Memorial Day

I recently read a few articles saying that our current "War on Terror /War in Iraq" has lasted longer than our fighting in World War II. For Memorial Day I thought it would be interesting to look at key dates during both events and compare the performances of each market. I only have data in the 1940's for the Dow Jones Industrial Average. {DJIA} I am using the S&P 500 {SPX}for modern data. These are obviously not the same but are comparable because each was seen by the public as the most representative market index at the time. I am also going to use all of World War II's chronology. Our economy was increasingly influenced by the war's events in 19401-41 even though we did enter the fighting until after Pearl Harbor. Therefore World War II percentage returns are from September 1, 1939 which is when Germany invaded Poland. All percentage returns are rounded and dividends are not included.

World War II

Date/---------- Event/------------------------------ DJIA----% Return/------- Comment
09/01/1939--- German Invasion of Poland ---134.40 ------------Mkt. up 15% in next 2 weeks.
06/06/40------ German Invasion of France--- 114.50-- {-15%}--Mkt. drops 25% in 3 weeks.
12/08/41------ Pearl Harbor---------------------- 112.50---{-16% }
05/06/42------ Battle of the Coral Sea--------- - 97.10----{-28%}---Bear Market lows.
06/09/42------ Battle of Midway---------------- 105.10---{-22%}--Nearly 10% Rally from lows.
02/02/43------ Fall of Stalingrad-----------------125.90----{-6%}---30% rally off of May lows.
06/06/44------ Normandy Invasion-------------142.20------- 6%--46% rally off of 1942 lows.
05/08/45------ V-E Day-------------------------- 166.40------ 24% --70% rally off of 1942 lows.
09/02/45------ Formal surrender of Japan----- 173.90------ 30%--80% rally off of 1942 lows.

Note: There is no exact start date for our current fighting. Most use September 11, 2001. Some date the war back to the mid-90's bombings at US military bases in Saudi Arabia. I am using the suicide attack on the USS Cole as the starting point for computing percentage returns of these events. Again all information is rounded and dividends not included.

War on Terror

Date/-------------- Event--------------------------------- SPX------ % Return----- Comment
10/12/2000--- Attack on the USS Cole-----------1,329.78 ---- Al-Qaida sponsored attack.
09/11/01------ New York & Washington DC attacks---- 1,092.54---{-18%}--Prices as of 9/10/01
09/17/01------ Markets Reopen---------------------1,038.77---{-22%}
09/21/01------ Market's low after the attacks------ 965.80---{-27%}
March, 2002--End of major combat in Afghanistan---- 1,165.58---{-12%}-Mkt. rallies 20% off of its lows.
March, 2003- Operations in Iraq------------------- 833.27----{-37%}-Current mkt. cycle low.
04/09/03------ Fall of Baghdad------------------------ 865.99----{-35%}
12/13/03------ Capture of Saddam Hussein---- 1,068.04 ---{-20%}- 28% rally off of 2002 lows.
11/08/04------ 2nd Battle of Fallujah------------- 1,164.89 ---{-13%}-40% rally off of 2002 lows.
01/30/05------ Iraqi Elections---------------------- 1,181.27--- {-11%}

Extra credit: A prize for the 1st e-mail back to lumencapital@hotmail.com who can tell me which state has a holiday celebrating V-J date on the 2nd Monday in August? Hint: All family or employees of Lumen Capital Management are excluded from this contest.

19 Years-"Irrational Exuberance"

But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? (…) ("The Challenge of Central Banking in a Democratic Society” (http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm), December 5, 1996)

The markets shook off the debacle of Long Term Capital Management {LTCM}and continued on its merry way. Stocks rallied from the bottom of that crisis almost 25%. Again most of this gain came in a 30 day trading period beginning in mid October, 1998. The SPX added almost another 20% in 1999. But the overall market labored, trading in a 200 point range for most of the year. In fact by mid October the SPX was only 20 points higher than it had been in January. Most of 1999's gains came in a 20 day trading period from the end of October to mid November. In general individual stocks began to experience higher levels of volatility-higher price swings both intraday and over longer trading periods.

Investors seemed different after LTCM. Share valuation became a major issue. Bearish investors pointed out that stocks were absurdly priced based on most traditional metrics. The cheerleaders believed in a new economic paradigm-that technical advances in productivity and new invention justified current prices. Federal Reserve Chairman Alan Greenspan seemed to be on the side of the bears. He had publicly worried about stock's valuation in a famous speech. His “irrational exuberance” quote was by the end of 1999 very well known. But it had been uttered in December of 1996 and the SPX was 500 points or almost 70% higher in between.

