Pir Sahib on Wall Street (Part –1)

On October 24th we had the pleasure of listening to some very wise and insightful people share their views on the state of our financial markets at “Valuefest 2002,” the Fall Investment Conference, in New York, sponsored by Grant’s Interest Rate Observer. James Grant, the conference host, is a widely respected old hand who’s penetrating eye is never shy to see right through the ‘emperor’s new clothes.’ This year the conference hall was overflowing. By contrast, back in 1999, as astute observers pointed out, there were less than half as many present.

One of the featured speaker’s, Ravi Suria of Duquesne Capital, a soft spoken and brilliant fellow, was to reveal his findings about America’s cherished corporate icon, General Electric. The title of his talk was, “GE Capital: fact, fiction and book value.”

When it was Suria’s turn, Jim Grant took to the podium instead and informed us that there was a last minute cancellation. “It is a sad reflection upon our times,” Grant began, as he went on to explain what he had just learnt. Earlier in the day, Jim elaborated, word went around Wall Street that GE’s shares were expected to come under pressure because Ravi Suria was talking about the company before Grant’s conference. The powers that be at Goldman Sachs and Morgan Stanley put pressure on Suria’s employer, Duquesne Capital, with the result that Ravi called Jim and expressed regrets at his inability to make the scheduled appearance.

We wonder why Ravi Suria was coerced into silence? If all is as well at GE as the suits in the brokerage houses would have their clients believe, what was the need to pull such strings? We cannot help but mull over such questions. That night we stayed up late and kept wondering.

Some days earlier, an old friend from school who is an eye specialist in Saudi Arabia, we call him ‘Pir Sahib,’ had phoned to say he was in the country on business and that if we would like to catch up, he had a day to spare. We were off to attend the Grant’s conference but we urged him to meet up with us in New York, so he did. His visit afforded us the luxury to indulge the paranoid feelings we have about our coming blindness. We freely sought his professional opinion while marveling at the vibrancy of downtown Manhattan, strolling along Wall Street and Broadway.

Walking in front of the Stock Exchange, Pir Sahib told us that droves of individual investors in Saudi Arabia, who were honest, hard working and well paid professionals, had collectively lost vast amounts of capital in the US equities market.

This was a very common story even here in America, we assured Pir Sahib. We wondered, though we did not say it aloud, why the clever Saudis blindly trusted the US equities market? They, of all people, should have known better. We don’t imagine they would ever buy a camel without checking its teeth, yet they piled up in Intel and Cisco without checking?

Pir Sahib said that though he was never in stocks, there were many who still held on to their shriveled up stock portfolios and fading dreams of early retirement. His colleagues in Saudi Arabia, Pir Sahib said as he pointed at the exchange building, really wanted to know if the US stock market will get any better, any time soon. We all wish we knew the future.

In October, 2002, the Dow Jones Industrial Average has seen its best monthly gain since 1987. The first one third of the month saw the lowest stock price levels in five years, but in the remaining two thirds of the month stock prices shot up with unabashed ferocity. It was a flash back to the giddy days of the 1990’s Great Mania.

The investors’ mood, as portrayed by the media, has gone from deep depression to wild euphoria in three weeks. Many seem to think that the financial storm has finally blown over. Others are only cautiously optimistic. A few continue to wonder and fewer still are outright skeptical.

So what is the answer? Have the good times returned? Has the market bottomed out and a new bull market begun? What will happen next?

We, of course, don’t know what will happen and made that clear to our friend. But we do have some idea about what should happen, and most likely could happen.

We belong among those who are not convinced of the fairy tales told by Wall Street’s snake oil salesmen who masquerade as investment professionals. These ‘pros’ are the shamans of The Street who will go to any length in convincing their clients that the Tooth Fairy is alive and well and that pigs can really fly. They are always quick to commit other people’s money to chase after paper tigers with high sounding names, without giving any thought to valuation. To their ilk image is everything. Style matters to them, substance does not. Most of them could not tell the difference between gold and glitter. And the few who could, wouldn’t care, because after all, its not their own money that they throw away. There is a basic conflict of interest between their pocket books and those of their clients.

We, on the other hand, are the agnostics of Wall Street. However, we like to think of ourselves as rational pragmatists. Strangely, in Wall Street’s lexicon we are labeled the fundamentalists.

As any rational freethinker who has been among true believers knows, it is often futile to argue with the faithful. To say to the devoted that Moses could not possibly part the Red Sea, nor Jonah live in the belly of the whale, is like casting pearls before swine. With complete disregard to the laws of nature they would have Jonah three days and three nights in the belly of the whale and then return, hail and hearty.

Many of the faithful are still fervent believers. Their faith has been severely tested over the past two and a half years, but they are willing to recant their doubts and seek absolution at the slightest hint of the Second Coming.

