Most people still don’t know what hit them. They thought they would be safe in Intel. They thought they could hide in Cisco. They didn’t think the granite wall of Microsoft would ever crack below 100, let alone crumble to 90, 80, 70, 60, 50, or – this isn’t happening! – 40 measly dollars per share! The prudent among us didn’t traffic in shooting stars like Scient or Viant or Internet Capital Group, bits and flashes of light that arced long enough to attract and destroy tons of capital. You and I owned the good ones, the solid, long-lasting blue-chip tech, those wonder companies that beat the estimates effortlessly. We bought only the trusted techies that never go down. We thought these stocks were growth annuities that one could buy and forget about, and total up all the gains at year’s end.
Now, as we reflect on the miserable year past, where all the averages dropped single digits, except that mangy Nazzdog, which shed almost 40 percent of its value, we are waking up to the idea that any stock, but particularly any technology stock, has a tremendous amount of risk to it. We are discovering that diversification does not mean buying Compaq and Intel and Sun Micro! Those three turned out to be joined at their sagging hips. On New Year’s Day, it finally dawned on too many people that they may not have been such stock-market geniuses after all. That they were simply bull-market players, that derisive term we professionals apply to jokers who lose more in bad times than they ever make in the good years.
To which I say, relax. Now that I’ve retired from managing a hedge fund, where I could trade in and out of a stock in seconds if I didn’t like the way it drooped on my screen, I am in the same private-investor lifeboat as everyone else. I now have the same longer-term time horizon as you should have.
My new job, finding stocks and, instead of trading them, owning them, challenges me far more than I thought it would. It forces me to think about what will happen to companies three or four more Fed eases down the road. For example, now that the Fed has started letting up on the brakes, it is time to buy the stocks of companies that directly benefit from the lowering of rates: banks, savings-and-loans, and brokerages. And when the Fed really puts its foot on the gas, cutting rates faster and faster, you have to gravitate toward what is known in my business as deep cyclicals – i.e., companies that start doing well after the economy goes into high gear. That’s when you want to be in the paper and chemical stocks, and even the metals. I have to think that far out into the future now, and I’m psyched.
I do so with some degree of contrition, though. From 1996 until the spring of 2000, a tremendous number of you wanted to be me, the gunslinging fund manager, shooting in and out of stocks on a moment’s notice. But when stocks crashed in April, I stopped shooting, while many of you didn’t. Now some of you are out of bullets. Yet this is precisely the moment, at the beginning of the new cycle, when you want to buy and hold and let the Fed work for you. Now the tables have turned: I want to be you. I want to get long and stay there and let the business cycle make money for me.
And in preparation for managing my own finances, I have put together a Survivor’s Guide to this new hard market. I can show you where the bulls still live and the bears prey on senseless online neophytes who are waiting for the next big IPO or the next Microsoft. I can even suggest a scenario for how things just might work out positively this year, exactly the outcome that few professionals expect for 2001.
But first, what can we learn from last year’s fiasco?
We have to address it, because what happened in 2000 may turn out to be less aberrant than we want to admit. So many of us made mistakes, casualties of our own hubris, that we have to learn not to repeat them if we are to remain in the stock market. (For the record, I retired with a plus-35 percent year, so I may very well be worth listening to on the subject.)
One thing is certain: If you traded a stock that did not even exist before 1998, chances are you lost a fortune. You’re probably thinking that the market must be rigged or that you’re just stupid or that you will never, ever be able to get it right again. Guess what: You’re right on all three counts. If you didn’t switch out of the newly minted tech at some point in early 2000, you were stupid. The game was rigged, because most of these companies weren’t seasoned and the callow managements didn’t know what the heck they were doing. And you may never get it right again, at least all by yourself, so perhaps this time you shouldn’t do it all on your own. Which brings us to the first of four hard lessons of 2000.
Doing it yourself is not for everybody. Five years ago, I used to tell anybody who would listen that the Net and all its information would revolutionize stock investing. The Net, and sites like TheStreet.com and its competitors, CBSMarketWatch and the Motley Fool, would serve as your personal Home Depot, where you could get all of the tools you needed to compete with, if not beat, the professionals. To some extent, that happened. You could learn about stocks and execute trades with extremely low commission costs. But just as everyone can’t build a house or wire tricky electrical devices or install a furnace, there are investing tasks that turned out to be too overwhelming and time-consuming for most people.
This conclusion is painful for me, because as someone who encouraged people to go online, I never thought that it would turn into the reckless binge that it became. I never thought that so many people would financially electrocute themselves or shoot one another in the heads with nail guns. But that’s what happened.
