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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

PARIS, FRANCE 
THURSDAY, 16 NOVEMBER 2000 

 

Today:  Value vs. Momentum...The Law of Perverse Outcomes

*** Greenspan's Fed holds steady course...but "evidence of 
a slowdown mounts..."

*** Margin debt down 16%...with a lot further to go....

*** World markets topping out...will biotechs be the new 
dot.coms?...High Tea at the Savoy...and more...

*** Alan 'Harry Potter' Greenspan met with his little band 
of central banker magicians yesterday. They neither raised 
nor lowered interest rates, as expected. But they didn't 
move to a neutral stance either, which disappointed Wall 
Street, especially the financial stocks.


*** The Fed said that the battle against inflation was not 
entirely over. Meanwhile, "evidence of a slowdown mounted" 
said the Financial Times, "with ... a decline in factory 
output, an abrupt slowdown in stockpiling among retailers, 
wholesalers and factories, and a weakness in the loan 
portfolios of major U.S. banks."


*** Stocks nevertheless managed a modest rise yesterday. 
The Nasdaq gained 27 points. The Dow gained 26. 


*** 1656 issues advanced on the NYSE; 1188 declined. 74 hit 
new highs; 62 hit new lows.


*** Investors are still believe in the power of stocks to 
make them rich...and in the magic of the Fed Chairman to 
make sure nothing goes too seriously wrong. 


*** Abbey Joseph Cohen says "stocks are at their best 
values of the year." This is, of course, undeniably true. 
But the question is whether or not they will be even 
greater values in the months ahead. 


*** The trouble is that stocks are still far too attractive 
to investors. They are still pouring money into mutual 
funds, and still willing to go into debt to buy shares - on 
the theory that capital values will rise faster than the 
cost of credit.


*** Richard Russell reports that margin accounts have 
fallen from their peak of $278 billion at the height of 
Nasdaq mania in March to $233 billion today. But Russell 
cites the work of Dr. Sloan Wilson who said that a bear 
market should reduce margin accounts by 90% - which would 
give us a target of just $27 billion for margin debt when 
stocks are ready to head up again. 


*** Also from Russell: "The Dow Jones World Stock 
Index...has formed a huge top, then...broke sharply below 
its May low. This suggests to me that a world economic 
slowdown is on the horizon... The next U.S. president is 
not going to have a picnic."


*** Oil is at $35.48 after rising 71 cents in N.Y. 
yesterday and dropping back a little in trading in Asia 
overnight. 


*** There was little action in the currency markets. The 
euro still refuses to rise and the dollar refuses to fall.
For now.


*** "We have just not even begun to appreciate the effect 
of biotech on culture and on society," observed Greg 
Blonder in Barron's. "I think we have completely 
underestimated its impact," said the former MIT scientist 
with 70 patents, now a venture capitalist.


*** "Could biotechs become the market's next dot.coms?" 
asks a Barron's headline. Blonder and a lot of other people 
think so. "Since mid-1999," writes Michael Shaoul, Vice 
President of Oscar Gruss & Son, "the biotechs have 
generated impressive gains and, even in the face of the 
market's recent volatility, a number of them remain at or 
near all-time highs, while many of their brethren in other 
areas of the tech universe have been battered."


*** As with the rest of the tech universe, very few 
investors understand what happens on Planet Biotech. But 
they have heard that the new technology may be able to 
perform wonders - such as growing new organs and greatly 
extending the human lifespan. Surely there must be money to 
be made. And since investors are sure that there is a 
fortune waiting for them somewhere ...why not in the 
biotech space?


*** "Nevertheless," writes Shaoul, "the economic value 
being placed on the companies at the center of these 
achievements isn't founded in reality...the group is being 
over-valued on a fundamental basis..."


