The Maestro

“I am not the world’s greatest conductor…I am just the only good one.”

Toscanini is supposed to have said.  He was an energetic master of the baton, always in command and an absolute perfectionist.  Slonimsky wrote Toscanini’s ability to communicate with his players and singers was extraordinary and he was affectionately known to them as: “The Maestro.”

It is in the spirit of Toscanini that investors will profit in the coming year. It has taken a Maestro’s verve to excel in order to win in a world of investments where losing money means making money, where one is rewarded for consuming and penalized for saving. Toscanini’s energy is required to profit in a market where risky investments are safe and safe investments are risky. This environment is not necessarily a good or bad one but it does mean profitable investing will be made more treacherous as a result. As an example, Caterpillar recently traded to a 52-week high in spite of the fact that the company’s latest report indicated it has more debt, less profit, less return on equity, less sales as a percent of stock price and the highest price-to-earnings ratio as at any time in the past eleven years.

Toscanini’s penchant for perfection however would be tested with broad market strategies; as there is little in the way of logic and reason by which a perfectionist feeds. Consider that insiders are selling shares as fast as at any time since 1987. Biderman paints the bearish liquidity picture by highlighting a ‘lack of corporate buying and a ton of new offerings.’ Financial sector debt now exceeds $10 trillion, Daughty charges. But it was less than $2 trillion in 1987.

Stansberry illustrates the glacial shift from U.S. homeowners to home-renters:

“…before 1997, around $50 billion a quarter was being borrowed against homes.
Today the run rate is near $200 billion per quarter, or four times more.”

With excellent insight, Newman sliced to the core of the question of why jump-starting the U.S. economy has proved so god awful difficult.

“In 1997, the economy was able to generate a dollar of GDP with less than $3 of private borrowing. Today it takes about $5 of borrowing to generate that same dollar in GDP. And tomorrow? As long as rates remain low, perhaps there’s a chance we continue to muddle through…”

Davis remarked we’ve got this $32 trillion debt bubble out there, and it is as risky as can be. And, yet, rates are plunging, so everything looks manageable. It is true that half of all outstanding mortgages were refinanced in the last 18 months. It is also true we’ve had 2.4 million bankruptcies filed since the economy started up in the fourth quarter of 2001. But, with rates down at these levels, we are managing.

Alas, the Great Toscanini surely must have managed to deliver fine performances amidst less than perfect circumstances; we too will continue to forage among the most profitable pockets in a chaotic economy and seek to continue to deliver a fine performance in the spirit of a “The Maestro.”

Let the Data Do the Talking

Our most current research indicates:

Unless the NYSE’s value falls roughly 5.8% from current levels (using the value on September 15, 2003), the probability of a significant market pullback in the near-term is low, ceteris paribus.

While it is true that there is a better than 1-to-1 probability that the Nasdaq Composite may be poised to give up some ground in the near-term (written in late September 2003), the S&P 500 model provides no signal at present.

To be clear, the formation recorded for the Nasdaq Composite doesn’t always occur at tops, but, when it does, it helps build our confidence in the reliability of the signal, to paraphrase Swerlin. More specifically, heavy shorting of stocks listed on the Nasdaq could prevent said sell-off from materializing.

This data is comforting, to be sure. Nevertheless, the “warning flags” mentioned in our July issue remains. As a conspicuous example:

Comments on Recent Portfolio Management:

With some holdings having been on the books for well over 12 months, we were delighted with the timing of our decision to offload massive treasury debt.  In hindsight, we missed the top of the treasury market by only 10 days – selling May 30 with a market peaking June 13!

We continue to monitor the risk in our portfolios vis-à-vis the broad market.  For instance, on a day when the U.S. market was down ~1.35%, seven of the top twelve positions in all portfolios, we hold, were positive for the day. (Data day: June 23, 2003)

The Jeweler’s Eye

“A penny to spend and a dime for the bank”

John D. Rockefeller famously advised youngsters with this savings ratio. Times change and today’s investor must plot a course for profitability amidst a U.S. Consumer, particularly young consumers, employing the near opposite approach of that of Rockefeller’s.

