Technology Investor 

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

Previous Columns
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 bronchitis."

"Feel good" -- Part 1. Cumberland Advisors is a respected firm. They recently did a piece on "Pharaoh’s Dream."

Behold, 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 Pharaoh’s 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.

Here’s a quick summary of the Pharaoh’s 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 & Poor’s 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 Barclay’s 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 years.

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 investor’s 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.

Here’s why we believe that the lean years are over and that a big bull move is now directly in front of us.

Various value 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.

We initially 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 by then.

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 buybacks.

Simple math 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 Cumberland’s 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 world’s 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 maker’s 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. Worker’s 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 doesn’t 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.

"Feel good" -- Part 2. Managers and Investors, Well Met by Gretchen Morgenson.

IT’S annual meeting season, and for many corporate executives that means picking through picketers, getting a grilling from gadflies, and sizing up snarky shareholders.

But tomorrow afternoon at the Jefferson Hotel in Richmond, Va., quite a different scene will unfold. There, at the Markel Corporation’s annual meeting, some of the nation’s 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 celebrated.

Unlike executives 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.

It isn’t Omaha, it isn’t Warren Buffett and it isn’t Berkshire Hathaway — but it’s 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 holders.

A family company that first issued stock to the public 20 years ago, Markel has patterned itself after Berkshire Hathaway’s insurance companies. It is much smaller, of course; premiums earned last year were $2.2 billion versus Berkshire’s $24 billion, and Markel’s net worth of $2.3 billion pales next to Berkshire’s $108 billion.

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.

Markel’s method — handling its shareholders as partners, its customers with esteem and its investment portfolio with care — has produced results. From 1986 to 2006, the company’s 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 Markel’s stock investments have averaged 14.3 percent annually.

The company’s shares trade at $466, twice its book value. They have more than doubled over the last five years.

The man in charge of Markel’s 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.

“We’re 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 we’re 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 other spirits.

In addition to its investing style, Markel declines to join the crowd in other ways. On the issue of executive pay, for example, Markel’s 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 what’s the point of that?” Mr. Markel asked.

Last year, Markel’s top three executives made around $600,000 each in salary, unchanged from the previous year. Cash bonuses based on the company’s performance roughly equaled the salaries; three of the six named executives received relatively modest restricted stock awards while the three others received none.

Another unusual aspect of Markel’s 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 Markel’s shareholders have to worry about options backdating scandals at the company. After all, it’s hard to have these problems at a company that declines to dispense stock options.

“We did have some stock options in the late ’80s,” Mr. Markel said. “But we discontinued them. We felt a stock option was a gift that didn’t really create an ownership mentality.”

Instead, the 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 tomorrow’s 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 Markel’s product line managers one on one after the meeting, during the cocktail hour.

“We’ll 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. “We’ve done reasonably well,” he said, “but when we’ve had a bad year, we’ve been pretty explicit about saying what the problem was and how we’re 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.”

Markel’s past performance may not be prologue, of course. And if this year’s 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 that’s saying a lot.

Power 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.

How 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.

Family support:
The prospective father-in-law asked, "young man, can you support a family?"

The surprised groom-to-be replied, "well, no. I was just planning to support your daughter. The rest of you will have to fend for yourselves."

First time ushers
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 before eating?"

"No sir," he replied, "we don't have to, my mom is a good cook!"

The revenge of the water pistol
when my three-year-old son opened the birthday gift from his grandmother,

he discovered 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 . 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.
Go back.