MarketVVizard's Market Thoughts

Top 460. Nov 5, 2003 11:35 AM

» Kirk - On Fire

.
My portfolios, personal and newsletter, has been on FIRE.

I worry that money is flowing into the stocks that are working well on great fundamentals so I have taken some nice profits AGAIN just today.

I did put a bit of the money taken out into some microcaps I like. FNSR has actually outperformed CACS just a bit since I took profits in CACS (5% of my personal shares @ $9.90) and rolled some of those into FNSR at $2.97 (now $3.87 just days later). I even bought 4,000 wavc at 26¢ for a real flyer. Chart looks good and I like the technology. If I take $5K or $10K out of one stock, I often like to put $1K somewhere else.

The really important thing is I am adding to my cash so I have money to buy a dip plus I've added a few with good momentum AND decent valuation. I really do think this bull will run some and most are off on how they measure sentiment, insider selling, etc.

-- posted by Kirk

Top 461. Nov 6, 2003 7:02 AM

» Normxxx - The BEAR Case

Wave Signals Commentary full text
By Mike Drakulich 11-5-03

ARE WE STILL HERE?

I can also talk about risk/reward and probabilities. This current market by any reasonable measure is one of the most "highly over valued" markets in history. We are seeing things like insider selling NOW at all time highs, after weeks and recent months of decade plus extremes. Inv Intell Bullish percentage readings consecutively above 50% is setting all time records for this long lived survey of advisory sentiment.

The same over valued speculative stocks that lead the market to the mania/bubble top in 2000, are once again leading this rally, "real" Bear to Bull market changes are supposed to see leadership changes, that has clearly not happened here. "No or low" earnings(being very generous here!) stocks are seeing huge percentage increases while more quality value/P/E stocks lag.

Bear markets are supposed to KILL speculative sentiment, does or has anyone seen that in this rally? Recently Nasdaq margin levels exceeded those seen at the 2000 high, no "speculation" huh? And why are key market stocks like GE/WMT/IBM/MSFT lagging and trading so badly?

None of this is short term timing data, I try to use Ewave patterns and technicals for that. But I think it should put in a proper perspective what the "common sense" risk/reward parameters are from current levels. As we saw in 1999/2000 these things can get and go to even more ridiculous levels, lets watch and see just how crazy this one gets.

It seems that to many 1999/2000 never happened, apparently it was just a bad dream. Since movie "sequels" are so popular, it appears very possible Bubble 2 is now playing at your local stock market. Now, how long will it run.......

[Editor's Note: I'm betting on a December-January decline. No reason, except that noone will be expecting it. And it would be a reprise of last year. (There's nothing the market likes better than a repeat when noone is expecting it.) ]

-- posted by Normxxx

Top 462. Nov 6, 2003 8:41 AM

» Jas_Jain - Re: On Fire

In response to message posted by Kirk:

Those who live By the FIRE, die by the FIRE.

But, who am I to argue with success.

Jas

-- posted by Jas_Jain

Top 463. Nov 6, 2003 8:49 AM

» Normxxx - The BULL Case

Street Patrol full text
7 reasons (and 15 stocks) for year-end optimists
By Robert Walberg

Too many killjoys say the current upswing is too good to last much longer. Here's why they're wrong -- and how to ride this terrific trend.

7 reasons for optimism
One of the basics of technical analysis is that the trend is your friend. It’s a little trite, but sometimes we overanalyze the market and talk ourselves right out of good positions. If you find yourself conflicted by the growing cacophony of bearishness, step back, take a deep breath and consider the following seven reasons it’s important to stay the course.

Earnings: More than 80% of the S&P 500 ($INX) companies have reported earnings over the past few weeks, and the numbers are sensational. Third-quarter earnings are up 20% over last year, or about 5% better than the market expected. Equally as important, companies have generally raised guidance for the next couple of quarters. In other words, the earnings news should be decidedly bullish for at least another six months. Soft comparisons and aggressive streamlining are big contributors to the favorable earnings backdrop, but it’s also important to note that demand also is ramping up, albeit slowly. However, with the bottom line highly leveraged because of leaner operations, even a modest pickup in demand (beyond expectations) would result in even stronger earnings growth than currently projected.

