Contributed by Bill
Publisher of: The
Fleet Street Letter
TUESDAY, 7 AUGUST 2001
*** Productivity miracle to be 'officially revised away'
today...Market crash risk: high...oooohhh, scary stuff!
*** Cisco steps to the plate - will they make it 15 in a
*** "Financial Whoring" - the world's second oldest
profession...Twilight of the boomers: meaner and more
spartan...and so much more it hurts!
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*** Today's the big day...the world will officially
learn that the productivity miracle - the aegis of the
American economy - was a "sick joke." And that the
chimera of a new era was nothing more than...well,
*** You'll recall that Dresdner Kleinwort Wasserstein
Global Equity Strategist Albert Edwards wrote a note to
his clients on Friday warning them that today, "The U.S.
'new paradigm' will then be officially revised away!"
*** Edwards went on to suggest, "the risks of an equity
crash are high."
*** Longtime DR readers will, of course, be puzzled by
the hullabaloo made out of this story. Aren't these
Dresdner guys a little late to the table?
*** The "news" of the demise of the American miracle
economy has long been hammering away at the market.
Bill, your humbly vacationing editor, penned a dirge for
the New Era on May 5th, 2000 - over 15 months ago. And
whatever information is included in the Bureau of Much
Belabored Statistics report has likely been digested by
a plethora of Wall Street insiders...
*** Our prediction: the "news" will be a dud. Heck, we
might even see a little boost in the markets today.
*** Today too, all eyes are on Cisco...after beating
estimates "by a penny" 14 times in a row, Cisco Systems
will report 2nd quarter earnings...will they too lay a
big fat egg? See Dan Denning's comments in a guest essay
below. But first, let's see what's shakin' on the
Eric Fry reports from New York:
- In the absence of any real news yesterday, several
negative stories from Barron's over the weekend set the
tone for the day's trading.
- Notable casualties of the Barron's onslaught included
GE, Intel and one lesser-known company called
PolyMedica. "Federal investigators are closing in on
PolyMedica, the country's largest provider of diabetes
home-testing kits," reports Cheryl Strauss Einhorn. "A
federal Grand Jury is looking into possible Medicare and
investor fraud at the Woburn, Massachusetts-based
firm..." The stock fell 32% on Monday.
- Concerning General Electric, Barron's writes, "America
will be awash in electric power soon. Bad news for
electric utility stocks - and for GE." The stock headed
south from the opening bell - dragging the Dow down with
it - and finished more than 3% lower by closing bell.
- Lastly, Alan Abelson poked fun at Intel President
Craig Barrett's pronouncement that the worst is over for
the personal computer industry. (Thorough Daily
Reckoning readers will recall that we too, poked fun at
Barrett a couple weeks ago).
- Abelson, citing the work of Fred Hickey, writes,
"...[A]top a 20% decline in June, PC sales were down
25%, year-to-year, in the first week of July, 47% in the
second week of July and 38% in the third week...[T]he
trend is not exactly heartening and, as a matter of
fact, such gosh-darn awful numbers have never been seen
- Intel shares slid almost 4 1/2% on Monday, and many
other semiconductor company stocks suffered even larger
losses. By the time the dust had settled, the Dow had
fallen more than 111 points to 10,401 and the NASDAQ had
dropped 32 points to 2,034.
- Every once in a while, a few female strippers (always
fully clothed) hang out down on Wall Street handing out
invitations to "gentlemen's clubs." There are whores on
Wall Street as well, but they wear suits and ties
(except on Fridays) and vacation in the Hamptons.
- In fact, on Wall Street, the basic job description -
sell self, get money - doesn't change much.
- Financial whoring is nothing new, of course. It is
perhaps the second oldest profession. But it has gotten
a lot of attention recently under the nomenclature:
"conflicts of interest." A wide range of abuse is now
coming to light...the most egregious of which, as we
pointed out last week, was the habit of some Wall Street
analysts to buy certain stocks for their own account
before issuing "buy" recommendations.
- A far more prevalent practice has been the tendency of
many sell-side analysts to issue and maintain buy
recommendations - no matter what - on the companies who
have hired their firm's investment bankers.
- Consider Prudential Securities analyst Nicholas
Heymann. We have absolutely no doubt that he is an
honest and upstanding individual. However, according to
Crain's, Mr. Heymann "keeps a sailboat at the dock of
one General Electric Corp. executive and his Jet Ski at
the house of another. There, he spends July Fourth at a
barbecue swarming with GE execs, many of whom he invites
to an annual bash back at his house in Vermont. The
party also includes some of his clients, who just happen
to be investors in GE stock. No wonder that down on Wall
Street, the highly-ranked stock picker for Prudential
Securities Inc. is considered Mr. GE."