The new issues market churned out deals as fast as companies could put the ink to paper. The quality of most of these companies was less than ideal. Most of the initial public offerings of stock in this era had little in the way of operating earnings or corporate history. Most were just concepts on pieces of paper and in reality nothing more than exit strategies for the owners who had created them. It was as if the corporate finance departments all around Wall Street sensed that a marvelous door was creaking shut and it seemed everybody wanted out before it was locked closed perhaps forever.

Corporate profits were booming and corporate spending on technology had never been higher. This was largely the result of fears of massive computer infrastructure failure on January 1st 2000. This so called “Millennium Bug”-the fear that archaic computer code would crash on this date had been the subject of much speculation in the press for at least two years. The hype plateaued as the world closed in on the century’s turn. But the new year/century/millennium came and went with nary a tweak in global computer networks.

The big bad investing event that most of us worry about usually isn’t the ogre that ultimately attacks us in the dark. Almost unnoticed, buried underneath the headlines, was that customs authorities had uncovered and stopped a car full of explosives at the US-Canadian border. The driver's destination had been the Los Angeles International Airport and his goal had been to disrupt the millennium celebration by blowing up the main terminal at midnight. He was affiliated with a terrorist group named Al-Qaeda.

At any rate the New Year came without incident. The SPX staged a last gasp move and managed to crest the 1,500 level in March 2000. It made one last high when somebody printed 1552.87 on March 24. From its lows in December, 1994 to its high, the SPX was up over 240% {excluding dividends}. Mark Twain supposedly once said "never confuse brains with a bull market. In this kind of advance geniuses were being created daily. March, 2000 saw the largest percentage influx ever of new money into mutual funds passing the previous monthly record set in October of 1987. Most of that money went into technology which was hottest and most visible sector at that time….. To be continued.

Note: The next post on this blog will be after the Memoral Day Holiday. Have a safe weekend.

Noticing Stocks

A Prediction on the Press:

In the next couple of days the popular press will probably take notice that the market has had a pretty decent run over the past 10 days or so. I've already illustrated in other posts that stocks experience sharp upward thrust in price. This upward movement usually comes in trading periods lasting 1-to 40 days. This equates to short trading bursts usually lasting less than 2 months. Often this type of move happens after periods of grinding price decline similar to what we've seen since the beginning of the year. Let's illustrate some quick moves that have recently occured*:

Nasdaq Composite up nearly 5% in the past 6 trading sessions.*
S&P 500 about 3.5% in the past 6 trading sessions.*
Nasdaq 100 Trust {QQQQ} over 10% since April 29 lows.^~
SPDR Technology Sector {XLK} almost 10% since early April lows.^~

Still this move only gets us back to where most stocks traded in mid march. That means the majority of equities are still lower than where they finished 2004. I still operate under the thesis that stocks are for the most part trying make it back to breakeven by midyear. That thesis can obviously change as events dictate, but for now it looks plausible.

In general at this time, stocks look just a little overbought-meaning that in my opinion the majority of equities may have moved higher a bit too fast. Please don't take this to mean that there is no value left in stocks. There are still a few sectors and individual stocks that I think are attractive based on their current prices and on a fundamental basis. Still a pause in this advance or even a small pullback in share price is a higher probablilty now for most stocks. I still think such a pause would just set the market up to get us to back to where we were on January 1, 2005.

The irony is that if the market does pause for a bit it will most likely happen just when the press begins to notice that stocks may have come back from the dead. And speaking of irony.... the oil universe is down about 10% in the last month, its price peaks coinciding with certain well known voices in the investment community predicting $100 a barrel oil. On the opposite side technology has made a similar move higher {see XLK listed above}. Technology started moving up about the time oil peaked and as some of the same voices said that technology was dead. In the long run both of these predictions may prove to be correct but for now they just look silly.

Again I'm just giving you my thinking here. I'm not saying that this is going to happen, or that others should act based on my thoughts. I've been saying for almost 8 months that the market is still consolidating its 2003 post-Gulf War move. (Clients: see my end of the year letter sent in February 2005. All others see my April 28th, 2005 post). We'll change the thesis as events warrent. For now it appears to be on track.