*** PC makers fell yesterday, while Intel and Micron rose. 
William Fleckenstein comments on the 'disconnect': "It was 
as if they were pretending they were just names, and not 
businesses that make the parts that go into PCs..... In my 
opinion we are not too far away from pre-announcements in 
PC land - probably starting sometime in the next couple of 
weeks. In this quarter, folks are finally going to come to 
the conclusion that PC stocks deserve much smaller 
multiples because it's a terrible business, arguably no 
better than making televisions or some other consumer 
appliance." (see: Things that go bump in the night 
http://www.dailyreckoning.com/body_headline.cfm?id=761)


*** "While the Internet/telecommunications/technology 
bubble is in the process of collapse," writes David Tice, 
"the dangerous real estate bubble is running unabated. The 
Mortgage Bankers Association reported that mortgage 
applications increased almost 6% last week to its highest 
level since June of last year. Considering the historic 
mortgage-lending boom, there should be little surprise that 
home construction remains quite strong and housing 
inflation continues to accelerate in many markets." (see: A 
Truly Extraordinary Financial Environment 
http://www.dailyreckoning.com/body_headline.cfm?id=762)


*** We had a long day yesterday - taking the train over to 
London in the morning and back in the evening. We had 
intended to stay overnight - but the hotels were sold out.


*** Addison had never been to High Tea in London, so we 
continued our meetings at the Savoy (Brown's was booked). 
There is probably some unwritten rule against discussing 
business matters at tea, but the whole experience has 
drifted down market in recent years anyway - as tourists 
from all over the world rush to London's grand old hotels 
to empty their pockets in front of liveried attendants and 
white-gloved waiters.


*** A few tables down from us, two women looked like they 
might have walked right in from Boone's Mobile Estates in 
Upper Marlboro...while at an adjoining table a man who 
looked as though he lived before the introduction of 
mirrors, sat without friends. There was no one to tell him 
that he looked ridiculous and he couldn't see for himself. 


*** But the experience had its uplifting moments, too. On 
the other side of the room, a decrepit man fondled the hand 
a beautiful young woman who reminded me of a Vargas Girl 
pinup. The man - at least 20 years older than I am, and 
probably a half-century older than the woman - gave me hope 
for the future. If something should happen to Elizabeth, 
perhaps I will be able to make a fool of myself too.

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VALUE vs. MOMENTUM...THE LAW OF PERVERSE OUTCOMES


Bryant Gumbel, Tom Brokaw, tennis star Andre Agassi, Miami 
Dolphins owner Wayne Huizenga, NBC President Bob Wright, 
CMGI Inc. Chairman David Wetherell, and Joe Flom of the New 
York law firm, Skadden, Arps, Slate Meagher & Flom. - all 
these men were given an opportunity to buy 'insiders' 
shares of a company called Dreamlife, promoted by Tony 
'Awaken the Giant Inside' Robbins.


What Mr. Robbins awakened inside these movers and shakers 
was the craven little scamp, greed, not a giant of virtue 
and achievement. And he did so by setting off an alarm that 
awoke them with the opportunity to buy a $16 stock for just 
$8. Even given a lock-up period of 6 months in which the 
insiders couldn't sell, this deal had to be what the boys 
on Wall Street would call a 'no brainer'.


Alas, dear reader, contrary to what you may have commonly 
observed, even the absence of brains is no guarantee of 
success in modern America. It is, of course, a big 
advantage, but even near-perfect stupidity and ignorance 
cannot be counted on to overwhelm the Law of Perverse 
Outcomes.


If ever there was a growth and momentum play, Dreamlife was 
it. The company came out of nowhere with nothing and grew 
to be worth hundreds of millions of dollars in almost no 
time. Not only that, but its ownership list included some 
of the most celebrated personalities and heavyweights in 
the nation. Unburdened with a realistic business plan, 
operations, profits or even sales...the stock floated upon 
the steamy expectations of the manic market like greasy 
bubbles on the surface of homemade soup. 


But that was several months ago. Now, the heat has been 
turned down and the price of Dreamlife shares has fallen to 
$3. But even that price fits as awkwardly on the Dreamcast 
business as a white dinner jacket on an Iowa hog. With 
40,000 shares outstanding, it presumes a market 
capitalization for the firm of $120 million. And yet, 
Christopher Byron, Bloomberg columnist and my source for 
this story, says that Chase Manhattan recently refused to 
lend the company a paltry $1.5 million without an outside 
guarantor. 


