The BMW Method
The Chicken and the Egg

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By BuildMWell
June 8, 2004

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The following was posted concerning Circuit City, but it also refers to Best Buy. I would like to take this one excellent question and try to answer it for the whole country at large. First, here is the question:

"Why did the market cease to grow in 2000? Was it because they had reached saturation along with their rival Best Buy? That is my guess- if that is the case- then they really are relying on improving margins (which is limited, and out of their control with COGS) or will have to kick out dividends to make this a compelling investment in my mind."

I do not think the market quit growing in 2000, I think the money ran out. In March of 2000 the bubble burst because stocks were over-priced and the economy could not hold them up any longer. Internet stocks were hit the hardest because their price was based on future growth that could not be sustained without a booming economy and lots of hype. But, why was the economy booming in the first place? I say it was because of the booming stock markets.

When times are good, unemployment is low, there is lots of money flowing and most stock investments grow nicely as businesses boom. People are happy because the future seems bright, they open up their pocketbooks and spend their discretionary money on all sorts of things that they would not buy if they feared that their job was in jeopardy.

Stock investors buy and sell all the while, but they take some of their windfall profits and also buy lots of discretionary items. When the good times are rolling, everyone is buying all sorts of things including more stocks. Thus, stocks go up even more and even more investors feel more flush with cash. The boom is in place and almost everyone is an investor.

Now, all this time the Fed is telling us that inflation is in check. They have inflation fears, but that nasty old inflation has not reared its ugly head yet. The investors like that and buy more stock.

Of course, the real problem is that the "inflation" is in the markets themselves. That is where the real problem is. So, the Fed Chairman comes out and tries to warn us...he speaks of "Irrational Exuberance". The markets go down for a few weeks and then decide that the Fed Chairman is a nut case. What does irrational exuberance mean anyway? It doesn't mean inflation, does it?

So everyone goes back to playing the game of buying stock and selling to pay for their new discretionary purchases. The companies that make up the markets continue to make great profits and their stocks soar in price. Obviously, Alan Greenspan was a quack. Look at the markets!

It is the Chicken and the Egg thing...all over gain!

Actually, the proof is right there in the government's Income Tax Revenues. If we look at 1998, 1999 and 2000. We see that the government was fast balancing it's budget. Revenues were soaring and expenses were staying relatively flat while still going up. What sucked up the deficit was income tax revenue. But, where did it all come from?

It came from Capital Gains Taxes. When you look at the data, you will find that "Income Taxes" soared during this period. But, Income Taxes include Capital Gains Taxes. There is no break-out of the two for us to see. So, how do I know that Capital Gains Taxes were the reason the deficit shrunk? It is right there in the Federal Government's numbers. It is in the Social Security revenues numbers.

Guess what? The Social Security numbers were flat. The same working class worked the same hours to pay their taxes but one tax went way up while the other actually went down as a percentage of total revenue. How can that be? Hours are hours.

OK, we know what happened in 2000. The bubble burst on the over-priced stocks. But, if I am right, the economy burst with it because the ability to take capital gains popped. The government's bubble burst too. Their windfall capital gains taxes quit in a heartbeat. The instant that most stocks started down, the capital gains taxes slowed and soon stopped as people turned to Capital Losses instead of gains. Thus, we should have seen a huge increase in the deficit. And, we did.

Mt friends, it all fits perfectly. But, you must see the big picture. We have to understand the driving forces and work to make them help us. One driving force was the cut in the Capital Gains Tax rates in the mid 1990s. The rate had been at your income tax rate before that. Suddenly the Cap. Gains rate was 20%. This encouraged people to take their gains and to pay the tax. But, first you have to have a capital gain to be taxed. A low tax rate does you no good if you have nothing to tax. So, people have to buy stocks and the stocks have to go up before there is a gain to tax.

But, if lots of people buy stocks, the stocks go up in price! See why the whole thing works? If the stocks go up, the only way to get the tax break is to sell and take the gain...then you buy more stocks or a new car or a wide screen TV set. That is why Circuit City stock peaked in 2000. At least, that is my opinion.

OK, what has happened since then? We had the recession, we elected a new President and he reduced the Capital Gains rate to 15% PLUS he reduced the tax on dividends to 15%. If a cut to 20% did what it did in 1995 to 2000, what will a cut to 15% do from 2003 to 2008?

I say it will do a lot of positive things. The fact that the stock market is not running up like a rocket ship is that people do not have the money to buy stocks...they lost it in the bubble pop of 2000. They have to work to earn the money to invest. And, to slow things down even more, they are scared of the stock markets because of the bubble. IT will take some time for the whole thing to come back again...but it will. People do not change. Greed will endure and people with their money in bonds at 4% will soon be sorry as they watch other people make more than that in a month with a stock. Of course, by then, the bond holders will be trapped because their bonds will be dropping in price and they will refuse to take a loss and get out. The smart ones will take the loss, write it off against capital gains before paying any tax and then ride the stock market to new highs. You know the markets will make new highs eventually, don't you? The only question is, "When?"

This is not rocket science. This is just the way it is in America. Things go up and things come down. The key is to know when to buy and went to sell. I use the BMW Method to spot those times. And, even in the bad times, individual stocks are going up. Look at CAT and MO from 2000 to 2003. Those two stodgy, old DOW30 stocks went up like a rocket while the DOW went down about 40%. Great stocks at the lowest possible price are always good buys. But, how can we spot them? I think you already know the answer.

Think about what I have laid out for you here. Does it make any sense? If not, please tell me because we are all here to help each other. It makes complete sense to me, but maybe I have missed something important.

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