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Past Commentaries

Current Commentary, Review and Outlook
October 5th, 2000

To My Clients, Friends & Observers:

Mark Twain said, "A man who does not read great books has no advantage over the man who cannot read them." One of the great books is The Power Elite, written by C. Wright Mills in 1956. It should be required reading for every scholar, as much as Macchiavelli's The Prince. Mills was a Columbia University professor, regarded as an iconoclast by his fellow faculty. His book is a compelling argument that America is not as democratic as it seems. It dissects the American social strata and the influence of the military, corporate and political elite. The book is a masterwork of perspicuity and critical thinking, as timely today as 40 years ago.

While I don’t spend much professional time on political and social analysis it is important to be critically aware of current events and the economic changes wrought by military, corporate or political influence. The current desperation of the power elite fairly jumps out of the newspapers and television screens in bas relief to the relatively mundane events that are cautiously reported by the (corporate) media oligopoly. Power is the universal currency, readily convertible to cash. Follow the money to find the pattern. Some recent floats in the passing parade fail to dissipate from memory.

With four months left in his term, our president goes to Lagos, Nigeria to deliver a sermon on aids prevention and fifty million dollars. How much of that fifty million will actually go to aids prevention in a shining democratic light like Nigeria is speculation. It is probably more significant that Nigeria is an OPEC nation, second only to Libya in oil and gas reserves on the African continent. There is a quid pro quo here somewhere.

Our local congressman has a political fund-raising gala in Washington, attended with our president and Massachusetts’ senior senator. The congressman raises $250,000 for his campaign. While providing full and flattering coverage of our popular political celebrity, not one local TV or radio station mentions that he is running unopposed.

Then again, this is Massachusetts, where our sitting governor was elected with over $800,000 of pre-existing, personal credit card debt.

Millionaire candidates that say absolutely anything that anyone wants to hear to garner votes lead us to either of two conclusions: if they actually believe what they’re saying they are dangerous and frightening; if they don’t believe what they’re saying they are unbearable cynics and liars. If this is a pathology, it illustrates the greater appeal of power over money.

Our justice department is demonstrably, politically motivated. Apart from stonewalling against investigations of corruption and security breaches there is no principled rationale for anti-trust enforcement or lack thereof. The media industry has never been more consolidated. So too for the pulp and paper industry. The company that initiated anti-trust action against Microsoft is now part of the AOL/Time Warner empire (Netscape).

Soft money corporate contributions to the political parties have never been higher and there is no end in sight. In Iran they call it baksheesh. Here we call it lobbying.

Taxes as a percentage of GDP have never been higher and this in a protracted period of unprecedented economic growth. And yet the clamor against tax cuts is positively shrill. Every economic transaction has a tax, or 3 or 4, associated with it. Apart from income taxes, an additional 15% of income goes to Social Security/FICA taxes, which is immediately spent from the general fund by a ridiculously inefficient bureaucracy. There is no "trust fund" until funded.

Our acclaimed Fed chairman has inverted the yield curve, a recessionary action. The Fed is charged with regulating money supply and providing a monetary climate in the best interests of the economy. His remarks most attended to are those regarding his concerns about the (disintermediary) stock market, something over which he has neither rightful control nor authority. He has raised interest rates 6 times, further strengthening an already strong dollar.

Oil prices have tripled. Oil prices and interest rates move in the same direction.

The Financial Accounting Standards Board (FASB) will complete in the first quarter of 2001 its elimination of "pooling of interests" accounting in business mergers and acquisitions. There is legislation pending in congress against this FASB amendment. The composition and the work of the FASB is essentially political. Eliminating pooling of interests will have a dampening effect on m&a activity and force significant changes in EPS reporting.

Unless you subscribed to international news services, as we do, or watched the BBC on PBS, you would not have been aware in early September that over 80% of gas stations in France had no gasoline, a result of public insurrection over gasoline taxation that has since spread across Europe. I shudder to imagine such a situation in the USA. Astonishing that this was not even reported by our media for weeks.

The European Union is experiencing problems with its newly-minted currency, the Euro, which has not held its value as well as had been hoped. Whoops! Wonderful time to shop in Europe if one could find the time. The Euro will prevail, at some value.

Party lines and ideologies are immaterial. The power elite is never voided. As much as nature abhors a vacuum, part of human nature is relentlessly dominant and political. Technology and the world economy are changing faster than governments’ ability to regulate. The political aristocracy is struggling to keep up. Information and travel without leaving a desktop have empowered millions as never before. At the same time the internet has become the greatest spying mechanism a government could ever dream of. It’s no wonder that security and privacy mechanisms are not yet mandated despite the plethora of devices available.

Political power is like hydraulic pressure, neither good nor evil, just there, to be used for either.

The Markets

While we were optimistic at the beginning of the year we have been saying right along that the probability for such a long string of 20% index gains continuing was low. We stated in our March 3rd commentary that the NASDAQ was at an unrealistic valuation and that old economy stocks had more potential to outperform new economy stocks in the near term. The NASDAQ is down 32% and the S&P 500 is down 7.5% from their respective highs.

Realistically, the "exuberance" would have to be "irrational" to sustain the all-time highs in the indexes at the end of March. Six Fed hikes, an inverted yield curve, and $35 oil has to take its toll. My hopes for $25 oil by year-end are dashed going into heating oil season with very little new production as yet. Perhaps by spring we will see some price relief and a Fed rate cut or two.

Our attention is directed to companies that are assimilating new technologies rather than producing technology. New technologies and variations continue to proliferate and the impact on earnings has forced a cold reassessment of many of our best performing equities. Two examples: Cisco Systems, which we liquidated by half in March and completely by mid-June; and EMC, the same procedure.

Both are examples of excessive valuations and unrealistic earnings expectations, as well as an inflection point in the quality of earnings. They also presented opportunities for unexpectedly large capital gains with little likelihood of continued growth in value. Further, both these companies that we sold were no longer the companies we had bought. Both are besieged by other technologies in an industry nobody can predict accurately. Both are morphing into software companies. And both are excellent, well-managed companies that we may choose to own again.

New equity portfolios that we are building are 35% in cash, have a P/E of 23, and a dividend yield of 1.7% compared to the S&P 500 which is 27.25 and 1.1% respectively. The P/E of the S&P 500 has dropped from 36 two years ago to 26 two weeks ago. The P/E is creeping back up as weaker earnings are reported. It will stabilize as prices fall.

We bid a fond farewell to the great J.P. Morgan & Co. which is being acquired by Chase Manhattan for stock. We do not choose to own Chase and have taken the proceeds from JPM and deployed them in Morgan Stanley Dean Witter (MWD), one of the last great, as yet unacquired, jewels in the investment banking, financial services industry. Phil Purcell, the chairman of MWD, is a genius and has built a powerhouse of a money machine. The company has an eight- year history of dividend increases. Earnings and income exhibit high quality growth and despite the recent earnings warning we believe the company is priced at a reasonable discount.

Best regards,