November 2000 Newsletter
Issue Eleven, Volume One

TIME FOR BONDS AGAIN?

By Mike Gasior

Every month I sit down and try to decide the subject for the upcoming newsletter. I have never chosen the topic in advance; thinking that it would always be more spontaneous talking to you about something current in the news. This month is no exception and is the result of some recent speeches I've given. When I began my career in the investment business it was dominated by bonds and I am a tried and true fixed income guy. In the very early 1980's the stock market just plain sucked, and bonds were the place to be. As a brand new broker I was trained early to "cold call" for clients using bonds. Generally I tried to avoid opening new accounts with stocks as they could blow up in your face and lose you a newly acquired client. As a matter of fact, a lot of my opinions about the stock market are driven from my experiences from that time. By now you all know my viewpoint that history tends to repeat itself. Well, this current NASDAQ experience is no exception and there is still more blood to be shed. Before I drive us into that ditch, let me take care of some pending business first.

LEVITT GOES OUT IN A BLAZE OF GLORY

Since our friend Arthur Levitt's tenure is going to end whenever this ridiculous Florida recount is over (never?), it seems as though there are many initiatives he wants to ram through before they change the locks on his office. Last month I talked about Fair Disclosure and how they might prohibit accounting firms from offering consulting services to their clients. Since that issue, it seems as though four of the "Big Five" firms as well as the AICPA have come to an agreement about restricting audit firms from providing certain types of services. The draft of the new rules number some 200 pages and appears as though it should pass through Congress without too much of a battle. I figure if the accounting firms seem to be in agreement with it, then it can't be all that bad for their business. It was reasonably clear that Congress was not very receptive to the original draft the SEC wanted to push through, and that the industry had fought so fiercely. The compromise is most likely something that both sides are pleased to have in order to bring the issue to a close.

Now our friend Mr. Levitt is proposing that public companies be required to disclose when they award large amounts of options to top company officials: i.e.; any granting of options that would significantly dilute shareholders percentage of ownership without seeking shareholder approval. The New York Stock Exchange is already looking into such a requirement, but the NASDAQ isn't. Mr. Levitt says that if the markets don't rectify the situation soon, the SEC will have no choice but to intervene. He also warned that analysts might begin getting a lot closer look as to whether they have a conflict of interest when they recommend a stock on TV, radio or in writing. I don't think most people realize that many firms AND analysts are receiving stock options on companies they have an investment banking relationship with. I do think, however, that they might take anything an analyst says about a stock they had options on with a grain of salt. Truthfully, it amazes me sometimes that there aren't already rules in place to prevent such things. How in the hell am I supposed to trust an analyst who has an equity stake in a company they are recommending? And how could the management of a company reward themselves with a boatload of stock options while they water my holdings down with it all being legal? Both seem stupid and should have been illegal a long time ago. I must agree with Mr. Levitt about these changes.

I did receive one worthwhile note regarding the Fair Disclosure rule however; even though the guy began by calling me "an idiot". He argued that a rule like Fair Disclosure might cause companies to be too cautious about what they say at all, and might even lead some to not say anything. Truthfully I could see some of that happening, although nowhere to the degree mentioned as in Germany and other countries. There companies are allowed to make almost no information available and the investing public is flying blind. That sounds a little too much like an Oliver Stone movie to me. The rule is a good rule and it was a long time in coming. Nothing in life is perfect.

T+1 NOW PUSHED TO 2004

It was a great honor and pleasure to be invited to speak to Citibank's Institutional Trust Conference several weeks ago. I would like to thank them for the invitation and their wonderful hospitality.

In one of the sessions I shared with a Bob Anderson, from the Depository Trust Company, we focused on some of the issues currently facing the markets. I was pleased to hear Bob say that it seemed very likely that the SEC is going to push the date for the United States going to T+1 until June of 2004. This will also come as a huge relief to those of you, who are ultimately responsible for making the changes necessary, to allow it to happen. I encourage you not to waste any time now that you've been given this wonderful gift. This means you basically have 42 months to make dramatic changes in your organization. Don't start screwing off now. I would argue that this is your lucky day.

And speaking of lucky days, I was also the fortunate winner of the long drive contest during the Citibank golf outing. This pales in comparison, however, to the sight of some of my golfing partners losing control of their golf cart and slamming off the cart path, down a hill and landing on an enormous cactus bush. There were a few casualties from cactus barbs as seven of us lifted the cart off the bush to safety. To protect the guilty I won't mention any names, but it was too funny. I thought I was going to pee my pants.

BONDS - THE PLACE TO BE?

Clearly I have admitted my soft spot for the bond market and I recently had the best time speaking to the Bond Market Association at a get-together down in Irving, Texas. I must thank them for having me and I thoroughly enjoyed being surrounded by nothing but fixed income people for a day.

As I sat and listened to some of the conversation in the group sessions, it began to crystallize in my mind that this might be the beginning of a new era for bonds. I don't know exactly where I acquired the ability to see the larger picture when others view of the forest seems to be obscured by all the trees. I hate to keep rubbing my call on the NASDAQ in your noses, but when it went over 5,000 this past March I had to write my newsletter that very day to tell you it was over right then and there. As I write this it currently stands at 2755.34. The level of 5,000 wasn't just overvalue. It was outright stupid. Even my call on Priceline.com two months ago makes me look like Kreskin, yet I don't see why EVERYONE didn't see that coming. Priceline.com reached the point where they were responsible for 4% of ALL airline tickets sold. That is truly amazing and represents an amazing accomplishment. What was stupid was that Priceline.com's market capitalization at the peak was greater than all the major airlines COMBINED!! Now isn't that the stupidest thing you've ever heard in your whole life? Well listen to this next story carefully.

