Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Friday, March 9, 2007: The
downdraft is not over, I believe. But it appears to have settled for the time
The game remains staying conservative (no margin buys), own only great stocks
(and great index funds) and no panicking. I read a lot on Gray Tuesday (as the
475 point fall on the Dow is now called). Here are the two best pieces.
One of my favorite financial writers is James Surowiecki. He has a piece in
the March 12 issue of the New Yorker called Reasonable Panic:
of March 8, has this piece, "Why investors should still be wary."
After last Tuesdays
stockmarket rout, which sent the Dow Jones average down more than four hundred
points and erased more than half a trillion dollars of market value, Wall
Street analysts and reporters quickly found a culprit: China. The Shanghai
stock market had plummeted almost nine per cent before the U.S. market opened,
supposedly raising concerns about the health of the Chinese economy and spooking
U.S. investors. Other explanations were floated as well. Alan Greenspan had
given a speech the day before warning of the possibility of recession. The
government reported a sharp decline in durable-goods orders, suggesting that
U.S. manufacturing was slowing down, and there were discouraging numbers from
the housing market. All in all, it was a day with its fair share of bad news.
At first glance, however, it didnt seem like bad news that was worth
half a trillion dollars. So was the whole thing just a temporary fit of hypochondria?
Did investors sniffle a few times and then all decide they were coming down
with avian flu?
Some of the
decline can certainly be attributed to some less than rational investor behavior.
The slump in the Shanghai stock market, for instance, while precipitous, was,
from the perspective of the U.S. economy, a non-event. For all the talk about
the integration of global markets, there is very little foreign money invested
in the Shanghai Stock Exchange, thanks to government regulations. Furthermore,
the Shanghai sell-off appears to have been driven not by doubts about the
well-being of Chinas economy but by local anxieties about possible new
measures designed to curb speculationsomething that would make no difference
to American corporations. But the sell-off dominated pre-market news on Tuesday,
and so investors were effectively given the message that Chinas problems
really were Americas.
problems, because, as economists have found, investors often overvalue new
information, particularly when its presented in dramatic fashion. In
one famous experiment by the psychologist Paul Andreassen, investors who selected
a portfolio of stocks and then saw nothing but the stocks changing prices
managed their portfolios significantly better than investors who were also
given a stream of news about the companies theyd invested in. The reason,
Andreassen suggested, was that the medias tendency to overplay stories
led investors to place too much weight on news that turned out to be of only
transient importance. This doesnt mean that investors should be kept
in the darkindeed, markets work best when participants are drawing information
from many diverse sourcesbut when a single story like the Shanghai sell-off
captures everyones attention investors will often overreact. This effect
is magnified by the prevalence of short-term and momentum trading in todays
stock market. If an investor thinks a piece of news has a chance of causing
a sell-off, he is likely to respond by selling, too, thereby feeding the frenzy
Some of Tuesdays
drama, then, was the result of a mild bout of investor hysteria. But its
likely that much of it had more sensible underpinnings. While the past few
years have been exceptionally good for American companies, with interest rates
and labor costs low, and profits at historic highs, a host of potentially
huge risks continue to loom, including the threat of terrorism, Americas
huge current-account deficit, and the possibility of a slowdown provoked by
the end of the housing boom. If investors collectively decided that there
was a slightly greater chance of even one of these risks becoming reality,
that could have provoked the market decline we saw on Tuesday.
It may seem
unlikely that a small change in investor expectations could lead to such a
big sell-off. But stock-market investors are trying to predict how much money
companies are going to make over the next fifteen or twenty years. Over a
period that long, relatively small changes in the present can have huge effects.
A ten-billion-dollar company that grows at ten per cent a year for twenty
years, for instance, will be, at the end of that period, twenty billion dollars
bigger than if it had grown at eight per cent a year. So while big market
swings in reaction to poor earnings news or bad economic data often seem exaggerated,
evidence suggests that they often turn out to be justified. For instance,
a new paper by the economists Borja Larrain and Motohiro Yogo that looked
at U.S. companies from 1926 to 2004 found that the movements of companies
stock prices followed changes in their expected cash flow. And a new simulation
by three British economists shows that even a stock market made up of investors
who are rationally adjusting their forecasts of future business cycles will
generate the kinds of volatile price changes that you see in real stock markets.
In other words, even when investors are sensible their collective activity
is quite capable of occasionally sending the market down four per cent in
mistake to read sharp declines as portents of certain doominvestors
are saying that theres a better chance of bad things happening, not
that those things will happen. Although that may not be exactly comforting
news, in some sense Tuesdays sell-off was paradoxically reassuring.
