Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Monday, September 10, 2007: Upstate
New York where we have a country house has had the driest summer in eons --
until Saturday when my wife wished for rain for her newly-seeded lawn. On command,
the skies opened up. Two days later it's still raining. My wife is now worried
her lawn will wash away. There are several obvious morals in this. If God listens
to my wife, how to get my wife to be my conduit? Suggestions welcome.
economically remain squirrely. Which is why I keep saying, "he who has
cash will be king." See below.
pieces worth reading. First from my friend Donald Luskin who runs an investment
advisory consultancy, Trend Macrolytics, with lots of institutions as high-paying
Could Lead to Ugly Inflation Woes
LAST WEEK I made the bold, if not downright crazy, prediction that that the
Federal Reserve would not cut interest rates at the upcoming FOMC meeting
on Sept. 18, despite widespread panic in credit markets.
But then again,
it probably seemed crazy when I said to buy stocks three weeks ago when it
looked like they were going to zero. At this point stocks have recovered half
their losses in this correction, and stand less than 5% below all-time highs.
I still love
stocks here. But as we get closer and closer to the FOMC meeting day, I'm
getting more and more nervous about that rate cut prediction. The expectations
embedded in Treasury bond and fixed income futures markets are clearly calling
for a rate cut in fact, they're screaming for a rate cut. I'm getting
concerned that when push comes to shove, the Fed 's not going to want to disappoint
those expectations, and take the risk of setting off another bout of volatility.
And this morning's
report of four thousand net payroll jobs lost doesn't help my cause very much.
But at the same
time, there's one thing we know for sure: The Fed doesn't want to cut rates.
If it did, it would have cut them already. The simple fact that the Fed is
waiting for the official FOMC meeting speaks volumes. It means expectations
or no expectations, a rate cut is not a sure thing. I can still dream!
So let's do
some scenario modeling. What if the Fed does cut rates, and then again what
if it doesn't?
If the Fed doesn't
cut rates, then an awful lot of people will be surprised, disappointed and
scared. I would think there would be an immediate and severe negative reaction
in stocks, and a general hue and cry that Ben Bernanke isn't half the man
that Alan Greenspan was.
But then I think
cooler heads would prevail. The reality is that Bernanke doesn't really need
to cut rates. The Fed is pumping billions upon billions of dollars every day
into the economy through ordinary open market operations at the existing fed-funds
rate of 5.25%, so no lower rate is really needed.
And if anyone
looks carefully at the real record of Greenspan, they'd realize that Bernanke
has already done more in this panic than Greenspan did in 1998 in the Long
Term Capital Management crisis. Then stocks fell 19.5% before Greenspan cut
the fed-funds rate. In this panic, Bernanke has already cut the discount rate
and stocks never fell even 10%, based on closing prices.
And if Bernanke
hangs tough, I think soon it would be understood as a sign of strength, confidence
and leadership. After the initial shock, I think stocks would quickly recover.
So what happens
if the Fed does cut rates? Because that's what everyone expects, it probably
won't have a lot of impact. If the cut is 25 basis points, then some people
will carp that it should have been more. But other than that, it probably
won't make much immediate difference unless the FOMC puts out a statement
that radically changes the Fed's long-term outlook in some unexpected way.
I would think the news of a cut would be somewhat of a stimulant to stocks.
At least the risk that there would be no cut will be off the table. The Nervous
Nellies out there will understand that Bernanke is on the job.
But at the same
time, I think that a rate cut will have other effects and less benign
ones. In fact, with the market so completely expecting a rate cut right now,
we're already beginning to see some of those effects.
Have you seen
what's happened to the price of gold this week? As I write it's over $700.
Have you seen
what's happened to the price of oil this week? It's up to within a percent
or two of all-time highs.
Have you seen
what's happened to the dollar on foreign exchange markets this week? As I
write it's making new all-time lows.
one word for all that: inflation.
The fact is
that we got into the present credit crisis because of inflation. I know it
hasn't shown up much in the official statistics like the Consumer Price Index,
although that is higher than the Fed would like. But for the last several
years, the Fed has been printing way too much money. So much, in fact, that
banks practically gave it away in you guessed it subprime mortgage
loans, where the borrower barely had to even be alive to qualify.
Now, with the
Fed already injecting billions into the troubled markets every day
even before interest rates are lowered the fires of inflation are being
stoked all over again. The Fed seems to think that the only way out of the
mess that too much money created is to print even more money.
