September 2002 Newsletter
Issue Nine, Volume Three

DROWNING IN A SEA OF FOOLS

By Mike Gasior

Every month many of you write me to ask all sorts of questions. Occasionally I have a little time available to respond to you personally via e-mail, but all too often the question sits in my mailbox collecting dust, but no answers. For a change of pace, I figured I would let the readers dictate the direction of this month's edition. Let me know what you think.

I will pose each question in all upper case letters and then answer them. Without any delay, let's get this show on the road.

THERE IS A FLAWED LOGIC IN YOUR JULY NEWSLETTER. IF, AS YOU PREDICT THE STOCK MARKET WILL NOT MOVE FOR THE NEXT DECADE AT THE LEAST (RETURNING LESS THAN THE 4.5% TREASURY NOTE YIELD) WHY WOULD IT MAKE SENSE FOR SOMEONE 35 YEARS OLD OR YOUNGER TO BUY STOCKS NOW? WHY NOT WAIT A DECADE?

Waiting a decade may seem to be what I am advising, but I have written many, many times that timing the stock, or any other markets, is a suckers game. There are very few people in history who have shown any actual track record for being able to do it.

So my own feeling is that if you have enough time before your retirement you might want to accumulate a boatload of stock over the coming decade (or more) so you will be nicely positioned for the next huge move upward. Keeping in mind, of course, that the next big move may not occur for 10 to 20 more years from now. Already people will read this question and wish they had jumped on that 10 Year Treasury Note with it's 4.5% yield back in July, never mind the 5.5% it was paying back in December when I told you that it would be the best investment you could buy for the next 10 years. That return is already down to around 3.6% and likely going lower still.

My point here is the same as it has been forever. The stock market offers the best return of any investment if you have a long enough time horizon. Don't buy into any of the crap about what the market returns during any 10 year period. These are all lies and I can show you PLENTY of 10 year periods when stocks were the worst investment you could have owned. The Dow Jones Industrials and S&P 500 are still much too high, and the NASDAQ is going to be below 1,000 before you know it...perhaps before I write next month's edition of this newsletter.

I DISAGREE WITH YOUR BLANKET STATEMENT ABOUT REAL ESTATE VALUES. MOST OF THE FLUCTUATION IN HOUSING COSTS BY GEOGRAPHICAL REGION HAS TO DO WITH THE MARKET VALUE OF THE LAND THAT A HOUSE SITS ON. IN MUCH OF THE MIDDLE OF THE COUNTRY, THIS LAND IS MUCH CHEAPER, AND THE COSTS MUCH MORE STABLE. ALL THE AREAS YOU MENTION AS BEING HIT HARD BY THE REAL ESTATE BUBBLE IN THE EARLY 90'S ARE AREAS THAT HAD SEEN A HUGE RUN UP IN HOUSING COSTS ONLY BECAUSE OF THE MARKET VALUE OF THE LAND THEY SIT ON. THE VALUE OF LAND, HOWEVER, APPEARS TO BE MORE VOLATILE THAN THE VALUE OF BRICKS AND MORTAR SETTING ON THAT LAND. THIS IS THE MAIN CAUSE FOR FLUCTUATING HOUSE PRICES. SO IN CONCLUSION, I SUGGEST THAT HOUSING VALUES ARE MUCH MORE VOLATILE IN AREAS WITH HIGHER LAND VALUES. SO A 25% DROP IN PARTS OF THE COUNTRY YOU SPEND TIME IN MAY BE REASONABLE, BUT I WOULD SUSPECT A MORE MUTED DECLINE IN MOST OF THE MIDDLE OF THE COUNTRY WHERE LESS OF THE HOME VALUE IS BASED ON LAND VALUE.

Making it clear that I'm not speaking about this particular question, it does continue to amaze me how easily humans are able to rationalize just about anything. "Yes, I know he beats me but he really DOES love me."

Secondly, the parts of the country that I've "spent time in" during the past 60 days include New England, Southern California, Minnesota, Kentucky, Ohio, Illinois and Missouri. I won't bore you with where I have been in the last 12 months since that would include 25 states.

Real estate values are based upon many things, one of which is certainly the plot of ground it sits upon. Then we must also consider the costs of the building materials, supply and demand as well as the general health of the economy.