Bonner calls the American Consumer “the world’s mouth.”

A most conspicuous violator of Messer. Rockefeller’s proposed savings ratio is Generation Y. A study conducted by Harris Interactive suggests that today’s Generation Y (consumers aged 8 to 21) credo would read:

‘A penny to save and a nickel to spend’

If the $211 billion that Generation Y will earn in 2003 would be allocated according to Rockefeller’s advice, the proportion could be graphically represented as follows:

Instead, based on the results of a nationwide survey, this group’s spending and savings will be apportioned as:

According to a NACS report of September 5, 2003, “the study results indicate that youth income is down over the past year, but spending is up.”  ‘This shows that this age group has been willing to forgo savings in order to keep their spending levels consistent,’ said John Geraci, vice president of youth research at Harris Interactive. ‘It is a very optimistic generation, and they demonstrate a great deal of confidence that the economic rebound is around the corner and that good times are ahead for them.’

The question then becomes: What companies stand to benefit from this ‘very optimistic generation’? In one of the more surprising data points contained in the report, only 15% of Generation Y consumers buy online. So ‘playing the internet angle’ is perhaps no more profitable as with adult consumers.

Our research indicates Generation Y spending materializes in electronics/games, retail clothing and entertainment; mostly made in Asia.

A curious and indirect link for investors to gauge the fuel supplying Generation Y’s spending power is: their parents’ financial welfare. For the same report shows “A majority (87 percent) of income for children under age 13 years is parent supplied – either through allowances, asking parents for money, or through money earned from special chores or household work. In contrast, 37 percent of teens’ income and 7 percent of young adults’ income is parent-supplied.
Not surprisingly, teens and young adults rely predominantly on paid jobs for their income.” (per NACS, September 5, 2003)

As explained in the opening section of this report, resistance remains on the path to paying off high liabilities. Yet, these parents have managed to muddle though as of the writing of this bulletin.

At this point, we would like to identify the “sweet spot” for the investor as regards this societal urge for high consumption – parents’ desire to continue to fund the high consumption of their children and their own, for that matter.

As parents intend to fund this spending they will increasingly lean on income from asset backed securities and firms selling income generating investments. Closed end debt and preferred stock represents the former while the latter is served by mortgage investment firms which allow parents to tap into the equity of their residences.

If you permit us to step back from our normally quantitative backed commentary, we have a suspicion that more of these creditors stand to be pushed to the limit and will adjust their financial planning in order to avoid falling through the cracks into the realm of bankruptcy. The behavior we speak of is akin to that of Jimmy Stewart’s character in the Christmas classic “It’s A Wonderful Life.” Moviegoers will recall that his character attempts to use cash value of his insurance policy to cover his financial shortcomings.

Today’s behavior includes tapping out home equity and funding high levels of insurance in lieu of disciplined traditional periodic investment plans.

Case in point, a Congressional Research Service analysis of Census Bureau data in 2001 found:

“50%+ of employees aged 25 to 64 don’t own retirement savings accounts of any kind.”

History tells us markets may extricate excessive debt in one of several methods. Whichever method is utilized, the fact remains the debt will be extricated at some point. Drawing comparison to the Savings and Loan debacle, we have constructed a proposed tracking schedule by which investors could follow a plausible exit for the U.S. economy from a debt laden consumer base.

see the dot.Mom bubble, November 10, 2001

Whatever the final outcome, the U.S. economy eagerly awaits the time when those facing crushing debt and possible bankruptcy can enjoy a ‘Wonderful Life’ and fund spending from current assets rather than future liabilities.

Until that time manifests itself, we have added a good number of insurance companies and quasi-insurance firms to our portfolio mix.

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