*Source CNBC: "Closing Bell," May 23, 2005.
^Market Data taken from sources deemed to be accurate but cannot be guaranteed.
~Mr. English, his affiliates, controlled accounts and certain clients hold positions in QQQQ and XLK although positions are subject to change at any time.

Please note market information is for informational purposes only. Unless you consult with Mr. English and he understands your investment profile, you act on information contained in this post at your own risk.

19 Years-Long Term Capital Management

In the late 90's it seemed that almost nothing could derail the stock market locomotive. Even the Kosovo War fought between NATO and what remained of Yugoslavia failed to put a dent in the market's money machine. The advances in productivity and creativity as then promised by the internet had become that era's golden goose. Whole industries and companies that had started for almost nothing {businesses which had been tracked out on the blackboards and spreadsheets in the back alleys of Silicon Valley} were brought public with market caps in the billions of dollars, making instant millionaires out of those that spawned them. Corporate America was on a mad spending binge to outfit itself with this latest technology and to prepare for what was widely feared to be a computer meltdown on January 1, 2000.

I left William Blair in May of 1998 for the opportunity to join Alex Brown (one of the oldest brokerage firms in the country which had recently been purchased by Banker's Trust). At that time the S&P 500 (SPX) traded around 1111. People even then were beginning to worry about how far and how fast the market had moved up (it was up over 140% since 1985).

By the midpoint of the year investors had other concerns because the market had taken on a different character. Stocks experienced their first valuation correction in almost 3 years. This and the raising of interest rates caused some real stress in the financial system. Then in October of that year a major financial hemorrhage occurred owing to the stresses induced when the hedge fund Long Term Capital Management {LTCM} suffered a string of catastrophic losses. The downfall of the fund actually started in the spring as LTCM started to see negative returns for an investment strategy {Bond Arbitrage} that in theory was not supposed to ever lose large amounts of money.

There is an old expression amongst traders that "the market holds in reserve a bullet with your name on it". That bullet found LTCM in the late summer of 1998. What ultimately did in LTCM occurred when the Russian Government defaulted on its sovereign debt. This was money in the billions of dollars Russia had borrowed from Western financial institutions since the fall of the USSR in the early 90's. This is again something in the world of finance that theoretically isn't supposed to happen. Reason has always held that governments can tax or borrow more money to pay off bondholders. Unfortunately such defaults occur often enough that this theory should be scrapped. Now the Russians were saying NYET on repayment. As a result panicked investors sold most of their other bonds, particularly those of less credit worthy foreign governments, to buy U.S. treasury securities. LTCM found itself on the wrong side of this trade and by early September had lost almost 2 billion in capital.

One of the problems that occurred was LTCM's extensive use of leverage {borrowed funds} and it was on the hook to the banking world to the tune of billions which nobody was sure could be recovered. LTCM experienced a "flight to liquidity". It's investors, fearing the fund's solvency, wanted their money back right away. Unfortunately there wasn't enough in the kitty to pay everybody out. This prompted a bail-out by many of the top international banks organized by the Federal Reserve in New York. The motivating fear was a vicious chain reaction as LTCM sold its securities to cover its debt and redemptions. Investors worried that a further drop in prices would force other institutions to liquidate their own debt, spreading a downward price spiral which might wipe out the financial world as it then existed.

LTCM was the worst financial crisis witnessed since the stock market crash in 1987 and it is impossible to do justice to this complex story in a few paragraphs. The SPX lost about 18% from July to mid-October. Some financial institutions never recovered. Banker's Trust itself was weakened by the ordeal and sold itself to Deutsche Bank later in the year.

The markets rebounded once it became apparent that the banks were in the process of stabilizing the situation. The SPX recovered most of its summer decline in about 30 trading days, It added about 20% in that time period, once again illustrating that stocks often have very large explosive moves in relatively short periods of time.

The SPX traded as high as 1230 by the end of the year. Even though the market had witnessed and survived a major financial crisis, stocks still managed to tack on another 26% in 1998 (more if you add in dividends). But the underlying tone had changed in new and subtle ways.....To be continued.

Welcome

Hello!

Today I have officially gone "live" with this blog. While you can find a certain amount of content written as far back as the end of April, this has mostly been in a testing stage. I've had a few people review the site from different backgrounds so I could test their reactions. I've decided to open this site to the rest of the world at this time because most of of the feedback from my "test group" has been positive.