Economy: Last quarter’s annualized GDP growth of 7.2% bears repeating. Even if you assume that the number is inflated a bit by the tax rebates, you have to be impressed by the economy’s momentum. As long as inventories remain lean, we could be looking at quarterly GDP growth north of 4% well into next year. That’s very encouraging. Of particular interest in last quarter’s GDP figure was the strong 15% growth in business investment on software/equipment. Given that the recent recession was triggered by a dramatic decline in business spending (especially in technology), a reversal of this pattern is essential to sustaining growth.

Interest rates: Despite the strong economic growth, interest rates remain extremely low by historic standards because of the lack of inflationary pressures. Rates will either remain essentially flat or move modestly higher from here over the next six to 12 months, but at this stage slightly higher interest rates won’t dampen the enthusiasm for stocks. Clearly, higher interest rates alter the valuation equation a bit, but as long as the rate rise is tied to a growing economy that’s producing jobs and driving earnings growth, the bull market will not be undone by modestly higher interest rates.

Seasonals: Moving from market fundamentals to market technicals, we are entering what has historically been the best six months of the year. Over the past 53 years, the Dow Jones Industrial Average ($INDU) has gained 10,560 points during the months of November through April. It’s also important to note that during these best six months, the Dow has risen in 41 of the 53 years, for a success rate of 77%. Basically, history suggests that the market has at least another six months of gains left -- potentially rather impressive gains, as the Dow has averaged a 16% advance in the November-April period when the index was up by at least 9% in the preceding May-October period (as it was this year).

Momentum: All the major market indices are enjoying strong double-digit gains this year. The number of stocks establishing new 52-week highs each day continues to dwarf the number of stocks setting new lows. Volume figures remain bullish, as we routinely see more volume on up days than on down. The indices continue to hold above their 50- and 200-day moving averages, with both averages trending higher. Why on earth would you want to sell stocks in a market exhibiting this kind of underlying strength?

Cash inflows: With interest rates expected to hold steady or rise slightly, bonds are no longer a very attractive alternative to stocks. Consequently, we are witnessing money managers engage in a steady and very meaningful rotation back into stocks from bonds. Many managers were slow to buy into the current bull market and, as such, they are now chasing performance. This dynamic, along with the evolving economic picture, suggests that we will continue to see money flow out of bonds and into stocks. These cash inflows act as the fuel that drives the market engine and help to explain why the market rebounds on every dip.

No place else to be: We have the world’s largest economy growing at north of 7%; corporate earnings growing by more than 20%; inflation in check and interest rates at historically low levels; a manufacturing sector on the mend; job growth beginning to kick in; the most creative and productive employee base in the world; and high levels of consumer confidence/spending. I don’t know about all of you, but with that as my backdrop there’s no place else I would rather be investing than in U.S. equities.

-- posted by Normxxx

Top 464. Nov 7, 2003 8:57 AM

» MarketVVizard - Hussman on GDP

November 2, 2003

John P. Hussman, Ph.D.
All rights reserved and actively enforced.
Deconstructing GDP

In recent months, I've noted that third quarter GDP was likely to be very strong, with the probability of a fourth quarter follow-through driven by inventory rebuilding. Last week's explosive GDP report stirred the hopes of some investors for more sustained growth. CNBC's Squawk Back poll of the day asked viewers to respond to the 7.2% GDP growth rate for the third quarter; 60% of viewers voted it “a sign of things to come”, with just 40% identifying the report as “a one-time pop.” Judging from the market's tepid reaction on Thursday and Friday, this enthusiasm may be premature.

The three engines of any economic recovery are invariably autos, housing, and capital spending. True to form, the highlights of the report were real personal spending, which surged 6.6% (paced by explosive 26.9% annual growth in durable goods – largely auto sales); residential investment, which soared by 20.4%; and investment in equipment and software, which increased by 15.4% at an annual rate.

