August 30, 2002

August 30, 2002

I’m writing at the end of August to give a bit of an interim update. We are getting a lot of calls from clients and friends asking about our view of the U.S. market. Have we seen the MOABO (Mother of all Buying Opportunities) as one of our clients and friends calls it or is the current market rally just a bear market bounce?

Our answer is both. In our opinion, the market has presented us with both a bear market bounce for most big cap tech stocks and for former leaders of the last market cycle, but it has also presented us with a wonderful buying opportunity for many beaten down stocks. In terms of valuation, many U.S. stocks today are cheaper than they have been since 1974. According to our analysis perhaps 25% of the non-tech stocks in the market are undervalued.

The frightened bear camp says 1) yes they may be cheap, but they will stay cheap for years or 2) yes they may be cheap, but a major depression may develop and earnings will disappear.

We disagree with both negative scenarios. To answer objection #2, the U.S. economy is growing at a 1 or 2 percent rate. Slow, but acceptable. The Federal Reserve and virtually all politicians looking at a major election in 2004 will do anything in their power to avoid a serious economic downturn in 2003 or 2004.

To answer #1, the only scenario that we can see that would keep U.S. stocks cheap for a prolonged period are a war on U.S. soil or a major energy crisis. We believe that although terrorist incidents may occur in the future, a major war on U.S. soil does not look imminent. A major energy crisis precipitated by a war on Iraq may develop but the U.S. and Europe are busy building pipelines from former Soviet Union oil fields to ports and overland to Eastern Europe. Further, many oil producing countries in the mid east and elsewhere are prepared to increase production to fill any shortfalls. Still, a major oil embargo would cause a prolonged sideways market in the U.S., Europe and Asia. What are the odds of a major oil embargo? We believe they are about 20%. In the event of an embargo, we believe US stocks go sideways. In the more likely non-embargo case, U.S. stocks could rise steadily.

Today’s under-valuations in some sectors of the market are unique and have not been seen since 1974 in our opinion. As an analyst and portfolio manager I am thrilled with the low prices, low P/E ratios and deep discounts to book value that we uncover daily in different areas of the market. Within the following industries, utilities, energy services, energy, consumer services, business services, basic industries, transportation and some financial stocks, we see good values. However, not all industries look attractive. Many of the companies in technology and other areas of the market such as biotechs, drugs, hospitals, and HMO’s remain overvalued. We are concerned that because of the election in 2004 and the fact that healthcare companies have been raising prices rapidly. The hospitals, HMO’s and pharmaceutical manufacturers may be politically vulnerable to price rollbacks or limited price increases in 2003 or 2004. Technology stocks in general, are still selling at high valuations versus their expected earnings. These are market sectors we would avoid.


The US dollar has recently moved sideways versus the Yen and the Euro. We anticipate that this sideways price action will soon give way to a new bout of weakness. We continue to believe that our positions in the Euro and short-term European Government bonds offer good prospects for appreciation. Recently, we have taken some profits in our Yen and Euro positions. The cash will be used to buy stocks when opportunities present themselves.


Gold is in a sideways phase, with the metal fluctuating between $300 and $320 per ounce. North American gold shares have risen by 5 to 10 percent while gold itself has been quiescent. South African share have declined primarily due to the demand by the South African government that black South Africans own at least thirty percent of all mining properties within the next 10 years. An initial government proposal has been circulated to both the mining ministers and the mining companies, and they continue to negotiate the issue. This will keep South African gold shares at a substantial discount to other gold shares. Four fifths of our gold positions are in non South African issues and we are planning to take profits in the South African and shift to Australian, Canadian, U.S. and other gold producing areas.