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 Monday, October 17, 2005: We have sun in New York. Finally. No more talk of gloom and doom. Until my favorite realist emailed a piece from today's USA Today:

Market bears: Lack of karma spells crash

NEW YORK — As stocks' malaise lingers, Wall Street bears — the doomsayers who often warn of impending price drops — are getting bolder predicting the 3-year-old bull market is near an end.

The bears' outlook, which more optimistic market players often shrug off, appears to be gaining credence. The reason: The obstacles confronting stocks, ranging from rising interest rates to the threat of higher inflation to soaring home-heating costs and debt-choked consumers, keep mounting.

"A mood shift has occurred," notes Woody Dorsey, a behavioral finance expert at Market Semiotics. "The preponderance of known negatives is finally being recognized."

That's reflected in the Dow Jones industrial average, down 4.6% in 2005. Even after Friday's gains, the Dow has lost value in seven of 10 trading sessions this month, is down 2.7% in the fourth quarter and last week notched its lowest close since May 13. The current bull is also aging, now six months older than the median bull market of 2½ years.

Angst is also evident in the gloomy comments issued by bears:

• Tom Au, author of A Modern Approach to Graham and Dodd Investing, pulls no punches: "This is the beginning of the bear market that I have been predicting." His worries include the poor start in October; the fact this is a post-election year, which has historically been a bad time for stocks, including scary sell-offs in 1929 and 1973; and the absence of the bull market for most of 2005.

"The karma of the market is no longer there," says Au, who predicts a serious downturn lasting into 2007. "People are running scared."

• Peter Schiff, chief global strategist at Euro Pacific Capital, used the "C" word, as in market "crash," in a recent missive to clients. Fueling his anxiety: the belief that inflation is a bigger problem than feared, which will force the Federal Reserve to keep boosting interest rates. Higher borrowing costs, he argues, will burst the housing bubble and throw the economy into recession.

Says Schiff, "There is nothing the Fed can do to combat inflation unless they hike rates aggressively."

• Ken Tower, chief strategist at CyberTrader, says another bad sign is the disinterest in stocks. "It's all about supply and demand, and if you've got no demand for stocks, prices are going lower."...

Our lessons:

1. When in doubt stay out.
2. Sell weaker investments. Get more cash.
3. Get stronger selective investments. Be wary. Strong investments today are weak ones tomorow.
4. Say NO more often. Stay away from startups.
5. Some commodities tend to be stronger, when markets are weaker.
Don't panic. No one can predict, even me.

Best of all: we're still alive (despite my weekend tennis losses).

Assuming honesty or not? When you're checking out a potential investment -- doing your due diligence -- you assume the players are honest. This is fundamental. Most people are. But the world has changed. There are huge monies chasing few opportunities. This provides great incentive (and pressure) to create "hot" companies, like Refco, Krispy Creme and my paint company. Remember the paint company? Great technology, lousy management. Turns out management has not paid its employees their salaries or expenses in some time and is encouraging its people to fib to potential investors. Not good.

Do they take your advice? A good measure of whether you want to deal with / invest in a company is whether the management listens to you. I remember hearing a presentation by a company selling software to big banks, including Citigroup and Bank of America. I asked the pitching president how he dressed when visited the banks? He said as he was then dressed -- khakis and open shirt. I asked how his banking clients were dressed -- in dark suits. I suggested he might dress accordingly. He got upset and threw me out of his office. Two years later he went Chapter 11. That was an eggregious example. But the willingness to listen is a key part of my due diligence process. Sadly, most entrepreneurs don't listen. And sadly, most go broke.

Do they WANT to believe? Too much money chasing too few opportunities means that when the "opportunities" come along, the frenzy to grab them means due diligence and skepticism fly out the window. That's how all those nice people got taken for such a gigantic ride by Refco. The nice people include the firm's accountants at Grant Thornton, the savvy dealmakers at Thomas H. Lee Partners who gobbled up the biggest stake in the broker, the experts at lenders like Bank of America (BAC ) who extended big-time credit, the whizzes at Wall Street houses like Goldman Sachs (GS ) that led the firm's IPO two months ago, and the money managers at institutions like TIAA-CREF and Oppenheimer Funds that bought freshly-issued Refco stock.

What's amazing about the Refco fraud/disaster/idiocy is it was there in black and white for all to see. All you had to do was read the Refco paperwork and ask yourself simple questions, like why were two government agencies (not one -- but two) government agencies investigating Refco? Read Sunday's New York Times piece by their talented financial reporter, Gretchen Morgenson:

If Refco Isn't Scary, What Is?

SECURITIES regulators and pundits say that there will be no financial market tremors emanating from Refco Inc., the enormous commodities and financial services firm that, after more than 30 years in business, hit the skids last week. Maybe so, but it seems incomprehensible that a financial domino this big can topple without making a sound. Refco, after all, was one of the largest players in commodities, derivatives and United States Treasury markets, operating in 14 countries and serving more than 200,000 clients.

Financial market tremors or not, there is plenty to be afraid of in the Refco mess. First, of course, is the frightening spectacle of the company's chief executive, Phillip R. Bennett, hiding a personal loan from Refco worth almost half a billion dollars from his shareholders, as described by prosecutors in their suit charging him with securities fraud. Then there is the inability of Refco's auditors or investment banks to notice the repeated shuffling of this loan on and off the company's balance sheet.

Watching a company that went public just two months ago sink from sight is also disquieting, of course.

But scariest of all may be the fact that supposedly savvy institutional investors who are fiduciaries - TIAA-CREF and Oppenheimer Funds, for example - bought Refco's shares in spite of the hair-raising risk factors detailed in the prospectus.