So the typical engines were on fire in the third quarter. Unfortunately, it was the kind of fire that you get when you empty a can of lighter fluid into a barbecue – a huge ball of flame, lots of excitement, and if you're lucky, just enough follow-through to cook a burger.

Debt and Taxes

At the risk of burning off an eyebrow or two, let's take a closer look at that lighter fluid. It's widely recognized that one-time tax credit checks were a factor, but the extent of this impact is not well appreciated. Personal income increased $91.0 billion in the third quarter, which is 4.0% annual growth in nominal terms. But the PCE price index increased by 2.4%. This means that real pre-tax personal income advanced by only about 1.6% at an annual rate. In contrast, real after-tax personal income soared 7.2% at an annual rate. This observation is echoed by analysts at Bridgewater Associates, who report “without the tax cut spending, personal spending would have grown 1.2% (instead of the actual 6.6%) and contributed only 0.9% to real GDP growth (instead of 4.7%).”

Oddly, the other can of lighter fluid hasn't received much attention. As the quarter began, mortgage rates were at new lows on Alan Greenspan's remarks about deflation risk. This plunge in interest rates was predictably accompanied by a remarkable surge in the mortgage refinancing index. Housing and durable goods sales – the two forms of investment that have a measurable sensitivity to interest rates – also surged as a result.

In general, the response of housing lags interest rates by a few months, so the beneficial effects of the mortgage refinancing spike carried through the bulk of the quarter, contributing to that 20.4% explosion in real residential investment. Given that interest rates have surged higher from those lows, accompanied by an equally dramatic plunge in the mortgage refinancing index, forthcoming GDP growth will be at the mercy of other factors.

In short, the GDP report was a ball of fire ignited by a big can of one-time tax credits and another big can of cash-out mortgage refinancing. Consumers received a bunch of lump-sum distributions and spent them on consumption goods, autos, and housing. To expect this spending to continue in the absence of such distributions requires very strained analysis.

This isn't to say that the report was a complete artifact. Spending on equipment and software did increase at a 15.4% annual rate, driven by upgrading of computer equipment, laptop sales, and legitimate investment such as database and web-enabling software. This category only represents 8% of GDP though, and the faster growth largely represented pent-up demand, but it is at least positive that businesses finally acted on that demand. A number of companies we own would benefit from a continuation of this sort of spending, though I would expect any further gains to be at a slower, more sustainable pace.

Finally, the explosive demand during the third quarter led to the lowest inventory-to-sales ratio on record. This will predictably support output growth during the fourth quarter and beyond, as companies rebuild inventories. However, without the massive lump-sum boosts to disposable income we saw in the third quarter, there is little reason why companies cannot build inventories gradually, without the need for significant shifts in employment. So while it's likely that inventory rebuilding will be supportive to GDP in the coming quarters, the case for rapid growth in GDP and employment on that account is exaggerated.

Retrospective Trading

The mutual fund industry has come under scrutiny for allowing (and in some cases engaging in) retrospective trading. This primarily involves two issues:

The first is the practice of knowingly submitting or accepting orders initiated after the 4:00 P.M. close of trading (often based on information reported after the close), yet filled at the NAV as of the 4:00 P.M. close. While batching and processing orders from brokerage companies ensures that a large portion of orders received for mutual funds will be delivered to those fund companies after the close, it is illegal and predatory to initiate those orders after the close.

The second practice generally involves international funds. Unusually large advances in the U.S. markets are typically followed by similar advances in international markets once they open for trading. Purchasing an international fund on the basis of a strong U.S. market close (priced at net asset values that reflect the preceding day's foreign stock prices) is therefore also a form of retrospective trading. This practice is currently legal, but is clearly predatory, because it dilutes the gain that existing shareholders would otherwise enjoy. It is also a breach of fiduciary duty if it is done by fund managers.

Neither of these practices are properly described by the term “market timing” – they are much better described as “retrospective trading”: transactions executed at net asset values that do not reflect fair market values as of the time that the order is placed (generally because the market in question is closed at that time).

