for several more years. If the end were predictable it would be very simple to do the optimal thing.

During this bull market a case can be made that the best way to invest has been to buy the highest valued stocks that can be found. That way you can be assured you have bought something everybody wants. This runs counter to traditional investing philosophy. Warren Buffet would think this is crazy, but perhaps it is not. I'm a coin collector. Let me give an example from this world. It has always been the case that the most rare and highly priced coins have been the ones that have gone up the most. The more common coins have grown little in value. The same holds true in the art world. One can buy a very pretty and reasonably priced painting and expect it to go up little in value. It is the well known works by the grand masters that continue to astonish as the price continues to climb. I believe NTAP to be such a stock. It has already grown in value beyond all expectations, yet there is nothing to keep it from growing even more valuable as long as it is not discovered to be a fraud (i.e. the growth begins to decrease).

Once you have what you consider enough money to live out your life in modest comfort, it is reasonable to move some of that into less lucrative, but assured gains like bonds or real estate. You will never find a rich person that has all their money in the stock market. A million dollars will give you $80 to $100,000 a year in interest and the principal remains intact. There is no risk other than lost opportunity. At some point capitol preservation becomes paramount. If the market goes south a lot of equity money will run to these areas and inflate that figure greatly. Interest rates will go up. Remember also that the prices of bonds change. They are traded regularly. Bond investors are not counting on the interest rate alone for their profits. If you buy them when the are not popular, their value can double (not counting the interest rate) when conditions change. They can be charted and traded just as one generally does with stocks. Buy low and sell high. I once bough bonds paying 13% and sold them a year later for much more than I paid since the interest rate fell making 13% zero coupon bonds much more valuable. The 13% was just gravy.

Most investors I know have a personal goal that, when reached, plan to move their money into safer investments. The trouble with this is we don't know if the market can soar long enough to get there, or, perhaps when that number is reached greed will take over and they will hang on for "just one more double". The ideal solution seems to me to be after you have several hundred percent returns on an issue, remove the original investment and invest it in bonds or money market funds. The difference will hardly be noticed.

Even during these heady times in the stock market I have most of my money invested in apartment buildings. I also have other "silly stuff" like gold and silver (much in the form of rare coins and bullion). I often think, "What if I had put all this money into stocks?" I really would have done much better. It turns out that my diversification has been a mistake, but I never could have predicted this outstanding market. Still, I have enough in stocks alone to live out my live in comfort if I withdrew today. At the same time I could lose it all and the lifestyle of myself and family would not be seriously undermined (I would have a good cry, but it would not be really important). I think this is the correct proportion to invest in equities despite my mistake of investing too little too late.

When IT either slows or stabilizes due to stratospheric PEs or revaluation, it will be time to invest in lower priced "baby boom" stocks like Winnabago, drugs, or cruise lines. Whatever baby boomers need. In fact it is the boomers that need the build-out of IT. If you follow the needs of this lump of people, you can't go far wrong for the long haul.

Here on TMF they advocate LTB&H. One thing you can be sure of is that if you hold a company forever, you will lose your money. Most companies cease to exist. I doesn't matter if the investment goes to millions if it is ultimately headed to zero. In the end they are all making buggy whips. Many companies remain productive for generations, most don't. The best an investor could have done at the turn of the century would have been to buy oil, autos and railroads. In fact, that's about all that would still be in business today. Still, much of this should have been sold to buy other things. The world changes and so should your portfolio.

There is one more thing to consider. Even in the worst of times there are some few stocks that will give excellent returns, they are just fewer and harder to find. There are also times when we should not be in stocks at all. The trouble is that it is nearly impossible to predict ahead of time when that will be. As HighReturn would say, "Money is not properly invested until it is well spent and enjoyed".

wolfeman

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