A few notes regarding questions I have received:

I have turned the comments section off on most posts. Legal concerns prompted me to do this . Please address any questions or comments to lumencapital@hotmail.com. I will either address them in a separate e-mail or post answers here if I feel there's a benefit to doing so.

A blog is meant to be more of an informal style. I am trying to strike a happy medium in not only what I write but it's tone. Please keep in mind that I have a clientele that ranges from very sophisticated investors to people who don't give a rat's hoot about the markets. I am trying to write for and explain the world of investing as I understand it to everybody.

This blog shows the most recent entry first. To keep to the timeline you need to go back to the April archives and read the entries in reverse order. Each entry is designed to be read in about 5 minutes.

Except in a general manner or to use them to illustrate a point, I will not discuss individual stocks or personal portfolio questions at this site. If I do discuss individual securities I will disclose whether I or my clients own these securities. You will usually see a footnote at the bottom of the post similar to this: "Long XYZ common in both individual and/or client accounts although postions are subject to change at any time."

I think I'll stop for today. I thought I would reprint here my introduction from April {first printed April 26, 2005} to review my general goals and outlines for this blog.

From April 22, 2005:

Solas

Hello and Welcome!

One of my promises at the beginning of the year was to begin an investment series that covered a multitude of topics. Yet as you all can see it is almost May with so far nothing written. It has not been for want of trying but rather timing! I have a lot that I want to cover and not enough time to put it all into literate thought. As an experiment I am going to try for a time to put out parts of this series in serial form on the internet. A blog so far seems to me to be the best opportunity to focus on what I want to write in a time efficient and hopefully interesting manner. However, please keep in mind that so far this is a hit or miss experiment. I don't yet know if this is going to work, how it's going to look or even if I am going to be satisfied with the end product. As a work in progress, especially at its inception, this may be a hit or miss endeavor. I don't know yet how to import charts or pictures or do many of the things that make this look pretty or more professional. Nor am I going to take time away from my business to become an expert blogger. I do over time hope to make this better. I welcome your comments and suggestions.

What this is:
A learning experience.
A way for me on occasion to make a point.
A way for me on occasion to discuss markets and investing.
A place for me on occasion to discuss the vagaries of life and perhaps editorialize.
A place to discuss the investment process.

What this is not:
A forum to tout any form of individual investments. (Particularly individual stocks).
A place for me to give individual investment advice. (Call me or others for this).
A theatre for me to tell you how wonderful I am.
An environment for me to make stock valuation predictions. i.e. "XYZ is worth 50 dollars!"
And anything else that I might think of going forward.
Well with the introduction out of the way, let's begin.

Looking forward to hearing back from you soon.

Chris

19 Years-The Long Boom

1994 was the last year of the last decade when the market lost money. Even then it was not by much, maybe, 1% after dividends. Still the decade of the 90’s had not gotten off to a great start. On January 1, 1990 the SPX stood at 359.69. 5 years later it was at 459.27- a total 5 year gain of just over 27% or a bit over 5% per year (not including dividends). Not bad but certainly nothing to put up in large banners either.

Yet at this point and unnoticed by most, a quiet revolution in technology was taking place. It had really started in the late 80’s as corporate America began to embrace the computer in a big way. It had found its way into the home as consumer price points on personal computers (PCs) came down and as products like the mouse and Microsoft windows made the machines easier to use. Now the scope of this revolution has been better chronicled by others but I want to throw in one point. In the mid 90’s you could walk into any computer store and see setting there on the shelves whole industries in everything from equipment to gadgets to software that simply had not existed 10 years prior. Almost unnoticed by many a whole new world had arisen and all it needed was one spark for it to really catch on. That spark was first provided by companies that built closed computer networks. AOL comes to mind here*. Later it was dominated by the open framework of the internet.

Wall Street had noticed of course and during the early 90’s technology companies had outperformed the overall market. By the mid 90’s even mainstream America was catching on. Also the economy had largely shaken off its lethargy. It was growing and creating jobs in a fashion largely unseen since the 1950’s. Thus began the long boom of the late 90’s-a 5 year period in which stocks had annual high double digits appreciation and suffered only 1 period where the markets declined more than 15%. From the 459.27 starting point on 1/1/95 the market would go on to post an increase of almost 220% (excluding dividends) ending the millennium at 1469.25.