Market timing also involves costs to mutual fund shareholders, but primarily in the form of commission costs and market impact. Essentially, market timers believe that they can forecast short-term movements in the market, and make transactions on this belief. I don't believe that this sort of forecasting is possible, and also believe that mutual funds should defend long-term shareholders through the use of redemption fees for short-term holding periods. However, it is incorrect to use the term “market timing” to describe the predatory “retrospective trading” practices that have recently come to light .

Redemption fees work

Regulators are moving quickly to address the scandal. I think the best way to handle the problem really is through a requirement that funds impose redemption fees on very short term holding periods (for Pete's sake, is it too much to expect shareholders to hold a fund for say, 5 days?) While this would impose a cost to short-term traders by reducing their trading flexibility, it compensates long-term shareholders for trading costs and disruption. The exception to these redemption fees would be funds that trade strictly in actively traded futures contracts. The reason here is that the futures markets generally reflect fair market values even if the underlying securities markets are not yet open. There is no doubt that if sufficient interest exists to “time” the foreign markets, futures-based funds would gladly fill that need, without undue retrospective trading risk to existing shareholders.

Don't require investors to fly blind

One ill-considered proposal is to require all fund orders to be delivered to mutual fund companies by the 4:00 P.M. close, which would impose something like a 2:30 P.M. cutoff to place mutual fund orders for a given trading day. The reason I oppose this is that it effectively forces shareholders to “fly blind” for an hour and a half, having committed to a purchase or sale based on market prices that may move dramatically and adversely between the time the order is placed and the time the fund is priced.

In short, this proposal obligates investors to take delivery at a later, unknown price every time they buy a fund. This is like forcing them to write a put option with a life of 1.5 hours, with no compensation. Given that the CBOE volatility index has averaged about 22.4% over the past decade, the approximate market value for such a put option on the S&P 500 index would be about 2.5 points. In other words, the implicit cost to shareholders of "flying blind" would be something in the neighborhood of one-quarter of one percent of their assets every time they trade in a typical growth fund , less for very stable funds, and significantly more for volatile investments like technology funds. There are better solutions.

(Geek's note: The specifications of the option are unusual because the strike price is stochastic, but the underlying mathematics are the same – you take a one-sided value-weighted integral of the price distribution, which is just Black Scholes).

Again, a good solution is simply to require redemption fees for very short holding periods. Meanwhile, plenty can be done by enforcing existing laws against brokers and fund companies when there is a clear pattern of retrospective trading like those that have recently come to light. This enforcement will work, without new and heavy-handed regulations.

Outside of international funds, where retrospective trading really does pose a risk, I think soft dollars and inappropriate 12-b1 charges are more detrimental to the average shareholder. I have little doubt that these will be under hot lights in the future.

The Hussman Funds are designed for long-term investors

Since the securities traded in the Hussman Funds are generally actively traded and have timely bid, ask and last sale information as of the 4:00 P.M. market close, the likelihood of retrospective trading would be negligible even without redemption fees. Still, because I believe that attempts to “time” the Funds would be disruptive and ill-considered, and also to discourage short-term investors for whom our approach is unsuitable, I've always insisted on a 1.5% redemption fee in the Hussman Funds for holding periods of 6 months or less. This redemption fee applies both to the Strategic Growth Fund and the Strategic Total Return Fund, as well as transfers between the funds, but again, only for holding periods of 6 months or less. The redemption fees we collect are added to the net assets of the Funds for the benefit of our remaining shareholders.

The Hussman Funds are designed for long-term investors following a disciplined saving and investing program. As I note in The Two Essential Elements of Wealth Accumulation, I strongly believe that investments – even small ones – should be the first checks you write, as if you were paying a bill. With the exception of a tiny percentage in money market funds, all of my own liquid assets are invested in the Hussman Funds. I make no attempt to “time” these investments (they are made automatically at the beginning of each month) or to trade in-and-out of the Funds.

