Technology Investor 

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 Monday, September 18, 2006: I spent much of the weekend reading deals and saying NO. This gives boredom a whole new meaning. Reasons I gave:
1. Enough allocated there already, i.e. housing.
2. Wrong industry, i.e. telecom.

3. Narrow product line, Just a bit of a solution, not the entire solution. .
4. Insufficient upside.
5. Crazy speculation, e.g. an equity linked note linked to the currencies of Mexico, Brazil, Argentina and Chile. Not exactly retirement money.
6. The "Too Hard Basket" for the management and monies involved.
7. A preference for bike riding, a picnic in the park and an afternoon nap, i.e. Cash is King and it has fewer worries.

Good news. I chucked a lot of paper. My desk feels airy this morning.

I caught up on business reading. BusinessWeek argues persuasively that medical jobs are propping up the economy. Nowhere else (including tech) are providing jobs as health care is. Says BusinessWeek, "Since 2001, the health care industry has added 1.7 million jobs. The rest of the private sector? None."

My conclusion: Without the explosion in medical jobs, we almost certainly would be facing a recession in 2007.

The Hedge-Fund King Is Getting Nervous: The most important weekend article was a Wall Street Journal piece by Susan Pulliam which delved into Steve Cohen's hedge fund world. Two things were significant about the article:

1. That Cohen allowed her to see him. The man is very private and doesn't mess with reporters. Few stories have ever been written about him.

2. The conclusions that he is reaching -- namely the hedge world is changing dramatically and there is a chance -- obviously a serious one -- that several funds will "go off the ledge." You should read the entire piece. Click here. The online piece doesn't include the chart, which I scanned from the printed paper version. Here are some excerpts:

Inside billionaire Steven Cohen's hidden world of massive trading and lavish art. Is the party over? At home with Van Gogh, Gauguin and a skating rink

STAMFORD, Conn. -- It was the kind of day that can give a hedge-fund tycoon nightmares. As stocks fell on the afternoon of June 12, the largest holdings of Steven Cohen's more than $10 billion hedge fund were falling even harder.

Mr. Cohen, whose trading acumen, monumental compensation and sprawling art-laden home had made him a trailblazing star of the hedge-fund boom, watched the carnage unfold on eight computer screens arrayed around his desk. From time to time, he leaned back and rubbed his face. "Oh, boy," he said to himself.

The 20,000-square-foot trading room at SAC Capital Advisors, chilled to 70 degrees to keep traders alert, was hushed. Mr. Cohen, who sits at its center, likes it that way. Phones blink rather than ring. Computer hard drives had been moved off the trading floor to eliminate hum. Rows of traders wearing SAC fleece jackets watched Mr. Cohen nervously, waiting for an order to sell shares.

But Mr. Cohen wasn't budging. Less than an hour before the stock markets closed, Mr. Cohen, biting his nails, compared his sinking stocks to a plunging department-store elevator. "There goes ladies lingerie," he said, to no one in particular. By day's end, his firm had lost $150 million, or 1.5% of its assets -- one of its worst one-day showings ever.

In years past, Mr. Cohen might have sold frantically as the market fell. He had achieved celebrity status in the hedge-fund world, overshadowing such influential managers as George Soros and Julian Robertson Jr., with a hair-trigger approach to trading that was extraordinarily profitable. When stocks appeared to be mispriced, Mr. Cohen would pounce, then he would bail out as soon as they ticked in the right direction. His success had inspired a generation of scrappy Wall Streeters -- some of them with no experience whatsoever handling other people's money -- to open their own hedge funds.

That quick-trading game is now over, says Mr. Cohen. With about 7,000 hedge funds competing for investment ideas, good stock investments are getting more scarce. "It's hard to find ideas that aren't picked over, and harder to get real returns and differentiate yourself," he says. "We're entering a new environment. The days of big returns are gone."

To make matters worse, the stock market, he says, is no longer as forgiving for investors. The tailwind of low interest rates, low inflation and strong corporate profits, he says, has been lost. There are no more easy pickings, he says. ...

Mr. Cohen says he is now making bigger bets and holding the stocks longer. The throng of rival hedge funds could create a dangerous logjam, he says. Mr. Cohen worries that some of his largest holdings are also favored by other hedge funds. A rush for the exit could spell trouble. He says he expects that eventually there will be a sudden and sharp reversal in the stock market -- but he's not worried about that happening this year. "There will be a real decline that may devastate hedge funds that have crowded into the same stocks," he predicts.

"Hedge funds are bigger than they used to be. Their positions are bigger," he says. "I worry that if everyone were to sell, could we get out?"

