– A reprint of our February 2000 Commentary
Quite often, when one of my Texan friends really wanted to make a point, he would say that something was “Strong as Mary’s Breath.” I would find his point to be very difficult to misconstrue or be quickly forgotten. Sort of like Cormac McCarthy’s lesson about wolves and kids.

There is no question that the tech stocks were as “Strong as Mary’s Breath” in 1999 and in the early part of the still New Year. The vast majority of the stock market indices around the world were also on the plus side in 1999 with many recording new highs to close out the 20th Century.

However, more stocks were down in 1999 than up. The major U.S. indices were misleading again in 1999 as in 1998. For example, 63% of the stocks listed on the New York Stock Exchange were down in 1999 as were 52% of the Nasdaq stocks. Thirty stocks in the S & P 500 accounted for 100% of its gain, meaning the remaining 470 stocks produced no gain.

The International Herald Tribune’s 1999 year-end Business/Finance section began with the headline: “In a Year of Records, Most U.S. Stocks Fell — Internet Stars Obscured the Overall Picture.”

We are witnessing markets where stocks trade at unheard of valuations. Many well-known analysts from major brokerage firms are raising target prices on their stocks without raising their earning forecasts. Recently we noticed an analyst’s Buy recommendation on a large, well-known stock that had already exceeded his target price. His rationale was that, although the stock had exceeded his price objective by, I believe, about 15%, there was a “possibility” of some type of merger that could lead to an even higher market price.

On December 8th Yahoo!’s stock price increased 25%, as the company became part of the S & P 500 index. In dollar terms Yahoo’s market value rose to $91.6 Billion versus $73.9 Billion the previous day — a $17.7 Billion increase! — for that reason alone. All we can say is Yahoo!!!

Euphoric valuations are hardly the preserve of the Internet. Fifteen technology stocks are today worth more than the entire market a decade ago. All stocks put together are worth a record 172% of U.S. economic output, more than double the level before the 1987 plunge” according to the January 18th Wall Street Journal. Now that’s “Strong as Mary’s Breath!”

We admit to having misjudged the prices people have been and continue to be willing to pay for many tech, biotech and internet stocks. It’s little consolation that old hands such as Warren Buffet, Alan Greenspan and Merrill’s Charles Clough, to name but a few among legions of Value Investors, are also befuddled by present market Valuations. Value is out, and the New Paradigm is in!

We are enthusiastic without reservation about the medical and technological advances that are occurring right now and that will occur in the foreseeable future. The problem for the investor, however, remains how best to play the game as Investing today is, after all, an exercise in Game Playing of the highest order. There have been, are and will be extraordinary rewards coupled with extraordinary risks.

In the olden days when the president of a company would enthusiastically tell us how great business was and that the company was operating on three shifts in order to keep up with demand, we would occasionally visit his company’s parking lot at two or three in the morning and count the cars. If the lot was full, management was probably telling the truth. If not, we would look for a different investment. That type of fundamental analysis is now Jurassic Park. In the latter 1990’s and 2000 a great deal of investment analysis consists of looking at the monitor and playing “Last one out is a rotten egg!”

Hindsight has become and will continue to be a more valuable financial marketing tool than ever. Stock and financial service vendors will proclaim Victories interminably on television and in the print media while the sheep that have been shorn will move on with hardly a whimper.

A suggestion: If you feel compelled to inquire about a stock’s valuation, you probably cannot afford it. This advice also applies to companies where the name and stock symbol are known, but its basic business is not. Leave those for the Momentum Players.

In addition to the subject of Valuation one must consider the subject of Volatility. Today we are witnessing both Valuation and Volatility extremes that have never been seen before. Prior to and since the beginning of the New Year, both the stock and bond markets continue to be extremely volatile.

A good friend of ours relates that trading volatility has reached the point where neither he nor other New York Stock Exchange members can go out for lunch. The New York Stock Exchange Luncheon Club must resemble a nursing home these days — until after the close when the members might partake of an adult beverage or two or, on occasion, three.

