January 1, 2001

January 1, 2001


2000 was a very constructive year. We are grateful that some of the excesses of the last few years were corrected. Let us look at the scorecard. The S&P 500 was down 10%, Nasdaq was down 39%, Dow was down 6%. I consider it a good year because valuations of companies are gradually beginning to return to predictable levels and expectations are becoming more reasonable.

Since 1921, when thorough record keeping on the market began, the NYSE has appreciated about 10% per year, the OTC market (more speculative stocks) by about 12%, bonds by about 4% and inflation by about 3%. This pattern has been interrupted by two major declines where blue chips fell over 40%. They are: The Great Depression and the 1973-1974 bear market. In addition, we have had three periods where manias set in and stocks rose to unreasonable values based not on corporate earnings and growth rates, but on hopes and dreams which were not later borne out by the facts. These were in:

The late 1960’s – the conglomerates mania. The math used to fuel this mania said that 1 company + 1 company = 3 Companies, the new companies supposedly being worth more than the sum of their parts. Untrue.

The 1980’s – During the LBO mania of the 80’s, it was believed that a private company’s value is greater than a public company’s value. Also untrue.

The late 1990’s – The “new economy” stocks were often valued by new metrics or measures that justified extremely high valuations for companies with no earnings and no coherent plan to get to a condition of stable and growing earnings.

The “new economy” mania appears to be ending similarly to other manias and it may take a few years for the demise and discreditation of this new metrics era of valuing companies to be complete. We have seen the initial phase of the decline of this way of thinking and it has been terrifying and costly for the believers in the new metrics.

After the 1960’s conglomerates mania, the average price decline of the top ten conglomerates from the top in early 1969 to May 1970 was 86%. After the LBO mania, many LBO companies fell dramatically from 1987 for one or two years. United Airlines, for example, fell by 70%.

Now we are seeing the violent stock price correction of the new economy stocks remove all of the excess from some companies and part of the excess from most companies if we assume that the companies’ fundamentals have developed or will continue to develop as planned. The bigger problem is that many new economy companies are facing business prospects far less attractive than they had anticipated.

Many e-commerce companies have failed or are failing, as their business models were foolish and non-economic from inception. The better quality new economy companies with good products, efficient operations, growing markets and defensible product niches and strong earnings will be attractive when their valuations reach reasonable levels. In our opinion, a few have reached these levels, but most continue to be substantially overvalued and should be avoided.

With this general overview in mind, perhaps you would like some predictions for 2001.


The U.S. and Canada should have economic growth of about 1-3% on average. This is considerably slower than 2000. Europe’s growth rate will be about 1-2%. It can grow faster, but this will require Europe’s politicians to move away from the social welfare model that they have been embracing since the end of WWII.

Asian economic growth should average 4%+ in China, 4% India, and 3% for the Three Tigers – Korea, Singapore and Taiwan. Japan should limp along with 1% growth as politics will override intelligent economic policy and Japan will continue to fumble its way toward an economic recovery.


The Federal Reserve has given extremely strong hints that they will be reducing interest rates perhaps sooner than their next scheduled meeting on January 31. We welcome this probability, as we believe interest rates to be the single variable most correlated with stock prices. Lower interest rates equal higher stock prices. We anticipate that the Fed’s decision to cut rates will lead to higher stock prices in the first half of 2001. Lower rates, however, will cause the dollar to decline versus the Euro. If Bush is successful in implementing at least a token tax cut, and if the economy begins to grow more vigorously, the rally could continue. We expect companies with visible earnings growth to do well in 2001. Those with no growth or shrinkage in their bottom line will do poorly. So the key is identifying areas where earnings will grow.


After a decline from $1.17 to 82 cents versus the U.S. dollar the Euro has rallied to 93 cents. We expect the Euro to rise to $1.00 U.S. per Euro and are long the Euro in our aggressive accounts. The Euro is rising because it became undervalued and not because the European Central Bank is acting rationally.

Unfortunately for the Euro, socialism is well entrenched in Europe. After a rally early in 2001, we expect the Euro to again decline later in the year.