It was ghastly. People lost trillions in individual stocks, stocks they might never have bought if they had never gone online and found out how easy it was to trade! They bought stocks with less thought or angst than they picked movies out at Blockbuster. And when the stocks went down, they bought more, because, after all, they were taught to “buy and hold” and to “average down” and to “dollar-cost average.” They were not taught to sell, because every dip is buyable and everything, just like in a good old-fashioned Hollywood movie, works out in the end. Getting blown away by CMGI? Buy more. Extreme Networks got you down? Double up. How can you go wrong buying more Internet Capital Group at the bargain price of $30 if it once traded at $200? Well, how about if it ends the year trading at $3, as it did last year?
And who can blame ordinary investors? The pros made tons of mistakes, too. I have never seen so many mutual-fund managers drop 40 percent of people’s hard-earned capital so fast in my life, many of them household names who should have known better. The brokerage houses were no better. The dot-com dreck never came off the recommended lists until it was too late, and tech remained at the heart of most of their table-pounding because that’s where the underwritings were. And underwritings were where the profits were.
Still, some of the old-fashioned professionals, scorned as fuddy-duddies for dwelling on brutal times past, can teach the amateurs something and must belatedly be given their due. For example, they knew from training and history the value of diversification. Or, in English, you can’t just have a portfolio full of tech stocks, because tech trades together as a monolith, even if it shouldn’t. They could have served as much-needed circuit breakers for some of you do-it-yourselfers who overheated on highfliers.
Talking it over with someone can help. Some of the more harebrained, crazier propositions did get vetted out in the old client-to-human-broker process. My old friend Byron Wien, head strategist at Morgan Stanley, told me four years ago that people would still need to speak with other people before they made investment decisions, if only for a sanity check. But I argued that they would just go directly online. I was right, and he was right. They did do it by themselves, but they should have talked to someone else. Certainly, less capital would have been vaporized if we had simply run more of our investing ideas by others before pulling the trigger.
Investors and traders discovered during the heady days of 1999 and 2000 that if you are making a ton of money in the market, you can guarantee that you will make even more if you just leverage up your account. If you are going to turn $500,000 into $1 million buying stocks, why not borrow $500,000 from the broker and make double that? Brokerage houses issued margin by the billions and the public gobbled it up like popcorn. The loans were cheap, and the collateral, the stocks you owned, was right there in the account. You could borrow $500,000 from a brokerage house easier and faster than Bill Gates could get a $500,000 mortgage from Chase.
The dirty little secret behind the immense profitability of brokerage houses is the credit balance on your account. They loan virtually risk-free if they are prudent about maintaining margin accounts, because they already have your collateral in their possession. It can be sold in a flash with or without you, and I can’t tell you how many people wrote and told me how outraged they were that their positions were simply sold out when they ran afoul of the margin clerk. But they agreed to that sell-out provision from the get-go! The luckiest only gave up 1999’s and 1998’s gains. The unlucky souls gave it all up. That’s what happens when you buy stocks with the brokers’ version of MasterCards.
Margin debt turned out to be the biggest source of woe in 2000. Not only did it infect everyday buyers, but its contagion wiped out a whole officer corps of chief executives who borrowed against their tech stocks to finance their New Economy lifestyles. The top dogs at Safeguard Scientific, PSI Net, Worldcom, and the chimerical Priceline got sold out at the bottom when their margin calls came due. They distinguished themselves as the true goats of the 2000 game. I can personally attest to brigades of millionaires who are now thousandaires because of margin calls. They never thought the markets could go against them, and nobody told them otherwise. Shame on everyone, and, of course, better luck next time, if there is a next time.
In 2000 we learned the virtues of that long-forgotten, old-fashioned asset – maybe you once heard your parents talking about it – they used to call it cash. Somehow, at some point in the past five years, we decided that cash was like some weird form of flesh-eating disease, and as long as we didn’t have any, we were safe in our skins! Mutual-fund managers thought they would lose their jobs if they had cash lying around. Brokers swept accounts regularly to be sure there was no cash buildup – it all had to be “put to work”! Individuals thought owning cash meant they didn’t know what they were doing. Having cash meant you weren’t drinking at the greatest Bacchanalian Bull Bar of all time. Owning bonds, another form of cash if they are short-term (they’re riskier in the long term), also became sheer blasphemy, the equivalent of giving your portfolio a lobotomy. No wonder the ten-year bond turned out to be one of the single greatest-performing investments for 2000. It was the most despised and hooted going into the year! In 2001, we must disabuse ourselves of this notion that cash is terminal. You’re going to want a lot of it around for much of the year.
Finally, we sincerely believed, going into 2000, that only tech stocks were capable of making big money. It was the bizarro version of the classic Peter Lynch method (buying only the stocks of companies we know) combined with a bizarro version of the Warren Buffett method (buying tech “brands,” then holding them or buying more over time). This produced a portfolio of stocks we thought we knew that went down every day beginning in March. And so we bought more. We bought more of the Covads and the Rhythms and the Northpoints because they installed our nifty DSL lines that made us trade faster. We bought more Gateway and Dell because we liked our computers. We bought more Ericsson and Motorola because we liked our cell phones! And we were slaughtered every time.