Here is my very simple, common sense observation of this recent phenomenon in real estate values:

Housing prices have stretched in almost perfect proportion with interest rate declines. Period. Paragraph.

Someone who could have afforded a $200,000 home where rates were two years ago can now afford a home approaching $300,000. The simple, and perhaps sad fact is that being able to afford something doesn't by any means make it worth what you paid. People were able to afford Yahoo! stock barely three years ago at just over $200 per share and now I can buy all that I would like at something like $10.50 per share. More amusing about the Yahoo! example is that it's probably a better company fundamentally now than it was when the stock was above $200. Go figure.

Never in history has housing cost Americans more of their disposable income than it does right this minute and this recent run-up in values cannot be sustained. While I was generalizing about a 25% decline, I'll stick with my prediction. The actual declines will be higher in some areas and lower in others but the 25% average still seems pretty reasonable.

WOULDN'T PART 2 OF YOUR SEC PROPOSAL GIVE THEM TOO MUCH POLITICAL CLOUT? LIKE SUPPOSE THE HEAD OF THE SEC DISLIKED SOME COMPANY - COULDN'T HE THEN MAKE THEIR LIFE MISERABLE BY AUDITING THEM AD-NAUSEUM?

Yes. I got a lot of responses like this one and my suggestion does seem to fly in the face of my usual "less is more" stance about the government. I think I was just fed up with the hand wringing of the politicians wondering what went wrong. The simple fact is that the marketplace is cleaning up the situation right now by punishing what appear to be dirty companies while rewarding other companies, which seem more forthright in their accounting and reporting.

This current string of scandals will run its course and the market will be better because of them. I heard a fantastic quote from Warren Buffet that I will employ here since I think it's appropriate. "You sometimes don't know how dirty the laundry really was until the rinse cycle." I guess we now know that the laundry was pretty darn dirty, but hopefully we're heading quickly toward the spin cycle.

IT LOOKS LIKE YOUR BUDDY MARTHA STEWART MIGHT ACTUALLY END UP IN REAL TROUBLE AFTER ALL WHICH WILL MAKE YOU WRONG ABOUT YOUR PREDICTION ON HER.

Well I freely admit that no one would like to see Martha in an orange jumpsuit picking up trash along I-95 more than I would, but I really didn't think much would come of this whole ImClone thing. Frankly, I was pretty surprised and very upset that the U.S. Congress even had a hearing about her. With all of the gravely serious things going on in the world today, it makes my skin crawl to think that politicians spent 5 minutes talking about this wench.

I truthfully think she wishes EVERY single day that she could do this one over again considering how little money was actually involved. I'm quoting from my memory here, but I believe she sold a total of 4,000 shares of ImClone stock worth a total of about $277,000 that represented a gain for her of around $40,000. In the context of how much this whole fiasco will end up costing her she must want to go put a gun in her mouth.

On another criminal note, don't think the government is feeling all too cocky about locking up our friend Dennis Kozlowski of Tyco. Sure he seems to have taken Tyco money and paid himself fat bonuses, given himself sweetheart loans and decorated the bathroom with the now famous $2,000 wastebaskets and $6,000 shower curtains. All of that would seem to constitute misappropriations of Tyco funds and would seem like a slam-dunk for the prosecutors. The one small fact that the government needs to remember is that Tyco is a Bermuda based corporation and that Bermuda laws are the ones that govern whether or not these were illegal misappropriations. I make no claim to be any sort of expert on Bermuda corporate law, but I am aware that CEO's are allowed under Bermuda law to make expenditures of up to $250 million without any board approval. This doesn't mean that these things were legal expenditures or that Kozlowski is going to skate in this matter. I'm simply reminding you intelligent readers of my newsletter that things can often NOT be what they appear. Stay tuned on this one.

I WOULD LOVE TO HEAR YOUR OPINION WITH REGARD TO "HEDGE FUNDS" IN SOME FUTURE ISSUE. GIVEN THE NUMBER OF OFFERINGS LATELY (AS A COLLEAGUE OF MINE STATES: "THERE APPEARS TO BE A BULL MARKET IN HEDGE FUND MARKETING."), I WOULD IMAGINE THAT IT WOULD BE A TOPIC OF INTEREST TO MANY PEOPLE.