Stocks were once again the talk of the day. Whole industries formed around people who were quitting their jobs to day trade equities. My favorite commercial of the era shows a lady who runs home from jogging and pushes her child away from the computer shouting “Make way! Momma’s gotta trade!” Stories circulated of office pools where people picked stocks by throwing darts at the quotes pages of the Wall Street Journal. People were more interested in the markets than anytime since I had been in the business and…..and….and….nobody could have seen this coming at the end of 1994. In fact at that time many might have been tempted to buy bonds which in terms of yield could be found at 6-8% for pretty good paper.

At the beginning of 1998 I left William Blair to go to Alex Brown-(A firm that had recently been purchased by Bankers Trust). It was late summer of the equities boom yet a change was on the way as the markets entered a new and more dangerous period…….To be continued.

*AOL is currently owned by Time Warner (TWX). Mr. English and some of his clients currently hold positions in TWX although said positions are subject to change at any time.

19 Years-The Early 90's

Of course we all know with the benefit of hindsight that the war was a stunning success. Some may also know that the market rallied but may not realize by how much or how quickly it moved up. By February 13th the SPX stood at 369.02-a gain of over 16% in 20 investing days. It then consolidated this gain and had another 9% move in an 8 day investment period from 12/20/91-1/2/92. On the one year anniversary of the war, the SPX stood at 418.21-a gain of just over 32% (not including dividends). Much of this gain had been recorded in just 28 days.

The market paused through most of the rest of 1992. A slowing economy, a tightly contested election between Bill Clinton & then President Bush plus the need to consolidate that large 1991 gain meant that stocks were at the same level in November as they had been in January. This pattern of digesting large market profits is similar to what we have experienced in 2004 & 2005 as stocks have been consolidating the grand push off the lows made prior to the 2003 invasion of Iraq.

With the elections out of the way the markets found an excuse to rally. The markets which had suffered some pre-election jitters in October rallied 11% by mid-March. By the end of 1993 the market had advanced about 7% for the year. In March of 1994 I joined the investment firm of William Blair and Co. However, by March of that year the bloom was off the rose as far as stocks were concerned. By the end of March the SPX had declined about 9%. Again in a short period of time (3 months) it had given back its 1993 gain and was trading at November 1992 levels. A slowing economy (actually the end of a mini-recession) higher interest rates and the Clinton Administration’s attempts to exert governmental control over healthcare were the reasons behind this decline.

At the end of my Kidder, Peabody years the SPX stood at 445.76. The day I had walked in the door of this grand old investment firm the market had traded at 250.84. Through a market crash, a war and mediocre economic growth, stocks had still increased 77% (without adding dividends in the equation). If my math is correct this still averages about a 10% annual return. Even so a malaise had settled into the markets. But underneath the surface something wonderful had been percolating. We’ll discuss this in our next post.

We Interrupt this Program....

Just some quick food for thought......

-Oil below $50 a barrel means we ought to get some relief in gas prices later this year. It also makes those predictions of $90-100 a barrel that made the headlines this winner look either premature or silly. There's a lot more oil in the world at $50 bucks than there was at $20.

-For all of its ups & downs and the one day euphoria or angst, the markets are basically trading at the same levels they were a month ago.

-Strong retail sales today ought to put to rest for a time the argument that consumers are afraid to spend.
-Speaking of the consumer it just might be that one of the problems is that consumers have bought all the big ticket items that they need right now.

-Finally in regards to food, take a look at restaurants sometime and I'm not just talking about the trendiest nightspots or the flashy chains like PF Changs. Find the local watering hole in your home town. You know the places that serve good food, have a reasonable atmosphere, have been around forever all the while serving at price points that the average family can afford without breaking the bank. In short a place you might take Mom and the kinds for Sunday Brunch. These places are packed. And not just on Sunday. The sky isn't falling-at least not yet. :}

Now I'm off to Grandpa's in Glenview where I wait for the Irish Dance Gang each Thursday Night.

19 Years-To The Gulf War.

While Monday was the worst day for blue chips the following day was actually the worst for the rest of the market because the over-the-counter traders simply ceased to function or make markets in their securities. Sell calls to these brokerage desks were simply not answered and as a result by early in that day the markets were on the verge of locking down.

A friend of mine came back from lunch and announced to the office that the Continental Bank was failing and there was a line of people stretching around the block to take their money out of the place. This was not true. There was a brokerage shop in its lobby and in those pre-internet days panicked investors were trying to find out how much money they were losing by checking out quotes. A rumor floated up from the Chicago Board of Trade that a couple of traders, convinced that the country was suffering a meltdown, had hired an armored car to go to either above said Continental or First Chicago to take out all of their cash. I never found out if this was true.