Market Climate

As of last week, the Market Climate for stocks remained characterized by unusually unfavorable valuations and still modestly favorable market action. There are enough early divergences to warrant hedging about half of our stock holdings against the impact of market fluctuations, but for now, we continue to be positioned primarily to gain from market advances.

The distinction between production for final demand and production for inventory rebuilding is an important one. For that reason, it's worth keeping a close eye on transportation stocks in addition to overall market breadth. Financial stocks are also important to monitor here. That action will be informative about the prospect for corporate lending as well as any risk of abrupt shifts in the yield curve. Short-term interest rates remain quite low, but as I've frequently noted, the U.S. economy is much more sensitive to the risk of rising short-term interest rates than investors seem to recognize.

In bonds, the Market Climate remains characterized by modestly favorable valuation and modestly favorable market action. The Strategic Total Return Fund continues to carry an overall portfolio duration of about 7.5 years, meaning that a 1% (100 basis point) move in interest rates would be expected to impact the Fund by roughly 7.5%.

-- posted by MarketVVizard

The Two Essential Elements of Wealth Accumulation

Top 465. Nov 7, 2003 9:51 AM

» MarketVVizard - The Two Essential Elements of Wealth Accumulation

How to make them work for you

By John P. Hussman, Ph.D.

Wealth is not acquired through addition. It is acquired through multiplication.Very few fortunes have been made by adding up paychecks and overtime. Nor are they made through a huge one-time killing in the markets. Unfortunately, this is the path that many investors try to follow in achieving financial security. While a high annual income is certainly helpful in achieving great wealth, it is not the primary determinant. And while a major move in the market can certainly have an impact, any single move is rarely an important determinant of sizeable fortunes (unless that major move is responsible for wiping an investor out and terminating the ability to continue investing in subsequent years).According to statistical studies, two factors are most important in achieving wealth:

1) The number of years that an individual has been consistently saving and investing

2)The proportion of funds, on average, allocated to higher return investments such as stocks.

This does not mean that stocks should always be held regardless of price and risk levels. The historical evidence is clear that both the future return on stocks and their probable riskiness depends on the level of market valuation and the "uniformity" of market action (favorable trends across a wide range of indices). However, it is a fact that over time, very wealthy individuals have an average allocation to stocks which is above the norm. Most have achieved their fortunes by compounding a moderate but consistent rate of return over a long period of time.There is a simple mathematical explanation for why these two factors are most important in building wealth:

Future Wealth = Current Wealth x (1+k)T

Where k is the annual rate of return earned on current wealth, and T is the number of years that wealth is allowed to compound in value.Wealth accumulation is exponential. At a 10% annual rate of return, $100 compounds to $259 over 10 years, and to $673 over 20 years. At a 15% annual rate of return, $100 compounds to $405 over 10 years, and to $1637 over 20 years. So both the rate of return, and the length of compounding have enormous leverage in creating future wealth.Simply stated, if your goal is to accumulate a significant amount of wealth during your lifetime, you must first save something, and then exercise some amount of control over one of two factors: your long-term rate of return, or the time horizon T over which you compound your wealth.

Increasing the long-term annual return

For most individuals, the best way to increase the annual return over time is to allocate a larger fraction of their funds, on average, to higher return types of investments such as stocks. The pitfall here is that stocks are not always priced to deliver high returns. Historically, the price/earnings ratio on the S&P 500 has averaged about 14. When the price/earnings ratio has approached 20, stocks have typically returned less than Treasury bills for as much as a decade or more.While it is not possible to avoid every downturn in the market, it is essential to defend capital when the Market Climate suggests a poor tradeoff of expected return to risk. This occurs when both valuations and market action are unfavorable. Conversely, the best time to carry an aggressive position is when both valuations and market action are favorable, since the expected return to risk has historically been quite high in this climate.Investors often have the mistaken impression that taking high risk is the key to earning high long-term rates of return, regardless of the market environment. Unfortunately, when valuations and market action are uniformly unfavorable, market risk frequently translates into market losses. And in order to maintain a high long-term rate of return, major losses must be avoided.Hereâ€™s why. Suppose that you earn 20% returns in three consecutive years. Clearly, your average annual return is 20%. But suppose that in the fourth year you lose 20%. The combined effect of lost value and lost time has a profound impact on your annualized return. If you do the math, youâ€™ll find that for the overall 4 year period, the compound annual rate of return has dropped to just 8.43%.While risk-taking is essential to generate long-term returns, it is important to understand that market risk is typically rewarded much better in some Market Climates than in others. For more information on our Market Climate approach, we encourage investors to read our Prospectus, as well as the research paper Time Variation in Market Efficiency - A Mixture of Distributions Approach.

