Investment Outlook

March 2000 --- The NBT market

As time goes on, the sheer numbers of newly minted Internet millionaires becomes sublime. Although we don’t have any hard statistics to prove it, casual observation seems to bear out the notion that the past 3 to 5 years have seen some of the greatest growth in wealth in a couple of generations, at least in the U.S. Something people should perhaps consider is, what happens to all of the money? Does it stay in the stock market to be rolled over into the next big deal? Or does something more prosaic happen to it…spending it for instance? Every month, we are confronted by all kinds of economic statistics which exhibit continued growth in the housing sector, in car purchases and in overall consumption. Somehow, none of this activity shows up on the inflation radar screen. How can this be?

The standard explanation is that with the advent of the new economy, prices of capital goods and labor costs are kept low due to efficiencies and competition. This makes sense to some degree, but if you think about it, there is only so far you can go on efficiencies before you run into the immutable laws of supply and demand. The fact of the matter is, you need lumber to build those homes and you still require steel and aluminum to make the sleek SUV’s which are all the rage among the nouveau riche. In fact, you need gasoline to fill the fuel tanks of those SUV’s. As some have noticed, the price of crude oil has tripled to $30/barrel in just over a year due to substantial declines in inventory levels and rising concerns about the possibility of supply shortages. The price of nickel, a key component in the manufacturing of steel has hit an all time high as a result of the robust global economy. In many parts of the U.S., you can’t pay people enough to do menial jobs much less keep the highly skilled ones. The reality is, cost pressures are appearing in the goldilocks economy. And that’s not just our opinion; no less an observer than Alan Greenspan has been saying rather clearly, (that a feat in itself) that the growth in the US economy is very much in danger of being overheated. Granted, he’s been saying so for quite a while now, but this time, his warnings come as some of the aforementioned events have come to pass.

There is an old and sage saying in our business that ‘the trend is your friend’ and indeed it may be easier to explain away the recent upticks in certain commodity prices as aberrations in a long secular downtrend. Taken individually, each explanation has merit. Taken collectively however, the subtle changes in the background become more worrisome. Let’s review the background.

Oil prices are triple where they were a year and a half ago, in fact the price of crude has reached a ten year high. Current inventories of crude oil are below the lean levels of 1996. With the scheduled termination of OPEC at the end of March, there is great deal of concern as to whether OPEC would maintain current production levels. Supply shortages plus uncertainty of OPEC continue to put upward pressure on crude oil prices.

Aluminum prices are at five year highs. During the last year, aluminum prices rose 37% and now stand just 2% below their previous peak in August 1997. This upward trend is expected to continue for the year in view of production growth limited by a shortage of aluminum supplies and strong demand.

The price of lumber, while not at highs, are at levels not seen for four years, attributed by a strong rebound in U.S. housing starts last month. The price of palladium has doubled from $350 a year ago. Platinum prices are at 10 year highs and even that old dog gold has moved well off its low. The numbers of housing starts continues to climb in each monthly release of federal reserve statistics. In fact, the U.S. Housing Starts reached a 12-month high in January hitting 1.78 million, just short of last January’s high of 1.80 million (NAHB Economics Department). The level of unemployment in the U.S. is at a five year low, dropping down to 4% in January.

On the financial front, aggregate earnings of large US companies, trending up for over five years, have plateaued in the past six months. The U.S. long bond market has been in a downtrend for over a year, that is, with long-term rates rising. There is another old saw which says ‘don’t fight the fed’; well, the federal reserve has raised short-term rates three times over the past year and will likely do so again at their next meeting. Finally, if you have been paying attention, some of the major stocks in the US markets have undergone significant corrections over the past year. Even mighty GE, the icon of the blue chip market has come off 20 percent from its all time high made only a few months ago. This background change has been masked by all of the frenzied activity in the hot sectors of the market including net stocks, biotech stocks and IPOs in general, or what we shall call the NBT, Next Big Thing market.

So what do we do? If you’re an investor, that’s easy. Some of the greatest names in corporate America are being cast off as yesterday’s news. If as we expect, the markets get queasy here, they may even get cheaper, but not as cheap as the NBT stocks which will have the double edge of momentum working against them. The general strategy is to look for companies which have exhibited superior relative strength to the S&P historically but have been recently slammed. We will try to identify such companies as time goes on. Off the top, Citigroup and American Express come to mind as do Wal Mart and GE. In all of these cases, you are letting managers with historically good track records of ability run the firms for you.

If you’re a trader, the trick is to pay attention to the volume in the NBT stocks. In these cases, you can’t depend on the track records of management, since in most cases there is no track record…or even management. We have opined many times in past missives that the stock markets are trading as futures markets where fear and greed are the primary drivers. This is especially true of the NBT stocks. The recent strength in small cap issues underlines the public’s appetite for momentum plays and we suspect this trend will continue for a while. It’s now common to see obscure companies trading for pennies make sharp runs to achieve hundreds of millions of dollars in capitalization in only a few days based on marginal or nebulous announcements. Then in a similarly short time, the price collapses as people take profit and move on to the NBT. This phenomenon is akin to party revelers searching for the next hot place to party after the present party dies down. Isn’t America great!