- Crain's writes: "The fact is that for people following
Mr. Heymann's investment advice, his legendary closeness
to his flagship company has come at a troubling cost: an
unswerving predilection for positivism. In the nearly
two decades that Mr. Heymann has followed GE - through
expansions and recessions alike - he has only once seen
fit to downgrade GE from a 'buy,' a decision he
rescinded less than 72 hours later."
Back to Addison in Paris...
*** Okay...so we're not the only ones who think the BLS
unemployment numbers smell funny. Challenger, Gray and
Christmas, a consulting firm, released a private study
that found US businesses cut 206,000 in July - the
highest one-month hatchet job since the firm began
keeping track in 1993. So how come the BLS reports no
rise in unemployment? Well, if you add back in 155,000
uncountable jobs created - the so-called 'bias' factor -
voila! Only 50,000 people hit the dole last month. Not a
noticeable amount; no need to worry.
*** What else..."If you're like the overwhelming
majority of boomers," writes Daniel Okrent in Time
magazine, "your career has hit a brick wall, you haven't
saved enough, your pension is underfunded, your health
is deteriorating, even the medical advances that will
probably extend your life will, in an especially cruel
paradox, mean that later life will be meaner and more
*** "I loathe my generation," writes Joe Queenan, age
50, "we became culturally frozen in time at a very early
age and continue to think of ourselves as trailblazers.
It's completely pathetic."
*** According to The NYTimes, Okrent and Queenan are
purveyors of a new fad among boomers - "literary self-
*** Let me get this straight. On top of saddling the
nation with a mountain of debt, fulminating of the most
excessive stock market bubble in history and abusing the
world with the Bee Gees, we have to spend the next 20
years listening to boomers whine - and call it an art
Yikes...next they'll want something crazy, like
legislation guaranteeing we'll pay for their retirement
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The Daily Reckoning Presents: A Guest Essay in which the
author ponders the impact of red contact lenses on the
chicken farming business.
EVOLUTION, NOT REVOLUTION
By Dan Denning
After the market closes this afternoon, longtime DR
whipping-boy Cisco Systems will report its fourth-
quarter earnings. Analysts expect the company to earn
.02 cents per share.
But what do analysts know? Not much, if they are the
same analysts who did not foresee that JDS Uniphase
would lose $500 million dollars and .30 cents a share
when it last reported earnings.
Granted, seeing into the future is a murky business. We
don't profess to possess the ability ourselves. But
Cisco has valiantly tried to make things easier. It has
beaten analysts' estimates with Cal Ripken-like
consistency. Between 1998 and 2000, Cisco beat analysts'
expectations by exactly one penny, 14 consecutive times.
But don't underestimate Cisco's uncanny talent for
"guiding" analysts to a reasonable facsimile of its
current financial condition. Cisco's 11-year streak of
being in the black ended in May, when they announced
they lost $2.69 billion in their third quarter.
Nonetheless, odds are it'll come in at three cents later
today, come deflation, depression, or outright balance
I could be wrong. Maybe Cisco will take the write-offs
that others in the tech sector have. If it did so, Cisco
would be admitting to what has become embarrassingly
true: many of the companies it has acquired for stock in
the last two years are not worth the paper their shares
are printed on. More likely is that Cisco, like an aging
Hollywood beauty whose jowls have seen firmer days, will
opt for one last vanity pose in front of the Wall Street
As ghastly as things could get, the company has much
bigger problems than appearance. Take reality, for
example. Tech firms are facing a time when it's
increasingly difficult to know where their core
businesses are headed, how fast profit margins are
shrinking, and what their investments in other companies
are truly worth. Wall Street likes to call this a
problem of "visibility." It's another way of saying you
no longer understand what's happening to demand for your
Perhaps what's lacking, though, is a proper perspective.
It's not Wall Street's vision that's poor. It's the
Street's understanding of the impact of technology on
profits. If only Wall Street knew the story of the
chickens with the red contact lenses, their foresight
might be nearly as good as their hindsight.
>From 1910 to 1943, the price of a dozen eggs in America
hardly changed. Egg farmers' costs remained constant.
And as a result, so did profit margins. Margins weren't
good, either. Egg farming was pretty inefficient. It was
considered the job of the farmer's wife. And because
chickens were left to roam the barnyard, they often got
gobbled up by opportunistic dogs.
But from 1943 to 1986, an amazing thing happened. The
real price of eggs, adjusted for inflation, fell almost
80%. This was at the same time that the production of
eggs skyrocketed. Falling prices on higher volume. What
was going on?
