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Safe Is the New Risky

Blue chips—once considered safe havens for widows and other risk-averse investors—are not just battered, they’re down for the count. Blame it on the demise of balance-sheet magic.

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Nothing’s more dangerous these days than the safest stocks of previous generations. The market’s taken apart the stocks of virtually every industry out there once deemed “less risky” or “more prudent” or, to use a truly old-fashioned term, “blue chip.”

Yet we still pretend these stocks have some sort of cachet. You still hear people talking about their safe stocks as if they are somehow immune to the growling bear that has ruled for some three years since the market’s top.

Consider the case of utilities. When you go through your grandmother’s accounts, if she owned any stocks, she most likely had invested in utilities. We thought these firms, which traditionally paid out high dividends, would provide for seniors after they took their last paychecks. Nope. In the past few years, the companies in this industry, gripped by panic over how to keep up with the Enrons, took on staggering amounts of debt and turned into a marauding pack of energy traders. Solid companies like Duke Energy, American Electric Power, and TXU (Texas Utilities) imploded overnight thanks to a diet of loans that now mark them as the riskiest of investments. It was as if the whole industry had gone mad and embraced risk without a moment’s hesitation over who actually owned the stocks and why. (Somehow, Con Edison never got the bug, making it a legitimately safe entry in the most dangerous sector on earth.) These stocks, to borrow from Ralph Nader, are now unsafe at any price.

Or take the phone companies. Ma Bell used to be the ultimate widows-and-orphans stock. It had everything: solid growth, a pristine balance sheet, a bountiful and growing dividend. Now AT&T has the opposite: no growth, a horrid balance sheet, and a dividend that can’t be trusted. In fact, the whole industry’s in trouble. SBC Communications, Verizon, and Bell South have become among the highest-yielding stocks on the New York Stock Exchange, but only because their stock prices have fallen so fast relative to their static dividends. That’s a sign that the dividends may not be safe. Considering that the number of land lines is declining for the first time since the Great Depression, there’s reason not to trust these dividends or the companies’ forecasts, which, with the exception of Verizon, have been far too upbeat in the face of the challenges these companies face. I’d sell them all, right here, right now.

“I used to marvel that anyone pushed anything other than Coke or Bristol-Myers or Heinz. These companies never disappointed. And you weren’t going to see a bottle of Mitsubishi ketchup on the table anytime soon.”

But the lack-of-safety problem extends far beyond traditional utilities. When I got in the business as a broker at Goldman Sachs in the eighties, I always knew I could count on the food and drug stocks to provide steady growth and dividends. In fact, I used to marvel that anyone pushed anything other than Coke or Bristol-Myers or Heinz. Why bother? These companies delivered traditional double-digit growth and never disappointed. And you weren’t going to see a bottle of Mitsubishi ketchup on the table anytime soon.

How wrong did that turn out to be? Nothing’s more hazardous to your financial health today than owning Bristol-Myers Squibb or Schering-Plough, two stumblebums that might have to cut their dividends given their paltry performance of late. I thought that nothing could be worse than the pathetically routine estimate-cutting that Schering-Plough’s shareholders have had to endure—until Bristol-Myers last week admitted it had overstated its sales by $2.5 billion in the past few years. What a fiasco.

Or take Coca-Cola, a stock embraced by Warren Buffett as the ultimate in brand equity. This stock’s been on a sickening two-year slide that is showing no signs of abating. It’s still way too expensive on an earnings basis. Or McDonald’s, which hits a multiyear low literally every day. Even after its decline, I wouldn’t go near it. The stock won’t be cheap until it sells in the single digits—which is where I predict it’ll be any minute now.

Packaged-goods food companies used to be the ultimate in safety. They increased their space in the supermarkets yearly and increased their dividends just as consistently. But Campbell’s and Heinz have recently cut their dividends, as neither has been able to grow the business. Kraft, the spinoff of Philip Morris (now Altria), just reported a quarter so horrid that analysts were screaming at the management during the quarterly conference call, something that often happens in tech but never in this genteel sector.

What happened? Did business just get tougher everywhere? I don’t think so. For some of these industries, like power utilities and the phone business, stupidity on the part of management created the woes. But for the food and drug businesses, I think something else is at work: the end of earnings management. For years, companies in these businesses were able to smooth highs and lows by accounting legerdemain. They borrowed from this quarter and reserved from that quarter to give the market the “smoothness” it wanted so badly. With the accounting scandals of the past few years, though, that sleight-of-hand game has been brought to an abrupt stop. The result is that we see earnings as they are, not as we wanted them to be. And they are lumpy and ugly and inconsistent, just as business really is.

Welcome to the new reality. Stocks, all stocks, are now equally dangerous. The bear market, which began in technology, has now extended to every single sector. Heck, even the oil stocks, which should be rocking with the uncertainties in Iraq, go down every day. In short, the risks of owning stocks are as high as I have ever seen them, and the rewards the least certain. The wounds, self-inflicted or otherwise, are too deep to fix, even with a successfully prosecuted war.

Or, to put it a way even financial neophytes can understand: If you want safety, go buy a bond.


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