It was the very early 1980's and I was calling on one of my clients who always seemed to have an appetite for tax-free municipal bonds. I had some pretty good looking general obligation bonds yielding somewhere around 9.85% and carrying a AAA rating on them. So I called my client (named Bill by the way) to pitch him these bonds. In the middle of the pitch he stopped me cold and said "Mike!! Do yourself a favor pal. Don't call me again until you have some more of those 10% bonds!! You got me?" Well I figure he's still waiting for me to call (*@!hole that he was) since I never called him again. My point in this story is that we were in the middle of a VERY unusual time of investing history, yet in the middle of that time people had begun to think that was "normal". Well, it wasn't normal. Tax free bonds yielding in excess of 10% was NOT normal. Money market accounts yielding in excess of 20% was NOT normal. And Internet companies without a freaking nickel in earnings having a value in excess of American Airlines, United, Delta and U.S. Airways TOGETHER is NOT normal. Situations like this need to run their course and then end. Now both have. Now we can move onto the "next" thing.

THE NEXT THING

For the past 17 years there has not been a better place to be than in the U.S. stock market. It has been an amazing ride from a Dow Jones Industrial Average below 900 to over 10,000. It has averaged in excess of 15% for this time period, which is remarkable. And now it is over.

Everyone has been force fed these bogus statistics that the stock market returns something like 10% annually over "any ten year period" or some other similar crap. That's not even a lie. It's outright bullshit. Here are the facts:

Dow Jones Industrial Average

December 31, 1964 - 874.10 December 31, 1981 - 875.00

There are 17 years where the average literally didn't move at all and inflation was ravaging the economy. It was those years when almost any asset category outperformed stocks. Obviously, the past 17 years were the years during which stocks were the shining superstars. I beg to offer the idea that things are about to shift once again.

ALL ISN'T ROSEY IN BOND LAND EITHER

Let me begin with a very direct thought: I believe that bonds will outperform stocks in the coming years. I would wager a guess that the next decade might be the decade for bonds to shine. Their decade might be getting off to a bit of a rough start though.

I believe the media and the public always seem to be drawn to the stock market because they view it as sexier and more mysterious. Stocks are hard to predict, occasionally offer spectacular returns, but have always been dwarfed by the size of the corporate bond market.

So far in 2000 there has been $146 billion of stocks offered to investors as compared to the $935 billion in corporate bonds. The largest year ever for bonds was just two years ago when issuers offered up $1.2 trillion of bonds. Remember that the economy has been humming along pretty well for the past 10 years and that there has been an amazing amount of infrastructure being built in the Internet, technology and telecom industries. It was fortunate that there were lenders with money burning a whole in their pockets, willing to lend them the dough. And once again history repeated itself and too much money flowed into mediocre deals. Is this sounding a lot like the real estate disaster of the late 1980's? Yeah. I thought so.

Check out these numbers:

Bond Defaults 1993 - $1.5 Billion Bond Defaults 2000 - $24.7 Billion

When you look at "high yield" bonds right now you will find them yielding nearly 900 basis points (nine percent) more than comparable Treasury Securities. That is an amazing spread to me. It also forecasts to me that the amount of defaults is expected to increase by investors who buy these kind of bonds. This all might be pointing toward is a greater slow down of the economy a bit more than expected by many economists. This would be difficult for the stock market to digest and might result in the averages going quite a bit lower. I could see sometime pretty soon the NASDAQ at or below 2,000 and the Dow dropping to somewhere near 8,000. Perhaps in the next 18 to 24 months. The "flight to quality" that this will precipitate might bring the 30 year Treasury to somewhere in the neighborhood of 4.75% to 5.00%. Not to mention if there is another oil scare somewhere over the horizon.

I know I seem like a nutjob every single month when I send you this damn newsletter but remember I can be pretty scary sometimes. I don't mean to keep giving you a quiz every month, but tell me what all of the following companies have in common:

Cincinnati Bell Conseco Great Atlantic and Pacific Tea Company (A&P) Greyhound J.C. Penny Laidlaw Levi Strauss Manor Care Owens Corning Pep Boys Reliance Insurance Tektronix Tommy Hilfiger Warnaco Xerox

If you guessed that they ALL had debt rated as "junk" then YOU WIN!! Can you imagine that? That list is a who's who of corporate America and they all are now considered "Fallen Angels". My feeling is that the economy might find itself skipping the soft landing we all have been hoping for and head right into some degree of recession. Bad for stocks. Okay for quality bonds and cash.

IN SUMMARY

Bonds will outperform stocks for the next few years. I think maybe as many as ten years.

The NASDAQ has another 700 points to lose......at least.

LOOSE ENDS

One very interesting discussion among my friends at the Bond Market Association was the trading of bonds on the Internet, much the way that we have watched an explosion in that venue in stock trading. I will tell you what I told them; the majority of bonds are sold, not bought. While there might be a marketplace for bonds on the Internet, I maintain that the HUGE majority of bonds will be sold by humans to other humans. In this professional's eyes, any focus of energy to sell bonds on the Internet and AWAY from the traditional channels would be a mistake.

NEXT YEAR

Watch for our year 2001 schedule of seminars throughout the U.S. and Caribbean to be posted at http://www.afs-seminars.com in the next two weeks. We will offer more seminars than ever before including another week in Bermuda in 2001 and a comparable week in Grand Cayman. Please call my office at (860) 347-6568 for details, or check the website at http://www.afs-seminars.com.

http://www.afs-seminars.com

Copyright 2000, Michael Gasior. All Rights Reserved.

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