The Nasdaq has a record sell off one day and regains virtually all of its losses the next day. This Volatility continued in December as frenzied speculation in the tech and biotech stocks continued to the very last day of 1999. Extreme volatility has continued unabated in both stocks and bonds so far in 2000.

Several months ago the 30-year Treasury traded at a price to yield 6%. Its yield quickly rose to 6.40%, a very sharp move in a short period. Subsequently it traded back down to 6%. On January 20th the 30-year Treasury provided a yield of 6.75%, its highest level since June 1997 — two and a half years ago. Yesterday, February 2nd, it had fallen to the 6.33% level and traded down to a 6.06% yield this morning. Meanwhile 2-year, 5-year and 10-year Treasury bonds now provide higher yields than the 30-year Treasury as the yield curve has “inverted,” meaning bonds having shorter maturities now provide higher yields than many longer term bonds. This is another subject for another day.

A reminder: Mr. Market does not like higher interest rates although he may be a bit slow to register his dissatisfaction.

The American economy looks a bit like Goldilocks after she went to a beauty shop and came out even more beautiful. All this while Japan is struggling to jump-start its economy and while those watching the economies of France, Germany and other important European players are cautiously optimistic. France has even reduced its workweek to 35 hours in order to stimulate employment. Guess how that will work.

Meanwhile the Euro is extraordinarily weak as it trades around 0.97 to the U.S. dollar versus its beginning rate on January 1, 1999 of 1.17 to the U.S. dollar. And the U.S. worries lest the dollar becomes too strong against the Euro and the Yen.

A little trivia never hurts as we recall the old saying that “Good Things Happen to Good People.” On January 10th, when America Online announced it would merge with Time Warner, Time Warner’s stock soared 40% and Ted Turner became $2 1/2 Billion wealthier on the day. It is also noteworthy that on December 15th Bill Gates’ net worth exceeded the total worldwide value of the Ford Motor Company. Once again we are reminded of the Strength of Mary’s Breath.

In summary: It is entirely possible that 2000 could be another good year. Divergence in stock valuations creates investment opportunities. We are looking for financially sound growth companies that do not have a casino-type risk associated with their stocks. We are optimistic concerning investment opportunities in 2000 with the caveats that interest rates do not dramatically increase and that more stocks begin to have realistic valuations relative to those that trade in the stratosphere. The most important caveat of all, however, is the one that is unknown.

AT THE MARGIN (not in order of importance)

– February 1, 2000 marked the unprecedented 107-month U.S. economic recovery.

– The Core Rate of Inflation for 1999 was 1.9% — the lowest rate of inflation for the 32 years since records were kept. The Consumer Price Index for 1999 was 2.7%.

– The November U.S. Trade Deficit in goods and services rose to a record $26.5 Billion with a projected deficit for all of 1999 at $270 Billion — another new record.

– On January 18th Margin Debt was reported to have increased by 25% in the last two months.

– Russia: According to the International Monetary Fund, $15 Billion of capital was taken out of Russia in 1999 alone (IHT 1/31/99). Mr. Stanley Fischer, a director of the IMF said in a conference in Davos, Switzerland, “he thought it unlikely that a $4.5 Billion portion of an IMF loan package for Russia would be disbursed before Russia held its presidential elections in March.” Meanwhile, George Soros, also in Davos, called for the IMF to withdraw completely from Russia, and said the West could no longer influence events there. He said: “I increasingly think that the political developments are moving in the wrong direction and that the IMF should pull out. Meanwhile, the Russians continue to beg for more billions.

– US debt is approximately $5.6 Trillion while the face value of all derivatives contracts outstanding at the middle of last year was $92 Trillion or almost 16 ½ times total US debt.

John W. Hamilton
February 3, 2000 — reprinted February 25, 2002