Academics and policymakers have been arguing for a while now that investors
are foolishly indifferent to the risks facing the global economy. But last
weeks sell-off suggests that in the stock market, at least, investors
are all too sensitive to the many things that can go wrong. The effects of
last Tuesday may have been painful, but in the long run, this is probably
good news. In a risky world, its better to have wary investors than
Grey Tuesday, a Tuesday of a brighter hue: on March 6th, having endured a rocky
week, the world's main stockmarkets made up some ground. With impressive ease,
Wall Street shrugged off some unwelcome economic data -- and held steady the
next day too. After its most troublesome week since its bull run began four
years ago, the S&P 500 index had lost less than 4%, a mere sliver of its
gains. Most stockmarkets in the rich world had fallen back only as far as their
levels of early December. Shanghai, where the trouble began, stood merely where
it did in mid-February.
Is the storm
over? One puzzle for economists is that this week's data were if anything
more gloomy than last week's. Further evidence came in that the economic cycle
is ageing: America's fourth-quarter productivity growth was marked down sharply,
to just 1.6% at an annual rate; American unit labour costs leapt in the same
quarter, by an annualised 6.6%. Last week Alan Greenspan caused a scare by
merely mentioning the possibility of a recession; this week the former Fed
chairman put more precise (and worrying) odds on this happening -- one in
three. Yet the markets cheered.
It goes wider
than that. Look around the financial world (see article) and, even after the
recent adjustments, the days of low volatility, cheap money and ample liquidity
seem far from over. The yen is still relatively cheap, allowing some steamroller-dodgers
to talk breezily about a resumption of the carry trade (where you borrow in
the Japanese currency and invest in higher-yielding assets elsewhere). As
for risk, the spread on high-yield corporate bonds, compared with American
government bonds, has risen from very modest to slightly less modest: from
267 basis points in late February to only 310 points on March 2nd. Admittedly,
the Vix measure of American stockmarket volatility almost doubled on February
27th, to 18. But on long-term form, this is nothing special. It was above
20 even before the Russian crisis of 1998.
then hot air
It is here that
the argument begins. For wary observers, such as this newspaper, valuations
that seem out of step with historical trends (and, in America, the underlying
economy) are usually ones to worry about. Optimists tend to see a more enduring
state of affairs. Kevin Warsh, a governor of the Federal Reserve, spelt out
the case for optimism in a speech this week. Liquidity is confidence,ö
he said, before proceeding to set out what has boosted both sides of this
proposed identity in the past couple of decades: financial innovation and
America's strong economic performance, helped by "excess savings"
from abroad in search of high returns.
There is something
to this. In the recent past the number of financial markets has increased
dramatically. You can buy and sell not only shares, bonds and currencies,
but any number of derivatives based on them; you can trade in insurance against
the default of single companies or whole bunches of them; all manner of debt,
from solid company loans to fragile subprime mortgages, can be syndicated
or securitised, chopped into bits and sold on; and you can bet on myriad indices
of all the above and more. Never has the diversification of risk been so easy.
Rarely have once-risky bets seemed so safe. When borrowing is cheap and when
whomever you are lending to, or insuring against default, looks highly likely
to pay you back -- because the economy is booming or their house is sure to
rise in value -- where then is the risk? Bets are easier to make with confidence
when you know that financial innovation has made them easier to lay off again.
is when this strays into over-confidence. Mr. Warsh was right to note that
the reduced volatility of America's GDP and inflation over the past 20 years
or so may well mean persistently lower risk premiums and higher asset valuations.
Stability begets confidence -- or, , its equivalent, liquidity. However, even
if the ups and downs of the economy are less marked than they used to be,
they have not disappeared altogether. That, in effect, is the point Mr. Greenspan
has now made twice. Corporate America's profits have had a good run in recent
years, but they are cyclical phenomena and the cycle is turning. Especially
among financial companies, which have made piles from America's housing boom
and from the wonders of financial innovation, profits growth looks set to
that risk premiums should be permanently lower and asset valuations permanently
higher: by how much? The honest answer is that no one knows: that is what
financial markets are supposed to divine, and there is no guarantee that the
business of discovery will always be smooth. What you can say is this: in
part, the run-up in the prices of houses, shares and other assets does indeed
reflect the belief that inflation (and hence nominal interest rates) is likely
to stay low for a long while. In part, though, it is also the legacy of the
loose policies of Mr. Greenspan's time: liquidity is, to a degree, in the
gift of central banks. In the past few days financial markets have paused
for thought about the valuation of the increasingly ephemeral things in which
they deal. At some point, they will surely have to think again.
from the Economist magazine on Australia:
+ The Reserve Bank of Australia (RBA, the central bank) now appears more relaxed
on inflation prospects, and further interest-rate rises are unlikely. The RBA
believes that the headline rate of inflation will fall sharply in coming quarters,
with a slower decline in the underlying rate. Interest rates will probably start
to come down in the second half of 2007, but only slowly.
+ Good employment levels and fiscal handouts are likely to keep private consumption
growth strong over the forecast period despite still-high interest rates. The
government has plenty of money to spend on pre- and post-election sweeteners,
and it will manage to run large fiscal surpluses over the forecast period. But
slower revenue growth may eventually become a concern.
+ Although drought will exert a negative effect on economic growth in 2007,
GDP is still expected to expand by around 3% a year throughout the forecast
period. Sustained but not dramatic export growth will be the key to steady GDP
growth. Private consumption growth is unlikely to rise faster, and fixed investment
growth will remain modest.