Hedge funds, private investment pools for institutions and well-heeled individuals, now hold about $1.2 trillion in assets, more than twice what they had five years ago. Fat returns are becoming more elusive. In 2005, the average hedge fund returned 9.3%, below the 11.4% average for the past decade, according to Hedge Fund Research Inc., a Chicago consultant. By comparison, the S&P 500 index returned 7.7% last year. A record 848 hedge funds closed up shop in 2005, many of them hobbled by poor performance, according to Hedge Fund Research.

Mr. Cohen's reputation rests on an investing style altogether different from the buy-and-hold strategy espoused by influential investors such as Warren Buffett. Mr. Cohen believes that by scrutinizing trading patterns of a stock -- by "watching the tape" -- it is often possible to predict how the stock will move in the coming hours or even days. For years, he jumped in and out of stocks -- sometimes without any knowledge of a company's fundamentals, or even what it did. It was akin to picking out rocks in a river by watching the currents swirl around them.

Classic "value" investors such as Mr. Buffett insist that what other traders are thinking and doing is of no consequence to sound investing. Mr. Cohen is his polar opposite. He spends long days at the office in black jeans and worn sweaters, glued to his computer screens as he personally trades upwards of 300 stocks. SAC's trading floor bombards him with information about what's going on in the market. He soaks it all up. His eyes are often rimmed with fatigue.

On a typical day, SAC's trading accounts for 2% of overall stock-market activity. SAC pays securities firms an average of one cent for each share it trades, which adds up to more than $400 million in trading commissions each year, making SAC one of Wall Street's best clients.

For years, the relentless trading was highly effective. SAC Capital Management LP, Mr. Cohen's largest and oldest fund, launched in 1992, has generated an average annual return to investors of 43.5%, after he takes a sizable cut of profits. He and his partners keep 50% of that fund's gains, along with a 3% annual fee, far more than the 20% and 2% charged by most managers.

Mr. Cohen's colossal compensation inspired cocky traders who figured they could do the same, and dismayed others who disdained the frenetic momentum-style investing that underpinned the bull market of the 1990s. His net worth is estimated at about $3 billion, which SAC does not dispute. ...

Although SAC now employs more than 600, Mr. Cohen still spends much of his time at the office trading. By 8 a.m., he is usually planted at his trading station, where he stays glued for most of the day. He monitors stock, bond, commodity and currency markets on his screens and taps out email and instant messages to some of SAC's 225 portfolio managers and analysts, as well as to traders outside SAC. Mr. Cohen's own trading still accounts for 15% of the firm's profits. Portfolio managers feed him investment ideas and fill him in on chatter about what other hedge funds are doing. "He is in the center and cherry-picks the best ideas," says a former SAC manager.

A video camera and microphone stay trained on Mr. Cohen so traders and managers who don't sit nearby can pick up what he is saying and doing, including his frequent sarcastic comments, known as "Steve-isms." Often the traders mimic his trades in their own portfolios. ...

In 1999 and 2000, during the technology boom, SAC generated returns to investors of 68.1% and 73.4%, respectively, and copycat funds began to spring up.

Mr. Cohen and the growing hordes of rapid in-and-out speculators sparked debate. Shareholders who bailed at the first sign of trouble forced companies to focus on short-term performance. When hedge funds bought and sold huge blocks, small investors sometimes got whipsawed -- leaving some with the impression that a mysterious game was being played outside of their view.

Muttering began that fast-trading managers like Mr. Cohen enjoyed an unfair advantage over Main Street investors -- that they were, in essence, playing cards with a rigged deck. The substantial business they brought to Wall Street trading desks, critics speculated, gave them access to morsels of information unavailable to small-time investors -- confidential information about what companies and other investors were planning to do.

As Mr. Cohen's star was rising, some established hedge funds, including Mr. Robertson's Tiger Management and Mr. Soros's Quantum Fund, were losing their luster. They had prospered by making large bets on stocks, bonds and currencies based on deep research. Now they were eclipsed by a new breed of speculators. In 2000, Mr. Robertson returned money to investors, and Mr. Soros scaled back his involvement with his fund.

"The old guard wasn't crazy about me," says Mr. Cohen. "I used to hear it all the time." Some old-school managers disdained any investing that wasn't based on corporate fundamentals. "We were trading more than investing, and people frowned on it," Mr. Cohen says. "They looked at it and didn't want to partake. Finally, they said, 'Shoot. He's making money.' And they started copying me." ...

In the bear market that followed the technology-stock bust, the air of invincibility that had hovered over Mr. Cohen began to disperse. The stock market was tumbling. It was getting harder and harder to make a quick profit by darting in and out of stocks. Eventually, he found himself at a turning point.