The answer is simple. Firms producing eggs saw that
there were profits to be had in incremental
technological improvements. Aptly-named Darwin Farms of
San Francisco is the best example. Darwin Lewis was a
teenager growing up on chicken farm in the 1930's.
In his book, Bionomics, Michael Rothschild tells us the
first incremental improvement in egg farming came when
young Darwin realized moving the chickens into a shed
would enable farmers to find more eggs. Up until then,
farmers searched the farmyard for whatever they could
find. What's more, chicken mortality would go down
because the shed would keep the chickens safe from dogs.
And yields would go up yet again because more live
chickens meant more eggs.
Thus began the commodification of the egg farming
business. Each incremental improvement in the process
led to falling production costs and higher egg
production. The firm that accumulated incremental
changes the fastest always earned a higher profit per
dozen eggs than other firms. And as volumes went up,
prices came down for the consumer.
Today, just one Darwin Farms chicken coop houses 280,000
hens. 160 rows of parallel cages stretch 700 feet.
Rothschild tells us "the rows are arranged in pairs
stacked ten high, and each bank of 20 rows is separated
from its neighboring banks by narrow aisles. Running
along the floor, down the center of each aisle, is a
single rail, and atop each rail sits a rather bizarre
looking contraption - a feed-dispensing robot."
The most stunning improvement? Red contact lenses - for
the chickens. You see, one of the leading causes of
chicken mortality in farms is violence. All hatchlings
at modern chicken farms are debeaked with a hot metal
blade. It keeps violent hens from literally pecking
other hens to death.
But chickens, like Baltimoreans, still kill one another
in confined spaces. Each dead chicken is a profit lost.
And it's also a cost to remove and replace.
It had been known for years that red light made chickens
more docile. They spend less time fighting and clucking
and more time laying eggs. But installing red tints in
plant lighting wasn't feasible. Human beings can't see
in red light well enough to function. And when red
goggles were attached to the chickens, they ended up
getting caught in cage wire and strangling the chickens.
But in 1987, a Boston firm named Animallens, Inc
developed a red contact lens for chickens. Rothschild
reports that "...by using the red contact lenses to
reduce feed consumption and stop pecking battles, Darwin
had found a way to slash costs by about 4 cents per
dozen eggs." This was enough profit for Darwin to
actually buy back his farm from the bank, which had
repossessed it earlier.
As Rothschild points out, cost savings rarely lead to a
permanent profit advantage. In economics, it's known as
the Fallacy of Composition. You think that because you
do one thing differently, it will translate into a
permanently high plateau of profitability over and above
your competitors. But it doesn't work that way.
Your innovation is imitated and the cost savings accrue
to other businesses as well. Gradually, the advantage
disappears. What results for the consumer is an endless
cycle of falling prices...in fact, most products become
commodified over time.
And thus we arrive at the great challenge for today's
technology companies who wish to survive a sea-change in
their business. Will they understand that long-term
business success does not result from having a dominant
physical advantage? Change in technology is rapid. And
physical advantages, no matter how dominant they seem at
the time, are fleeting.
The real truth of the entire New Economy experiment is
that new technology alone does not create permanent
profits. At least, not in any way that investors can
take advantage of over a period of time. Profitable
businesses are built by steadily accumulating small
reductions in product costs over time. Businesses
It's a rare company that can prevent itself from
commodified extinction...even if they do beat analysts
projections by a penny.
The Daily Reckoning
Daniel Denning is the editor of the Daily Reckoning
Investment Advisory. For investment advice consistent
with the ideas in this essay, please subscribe to the
Daily Reckoning Blue Service:
The Daily Reckoning:|
author Bill Bonner
Bill Bonner is,
in spite of himself, a natural born contrarian. Early each morning, Bill
writes The Daily
Reckoninghis take on the financial markets and whats going
on in the worldand sends it off by e-mail before most Americans
alarm clocks have buzzed. Many readers say it's the first thing they want
to read when they get upnot only because it's informative and thought
provoking, but also it's inspiring, in its own quirky and provocative way.
Of course, there's
much more to Bill than his daily market commentary. He's also the founder
and president of Agora Publishing, one of the world's most successful
consumer newsletter publishing companies. Bill's passion for international
travel and big ideas are reflected in the company he's successfully built.
In 1979, he began publishing International Living and Hulbert's
Financial Digest . Since then, the company has grown to include
dozens of newsletters focusing on health, travel, and finance. Bill has
vigorously expanded from Agora's home base in Baltimore, Maryland since
the early 90sopening offices in Florida, London, Paris, Ireland, and
subsidiaries include Pickering
& Chatto, a prestigious academic press in London and Les
Belles Lettres in Paris, best known as a publisher of classical
literature in bilingual editions.