These are the faithful who jumped, en mass, into companies that split their stock, with the same abandon as the Israelites allegedly followed Moses when he split the ocean. They paid for Amazon shares the price that was far in excess of a thousand years of potential earnings. Recently they again drove up the price of Amazon above fifteen dollars, because now the company will only lose one dollar (as of Friday, 1 Nov, 2002, it was almost up to $20). Why they wish to pay between fifteen and twenty dollars for the privilege of losing one more dollar, we agnostics cannot understand. But perhaps we are wrong after all, and pigs can fly, rats never drown and corporate earnings don’t matter.

The financial typhoon that wrecked the Nasdaq has not dissipated. We believe that the present lull is in the eye of the storm. The seas are getting rough again, the wind is picking up and the clouds are thickening. Beyond the horizon we see heavy dark clouds and flashes of lightening. The distant roar of thunder is being drowned out by the loud thrashing of waves.

For the present moment, we shall briefly sample a few odd facts to get a glimpse of the macro picture. (We shall dwell more on the details in Part 2.)

· The total market cap of the US stock market at the peak of the 1929 euphoria was 81% of GDP, while the total market cap at the October, 2002, lows was still about 90% of GDP. By contrast, historically, the market cap in at the ‘bottom’ of bear markets has always been under 40% of GDP.

· Homeowners’ equity, despite the historically high home prices, is at an all time low. John Q. Public has kept up his frivolous ‘consumption’ of things he didn’t need, made in places he could not pronounce, with money he did not have. He has tapped out his new found home equity in the biggest re-financing binge in memory.

· The US current account deficit is fast approaching $500 Billion a year. In other words, to keep the economy where it is, let alone improve anything, more than one and a half billion dollars of foreign investment is needed every day.

· The total cost of government (federal budget, all fifty states’ budgets plus all the county and city budgets combined) in the US is about $3 Trillion per year. The total number of wage earners who get a W2 form, is 134 million. Assuming, they all work 40 hours a week and work all 52 weeks of the year, it costs $10.76 per hour, per worker, to support the government. The minimum wage is only half that, so it takes two minimum wage employees, per hour, to pay for the paper pushers in the government.

· All the “improvement” in GDP numbers is coming from non-productive ‘consumer spending’ and ‘government spending’. One of the largest components of recent GDP so-called ‘growth’ has been automobile sales that were propped up by zero percent financing. In other words by borrowing from next quarter and next year sales. Now auto sales are dropping off like a rock.

· Delinquencies, defaults and bankruptcies are all on the rise.

· In 2001, the Nasdaq 100 companies, reported an accumulated total of $82 Billion in losses to the Securities and Exchange Commission. However, the same 100 companies, for the same time period of 2001, reported a total accumulated profit of $19 Billion to the public through their touts on Wall Street. This is a discrepancy of $101 Billion. In other words, over a billion dollars average per company. That is the extent of lying that went on in 2001. This year the reported earnings are far worse and we have no idea how much even that is smoke and mirrors.

This litany can go on and on, but the point here is simply to emphasize that the picture ain’t getting’ no better.

Yet, regardless of worsening fundamentals, the faithful hearts can believe in the stock market’s skyward lift-off from its lows, just as Jonah emerged from the deep and Joseph rose from the well. Today’s Bulls are the true believers, and whether we like it or not, believers are usually in the majority.

They are the same people who bought Priceline.com at such astronomically surreal prices as would have put Jack’s fabled bean stock to shame. Jim Grant wrote back then, that if the same multiples, as assigned to Priceline, were also applied to American Airlines’ Saabre system (which was not only far bigger, but had essentially the same business model, an established clientele and real revenues), Saabre’s market cap would exceed the GDP of the United States.

Faith, especially the blind kind, is a force to be reckoned with. The ability of the crowds to scale up the astonishing heights of Mount Insanity is something we must never underestimate. There is no reason to think that the faithful cannot take the Dow back up to ten thousand. Though we doubt that, at this stage, they would even exceed nine thousand by very much. But then again, we also doubt Santa Claus.

The pig has passed through the python. The big party is over. Only stragglers remain rummaging through the waste bins.

Next Wednesday, when the Foolish Oafs Mismanagement Committee meets in Washington, they may dispense their 12th magic potion to Mr. Market, but we doubt if it will do much more than did the first eleven.

Was the stock market undervalued at its recent low on October 10, 2002? No it wasn’t. Not by a long shot.

In our humble view this is a long term bear market. It rivals (and may well surpass) the 1930s US market and the Japanese market of 1990s.

The bottom of this bear market could come sometime between now and the end of the decade. We shall, however, turn bullish as soon as the Dow trades down to somewhere between 4,500 and 3000; the S&P500 sinks to between 550 and 300; while the Nasdaq is between 900 and 350.

In the mean time we shall be content to wait and invest in gold, that ‘useless barbaric relic,’ which the Wall Street charlatans, wearing their Armani suits, Bally boots and carrying Gucci briefcases, dismiss with an arrogant frown on their upturned faces.