The hedge fund industry exploded during the 1990's growing from about a $15 billion industry in 1990 to about $500 billion by the end of 2000. The primary reason for this explosion is the fact that hedge fund managers share in the profits of the fund, with the most common split of 80% of profits going to the investors and 20% to the hedge fund managers.

My own logic dictates that we are going to witness a contraction in this industry, and perhaps a sharp contraction because of the decline in various world markets. The large, easy money made by some fund managers during the 90's is already a thing of the past and there will be plenty of managers who close their funds up the moment there is no money to be made, which is already happening.

In the defense of the hedge fund manager, I actually DO think that there is some argument to be made for hedge funds as a vehicle to ride out the stormy seas we are experiencing in the financial markets right now. Remember that the manager doesn't stand to make a dime unless the fund is profitable for the year, which may engender more conservative and fiscally responsible management. Any mutual fund manager who isn't/wasn't fully invested in the markets is likely to find themself getting fired. On the contrary, a hedge fund manager who went to 100% cash earlier this year is looking like the world's biggest hero to his or her investors.

IF YOU EVER FIND YOURSELF AT A LOSS FOR SUBJECT MATTER, IT WOULD BE INTERESTING TO HEAR YOUR OBSERVATIONS ON THE ECONOMIES OF BERMUDA AND CAYMAN, AS THEY ARE SO ENTWINED IN THE US AND INTERNATIONAL BUSINESS ARENAS.

I probably wouldn't have addressed this question, if not for my comments immediately preceding it.

I spend considerable time in both Cayman and Bermuda and have grown to love both places very much and have many friends there. Both of these economies have become financial markets of global proportion in the past decade and deservedly so.

Obviously, any continued decline in the financial markets or contraction in the hedge fund industry will be detrimental to both economies since both are firmly tied to the fate of the markets. Of course there is still tourism, although the two countries have taken a somewhat different path with regard to their enthusiasm about this industry.

During the past thirteen years I have watched Bermuda grow into a financial, banking and insurance powerhouse of global proportion with some of the world's largest and most powerful corporations doing business on the island. There is also now a vast population of Bermudians and ex-pats who are true experts in the machinations of the financial industry. In that same 13-year timeframe I have also witnessed three large, terrific hotels close (Bermudiana, Castle Harbor and The Belmont) and not be replaced. There has been a steady decline in recent years of people traveling to Bermuda for pleasure that continues and little initiative by the government to stem this decline, which is perfectly understandable given the rise of finance as the provider of revenue.

Cayman has been an offshore financial powerhouse for decades and has continued to grow and is now the capitol of the hedge fund industry. There is population of local, and ex-pat individuals who are among the best operations, accounting, audit and administrative personnel in the financial business today. From my own personal observation, the Cayman economy seems to be much more tourism friendly, which may be a nice cushion, should some air leak out of the financial industry.

I am clearly a huge fan of both islands and I hope, one of their biggest cheerleaders as well. Here are some of my favorite places on both:

Favorite Bermuda Hotel - Southampton Princess
Favorite Bermuda Bar - Pickled Onion
Favorite Bermuda Restaurant - Portofino
Favorite Bermuda Golf Course - Port Royal (somebody PLEASE invite me to play Mid Ocean)

Favorite Cayman Hotel - Hyatt Grand Cayman
Favorite Cayman Bar - Royal Palms
Favorite Cayman Restaurant - The Grand Old House
Favorite Cayman Golf Course - What golf course???