If the Fed does
cut rates, then the problem gets even worse. And if it cuts rates more than
once which is exactly what all the markets and the brand-name Wall
Street economists are predicting then it will get a lot worse. I've
written in this column about inflation often over the last three years. I've
said gold was going to $1,000. If the Fed cuts rates, then I'm going to have
to admit I was wrong.
Then gold isn't
going to $1,000. It's going to $2,000.
And oil is going
to $200. And the dollar is going to collapse against the yen and the euro.
And I think
in their heart of hearts, many members of the FOMC actually know this. That's
the reason I say they don't want to cut rates, and haven't already.
But fear and
temptation are ugly things. Under pressure, the best of us can go against
our better judgment.
I'm still hoping
the Fed will stand tough here. But in case they don't and I have to
admit it's looking like they won't I want to be long gold, oil, energy
stocks, and basic materials stocks.
If the Fed doesn't
cut rates, those are good growth plays anyway. But if the Fed does cut rates,
they're your insurance policies against an ugly inflationary future.
There are some
very smart people on Wall Street. And it's not you or me. One clearly is Steve
Schwarzman, chairman of the Blackstone Group that went public recently and whose
shares have not done well:
Steve wasn't buying his own shares. He was selling them to public investors
and China. The countrys investment arm put $3 billion into Blackstone
as part of the I.P.O. On paper, at least, that investment has been a huge loser:
The value of Chinas stock (which it bought at a slight discount to the
offer price) has fallen by about $840 million in fewer than three months.
Which once again proves the old adage: What is the fastest sure way to a small
fortune? And the answer? Start with a large fortune.
now worth buying at its much cheaper price? For the answer to that, read Andrew
Rose Sorkin's piece in The New York Times:
The Ranks of
the Comfortable Are Still Thinning
BY now, all
of Wall Street understands that the private-equity gravy train has jumped
the tracks. But few seem to realize how ugly the pile-up could become.
With the buyout
market in free fall, lots of attention has focused on a few obvious pressure
points, like which investment banks will rack up big losses on the $330 billion
in debt that they committed to pay for leveraged buyouts over the last year.
For the most
part, though, Wall Street seems to be taking it all in stride. James Dimon,
the chief executive of JPMorgan Chase, said last month that he was comfortable.
Let me offer a more dour view: wide swaths of Wall Street, and many of the
industries that serve it, are in for some serious collateral damage. Not only
has private equity been out of business for the last two months, but that
activity is not likely to resume with any significance soon. And when it does,
it will be at a fraction of its recent peak.
So what does
that mean? For much of Wall Street, a severe case of withdrawal. Forget about
cutting the size of bonuses: lets start really thinking about the possibility
of slashing jobs.
major investment bank in recent years had staffed up its financial sponsors
group which serves private equity firms and many now have
dozens, if not hundreds, of people devoted to the effort of calling on Henry
Kravis every day.
the thing: Mr. Kravis wont have much business going on, so the bankers
wont, either. Even if you redeployed a large number of them to other
activities, many jobs would have to go.
the line, the private equity firms themselves may begin to cut personnel,
or at least stop hiring. That goes against the grain for most private equity
firms, because their limited partners have pressured them to have increasingly
larger staffs, not smaller ones.
Why is that?
Well, it is hard to justify how the 2 percent management fee from a $20 billion
fund thats $400 million for those of you doing the math
is going to be divided among only 50 people. (Yes, if it was evenly distributed,
that would be $8 million a person, which doesnt even include possible
performance fees.) If private equity firms stop hiring, the ecosystem of irrational
compensation packages across Wall Street will also change.
In recent years,
private equity helped artificially inflate the market by hiring talent at
astronomical prices, pushing up pay scales at banks, law firms and hedge funds
anywhere that private equity tried to take talent from. Then there
are the support systems, which may also be taken apart.
management consulting industry: Its a dirty little secret, but most
of the big-name private equity firms had been outsourcing some, if not much,
of their due diligence on deals to firms like McKinsey & Company and the
Boston Consulting Group. The consultants, in turn, built up their own groups
to handle the enormous work flow.
(In case youre
wondering why private equity doesnt do all of its own spadework, heres
another secret: Its cheaper than hiring talent and get this
some of the cost of outside consultants can be charged back to the investors
as a deal expense.)
there go the consultants.
All those starry-eyed
M.B.A.s are in for a shock, too. For the last four years, M.B.A.s
have been clamoring for jobs in the private equity industry. About 11 percent
of Harvards M.B.A. class of 2006 secured private equity positions, up
from 7 percent in the class of 2004. And the number from the class of 2007
is even higher.
