Big Al and the Bubble Machine

Portfolio manager’s Letter April 2000

Last month Big Al made one more attempt to turn off the bubble machine, and of coarse the markets reaction was to rally. Then last Week, there was a story by Reuters in the local paper saying that several members of the FOMC where recommending that FED go to a ½ point increase at the February meeting. They did not at the February meeting, nor did they last month, but what about the next time? We have a lot of people paying a very dangerous game and if they will not listen to reason, its time to get out the baseball bat.

Make no mistake. This is not about inflation any more. It is about the bubble machine. It is not about low unemployment; it is about people who are going to loose their life’s saving because they believed what they heard on CNBC or because they bought a mutual Fund that was up 100% last year. But the bubble machine is still here, (new economy stocks do not borrow money, so interest rates do not matter).

This is where the irony comes in, because this bit of stupidity is Al’s fault. Back in 1994 Greenspan invented the idea of a soft landing, and now everybody assumes that recessions are politically incorrect. Now everyone assumes the worst that the future has to offer is an occasional soft landing. This a big part of the problem there are just too many people buying stock that a too young to have experienced a serious recession. The worst part some of these people are managing large amounts of money.

But interest rates do matter, a couple more taps on the petal or maybe one good swing with the baseball bat and you have the real thing. The “R” word. This is just my opinion, and I have been wrong before, but I, as investment manager, think we are at a place where the fed has no choice. Mr. Market has turned into a mule. Time to apply the 2×4 firmly between the eyes. A soft landing just is not going to cut it. We need a Radical Bubblectomy.

I, as investment manager, know that some will accuse me of being sadistic, but will not enjoy the pain anymore than anyone else. This bubble has become a cancer on the country’s economy; and the longer you wait to operate; the worse the damage becomes. The politicians watched The S&L Bubble for ten years while they tried to find a painless solution, but what they did was turn a 200 million dollar problem into a 500 billion dollar problem.

If we do have a recession the first thing that happens is the funny money disappears. No more IPO’s No more secondary’s. The second thing that happens is that companies start to cut back on capital spending. Tech stocks begin lose orders. Revenues decline and earnings tank. If Earnings are declining how do tech stocks justify today’s P. E. ratios. My, as investment manager, guess, and it is just a guess, is that the worst damage will be limited to those areas where the speculation is now rampant, but in those areas the correction will be as bad or worse than 1975.

Old Economy stocks have been in a bear market for a long time, and many of them may have already seen their lows. As I, as investment manager, am getting ready to mail this it is Tuesday, this afternoon with both the Dow and the NASDAG down more than 500 points Berkshire Hathaway A was up $2000 and holding most of our portfolios comfortably in the black. But, the new economy stocks are going to get hit. Corrections of 80% or 90% may be common.

Internet companies, with their funny money gone, will start to cut expenses. This is were it really gets interesting. One company’s expenses are another company’s revenues. As one company moves to cut its expenses their customer’s revenues will decrease and they will burn through they capital faster. As revenues start to decline how do you justify the Internet stock prices? Or even better how do you get the enterprise afloat.

I, as investment manager, know that this sounds impossible given the mindset we are exposed to from Wall Street and the Media. But they have no long-term memory (it might hurt the bottom line), and as long as the money is pouring in they have no time to think about their customers.