None of this would have happened if the Federal Reserve hadn’t taken action. Year 2000 had to be the first federally mandated bear market in history. But what’s a Fed to do? We had this glaring lesson of Japan staring us in the face every day, where, in 1989, the most prosperous nation on earth, if we use stock-market valuations, sank into a still-continuing depression that probably rivals that of the thirties in this country. Margin buying was at the root of the Great Japanese Depression. Near the height of their stock-market bubble, earnest Japanese brokers would call me at my hedge fund and say, “We are taking up the railroads tonight; you can buy 30,000 shares of Tokyo Rail at 300 yen and sell it at 350 yen tomorrow.” It was that simple.
“Why bother to even do the trade?” I would joke back. “Just deduct the commission and send me the proceeds.” They wouldn’t even laugh. That’s just what they were doing. So the Federal Reserve jacked up rates six times in succession and raised the cost of anything borrowed. The effect, not clear initially, was to create a most inhospitable climate for renting stocks with borrowed money, which is all that people were doing anyway. You needed to borrow the money to own the hundreds of stocks that traded in the 200s and 300s, and when they fell below the levels where your collateral was safe, you got sold out in a hurry. Because of those hikes, you were forced out of tech with the same gusto with which you dove into it. Anyone who switched from tech to nontech, literally anything nontech, made fabulous money in 2000. Phillip Morris bested all of the Dow stocks. Anything in your fridge or your pantry crushed anything in your personal computer or on the Net. In fact, we had a wild bull market in 2000 in everything from drug stocks and oil equities to the good old utilities and transports. Some of these stocks hit new highs every single day in the last months of the year even as tech stumbled, faltered, and crumbled into oblivion. This was the year when my mother-in-law’s ossified 1967-vintage portfolio, filled with the Niagara Mohawks and the Southern Energys, crushed the sharpies at Putnam OTC Emerging Growth and Pilgrim Baxter.
Then again, who didn’t? And will it be the same in 2001? The year began with a bang as the Fed aggressively eased interest rates. (The interest rates on your credit card won’t come down, but what the banks pay for the money they’re lending you will. And as they make more money, they become freer about lending money, which eventually makes all of us freer with our money … and that is supposed to restimulate the economy.)
So can we stick with those mundane winners of the second half of 2000? Or must we return to beaten-down technology, betting on a revival because the stocks are so darned low now? I wish it were that easy. I wish I could just tell you to plunk your money down on the values that the fourth-quarter selling created.
No can do. Two little problems stop me: earnings and stock price. Put simply, the earnings of technology companies are still plummeting, and the stock prices, if you back out through all of those years of splits, are still much higher than we thought. A stock like CMGI, which might seem so cheap at $5, is really closer to $100 without the splits. That’s an unholy combination of high expectations that must be dashed and high prices that must come down.
Wall Street is a silly place. Analysts will only recommend a stock if they expect up earnings year after year. But the recession in tech is so great that many companies will report negative “comparisons.” These “difficult compares,” as they are known in the business, will give way to the delightful “easy compares” in the second half of the year. That’s when I want to pounce on the group. Patience, another term that was rarely confused with brains during the heady days, may be your best friend when it comes to tech.
So what should we buy now?
How about the stocks that do well whether the economy improves or not? Can we just stick with Pepsi and Phillip Morris and Merck, to name three standouts from 2000? Can’t we continue to ride the United Healthcares and the General Mills’s? Listen carefully.
Now that Alan Greenspan has taken his foot off the brakes and begun to force interest rates down, you want exposure to the stock market. When the Federal Reserve eases, two things occur: The psychology toward investing goes from being absurdly negative to being ridiculously positive, and companies that use short-term borrowed money – banks, auto, and retail – soar. Some of this action had already been anticipated. We saw a surge in the bank stocks, and the lowly retailers roared back into action in the last few weeks of the year.
The auto stocks, crushed by the worst karma I have ever seen in my investing lifetime, will start working again as the Feds get the economy back into gear. I love Ford. And General Motors too, but not with quite the same undying passion.
It’s the financials, though, that really rock when the Fed injects liquidity. As part of my work at TheStreet.com, the place I have retired to, I have decided to link my new portfolio’s fortunes to the fortunes of those people who manage to make money in good times and bad. In financials, that means Charles Schwab and his eponymous Schwab, Hank Paulson at Goldman Sachs, and Sandy Weil at Citigroup. All three stocks seem like must-owns to me here, with only Goldman having sprinted too far to put on a full position. Any sell-off for the great Goldman Sachs, and you will see me buying stock for my personal account.