The Japanese yen has fallen steadily versus the dollar and the Euro. The yen has been hurt by the slow rot that has infected the Japanese economy in the form of failure by political officials to deal with the bank and insurance company bankruptcies. Instead of admitting that the banks are insolvent, they continue to hope that a miracle or perhaps an unforeseen positive event will allow them to avoid losing face. Their reasoning is “I was not in office when the problem was incubated and grew, why should I lose face just because I am in office when the financial institutions become insolvent.”

We occasionally get glimpses that they are going to take the necessary steps, but it never materializes. Until Japan deals with this problem by writing off bad loans and allowing insolvent institutions to fail, the Japanese stock market will do nothing more than rally periodically and continue to sink to new lows.


In our opinion, 2001 is a year of substantial opportunity for U.S. and European equities. Most U.S. and European non-tech stocks are fairly valued. Many are undervalued, but others continue to be overvalued.

According to our earnings model we expect S&P earning growth of only 1% in 2001. The S&P 500 could rise by 20% in 2001. The industries we favor are insurance, banking, medical equipment, medical services, hospital management, pharmaceuticals, natural gas and electric utilities. These industries appeal to us because their profit picture is intact and we expect solid earnings growth from these economic sectors. The expected interest rate cuts will benefit banks and insurance directly by increasing the value of their bond portfolios. Lower interest rate will benefit the other industries by decreasing the cost of capital and increasing P/E ratios.

Other industry sectors may have less visible earnings or poor earnings. We expect autos, airlines, some retailers, steels, chemicals, semiconductors and some technology equipment to have poor earnings due to increased consumer skittishness and lack of demand due to cyclical economic factors. We favor companies which can grow and are selling at reasonable prices vis a vis their growth rate. If a company grows 30% a year, but sells at one hundred times earnings, we would avoid it. We would favor a company growing at 30% a year selling at twenty times earnings.

Although we use many other economic and financial ratios in the course of our analysis of companies, we definitely prefer growth at a reasonable price.


We see three macro trends within which the economic, social and political environment are operating.

The aging population and growing wealth of industrial societies. The average American is over forty years old. The average Western European is in the same age group. These people can afford to save and invest for retirement and can afford to spend money on travel, healthcare and their estate plans.

Beneficiaries of this trend are also helped by the expected decrease in interest rates in 2001 – Banks, insurance companies, hospitals, pharmaceuticals, medical devices.

Companies that enable the technological revolution to reach every company and every home. It is obvious that Wal-Mart will be the world’s largest internet retailer. But who will supply Wal-Mart and every other company with the hardware, systems and software to implement it? Manufacturers of telecommunication equipment, computer servers, some chip makers, software vendors, network equipment and systems integrators and business services. Some of these companies are currently fairly valued; some are still overpriced. One must research these companies very carefully before investing.

Companies who are creating new industries because of deregulation. As natural gas, electricity markets and financial markets have been deregulated, there have been new industries created. Inefficient utilities have lost market share and new service companies have arisen. Instead of just supplying electricity or gas, these new companies now trade energy, sell to worldwide markets, generate supply worldwide and manage their customers’ electricity and gas needs at a lower price and with greater visibility than had previously been possible.
As the recent California debacle proves, politicians are unable to provide a stable long-term environment for the consumers and companies in their states. Short-term political decisions override wise long-term planning. Thus the demand for the new breed of integrated non-regulated utilities is increasing. In addition, fifteen years of under investment in energy infrastructure has added to price volatility. We need more tankers, pipelines, refineries, power plants and more new oil and gas wells to support our economic growth. This backlog of unfulfilled needs will be corrected in the next few years. Thus, we see opportunity in the companies that supply natural gas, oil and electricity to the economy.

The banking industry services have also recently been freed up to enter new markets such as insurance and investment banking. This has made banks more flexible, more profitable, and less cyclical. This has been, and will be, very positive for bank valuations in years to come.


In summary 2001 will provide opportunities in a number of areas. Thorough research will be needed to ferret out companies that can grow earnings within the industries outlined above.

We look forward to speaking with you in person. Please don’t hesitate to call if we may be of service in anyway.