Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Tuesday, May 15: My
new drug of choice is Levaquin. Its specs show it will work better than the
previous one, the Zithromax generic, which did not work on my two-week old "acute
good" -- Part 1. Cumberland Advisors is
a respected firm. They recently did a piece on "Pharaohs Dream."
there come seven years of great plenty throughout all the land of Egypt. And
there shall arise after them seven years of famine; and all the plenty shall
be forgotten in the land of Egypt; and the famine shall consume the land.
-- Genesis 41
OK, we will
stick our neck out right up front: the seven lean years of Pharaohs
Dream are over.
We believe that
the S&P500 will break out to a new all time high and set the stage for
the next upward leg of the US stock market. We believe that the S&P500
can reach 2000 by the second year of the next presidential term (2010) or
sooner. Furthermore, it is the tech sector that will lead this rally after
years of languishing in the NASDAQ bubble aftermath.
a quick summary of the Pharaohs 14 years. We will date them April 1,
1993 to April 1, 2007. First to the Fat years.
During the seven
fat years from end of Q1 in 1993 to the end of the first quarter of 2000,
the Standard & Poors 500 average rose from about 450 to about 1500.
It actually peaked at 1527.46 on March 24, 2000. Including dividends, the
total return for the S&P500 was nearly 400% in those seven fat years.
Since we are
an ETF only manager, we will convert this for you. Suppose you bought SPY
(Spiders) or Barclays iShares, (IVV) on day one and held them for total
return (price change plus dividends) in your IRA. Suppose you did this for
exactly 7 years and then sold them exactly on April 1, 2000.
With the ETF,
you would have achieved that 400% growth in your wealth. In those seven years
you would have had very low cost, tax efficiency and probably outperformed
most of your friends and neighbors.
Now to the lean
The seven lean
years start on March 31, 2000 (actually a week earlier as we noted above).
The markets experienced a substantial decline in the early period. That was
attributed to the NASDAQ bubble bursting, the September 11th attacks and the
recession periods which followed both events. The current stock market recovery
started with the Iraq War in 2003. Some would argue for a date in 2002. The
date is really unimportant. What IS important to note is that the current
bull market has been clawing its way back after the painful 2000-2003 losses.
Those memories have colored investors behavior. They fade gradually.
In the lean
years, the total return (including dividends) of the S&P500 for the seven
years ending on March 31, 2007 is 5.76% according to the Ned Davis database.
By contrast, risk-less US Treasury bills have returned 4 times more than this
stock market index during the same seven year period. US Treasury notes returned
11 times more than the market. Gold has returned 23 times more than the S&P500.
why we believe that the lean years are over and that a big bull move is now
directly in front of us.
oriented measures suggest that the S&P500 has another 30% to 40% of upward
potential in the next few years. We can reach this conclusion a number of
ways. We will examine just one of them.
expected the S&P500 to earn $93 in 2007. The first quarter numbers are
now mostly known. 2 out of 3 of the S&P500 companies are exceeding consensus
earnings estimates. With about 80% having reported we can now draw some powerful
inferences for the entire year of 2007. One of them is that our $93 number
is likely to end up on the low side.
The upward market
movement has been driven by the large cap stocks. These big guys comprise
the heavy weighting of the US stock markets. They are benefiting from the
weaker dollar. They have substantial cash. They are able to borrow cheaply.
Their cost of funds is under 6% before taxation or under 4% after taxes. Using
derivatives (swaps) they can lock in these costs of funds for several years
and they are doing so.
That is why
they are using cash or borrowing to buy back their own stock. It is a bargain
for them. The same applies to the private equity folks. So we have a diminishing
supply of publicly-traded equity which is being financed with cheap debt.
About $600 billion in stock value has been retired or retrenched to private
hands from the public markets. Shrinking stock supply and growing demand from
rising earnings is a recipe for higher prices.
The macro stage
supports our view.
In our slowly
growing low inflation US economy, we can expect the nominal GDP to increase
about 5% per year. That takes the US economy to about $17 trillion in output
by the end of 2010. The largest part of the non-government sector is in services
and is relatively stable. Healthcare, for example, will be nearly 18% of GDP
In such an economy,
we will see about 2%-to-2 ½% inflation. We expect 2 ½% to 3
½% real growth. In that climate, the S&P500 earnings can easily
increase about 7%-to-8% per year. Remember: earnings grow faster than the
economic growth because of the leverage in corporate balance sheets. For US
big cap stocks, this earnings growth is assisted by the international addition
to the US reported earnings. They come from the foreign subsidiaries of these
US companies. And the earnings per share are enhanced by the continuing stock
gets the S&P500 earnings to a $115-to-$120 range by 2010. A 17 price/earnings
ratio easily gets you to 1950-to-2000 on the S&P500 index. That would
still be within an environment of moderate economic growth and moderate inflation.