The catalyst was an enormous loss. In October 2002, SAC lost $100 million on Tenet Healthcare after it bet that the company's regulatory problems concerning its Medicare pricing weren't as severe as perceived by the market. When Tenet disclosed it had overcharged the government for Medicare services, its stock tumbled to $15 from $50 within days. SAC's flagship fund notched a return of 11.5% in 2002, its lowest annual return ever.

The number of hedge funds was mushrooming, and many were pursuing short-term trading strategies similar to SAC's. To make matters worse, in 2001, the New York Stock Exchange began trading all stocks in one-cent increments, abandoning the fractional system in which stock prices moved in larger increments of 1/8 and 1/16 of a dollar. Mr. Cohen says the change made it more difficult to make money with rapid-fire trading because it got rid of some of the inefficiencies that traders had exploited.

One morning, Mr. Cohen woke up with numbness in his arm. A doctor told him he needed surgery on his neck, and in September 2003, he had a disk removed. After the operation, he says, he briefly stopped breathing. He was saved, he says, after a private nurse he had hired to be in his room noticed the problem.

"I think there was a change after his surgery," recalls Mrs. Cohen, who says her husband "came out and looked at everything differently." Mr. Cohen says he has since grown closer to his siblings, and for his 50th birthday, he and his wife took their first lengthy vacation without their kids.

Over the years, many styles of investing have proven to have finite shelf lives. When too many investors start doing the same thing, that tactic often stops working well.

SAC's difficulties, particularly its ill-fated Tenet investment, led Mr. Cohen to rethink his approach. As he recuperated at home, he says, he decided to move more decisively away from short-term trading. He set up an SAC unit called "Intrinsic" and staffed it with 30 analysts to hunt for longer-term investment ideas. Mr. Cohen began investing in small- and mid-cap companies in the health care, energy and technology sectors.

SAC took a big position in Google Inc., betting that its profits would grow faster than Wall Street expected. The investment, begun in late 2004, netted SAC a $100 million profit. SAC now owns just $11 million of the stock, according to a recent regulatory filing. In January, SAC bet that Arcelor SA, a Luxembourg steel company that trades in the U.S. as American depositary receipts, would be acquired. The wager made SAC $75 million when Arcelor announced on July 7 that it had agreed to be acquired by Mittal Steel Co. NV.

SAC now hangs onto stocks for an average of six to twelve months. That might not qualify as long-term investing to Mr. Buffett, but it far exceeds the norm of several years ago -- often just a few weeks.

The payoff, thus far, has been solid, although not as dazzling as in the boom years. In 2003, SAC's flagship fund yielded 18.1% for investors, less than the 19.6% average hedge-fund return reported by Hedge Fund Research. In 2004, the fund returned 22.9%, far exceeding the 9% industry average, and in 2005, it returned 18%, compared to 9.3% for the industry. Through August of this year, despite the market turmoil that cost the firm $150 million on June 12, the SAC fund notched an 18% return. The average hedge fund was up 7% over that period, while the S&P 500 rose 2.7%. ...

Mr. Cohen concedes that holding investments longer and betting bigger could lead to lower returns. A year ago, SAC told investors the fund was aiming to return between 10% and 15% a year, people familiar with the matter say. ...

Mr. Cohen says he worries about whether SAC's investments are beginning to look like those of any other hedge fund. What's worked for SAC in recent years, he says, may not work going forward.

On June 9, around midday, Mr. Cohen walked off SAC's trading floor and slumped into a chair. The markets had been choppy all week. He was growing more certain that stocks were in for a significant decline, but ventured that it was more than a year away.

"The hedge-fund run is not over," he said. "I think the game is changing, and if it is, I have to react. We won't go off the ledge with everyone else."

Visiting the doctor's office
An 86 year old man walked into a crowded waiting room and approached the desk.... The Receptionist said, "Yes sir, what are you seeing the Doctor for today?"

"There's something wrong with my dick", he replied.

The Receptionist became irritated and said, "You shouldn't come into a crowded waiting room and say things like that."

"Why not? You asked me what was wrong and I told you," he said.

The Receptionist replied; "Now you've caused some embarrassment in this room full of people. You should have said there is something wrong with your ear or something and discussed the problem further with the Doctor in private."

The man replied, "You shouldn't ask people questions in a room full strangers, if the answer could embarrass anyone."

The man walked out, waited several minutes and then re-entered.

The Receptionist smiled smugly and asked, "Yes?"

"There's something wrong with my ear," he stated.

The Receptionist nodded approvingly and smiled, knowing he had taken her advice. "And what is wrong with your ear, Sir??"

"I can't piss out of it," he replied.

The waiting room erupted in laughter.

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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