Now I was fortunate early in my career to have found a mentor whom I shall call MC. MC came by my desk and said “You have to buy something in here and a couple of years from now you will be glad you did.” With great trepidation and for the few clients that I had at that point I picked up the phone and told them to buy General Electric. Today that split adjusted cost is around $4.00 per share. Somehow the market cobbled together a gain on that day held on to a rally and with some fits and starts seemed to have gingerly found its footing.

But the damage had been done. I knew investors who went bust being unhedged in options positions. A broker that went through training with me called his boss before the open on that Tuesday and told him he quit. People who had made plans based on the past 4 years had to put them on hold. And after their initial recovery the markets muddled along. The SPX closed 1987 with about a 2% gain but all everybody ever remembers is the crash.

The markets resumed a gradual recovery in 1988 and 1989. In fact by the beginning of 1990 the markets had staged almost a 40% recovery with the SPX trading back to around 360. Stocks had made it back to the pre-crash levels but it was a period where nobody cared. It was like a switch had been thrown and investors simply went away. Real estate and certain types of yield oriented limited partnerships were the investment vehicles of choice. But stocks were a dirty word for most. It was also not a good time to be a young broker. I had been in a training class for Kidder, Peabody with 39 others. Within a year there were 6 of us left and by 1989 just 2.

Finally in 1990 both the market and the economy seemed to be gaining some traction. In fact in late summer of that year the market looked like it was ready to take out some of its old 1987 highs. Then Iraq invaded Kuwait and everything stopped. As war became inevitable the economy came to a standstill and the market fell almost 20% by October's end. As the military coalition positioned itself in the desert and the politicians tried to avert a war the markets continued to be weak. On January 12th, 1991 the US Congress authorized the use of military force. Then Secretary of State James Baker (Yes him again) met his Iraqi counterpart in Geneva in a last ditch effort to find a peaceful solution to the crisis.

It didn’t work and the markets had one final sell off in anticipation of conflict. On January 14th the SPX stood at 312.49. The market had given up all of its post crash gains and traded at the same levels it had in the summers of both 1986 and 1987. Stocks had in this 4-5 year period (absent dividends) thrown up a big fat zero in terms of growth. As all eyes turned to TV for war coverage it was expected to see more stock losses as predictions of a long war and massive casualties sapped investors of their will…..to be continued.

Long General Electric for clients & in personal accounts.

19 Years-An Introduction & Black Monday

I am often accused of being an optimist. I guess if I'm to be tagged as anything I am more of a pragmatist in that I think that most of the time we muddle along and over time things work themselves out in the way they should. My world view on this comes from having seen and discounted much of what both the hope and glory and the doom and gloom crowd preaches. This view is not only related to the markets but to most of life itself. However here the subject is investing and over 90 % of the time it has been my experience when discussing stocks, things are never as good or as bad as the public and the media seem to think. That doesn’t mean the "public" is never wrong. They weren’t for example wrong after 9/11. But over time I have tried to apply this to what I believe to be a longer term pragmatic view of the markets. In this series I want to discuss why that is so by giving you my perspective of my almost 19 investing years. As you’re going to see there were as many bad times as good.

I am going to break this up into a series of articles covering the 19 years I have spent in "the business" & roughly matched to the times I spent at these firms: Kidder, Peabody & Co., William Blair & Co., Alex Brown (later Deutsche Bank Alex Brown) and from the time that I founded Lumen Capital Management. At the end, I’m going to sum up what lessons can be learned and may even have a surprise for you. Once this is done I want to begin writing about my view on the modern investment process, albiet with a detour or two.

I started with Kidder Peabody shortly after I graduated from law school in July of 1986. At the time the market as measured by the S& P 500 (hereafter SPX) after about a 4 year run was trading at 251.84. I spent almost a year training to be a stockbroker and was finally permitted to start trying to find clients in June of 1987. At the end of my 1st month as a broker the SPX stood at 318.66, a gain in less than a year of close to 27%. It was not hard to find people interested in the markets in those days. But then how could it have been. From it’s lows in 1982 the market was up in excess of 200%. The market had returned over 40% a year since it had broken out of a long consolidation period running from the late 1960s.