And we would still be seeing reasonably low interest rates centered on a 10-year
Treasury note yield of around 5%.
No dream here.
We are not attempting to make the case for stocks by excessively valuing the
stock market. Sure, a frothy and exuberant time will come just as it has in
the past. And by then it will suck in the uninitiated as it did 8 and 9 years
ago. We believe that is out in the future and possibly many years away. That
is why Cumberlands stock portfolios are fully invested, worldwide.
There are some
assumptions and readers may, of course, disagree. Here are ours. We are basing
our strategy on them.
We believe that
the worlds financial systemic risk is well contained by the global consortium
of central banks and institutions. Inflation is a risk but it is also high
on the policy makers radar screens. It seems manageable through skilled
application of monetary policy. The housing price adjustment is certainly
under way. But it has not turned into a recession and it is not causing contagion.
The US labor force is more than 95% employed. Workers incomes are rising.
The unemployment rate is decidedly skewed by education. It is under 2% for
college graduates and around 4% for high school grads with some college. Only
those who do not complete high school face a 7% unemployment rate. Is this
a problem? Yes. Does it derail our picture? No.
In sum, the
situation is neither bleak nor excessively frothy. We believe that an investment
policy should be centrist. Simply put, diversify broadly and worldwide. Own
some bonds now that real yields are positive. Keep the bond duration close
to neutral. Maintain what cash reserves are needed for comfort but otherwise
a fully invested strategy will serve best.
Lastly, be aware
that it is the shocks, the extraordinary events, which can sink the positive
outlook. Those shocks can be natural events like bird flu or hurricanes. Or
they can be politically driven like war, terrorism or protectionism. Those
risks always exist. One doesnt reposition a portfolio in anticipation.
Acting BEFORE they occur is a mistake like waiting for Godot. Life and investing
should not be done in a cave.
One can and
should react swiftly if any of the shock scenarios unfold.
good" -- Part 2. Managers and Investors, Well Met by
meeting season, and for many corporate executives that means picking through
picketers, getting a grilling from gadflies, and sizing up snarky shareholders.
afternoon at the Jefferson Hotel in Richmond, Va., quite a different scene
will unfold. There, at the Markel Corporations annual meeting, some
of the nations most contented shareholders will convivially convene.
Owners will hear from managers, managers will hear from owners and the wealth
creation that capitalism can bring to small and big investors alike will be
at other companies who approach their annual meetings with dread, the Markel
managers who will stand before their owners tomorrow have little to fear.
Their financial results are stellar, and their shareholders know that they
are on their side.
Omaha, it isnt Warren Buffett and it isnt Berkshire Hathaway
but its mighty close. Markel, a 77-year-old specialty insurance company
in Glen Allen, Va., has a superb record of conducting business properly and
profitably, of encouraging its employees to create wealth for themselves and
their company and of treating its shareholders like owners not bag
A family company
that first issued stock to the public 20 years ago, Markel has patterned itself
after Berkshire Hathaways insurance companies. It is much smaller, of
course; premiums earned last year were $2.2 billion versus Berkshires
$24 billion, and Markels net worth of $2.3 billion pales next to Berkshires
A niche underwriter,
Markel specializes in insuring complicated risks that larger, cookie-cutter
companies avoid. It is the leading provider of insurance to summer camps,
for example, and also insures horses, day care centers, dance clubs and vacant
property. Any area that gives standard insurance companies heartburn
we want to figure out how to get actively involved in, said Steven A.
Markel, a vice chairman at the company and a grandson of the founder.
That said, Markel
is conservative when it comes to loss reserves, choosing to keep them at levels
that are redundant, not deficient. Sometimes that crimps profits and upsets
quarterly earnings obsessed Wall Street, but Markel is convinced that its
shareholders ultimately benefit from a more cautious approach. The company
does not provide earnings guidance to Wall Street, thereby avoiding the quarterly
beat the number charade.
method handling its shareholders as partners, its customers with esteem
and its investment portfolio with care has produced results. From 1986
to 2006, the companys book value, the best measure of wealth creation,
has increased at a compounded rate of 23 percent annually. And over the last
10 years, the returns on Markels stock investments have averaged 14.3
shares trade at $466, twice its book value. They have more than doubled over
the last five years.
The man in charge
of Markels investment portfolio is Thomas S. Gayner, a value investor
who started out as an accountant but then became a broker and analyst at a
small brokerage firm in Richmond. In 1990, he joined Markel and began burning
up the track; he has generated average annual returns of 17 percent since
then. Mr. Gayner, 45, is also a director at the Washington Post Company.