That alone should
probably have been a sign of a market top. In any case, the partys over,
and its not clear where all these M.B.A.s will go.
were former bankers who had taken jobs at private equity firms and hoped to
return to the equity shops afterward. Now the door to private equity and banking
and dont forget hedge funds may be shut, too.
damage may keep mounting.
ultimate bellwether: a little company called SeamlessWeb. As an online food-ordering
service used by the major banking houses and law firms, SeamlessWeb does a
brisk business with young analysts who get stuck late at the office. Without
all those buyout deals requiring all-nighters, SeamlessWebs messengers
may not be as busy, either.
who still have jobs may finally get a good nights sleep.
happy stories. From two of my friends:
just bought a house. The
elderly couple used to winter in Florida and summer in New Jersey. They originally
had no real plans to sell it. I was going to rent it from them for a year,
while waiting for the home next door to go up for sale, but then the values
dropped, so I made them an offer. Their son (my "inside man") told
me what minimum offer they would accept from anybody. I got it partially furnished
for $130,000. My CPA hooked me up with a mortgage broker and now Citibank
just approved my loan (5% down, but I don't know what the rate is yet -- the
original rate quote was 6.85%, but I'm sure that has gone up a bit). Not bad,
considering that I went bankrupt in 2003, thanks to my four dud IPOs. Six
months ago, the house was $147,500, so I saved 12%.
I just got a
loan on a what might be a 62-story combination hotel/apartment building. The
lender called me, said they were going out of the mortgage business, but wanted
to close my loan -- if I signed that afternoon. The height of my building
will depend on my being able to buy air rights. I think I got the loan because
I've been in the real estate business for a long time. I'd hate to be starting
up at this time.
Now is not
the time to build a house. Building one is far more expensive than buying.
Trust me on this one.
While the cost
of building goes up, the cost of buying is going down -- perhaps even in tony
towns. From Bloomberg today,
in America's ritziest areas may decline by as much as 11 percent in the next
3 1/2 years, said Mark Zandi, co- founder of Moody's Economy.com, an economic
forecasting agency and unit of Moody's Corp. in New York. The last time these
markets fell was a dozen years ago when the Federal Reserve raised interest
rates seven times in 11 months.
Don't you just
love the precision of Mr. Zandi's prediction? My economics professor once told
me there are three types of economists: Those who can count, and those who can't.
As I've written
before, having a little cash is good thing. Serious bargains are beginning to
appear. Just remember to avoid Wall Street pressures "to put it work."
Which is a euphemism for losing money. Look what happened on Friday. The Dow
dropped 250 points -- nearly 2%.
I continue to
remain unimpressed with home builders, most of whom still represent a great
short. I'm making money on those Toll Brothers shorts I recommended a while
back in this column.
She was in the kitchen preparing to boil eggs for breakfast.
He walked in; She turned and said, "You've got to make love to me this
His eyes lit up and he thought, "This is my lucky day."
Not wanting to lose the moment, he embraced her and then gave it his all; right
there on the kitchen table.
Afterwards she said, "Thanks," and returned to the stove.
More than a little puzzled, he asked, "What was that all about?"
She explained, "The egg timer's broken."
to win a bet
A man from Texas walks into a pub in Ireland and declares "I bet I can
outdrink you with your Guinness. Ten pints in one hour!"
Old Paddy McFierney
goes up to him and says "I'll tink about it" and walks out of the
says the Texan "These Irish think they're big drinkers but he's just a
So, the Texan
sits down to a meal with his wife. An hour later Paddy McFierney turns up again
and says "I been tinking 'bout yer challenge and I tink I'll take you up
So Paddy and the
Texan drink pint for pint and an hour later the Texan is completely under the
table. As he can no longer talk his wife says to McFierney "you sho' beat
him fair and square, but why did you go away for an hour."
"Well I had to go to the pub down the road and drink ten pints to check
I could still do it!"
Okay, a farmer was stranded in freezing weather with a flock of sheep in winter.
He needed to get them to safety in a barn a few hundred yards away. Problem
was the footpath to the barn was blocked due to a tree collapsing under heavy
The only way he
could get them to the barn was by taking them across a neighboring (and not
very friendly) farmer's field which was already like a slippery skating rink
due to movements of said farmer's own sheep.
Our farmer donned
his spiky boots, devised a sled and hauled his flock across the field first
thing in the morning, so as to avoid detection.
However, the other
farmer was already awake and came out of the farmhouse, fists raised, accusing
our friend of trespassing.
trespass," our farmer protested.
on!" said the evil angry farmer, "you can't pull the wool over my
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 .
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