Increasing the time horizon

The best way to increase the time horizon T over which you compound wealth is simply to start saving and investing as early and consistently as possible. Consider an investor earning a 10% long term rate of return. If the investor saves $2000 annually in a tax-deferred account (such as an IRA) for 10 years, and adds nothing for the next 20 years, the value of the portfolio at the end of 30 years will be $198,575. Although the investor committed a total of only $20,000, the account will have grown nearly tenfold.Now consider an investor who fails to start early. Suppose that the investor saves nothing during the first 10 years, and then attempts to make up for lost time by investing $2000 annually for each of the next 20 years. At the end of 30 years, the value of this portfolio will be just $114,550. The investor has committed a total of $40,000, twice as much as the first investor, but because the funds were not given as much time to compound, the investor retires with just over half as much wealth as the early bird. The higher the compound annual rate of return, or the greater the number of years to retirement, the more dramatic the effect that an early start will have on the ending wealth.

Some advice about saving

The key rule of saving is this. Don't let your savings adjust to your spending needs. Let your spending adjust to your savings needs. It will help tremendously if you budget a certain amount of saving monthly, and make your investments first, as if you were paying a telephone bill. If you wait until all the bills are paid and all the spending is done, the result may be that you have nothing meaningful left to invest.Financial planners often advise that an investor should pay off all credit cards before starting an investment program. If the interest rate on credit card debt is quite high, or the debt is large in relation to your income, this is a correct approach. But if you own a credit card, you also know that the balance on a credit card tends to expand with the limit on the card. For most people, paying a credit card down (particularly a low-interest one) is the first step toward spending more money. The best strategy to manage credit card debt is to minimize the number of cards you carry. But if you ever want to save, then start saving now. Make your monthly investments when you pay your other bills, and treat them as if they had a substantial late-payment penalty. The penalty for starting a savings program late really is enormous.

The bottom line

Financial security does not require extraordinary income or investment "home runs." It requires, first and foremost, that you start saving and investing early, and add to your investments consistently.As for investment strategy, financial security requires avoiding large losses, particularly in environments that have been historically hostile to stocks. And it requires the willingness to take larger amounts of market risk in environments that have been historically friendly to stocks. The Hussman Strategic Growth Fund incorporates such investment shifts as part of its disciplined strategy, without requiring effort from our shareholders.

Because the Hussman Strategic Growth Fund varies its market exposure as the expected return/risk of the market changes, we believe that new investments in the Fund do not need to be "timed". Since regular investment and compounding is the key to wealth accumulation, we encourage our shareholders to make regular additions to their accounts. In part, our job is to make that decision an easy and attractive one.

-- posted by MarketVVizard

Top 466. Nov 8, 2003 2:37 AM

» Austrian - New Tax Legislation

There is a bill going through Congress which will be signed which will have a significant effect on the economy over the next two years. IMO the effects will be good for stocks, good for the dollar and bad for gold and commodities for the intermediate term. This bill will keep the various economic bubbles inflated until after the 2004 elections. The two biggest pieces are reduction of dividend taxes through 2006 and a one year tax reduction for corporate dollar repatriation from 35% to 5.25%!!! Please review your positions and outlook for the intermediate term in light of these government stimuli.

http://www.forbes.com/2003/05/16/cx_da_0...
Top Of The News
Tax Cut Calls Americans Home
Dan Ackman, 05.16.03, 9:12 AM ET

The U.S. Senate narrowly passed a tax-cut bill last night and it's hard to say what to make of it. The Wall Street Journal calls it "symbolic" and based on "budget gimmickry," but also a "potential boon to investors and the stock market." The Washington Post calls it "the third-largest tax cut in history," the paper failing to take into account inflation or the duration of the bill. The New York Times called it "sweeping," but USA Today labeled it a "temporary hiatus" from taxes on dividends. The White House calls it a "jobs" and "economic growth plan."