+ The current-account deficit will remain large, at around 5.5-6% of GDP (based
on IMF data). Australian Bureau of Statistics methodological revisions suggest
that the services account may be in better shape than was previously believed.
However, the income account will stay in deficit to the tune of more than 4%
the Economist predicts for Australia --
nice steady growth
GDP growth (%)
price inflation (average; %)
balance (% of GDP)
balance (% of GDP)
banks' prime rate (average; %)
rate A$:US$ (average)
rate A$:¥100 (average)
As I've mentioned
before, I like Vanguard's index fund that mimics the 300 largest
For the Economist's story, click
here. For more on the Vanguard Index Australian Shares Fund, click
To invest in Australia,
you need to open an Australian bank account. That's easy. Then you wire money
in or out, just like you do with an American bank account. You'lll have to pay
taxes to Uncle Sam.
a spare charger? For your cell phone, your BlackBerry or your iPod?
Next time you check into a hotel, tell them you left you charger there on your
last visit. They'll bring you a gigantic box of chargers and adapters their
previous guests left. Take your pick. You'll be doing them a favor.
friends speak highly of the Geek Squad: The Geeks
will visit them and fix their printing, network, virus, spyware disasters, etc.
Also do a little training. The Geek Squad is now part of Best Buy. They have
Geeks in each Best Buy store. For more, 1800 GEEK SQUAD or click
blown away by how many people are switching to Macs:. Frankly, after
seeing the disaster that is Vista and Office 2007 (all that time wasted relearning
the old commands) and having to reload Photoshop (once again), I'm even thinking
of switching. I was discussing Macs versus PCs with the technology editor of
a major international business magazine. His final email to me summed it all
I've never owned
a PC. I've been using Macs since 1987. I have to use a PC at work, of course.
But I do not understand why anyone buys them. The lack of viruses on the Mac
*alone* would merit a 100% price premium to PCs. I cannot believe how much
time people waste reformatting and reinstalling stuff on PCs. To buy one just
because it's a bit cheaper, is a false economy.
Neat idea: Apple
may come up with a new laptop this year that saves data on flash-memory chips
rather than hard drives, Bloomberg reports, citing analysts at American Technology
Research. Apple's biggest selling iPod, the Nano uses flash memory chips. The
benefit of using flash memory is that you can build a lighter, smaller, faster,
more durable, much longer-battery life Apple computer -- perfect for traveling.
I wish Microsoft were half as creative as Apple.
School's in. Amazing lessons:
Sixth grade science teacher, Mrs. Parks, asked her class, "Which
human body part increases to 10 times its size when stimulated?"
No one answered
until little Molly stood up, angry, and said, "You should not be asking
6th graders a question like that! I'm going to tell my parents, and they will
go and tell the principal, and you'll get fired!" She then sat back down.
Mrs. Parks ignored
her, and asked the question again, "Which body part increases to 10 times
its size when stimulated?" Little Molly's mouth fell open, and she said
to those around her, "Boy, is she gonna get in big trouble!"
The teacher continued
to ignore her and said to the class, "Anybody?"
stood up, looked around nervously, and said, "The body part that increases
to 10 times its size when stimulated is the pupil of the eye."
Mrs. Parks said,
"Very good, Jimmy." Then turned to Molly and continued, "As for
you, young lady, I have three things to say:
have a dirty mind.
Second, you didn't read your homework.
And third, one day you are going to be VERY disappointed."
America demands from its deeply religious
A young Talmud student returns to visit his family in the old country.
"Where is your beard?" asks his mother.
he replies, "in America, nobody wears a beard."
"But at least you keep the Sabbath?"
"Mama, in America everybody works on the Sabbath."
"You still eat kosher food?"
"Mama, in America, everybody eats in restaurants. It is difficult to keep
The old lady ponders this information and then leans over and whispers in his
ear, "Isaac, tell me -- you're still circumcised?"l
a happy day in the Newton family household.
Son, Michael got admitted to Harvard Business School and is off to Boston in
Happy son, Michael, HBS 2009
Even happier father Harry, HBS 1969 (yes, exactly 40 years). Amazing!
This column is about my personal search
for the perfect investment. I don't give investment advice. For that you have
to be registered with regulatory authorities, which I am not. I am a reporter
and an investor. I make my daily column -- Monday through Friday -- freely available
for three reasons: Writing is good for sorting things out in my brain. Second,
the column is research for a book I'm writing called "In Search of the
Perfect Investment." Third, I encourage my readers to send me their
ideas, concerns and experiences. That way we can all learn together. My email
address is .
You can't click on my email address. You have to re-type it . This protects
me from software scanning the Internet for email addresses to spam. I have no
role in choosing the Google ads. Thus I cannot endorse any, though some look
mighty interesting. If you click on a link, Google may send me money. Please
note I'm not suggesting you do. That money, if there is any, may help pay Claire's
law school tuition. Read more about Google AdSense, click
here and here.