The reason? Because Dreamlife is a nightmare that is about 
to end. The company is going broke. In 18 months of 
business, it has managed to lose almost $25 million on 
sales of only $28,000. 


The whole affair reinforces our belief in the 
aforementioned Law of Perverse Outcomes. Somehow, sometime, 
somewhere... people get, not what they expect, but what 
they deserve. Things sort themselves out. It all comes 
right in the end. 


Victor Niederhoffer, speculator extraordinaire...until his 
speculations produced such heavy losses that his hedge fund 
went bust...challenged this view in an article that I first 
thought was a joke...and still am not sure about. 


"Why high P/E stocks are good for you" begins the headline.


In the thin air of a bubble market, the helium filled 
stocks with high prices and low earnings, like Dreamlife, 
may rise faster than their denser brethren. But 
Niederhoffer seemed to be making a deeper point - that they 
are 'good for you,' like broccoli or confession.


"Risk pays," wrote Neiderhoffer, reinforcing the absurdity 
of his point and making you wonder why he didn't go broke 
sooner, "and that's why those risky growth stocks will 
always be better for your portfolio than value stocks."


Always? Risk pays when the real risk is over-priced...that 
is, when the danger is exaggerated in the price. Bond 
investors, for example, will find that their high yield, 
junk bonds from Amazon are good investments - if the 
company merely survives longer than the bond market 
expects. By contrast, risk will not pay when it is 
underestimated. If Amazon goes belly-up in 3 years rather 
than the 4 years that bond investors anticipate, Amazon's 
bondholders will discover that particular risk did not pay. 
Dreamlife shareholders seem to be as blind to risk...or 
perhaps, as dull to pain... as Mr. Robbins' firewalkers. 


"Value is back," Niederhoffer continues...perhaps with his 
tongue so far into his cheek that he is in danger of biting 
it off, "at the wrong time and the wrong place - just when 
investors should be loading up on growth and momentum 
plays."


Niederhoffer: "The main reason that growth investing will 
always outperform value investing is that markets pay an 
investor to lend long-term to companies with above-average 
rates of return. That's the process that leads to assets 
being deployed in their best possible uses. And that's the 
process that all stock exchanges show in their films to 
visitors to explain this. But strangely, the message has 
been lost."


No one doubts that investors generally get a return on 
their money from investing...nor even that there is some 
relationship between risk and reward, but that does not 
mean that investors don't occasionally over-invest in risky 
projects, reducing the yield per dollar of investment - and 
do not sometimes misjudge the real risk involved.


Niederhoffer and a colleague studied the returns from 
Nasdaq 100 stocks over the last 3 years. They found, not 
surprisingly, that when the wind picks up - as it did since 
1996 - the Dreamlike fluff flies high. In fact, those 
Nasdaq stocks least freighted with earnings rose most. From 
this he might have drawn the conclusion that the last 3 
years were unusual. Instead, he seems to think that what 
happened between 1996 and 2000 might continue forever - 
that is, that the most expensive companies (per dollar of 
earnings) will forever become even more expensive...a 
hypothesis so unlikely that it ranks alongside classics, 
such as: "I didn't inhale."


"High P/Es are good P/Es," Niederhoffer concludes...and "we 
intend to place some of our hard-earned cash from writing, 
and perhaps a few more from savings, into a little 
speculation on the least value-full of the Nasdaq 100."


If the next three years, are like the last three, 
Niederhoffer may be able to complete a full cycle...from 
genius to fool to genius again. And who am I to say that he 
won't?


But the Rehabilitation of A Speculator could also take much 
longer.


"After a portfolio of growth stocks is identified," said 
Bill Bernstein, quoted in Grants as he put his finger on 
Niederhoffer's LPO problem, "it becomes less profitable 
with time, and after a portfolio of value stocks is 
identified, its profitability improves."