Retailers come up second after a Fed ease, and this is where I like to go with a mixture of fallen angels and dominant players. Wal-Mart and Target are the dominant ones and make the most sense to me, but the one that keeps attracting my attention is Best Buy. Here’s a former highflier that got decked by the one-two punch of a slowing economy and what seemed to be a stupid-as-wood acquisition of Musicland, which owns the chain of Sam Goody music stores. Everyone knows that we won’t have to pay for CDs anymore because of the Net, right? Let me share something with you. It’s a thought that struck me in the waning days of my hedge-fund tenure. Richard Schulze, the CEO of Best Buy, may be one of the smartest merchants of the past twenty years. I have puzzled and puzzled over his acquisition of all those brick-and-mortar Sam Goody stores and can only conclude that Schulze knows the days of free music on the Net are almost over and wants to position himself as the national CD retailer. I want to join him as a shareholder.
You want cyclicals when the Fed is easing up. These are the companies that need the economy to be strong so their earnings will exceed last year’s benchmarks. Many of these companies, unfortunately, can be owned only for short, sharp bursts of performance, not my new style as a private investor. But if you are willing to be a tad nimble, try on MMM and United Technologies for size. The former just got a General Electric exec who will shake things up terrifically, and the latter has the best cyclical manager in the business, David George, at the helm. If these stalwarts don’t suit you, why not bet with me that Jack Welch tabbed the best man for the job of replacing him and buy General Electric itself, the consummate financial and industrial leader that has done extremely well even when the Fed was fighting the economy? Who knows what kind of numbers Jack Welch can put in his last year on the job with the Fed juicing the economy?
The ideas above could suffice for a portfolio in itself, but let’s put some spice into the mix: high-yield bonds. Everyone from Warren Buffett to Floyd Norris, the sour but sage New York Times columnist, has written positively about those pieces of paper known as junk bonds. The more adventuresome of you can actually pick a diversified portfolio of corporate bonds of the lesser-rated variety – I am drawn in particular to the high-yielding telco paper – but in general I prefer the pastiche method, a high-yield-corporate-bond fund. I don’t want fees weighing me down, so I’m buying the Vanguard High-yield Corporate fund. Better to diversify than to own the one piece of paper the Fed can’t save. And as the Fed cuts short rates, these companies will have much more of a chance to improve their balance sheets and their operations, and their low-grade bonds could become high-grade ones. That’s how you can make good capital gains and get good yields in the meantime. But remember, this only works when the Fed begins easing. You can usually keep it going only up to five months after the first ease. But I think that come fall, once the big gains have been made, you will have to sell these funds.
Finally, there’s room for a little cash here to be deployed when the inevitable sell-off occurs in the drug and health-care stocks, long my favorite groups. Keep your eyes on Pfizer, Merck, and HMO giant United Healthcare for any economic-related declines (i.e., bargains). These stocks drop anytime it looks like the economy is set to roar again. I like them because they have solid businesses that have been handicapped by eight years of potential Democratic political peril. That’s history. HMOs and drug companies plus George W. Bush in the White House equals 52-week highs for these stocks multiple times in 2001.
If you don’t think the Fed is going to cut rates aggressively enough, the best way to hedge your bets is with well-positioned companies like Pepsi, Philip Morris, and General Mills. But these are hedges only, and frankly, I don’t think you’re going to need them.
And how about tech? How about Intel and Microsoft? When do we wade back into Dell and Nortel and PMC Sierra and Nokia? The answer is obvious. When they’re done going down. So does anybody mind if we wait a little longer? Nobody did last year, and it knocked more people out of the game than any sell-off since 1987. You’ll get your chance. But if you feel like you’re just going to jump out a window if you can’t buy more tech now, especially when it rallies, then at least be sensible and stick with stalwarts like Cisco, EMC, and Brocade.
Can 2001 be a terrific year in the stock market?
When the Fed eases, the stock market works. But ever since the Fed made its dramatic move of cutting rates 50 basis points in the first week of the year, skeptics have insisted that it is too little too late and that the aftermath, another quick decline in stocks, proves that the Fed’s moves don’t matter.
That’s nonsense. The Fed has cut rates fourteen other times in the past 50 years. Thirteen times, the market rallied a year later. (The only time it didn’t rally was in 1968, when the Fed offered up only one rate cut, not a whole series, and then immediately started tightening again.) You usually made 20 percent on average twelve months after they began! That’s fantastic.
Put simply: This is the lowest-risk, highest-reward environment possible. You have the Fed – and history – totally on your side. It doesn’t get any better than that. That’s why I insist on finding stocks to buy and own right now, because at the beginning of an easing cycle, the odds are with you. It’s like you’re playing blackjack and you know you’ve got nothing but face cards left in that shoe. That’s when you have to put the maximum amount of money on the table. Stick with a diversified portfolio that includes historic winners, and you will find yourself loving the stock market once again.