The Senate bill also does something else: It tells Americans and U.S. companies abroad to send their money and their people home.

Most of the coverage of the Senate measure focuses on its oddly shaped sunset provision with respect to dividend taxes. Dividend income is now taxed like ordinary income such as wages. President George W. Bush took up the political cause of dividend recipients early this year, saying a tax on dividends was "double taxation," and made it the centerpiece of his tax--or jobs--plan. The bill would exclude 50% of dividend income from taxation this year. The exclusion would rise to 100% between 2004 and 2006 and drop back to nothing after that.

By extending and then repealing the tax break--a so-called sunset provision--the total price on the bill comes to less than $350 billion, a cap demanded by moderate Republicans and Democrats in the Senate. Senators who support excluding dividend income from taxes permanently are confident future Congresses will extend the plan.

Earlier versions of the legislation would have excluded dividend income from taxes only when the corporation paying the dividend had paid taxes on the income already--making the tax on the dividend itself a "double tax." That idea was scrapped in the bill passed overnight.

The whole idea that taxing dividend income is especially unfair is a relatively new discovery for the Bush Administration. The president didn't mention the idea at all when he ran for office or during the first two years of his administration. Ending taxes on dividends became a focus when Charles Schwab, chairman of Charles Schwab & Co. (nyse: SCH - news - people ), a discount brokerage, mentioned it almost in passing at the one-day economic summit last August in Waco, Tex. But this year, the idea has become all the rage, with the only real question in Congress being what specific form the dividend income exemption would take. Some bills would have exempted mainly the first $500 of dividends. Others would exempt all. The Senate bill would exempt half for a while, then all, then none--for now.

The Senate bill would also raise the tax credit for each child to $1,000 from the current $600, with families getting a $400 check for each child this summer, representing the larger credit. It would also let small businesses deduct up to $100,000 each year for the next five years to offset expenses on plants and equipment. Under current law, the maximum is $25,000.

The Journal's coverage of the tax measure focuses on a provision to allow U.S. multinationals a one-year window to repatriate profits from abroad at a reduced tax rate of 5.25%, instead of the current 35% rate. The bill would also eliminate a tax exemption for Americans working overseas.

Under current law, the first $80,000 earned by Americans working abroad is exempt from U.S. taxes, as are certain housing allowances. The idea was that these workers were already being taxed by the country where they worked, so the exemption was a way to avoid double taxation. That exemption would be eliminated, largely because the Senate needed revenue offsets to keep the total package under the $350 billion cap. Efforts to get rid of the provision eliminating the $80,000 exemption were narrowly defeated. But press reports indicate that Senators are confident that the exemption would be restored in the conference with the House.

Even if the exemption is finally eliminated, it's not clear what effect it will have. Nor is it clear what the impact will be of the measure reducing for one year the tax on repatriated profits. But in a time where the U.S. is fighting wars overseas and seeking to assert its authority in the war on terrorism, the implicit message of this tax bill is, ironically, "Yankee, Come Home."

-- posted by Austrian

Top 467. Nov 8, 2003 4:45 AM

» Austrian - Loaded for Bull or Bear

From Barrons this morning... Unusually straight talk from a fund manager.

