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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 AM EST Friday, May 26, 2006: Monday is Memorial Day. We remember the Americans who laid down their lives to protect the freedoms we enjoy every day. The American military is made up of hard-working, under-appreciated, underpaid men and women. They deserve a raise far more than we deserve another tax cut. If you have any sway, mention this need to your local congressman or woman.

What makes me sleep well:
1. A broad diversification of investments (see below).
2. Sufficient bonds whose interest will pay our family's lifestyle -- if everything else collapses.
3. Saying NO more often, and saying NO to startup ventures I have no control over or to investments I don't understand -- e.g. investments contrived by Wall Street.

Here's my present allocation. Improvements needed: More bonds, especially now they're paying more. More real estate. Problem remains sourcing quality investments.

Private Equity Funds
Leveraged Buyout Fund
Publicly traded Equities*
Mutual Funds
Muni Bonds
Closed end muni bond funds
Cash and floaters
Real estate syndications at cost
Distress Real Estate Fund**
Real estate loans
Private Equity Investments
Private real estate

* Includes money managers and hedge funds.
** No monies called yet.

The Enron guilty verdict and the Enron collapse: Will there be more Enrons? Yes. There are simply too many pressures on "the golf course"to earn big, to live big, to give away big, to make oneself "big." Ego reigns large in the boardroom, in politics, on stage, etc. Ego and peer pressures will definitely cause more Enrons. How do you protect yourself against investing in the next "Enron?" here's my Checklist:

1. Watch for huge outrageous payments or option awards to CEOs and chairman.
2. Watch for super optimistic statements by the executives on their new businesses, their new ideas, etc.
3. Listen to the hype. You'll see a spate of favorable research reports. The financial press will start writing hugely positive stories, bestowing "executive of the year awards" on the company. Your friends will start talking about the stock. Too much hype is a sure sign of too little reality.
4. Watch for growth in earnings and sales that boggle the imagination.
5. Watch for accounting irregularities and reports of "strange" events that don't happen in the normal course of business. Watch for signs of the company becoming a "Cockroach Stock" -- one small strange report leads to another slightly larger one, then another one... and finally the whole thing collapses.
Most importantly, don't violate our inviolate 15% Stop Loss Rule. When the stock falls 15% from its high, get out. No Ifs, Ands, or Buts. Get out.

The world economy is strong.

The Economist
's leader (first story) this weekend is positive:

Despite the rattled markets, the world economy is still relatively strong. Just don't bet your house on it. If you meet a bear in the woods, try not to panic or scream; on no account should you turn your back and run. As markets around the world have turned grizzly over the past two weeks, some investors seem to have forgotten the old hikers' maxim. After three years of big gains, many stockmarkets have tumbled by 10% or more in less than ten days. The loudest growls have echoed around emerging markets and commodities. Europe has surrendered most of this year's gains. Americans have so far escaped lightly, but they would be unwise to take comfort. Their housing market, the recent rock of their economy, is where a much grizzlier creature lies in wait.

Most investors tend to look first at equity markets—and they have certainly had a good run virtually everywhere. Yet a repeat of the slump after the bursting of the dotcom bubble in 2001-02 remains highly unlikely. In 2000 shares were wildly overvalued. Today price/earnings ratios in most stockmarkets are near, if not below, their long-term averages. This suggests that the slide in shares could be short-lived.

So what has caused this burst of volatility? One popular explanation conjures up fears of rising inflation and hence higher interest rates (see article). Yet this sits oddly with the fall in bond yields and the gold price over the past week: if inflation were the culprit, you would expect both to have risen. The real puzzle is not why volatility has suddenly increased, but why it had been so low in the past year or so. The answer seems to be an abundance of cheap money, which lured investors into complacency. Now they are starting to demand higher returns on riskier assets. Emerging-market equities and metals, not (generally safer) bonds, suffered the biggest mauling in the past week. It could be a healthy correction.

A formidable machine

Indeed, the recent jitters need not harm the world economy, which even bears admit has performed stunningly. World GDP has grown at an annualised rate of more than 4% for 11 consecutive quarters (see our economic and financial indicators). This is the strongest upturn for more than 30 years. Yet global inflation remains historically low. Strong growth with mild inflation is all the more amazing given the tripling of oil prices since 2003. Past oil-price shocks have caused stagflation.

The world has so far shrugged off higher oil prices with the help of two powerful economic forces. The first is the opening up and integration into the world economy of China, India and other emerging economies. This has given the biggest boost to global supply since the industrial revolution. Their cheap labour has cut the cost of goods. The threat that jobs in rich economies could move offshore has helped hold down wages. Although demand from emerging economies has fuelled the surge in oil and commodity prices, the newcomers' overall effect has been to curb inflation in the rich world.