I DON'T WANT TO ALARM YOU, BUT I HAVE AGREED IN GENERAL WITH JUST ABOUT EVERY OPINION YOU HAVE EXPRESSED SINCE I HAVE TAKEN YOUR NEWSLETTER, AND APPARENTLY LONG BEFORE THAT AS WELL. JUST TO RELIEVE YOUR ANXIETY, I WILL NOW EXPRESS A DISAGREEMENT. INFLATION IS ALL AROUND US. APPARENTLY THE PRICES OF AUTOMOBILES, APPLIANCES, CONSUMER ELECTRONICS, AND MANUFACTURED ITEMS IN GENERAL ARE STABLE. I DON'T KNOW ABOUT FOOD PRICES, BECAUSE I DON'T DO THE FOOD SHOPPING IN OUR HOUSEHOLD. BLESSEDLY, PRICES OF INEXPENSIVE TO MODERATELY PRICED WINES ARE STABLE, OR EVEN LOWER. (I DO NOT BUY EXPENSIVE WINES, MUCH LESS THE LUDICROUS "CULT WINES" THAT OVER-PAID TECHNOLOGY AND FINANCIAL TYPES BUY AS A FORM OF CONSPICUOUS CONSUMPTION.) HOWEVER, HOUSING AND CONSTRUCTION COSTS ARE OUT OF CONTROL, AND MEDICAL COST INFLATION IS HIGH AND ACCELERATING. IN OTHER AREAS OF THE FAMILY BUDGET THAT ARE MY RESPONSIBILITY, PRICE INCREASES ARE PERVASIVE. ITEMS THAT READILY COME TO MIND ARE POSTAGE, INSURANCE, ORGANIZATIONAL DUES, PROPERTY TAXES, THEATRE TICKETS OF ALL TYPES, ELECTRICITY AND NATURAL GAS, AND I'M SURE MANY MORE ITEMS THAT I WILL REMEMBER OVER THE NEXT SEVERAL DAYS. AFTER FOOLISH TALK ABOUT THE FEDERAL SURPLUSES BEING SO HUGE THAT THE NATIONAL DEBT WILL BE PAID OFF, WE ARE HEADING TOWARD MASSIVE DEFICITS AGAIN. OBVIOUSLY THE CONVENTIONAL INFLATION INDICES AREN'T PICKING UP WHAT I MAINTAIN IS HAPPENING IN THE REAL WORLD, BUT I BELIEVE I AM RIGHT.

You are right. Lots of those things mentioned DO seem to be creeping up in price and many of them do not factor into many measures of inflation including CPI. The fact remains, however, that U.S. and global employers find themselves in a "buyers market" at this moment and feel little or no inclination to pay employees more money. I had a gentleman in a recent seminar mention that employers were going to "have to" start paying more money so that people could keep up with skyrocketing housing costs. My immediate and simple response was to tell him that it isn't his employer's fault that he got himself in over his head with housing.

At this point I resort back to my simple economic fact of life that states that prices cannot continue to increase unless consumers suddenly have more money to spend on these things. The truth is that employers are not, and will not, increase pay very much in the coming years. This means that the price of many of the things mentioned in the question will need to decrease (perhaps significantly) to allow people to afford them. I believe this is the path we will be imminently be following...one of a deflationary nature and it may have already begun in some small pockets of the economy.

YOUR BRAIN TEASER QUESTION WAS TOO EASY FOR ANYONE WITH EVEN SEVENTH GRADE MATH UNDER THEIR BELT. WERE YOU KIDDING THAT IT WAS SUPPOSED TO BE TOUGHER THAN LAST MONTH?

I'll fix that problem in a couple of seconds. I got TONS of e-mails complaining the brainteaser was too easy. Well remember what your Dad always told you; "be careful what you wish for."

A QUICK CONCERT REVIEW

I had a chance to see The Who and The Counting Crows at the Greek Theater in Los Angeles last week from the fourth row and it was GREAT!

To see Pete Townshend and Roger Daltrey at 57 and 58 years old gives me much hope that there is still lots of life left in these bones of mine. The Who did about a 2.5 hour set and younger acts could learn a lot of lessons about what a live show is supposed to look like by watching them. The energy they put out was beyond compare and there are very few groups on earth of any age that could have followed these guys, nor would they have wanted to. If you have the chance to catch this tour in another city, I cannot recommend seeing them enough. Even if you weren't a Who fan, you will be by the time you leave.

THE MOTHER OF ALL BRAIN TEASERS

Well I've had quite enough of your belly aching about how easy these questions have been so I'm swinging back to a tougher (yet fair) question. Here goes:

Only one other word can be made from all the letters of INSATIABLE. What is it?

It may not be the mother of all brainteasers, but I hopefully stepped it up a notch and I'll measure how much complaining I get this month. If you are totally stumped, want to check if you got the correct answer or are a total lazy weasel, follow the following URL to get the answer:

http://www.afs-seminars.com/brainteaser_Sep2002.html

NEXT MONTH

You'll want to tune in for next month's edition to see what my Halloween surprise might be for you. You can probably already sense that it might be a little scary.

http://www.afs-seminars.com

Copyright 2002, Michael Gasior. All Rights Reserved.

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