At the end of
last year, Mr. Gayner oversaw $5 billion in fixed income securities and $1.8
billion in equities. He owns no subprime mortgages, no alternative investments,
no hedge funds.
uncomfortable in crowds, Mr. Gayner said. Back in 1999, we owned
no tech stocks and no telecom. When the market environment gets caught up
in things, generally speaking were not there.
He looks for
companies with four characteristics: profitability; management integrity and
smarts; an ability to reinvest returns on capital; and a fair price. His largest
holdings are Berkshire Hathaway; CarMax, a used-car seller; and Diageo, maker
of Johnnie Walker Scotch, José Cuervo tequila and Tanqueray gin, among
to its investing style, Markel declines to join the crowd in other ways. On
the issue of executive pay, for example, Markels board uses no compensation
consultant and no phony benchmarking process meant to justify higher pay.
A compensation consultant would say we could comfortably double our
salaries and not offend anybody, but whats the point of that?
Mr. Markel asked.
Last year, Markels
top three executives made around $600,000 each in salary, unchanged from the
previous year. Cash bonuses based on the companys performance roughly
equaled the salaries; three of the six named executives received relatively
modest restricted stock awards while the three others received none.
aspect of Markels compensation structure shows up in the employment
agreements with its executive officers. None include the payment of tax gross-ups
to cover the bills generated by parachute payments that are initiated
when a change in control occurs at a company. Such provisions are deplorably
common across corporate America.
Neither do Markels
shareholders have to worry about options backdating scandals at the company.
After all, its hard to have these problems at a company that declines
to dispense stock options.
have some stock options in the late 80s, Mr. Markel said. But
we discontinued them. We felt a stock option was a gift that didnt really
create an ownership mentality.
company provides low-interest loans to help employees buy Markel stock. What
we prefer to do is recruit employees who have a desire to build wealth and
who understand benefits of stock ownership, Mr. Markel said. It
has enabled us to avoid a big part of what has gone wrong at a lot of companies.
So it is not
surprising that Mr. Markel said he and the other executives look forward to
tomorrows meeting with shareholders. This year the company is trying
something new, he said, inviting its top independent insurance agents to mingle
with shareholders. Investors will also be able to interview Markels
product line managers one on one after the meeting, during the cocktail hour.
have about 400 people, Mr. Markel said. Half of them will be employees
who own stock, another quarter of them will be shareholders who bought the
stock 15 to 20 years ago, and another 50 to 100 will be long-term shareholders
who come to town for the event.
Mr. Gayner said
that the company has been blessed with stockholders who are not obsessed with
immediate gratification. Weve done reasonably well, he said,
but when weve had a bad year, weve been pretty explicit
about saying what the problem was and how were trying to fix it rather
than trying to gloss it over. There are no filters, and that has helped build
credibility and trust with shareholders over the years.
past performance may not be prologue, of course. And if this years hurricane
season turns out to be as bad as some in the industry fear, Markel will not
emerge unscathed. But at least its investors know that the company, its managers
and its board are in their corner. And today thats saying a lot.
corrupts. Absolute power corrupts absolutely. Also titled
"How dumb can you be?"
WASHINGTON, May 14 A World Bank committee charged Monday that Paul D.
Wolfowitz violated ethical and governance rules as bank president by showing
favoritism to his companion in 2005. ...
The report charged
that Mr. Wolfowitz broke bank rules and the ethical obligations in his contract,
and that he tried to hide the salary and promotion package awarded to Shaha
Ali Riza, his companion and a bank employee, from top legal and ethics officials
in the months after he became bank president in 2005.
an investment of $36 billion can turn bad. Really bad. Daimler (Mercedes)
paid $36 billion 9 years ago to buy Chrysler. Cerberus Capital Management is
paying $7.4 billion, mostly in the form of capital that Cerberus will put into
Chrysler. Of that sum, DaimlerChrylser itself will receive only $1.3 billion,
and the German automaker said Monday that the transaction will actually result
in a net cash outflow of about $678 million.
In essence, Daimler
is paying to be rid of the troubled Detroit automaker. Chrysler went from being
worth $36 billion to being a liability in fewer than ten years. Amazing stuff.
The prospective father-in-law asked, "young man, can you support a family?"
groom-to-be replied, "well, no. I was just planning to support your daughter.
The rest of you will have to fend for yourselves."
a little boy in church for the first time watched as the ushers passed around
the offering plates. When they came near his pew, the boy said loudly, "Don't
pay for me daddy I'm under five."
The Sunday school teacher asked, "now, Johnny, tell me, do you say prayers
he replied, "we don't have to, my mom is a good cook!"
revenge of the water pistol
when my three-year-old son opened the birthday gift from his grandmother,
a water pistol.. He squealed with delight and headed for the nearest sink. I
was not so pleased. I turned to mom and said, "I'm surprised at you. Don't
you remember how we used to drive you crazy with water guns?"
Mom smiled and
then replied..... "I remember!!"
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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