That, in turn, has magnified the second stimulus. Since the bursting of the dotcom bubble, central banks have pumped out cheap money. In 2003 average short-term interest rates in the G7 economies fell to their lowest in recorded history. Because inflation remained low, the central banks have been slow to mop up the excess liquidity. Cheap money has encouraged households, especially American ones, to borrow and spend lavishly. It is not just house prices that have surged ahead; cheap money has encouraged investors across the world to take bigger risks, creating several smaller bubbles. Together the huge boost to supply (from emerging economies) and the huge boost to demand (from easy money) have offset the burden of higher oil prices, creating the once-impossible combination of robust growth and modest inflation.

Don't panic

The era of cheap money is nearing an end. For the first time in 15 years, the three big central banks are now all tightening monetary policy. The European Central Bank has already followed the Federal Reserve's lead in raising interest rates; the Bank of Japan has stopped printing lots of money and will start lifting rates soon. Only now are the markets realising that interest rates may rise by more than they had expected. In the long term, rates should be roughly equal to nominal GDP growth, but in America and elsewhere they are still well below it. Optimists argue that America's economy is coping well with rising interest rates, but it hasn't really sniffed tight money yet. Without easy credit, dear oil will cause more pain.

Until recently, financial markets appeared to be betting that the Goldilocks economy—neither too hot, nor too cold—was safe from the bears. The rattled markets are a reminder that sooner or later growth will slow or inflation will rise. Inflation is not about to spiral upwards but with diminishing spare capacity, it could edge up. America has an extra risk because Wall Street suspects that Ben Bernanke, the Fed's new chairman, may be a soft touch on inflation. If that suspicion persists, he will need to raise interest rates by more than otherwise—or investors will do the tightening for him by pushing up bond yields. That would make other assets look expensive.

It is in the American housing market that the bear may growl loudest. By borrowing against the surging prices of their homes, American consumers have been able to keep on spending. The housing market is already coming off the boil (see article). If prices merely flatten, the economy could slow sharply as consumer spending and construction are squeezed. If house prices fall as a result of higher bond yields, the American economy could even dip into recession. Less spending and more saving is just what America needs to reduce its current-account deficit, but for American households used to years of plenty it will hurt.

For the world, it is best that America slows today. Later, imbalances will loom even larger. A few years ago, Japan and the euro-area economies were flat on their backs. Now they are growing “above trend”, so the world depends less on America than it once did. The boost to the world economy from China and India will last into the future, even allowing for mishaps. Wise investors should resist the urge to flee, reduce their holdings of risky assets and stare down the bear.

I screwed up: Alan Gordon, a reader, writes:

I am happy to report to you that you made a mistake in today's (5/25/06) column. ACI - Arch Coal, went from 86 to 45 because they just had a 2:1 stock split, something your chart did not account for.

I was lucky enough to buy it at 80...and it went to over 110, just before the split. But I was stupid enough to hold it as it retraced back down to its current $45. But still, I can't complain. It was my fault - no stop loss. I should have had a 8-15% stop in place.

Now, why am I happy you made the mistake? Because reversing out the 40% loss on Arch should change your Total Portfolio Profit/Loss from a Loss to a nice profit.

Great old fashioned musical. If you're visiting New York, see Pajama Game. Harry Connick, Jr., Kelli O'Hara and the cast of singer/dancers are simply superb.

The Pajama Game. We saw it last night. Was wonderful.

The French Open Tennis begins this Sunday: Set your TiVo -- but don't buy TiVo's stock. Its results of late have been miserable.

French Open Tennis
Time (EST)
Sunday May 28
12:00 pm to 5:00 pm
Monday May 29
5:00 am to 3:00 pm
Tuesday May 30
12:00 am to 1:30 am
Tuesday May 30
5:00 am to 3:00 pm
The June schedule is not up, yet.

Technology breakthrough
A British company is developing computer chips that store music in women's breast implants. This is a major breakthrough since women are always complaining about men staring at their breasts and not listening to them.

Murphy's Law Cousins -- Part 2:
Law of Bio mechanics:
The severity of the itch is inversely proportional to the reach.

Law of the Theater:
The people whose seats are furthest from the aisle arrive last.

Law of Coffee:
As soon as you sit down to a cup of hot coffee, your boss will ask you to do something which will last until your coffee is cold.

Murphy's Law of Lockers:
If there are only two people in a locker room, they will have adjacent lockers.

Law of Rugs/Carpets:
The chances of an open-faced jelly sandwich landing face down on a floor covering are directly correlated to the newness and cost of the

Law of Location:
No matter where you go, there you are.

Law of Logical Argument:
Anything is possible if you don't know what you are talking about.

Brown's Law:
If the shoe fits, it's ugly.

Oliver's Law:
A closed mouth gathers no feet.

Wilson's Law:
As soon as you find a product you really like, they will stop making it.

Have a great weekend. Hug the kids and the grandkids. Do something nice for the spouse. Think of our servicemen and women.

Harry Newton

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.
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