Centre Street Cambridge Corporation

Private Investment Counsel


October 1999

An old Wall Street hand once said, “a mine is a big hole in the ground with a liar standing in front of it.” Shareholders of the country's largest trash collection company probably felt the same way about landfills in July when the value of their investment fell about 60% after management cut its earnings projections for the company not once, but twice within a few weeks. One could say that the stock was trashed as institutional holders dumped their shares by the tens of millions in a desperate attempt to avoid being tainted by the foul odor of such a loser.

Aside from the cute metaphors offered by this situation, we found it interesting for the light it shed on the rigor of Wall Street research. Listening in on the conference call hosted by management to explain what happened, we could not help but be amused by the unusual and open hostility expressed by analysts, some of them from major brokerage houses. What had happened of course was that the esteemed members of the analytical community -- who are paid enormous sums to study industries and companies, make earnings estimates and bring in investment banking business -- had merely forwarded management's projections to their clients with little in the way of investigative filtration. A bad mistake. Then they complain about management's “damaged credibility.” Funny, we always thought that the analyst's job was to think independently and make every effort to protect clients from things like a $19 billion loss in market value in one stock in a single week. You may as well trade stocks online -- you lose money, but it costs less to get your trading ideas.

In spite of some strength among the large-capitalization and technology groups, the U.S. stock market continued its losing ways over the last three months, with the Dow Jones Industrial and S&P 500 averages both down around 6%. Since April 1998, most issues have been declining in price while the small group of stocks that really counts in the market averages actually lifted the Dow and NASDAQ measures to new record levels at times during the quarter. This may explain why mutual fund cash flows have slowed recently: most investors' results do not look anything like some of the popular averages. Since the stock market is considered a leading economic indicator, what implications might this broad downward movement have for the U.S. economy, and is the Federal Reserve paying attention?

Wiser heads finally prevailed at European central banks. On September 27, fifteen banks announced that they would limit their gold sales to 400 tons per year over the next five years. Uncertainty about the timing and size of sales from gold reserves had helped to depress the metal's price, prompting the industry and gold-producing nations to mount lobbying efforts aimed at changing the policy. In this case, industrial self-interest made sense: a mindless policy of selling regardless of price had completely demoralized the market (on September 21, the United Kingdom central bank sold 25 tons for around $255 per ounce -- about the cost of production). Gold prices immediately jumped $14 to $282 on the news. The next day, prices rose $45 at one point on panic buying, probably by short sellers (speculators who had borrowed metal to sell on the market, thinking they could repay the loan with cheaper gold at a later date). Whether this represents a longer-lasting return of gold to respectability remains to be seen. But it is a good illustration of how quickly a virtually universal sentiment (bearishness on gold) can change, given some catalyst.

The Twenty-First Century

In this, our final newsletter to be issued in years beginning with “19,” it seems fitting to make some general remarks, from an investor's standpoint, on the century coming to a close and on what the coming one might bring. On the surface, Wall Street has certainly come a long way in 100 years, from dealings on street corners and hand-delivered certificates to instantaneous transactions recorded in computer memories. Trading volumes, both in terms of number of different issues and shares, are enormously greater now; while certainly the most obvious change over time, we find it the least important or interesting.

More important has been the vast improvement in Wall Street's respectability. In the early 1900s, the U.S. was in some respects a developing country, albeit a rich one, with the corruption and crony capitalism one now expects to find in Third World regions. Railroad securities dominated trading in the financial markets (industrial company stocks were few in number and considered highly speculative). Markets were frequently subject to panics and speculative binges. Information on securities was hard to obtain and often inaccurate, and manipulation of trading was commonplace. Today's markets are much more transparent and honest. Securities laws and reforms instituted after the 1929 crash removed the more blatant forms of manipulation and improved public trust in the markets. Better informed government policies in the fiscal and monetary realms have generally contributed to lessened market volatility, especially in the post World War II period.

Most interesting to us has been the “intellectual history” of investment during the 1900s. Major schools of thought arose which attempted to give security selection a solid foundation in theory, something which it had previously lacked. Most notable were Graham and Dodd whose work in the 1930s formed the basis for the so-called “value school” of investing. Others, including John Burr Williams and Philip Fisher, wrote on “growth” investing. These two schools represent a dichotomy in investment thought that persists to this day. Beginning in the 1950s, a series of academicians employing concepts from statistics and higher mathematics focused on stock price fluctuations and their relation to risk and reward. Their studies led to what is known as “modern portfolio theory” and the “efficient market hypothesis.”

Here at the end of the century the contributions of these investment thinkers seem mixed. “Value” investing has produced some of the most successful and prominent practitioners, yet it is difficult to practice rigorously in the competitive environment of the investment business. “Growth,” on the other hand, seems to lend itself more readily to what normally happens in the business, with Wall Street's perennial optimism and most investors' interest in exciting future prospects. As for the contributions of higher mathematics, they are obscure to us. The modern portfolio theorists' infatuation with stock price volatility (what statisticians can measure) seems a step backward -- away from what should be a focus on underlying businesses. Regardless of these attempts to rationalize the investment process, trading in stocks, whether by professionals or the novice, remains, as always, heavily impacted by the human emotions of fear and greed. In depressed markets, fear too often inhibits otherwise rational investors from taking advantage of the investment value present at such times. When exuberance reigns, greed crowds out interest in anything but “growth”.

One must use care in looking ahead as it is tempting to project current trends indefinitely into the future (remember, just twenty years ago the popular press pronounced equities “dead” as an investment class after years of disappointing results) -- especially during periods of great enthusiasm. For example, it is easy to assume that the Internet and electronic exchanges will “democratize” investing for increasing numbers of participants. We can see this trend slowing considerably when the next bear market arrives and people realize that knowledge and experience are necessary when dealing with an environment in which, unlike that of bull markets, none of the popular strategies seems to work. We believe that fear and greed are unchanging constants in financial history that will remain regardless of whether stocks are traded in electronic communications networks or on exchange floors. Hence, we expect that investment operations will proceed pretty much in the same fashion as they always have, albeit at a more rapid pace. There will be the usual panics and bear markets, as well as optimistic bull markets. There will continue to be room for knowledgeable investors with a proper perspective on the markets, who possess sharp analytical skills and are able to think and act independently.

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More on online traders: recent investigations by state regulators reveal that 90% of day-traders -- the devil-may-care, gun-slinging variety of the species -- lose money. Just how much and how was made clear in a recent Barron's article. One individual lost $200,000 in a year's time, wiping out an inheritance, the equity in an apartment and a $30,000 credit card cash advance. He paid $120,000 in commissions. Another was a little luckier --he made $25,000 in trading profits over a two-year period. Unfortunately, it cost him $100,000 in commission expense. These people would have done better in treasury bills. At 100 and 200 trades per day, it's obvious who is making money from this business. As in any casino, the house always wins.


Dennis Butler, MBA, CFA