One example was the disclosure that Refco's internal auditors reported two significant deficiencies in its internal financial controls. Refco, for example, lacked "formalized procedures for closing our books." Sounds like a big deal, no?

Refco also said that it was found to be deficient in its ability to prepare financial statements "that are fully compliant with all S.E.C. reporting guidelines on a timely basis."

This is the way investors live now: a financial services company's inability to prepare its own financial statements does not preclude financial institutions from buying its stock.

Wait, there's more. Refco told prospective investors that it was under investigation by both the United States attorney in New York and the Securities and Exchange Commission. The S.E.C.'s inquiry centered on Refco Securities, its brokerage subsidiary, and its chief executive, Santo C. Maggio.

At the time of the offering, the prospectus said, Mr. Maggio was near a resolution of the matter and was ready to accept an order from the commission suspending him from any supervisory duties at the firm for one year. Nevertheless, "while complying with the restrictions of such supervisory suspension, Mr. Maggio would continue to work for us and Refco Securities in his current capacities," the prospectus said.

Isn't Wall Street wonderful? Where else would a chief executive about to be suspended for a year by his regulators keep the top job?

Such nightmare risk factors as those enumerated by Refco might not have been a deal breaker for potential investors if they liked what they saw on its financial statements. But warnings signs showed up there that the sophisticated investors shrugged off.

For example, as of February 2005, Refco Inc. had just $150 million in equity supporting $49 billion worth of assets. That's one thin slice of equity: 0.3 percent of assets. Equity at Bear Stearns by comparison was 3.5 percent of assets last year.

Readers of Refco's offering statement also found that the company had significant - and growing - derivatives contracts, carried off its balance sheet. As of February 2004, those arrangements totaled $69 billion and were made up of currency contracts, swaps and options. In February 2005, the contracts totaled $127.5 billion, and in May they stood at $150 billion. Given that Refco admitted to difficulties in preparing its financial statements, how confident could a prospective investor be in the company's ability to track the value of these contracts?

The company's capital expenditures of $14 million last year also seem ludicrously low. This is a company that has to manage information for hundreds of thousands of accounts, and as a serial acquirer of companies, was integrating many new systems into its own. All this would require sophisticated financial management systems.

Compare Refco's capital expenditures with those of Lehman Brothers, for example. Lehman spent $400 million on capital expenditures in 2004, or 3.4 percent of net revenues. Refco's $14 million in capital expenditures last year represented 1 percent of net revenues.

Neither did Refco's buyers seem to question why the company's chief financial officer, Robert Trosten, left the firm last October, just a few months before his company was to go public. Mr. Trosten was in line for a big payday on the underwriting, as other Refco executives were. The fact that he was willing to leave "to pursue other financial interests" might have made an alert investor wonder. And what about Refco's inability to find a new chief financial officer for two months? No problem.

Don't bother us with details. We are, after all in the anything-goes era where shareholders condone excessive executive compensation, accept massive dilution of their holdings from stock option grants and cheerfully buy into the corporate spin that masks operational realities. Why is it a surprise that investors chose to ignore the warts hidden in plain sight in Refco's prospectus?

Unplug your appliances. Going away for a weekend? Unplug your largest appliances -- especially those which work with remotes. Remember those appliances have to be ON to respond to the remote.

$580 millon for what? News Corporation has paid $580 million to buy, "a social network" used allegedly by 33 million teenagers. Go there and be amazed. It's total junk.

Why Join MySpace? asks their site. Five reasons:
» Create a Custom Profile (your name, your hobbies, your photos, etc.)
» Upload Pictures
» Send Mail and IM's (instant messages)
» Write Blogs & Comments
» It's FREE!

Commenting on

"We have become an atomized, alienated culture, and what people are looking for is a sense of community," said Jesse Kornbluth, former editorial director of AOL and now the editor of, a Web-based culture service. "Part of the attraction of the online community is that it is the place where the nerd can get the girl. In no other space does the witty, chess-playing nerd trump the football captain."

Harry's Prediction: will be dead within five years. It's a total fad. Congratulations to the owners for selling out at the right time.

This morning's news:

Treasury Secretary John Snow and other top American economic officials on Monday urged China to move faster in market-opening and currency reforms, laying out guidelines they said would make the country wealthier and more stable, while also reducing its huge trade surplus.

The headline on the story reads "U.S. urges China to reform economy."

Maybe I'm missing something. But what conceivable right does the U.S. have to lecture China? We run a gigantic Federal government deficit and a huge trade deficit. Were it not for China's buying our treasury bills, our interest rates would be much higher and our inflation would be rampant. How would you like to be lectured by a big brutish bully -- what many countries perceive us now as.

Favorite old Chinese proverbs
+ Virginity like bubble, one prick, all gone.
+ Man who run in front of car get tired.
+ Man who run behind car get exhausted.
+ Man with one chopstick go hungry.
+ Man who eat many prunes get good run for money.
+ Wife who put husband in doghouse soon find him in cat house.
+ Man who drive like hell, bound to get there.
+ Man who live in glass house should change clothes in basement.

Recent column highlights:
+ How my private equity fund is doing. Click here.
+ Blackstone private equity funds. Click here.
+ Manhattan Pharmaceuticals: Click here.
+ NovaDel Biosciences appeals. Click here.
+ Hana Biosciences appeals. Click here.
+ All turned on by biotech. Click here.
+ Steve Jobs Commencement Address. The text is available: Click here. The full audio is available. Click here.
+ The March of the Penguins, an exquisite movie. Click here.
+ When to sell stocks. Click here.

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. That money will help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
Go back.