Mass recognition is the last step in a financial cycle - 
before it reverses direction. Thus, not until everyone 
becomes aware that Niederhoffer is a fool will he become a 
genius again. And not until everyone becomes fully 
convinced that the bull market is over, then - it will be 
ready to begin a new climb.


Companies that everyone knows are declining in terms of 
growth and profitability do the obvious thing - they cut 
expenses and hustle for extra sales.


Meanwhile, companies that everyone knows as growth stocks - 
with rising earnings and profits - "become complacent," 
says Bernstein, "and tend to waste capital and decrease 
profitability... Thus, the long-term historical superiority 
of value, with its rising profitability... over growth, 
with its deteriorating profitability."


But Bernstein goes on to make a deeper point. "All 
investments," he says, "...have two return components - the 
investment return and the entertainment return." 


Daily Reckoning aficionados, if there are any, will 
recognize in Dr. Bernstein, a companionable soul. You may 
recall, months ago, that I suggested that dot.com and tech 
investors had a motive other than money. They were 
sacrificing themselves for the public good, I reckoned that 
day, figuring that they were over-investing their money so 
the new technologies would be built out more quickly than 
would be economically sound. They were like the Kamikaze 
pilots of Japan in WWII - caught up in the mass madness and 
willing to go down in flames for the cause. They did so, 
not by reason, but by instinct...so that the rest of us 
would enjoy the fruits of the new tech sooner than 
otherwise.


And at least they could feel good about themselves, even 
superior to the rest of us. With a flashlight of cash, they 
were helping to usher in the New Era.


Bernstein puts it differently:


"The purchase of a bubble stock has a high entertainment 
return, but this unfortunately crowds out most of the 
investment return. Investors accept low investment returns 
on tech stocks, I believe, for the same reason they accept 
low returns form a trip to Las Vegas - they derive 
considerable entertainment from it."


More particularly, growth stocks...even goofy 'growth' 
stocks like Dreamlife...allow investors feel superior. They 
are with it; they get it; they are hip to the New Era - 
forward-looking Digital Men, with modern art on their walls 
and a palm pilot in their pockets.


But it's expensive entertainment. 


Your correspondent,


Bill Bonner


P.S. If the general proposition is correct - that is, if 
things balance out in life...then just as you would pay a 
price for owning attractive growth stocks...you'd expect to 
be rewarded for owning unattractive value ones. This might 
be the same phenomenon that allows buyers of modern art to 
make a profit - they are rewarded for putting up with 
ugliness.


"There are stocks," says Bernstein, "that scare the 
bejabbers out of us, which can be thought of as having 
negative entertainment value, for which we are thus 
rewarded with return in excess of the market."


Tomorrow - some of the most unappealing stocks in America. 
Take these ugly puppies home and they will be your most 
loyal and trustworthy friends...fetching profits for as 
long as you own them.
 
 
 
 
About The Daily Reckoning:
The Daily Reckoning... "more sense in one e-mail than a month of CNBC."  That's what readers are saying about The Daily Reckoning.

Bill Bonner, recognized internationally as a brilliant writer, entrepreneur
and publisher of The Fleet Street Letter, offers you his daily market
commentary absolutely FREE. For the first time, outsiders are getting a peek into his powerful and profitable investment insights. Bill's practical contrarian advice empowers even average investors to protect their hard-earned wealth and achieve amazing gains.

Bonner writes his email letter from Paris, France, each morning --
describing the wacky, wonderful world of investment, politics and everything remotely related. Irreverent. Sharp. Honest. Thoroughly, unabashedly contrarian. It's also among the fastest growing e-letter on the Internet.  It's a brand new service... but it has a distinguished history..

For nearly 62 year, The Fleet Street Letter, the oldest investment
advisory letter in the English language has consistently delivered
invaluable economic and political foresights to savvy investors. Current readers regularly enjoy impressive investment gains even as the market falters. Here's more from his online readers...

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Open your mind with the most stimulating e-mail newsletter that you'll ever read, The Daily Reckoning. To receive this free daily email newsletter click here now.

 
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Last modified: April 01, 2001

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