The markets dominated the cocktail circuit back then as much as they did in the late 90’s or real estate does today. As we entered the late summer of 1987 the market hit its high of 335.90 and then stalled out. It was down about 11% a couple of months later. On October 14th, the Secretary of the Treasury James Baker announced a record trade deficit and that perhaps the dollar should fall on foreign exchange markets. Like a pin pricking a balloon the money exodus began. The SPX lost almost 3% on 10/14, about 2.5% the next day and a nasty 5% to close out the week on the 16th. Investors had a weekend to stew over what had just taken place and their verdict on “Black Monday” was to sell. The SPX lost almost 58 points in one day- almost a 21% decline. There has NEVER been a similar daily loss in my investment experience. Even after 9/11 the market lost less!

Since its August highs the SPX had lost over 30%. To put this in perspective a similar decline after 2000 took about a year and half to go down the same amount. Here stocks gave back over a years worth of gains in about eight weeks, trading at the same levels it had also seen in April 1986. As bad as this was, more difficult days were to follow……to be continued.

Junk

The news out this afternoon is that the debt of General Motors (GM) and Ford (F) has been downgraded to junk bond status. GM and F have a very large problem right now. Nobody wants to buy what their selling namely big trucks and SUVS. $50.00 gas fill-ups will do that to your sales. The automaker’s problem is largely rooted in their costs. On smaller cars & midsize sedans they simply can’t compete with the Japanese. Thus their bread and butter for the past 10-15 years has been the big gas guzzlers where they had some cost and sales advantage.

GM & F both have huge healthcare costs. I’m told that number per vehicle is something to the tune of $1,200 per car. GM’s medical bills will tally over 5 billion this year. Whether that’s exact or not is anybody’s guess. It is though correct to suggest that this places Detroit at a huge disadvantage vis-à-vis say Toyota.

Now like Social Security, healthcare has traditionally been considered an untouchable. In my view {that you always follow the money} we have seen whole industries blossom in insurance and medical cost containment whose sole purpose is to pass the buck of these costs onto somebody else. Detroit would prefer that somebody else be the states or the federal government.

For both companies and governments, healthcare is beyond the constraints of Adam Smith’s economic invisible hand in that 1} it is not subject to price competition. Its consumers-sick people-don’t bid out hospitals or doctors like they might a remodeling job. 2} its consumers and their families do not generally worry about costs when they need its services. For example, when you take your kid into an emergency room at 2:00 AM you generally don’t ask what it will cost before you try to fix whatever is wrong.

As we see this slow unwinding of the social contract between institutions and individuals, just as with Social Security the costs inherent in the system will eventually make it so that individuals are put more in charge of their own affairs or government in some form will be forced to do the funding.

No individual or client positions in either F or GM.

Where We're Going Part II, Bargaining Chips

Now we talked last about what the middle class is going to be offered in terms of the great give- up that is going to be expected of them as their promised benefits are cut in Social Security. The chip that will most likely be played will be some kind of expanded retirement accounts, after tax incentives to provide us with the means to fund these future liabilities. For most of us the two vehicles open to such investment are bond & equities markets and real estate, namely here residential as in your home.

But as governments have a more vested interest in the returns that these markets might provide, the more they will be interested in seeing a certain amount of stability (over a longer time period). To actuaries looking at reported real returns on Social Security at around 2%, the 7-8% historic long term return on equities looks mighty appealing. And the more that this becomes an attractive option the more pressure they will exert on these institutions. As far as stocks go, hundreds of billions of new investable dollars most probably passively invested (monies indexed to certain equity indexes) will likely mean a much bigger floor or cushion than we are currently experiencing.

It will also mean that the Government will probably be more proactive in seeking to eliminate or contain investment manias and market bubbles in their early stages before they are fully formed. In this scenario markets that can range say 4-15% in a given year with an occasional down period are preferable to the 1998-2005 period where stocks have in essence given a big fat 0 return. The Federal Reserve has a particularly effective way to do this by raising margin rates-the rate that is charged for those looking to borrow money to buy or sell stocks.

So look for stock prices to at some point have much more of an underlying cushion or base as all of this new money is cycled into the markets. But say goodbye to bubble mania for it could be a thing of the past. No more "Roaring 20's or Roaring 90's"!

Where We're Going Part I, A Shot Across the Bow.

So today I'm going to start talking about Social Security, Medicaid and its impact on investing.

Snore! Boring! Political Graveyard! A strange way to talk about stocks. But stay with me for a moment....If {and I want to stress this is a big fat political if} Republicans do what Democrats have always feared and dismantle what's left of Roosevelt's and Johnson's New Deal and Great Society, somebody ought to ask what comes next.

Now for those that are inclined to get into some large political debate with me on this I say don't waste your time. Because I'm not interested in discussing in here the moral or social consequences or even in the devil's details of what a final plan ought to look like. However, I am interested in what the deal is going to look like that is offered to the Middle Class in order to get them to politically sign off on this.

Make no mistake, anybody who is under the age of 50 should have taken notice the other night at President Bush's press conference when he talked about means-testing Social Security. This is the latest shot across the bow in the Government's attempt to completely retool the social safety net.

Here's basically what the President said. "Those that are paying in the most will get back the least." In politics most issues can be broken down by following the money. In the case of Social Security the money is with that great big chunk of us who live somewhere above the poverty belt and below the coupon clipping set. Because this huge lump of people has not only paid the most into the system but is likely to demand the most from it. A more coherent discussion of this can be found in an editorial written by Paul Krugman over at the the New York Times. You can link it here. http://www.nytimes.com/2005/05/02/opinion/02krugman.html?hp (I don't agree with all of Krugman's conclusions by the way.)

Look here's the problem. The system will at some future point go broke unless it's fixed. And there's no money in the Treasury to do the repair job. Just some big obligations by Uncle Sam to pay out the funds at a future date. That date starts now as the Baby Boomers begin to retire.

Now what's going to happen is those of us under about age 50 are going to wake up pretty soon and realize that the fix is in. All that money we've had taken out of our paychecks over the years-well its not really put away for our retirement. Matter of fact- it really is a tax after all. A 6.2% tax up to a $90,000 ceiling this year. A maximum of $5,449.80 in 2005. Oh by the way, tack onto that the 1.45% Medicade Tax Rate which has no annual limit and is another means-tested program that most of the Middle Class will unlikely ever be able to tap into.

So this is why I'm asking what is the deal going to look like and now I'll tell you what this has to do with investments. Because from my perspective the least painful thing for the Government to do is offer us more of the same. That means more money in 401Ks and IRAs and the like with perhaps better tax advantages. Perhaps an elimination of the estate tax or a lowering of its rates as a sop. Private Accounts within Social Security looks increasingly DOA. Anyway why care how your accounts do if you aren't going to see all the money?

And if I'm right then that money will almost by default eventually find its way into the markets as there are at this point few places besides cash or bonds currently available to put this money away. This would represent an incredible amount of new capital to support equity markets along with a government having a much larger vested interest in stocks' long term results. There's both good and bad in this. Stay tuned.......We'll start to unravel what this means for investors in my next post.

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Where We Are!

As of Friday's close {4/29/05} the markets have printed the following year to date declines:

Dow Jones Industrials: (- 5.5%) (- 7.2% off of its 52 week high.)
S&P 500: (- 4.5%) (- 5.9% off of its 52 week high.)
Nasdaq Composite: (-11.7%) (-12.3% off of its 52 week high.)

This grinding four month decline has brought these major averages back down to major levels of support (a price or price zone where stock buying power has historically been sufficient to halt a price decline). The back and forth up day/down day price action we have recently witnessed is often indicative of a market trying to find at least a short term bottom. Stocks have tested recent lows and held these price levels. Markets in 2005 have followed a pattern similar to that which stocks traced in 2004. If this pattern holds then it is likely that stocks should begin a short term rally back towards price levels stocks held at the beginning of this year. Certainly the investment community has a powerful incentive to get stocks back to as close to break even by the end of June. Investors tend to scrutinize their portfolios more closely at the end of June and the end of the year. Such a possibility means that the average stock could go up 5-10% between now and June 30th.

Now there is no law that says this is going to happen and all sorts of events could conspire to either limit a rally from here or stop it cold. An important event this week will be the Federal Reserve meeting on Tuesday. A benign Federal Reserve statement regarding inflation could mean more capital put to work in the markets. Any indication that they are close to being done raising interest rates could be the kindling to ignite a pretty good rally. I will be looking for clues of a rally in the reaction to this meeting and will in particular be paying attention to a few other clues which are usually indicative that stocks are going to advance. I'll fill you in on how I study and use some of these indicators in later posts. Next....Where we are going.