Loaded for Bull or Bear
Regardless of what the economy does, a veteran investor still find plenty to bet on

By SANDRA WARD

An Interview With Marty Whitman - Straight talk, with a touch of salt, from a guy with Street smarts. That's what you can count on from this longtime special-situations investor. Clients -- who've entrusted a total of $7 billion to his Manhattan-based Third Avenue Management -- can also count on him and co-chief investment officer, Curtis Jensen, and their team of research analysts at New York-based Third Avenue Management, to deliver strong performance on a steady basis. Among others of the funds they manage, the flagship Third Avenue Value Fund is up 34.8%. Over the long haul, Value Fund has gained 16.2% annually, on average, since it was formed 13 years ago. And another fund, Third Avenue Small-Cap Value is up an average 11.3% a year since its start in 1997. A sharp eye for finding well-financed companies whose assets are mispriced and whose stock prices are flagging, combined with the patience to see those asset values fully recognized, sets Whitman and his team apart from their contemporaries. And no one is more respected when it comes to identifying troubled companies capable of turning around. In fine form one recent morning in Manhattan, Whitman, as usual, pulled no punches.

Barron's: You've been in the business a long time Marty. What do you make of this market?
Whitman: We're bottom-up investors. We always have to operate on negative macro assumptions.

Q: Always?
A: Always. We always run scared. The U.S. economy and society have always done okay and will continue to do okay, as long as there is relative political stability and a relative absence of violence in the streets. If instability and violence were at all on our radar screen, we just couldn't invest. I don't necessarily believe these conditions will continue to prevail. I don't know how anybody with an IQ over 70 can be anything but utterly pessimistic about the long-term outlook for the U.S. economy.

Q: Why do you say that?
A: We've lost our manufacturing base. We're financially irresponsible. The whole world hates us and everybody's -- and I mean everybody's -- emphasis is on the short-term outlook. Will we get out of the recession by November 2004? Nobody, but nobody is focused on solving real structural problems, organic structural problems that exist.
But that has nothing to do with how we invest. For instance, we have been invested very, very heavily in Japanese non-life insurance since 1997 when the market was 20,000. The market is now 10,000. Yet, we've got a pretty good profit on the portfolio.
At the end of the day, for buy-and-hold investors in a climate of relative political stability and an absence of violence in the streets, the macro outlook is much less important than knowing the businesses you've invested in. The problem is everybody, Barron's and CNBC and Graham and Dodd included, puts emphasis on the macro, because they don't know how to analyze companies and they don't know how to analyze securities.

Q: But if you want people to think about the long term, don't you have to include the macro perspective?
A: Let me go back to Japan again. Given the climate of political stability and absence of terrorism, I thought we'd do okay and we have.

Q: But Japan hasn't been easy for you has it?
A: The stockholders aren't paying us because it is easy.

Q: You've been negative on a lot of sectors in the U.S.
A: We own virtually no common stocks, maybe 1%-2% of assets, of companies involved with the old-line manufacturing economy. We just don't do it.
The first thing we look at in a company is the quality of its balance sheet, or the quality of resources in the business. Starting from that base, there was no way we were going to consciously be subordinated to asbestos litigants. And there isn't an Old Economy manufacturing company not subject to asbestos liability.
On the other hand, we are by far the largest senior creditor of building-materials maker USG. We are much much more price-conscious than we are outlook-conscious. Our mantra is safe and cheap, in that order. Cheap is not a sufficient condition for us to buy a security. We have to have some margin of safety, and that margin comes in the characteristics of the business, not the price of the stock.
For us to own a common stock, the business has to have great financial strength, unless we screw up, which we do from time to time. If a business is not strongly capitalized, we are never going to be anything other than a creditor. As a general rule, if you're an unsecured lender to a holding company and don't have subsidiary guarantees you are structurally subordinated and that pervades all the debt instruments. One of the things we don't do is buy the holding-company debt of insurance companies.

Q: Why is that?
A: We wouldn't be a creditor of a parent company whose only assets are the common stocks of highly regulated, highly leveraged subsidiaries. That's asking for trouble. Look at Conseco and Reliance Group Holdings. There have been hundreds of similar companies that ran into trouble. Regulators are obviously looking after the policyholders. If you want to service the bonds, you don't look at earnings per share, you look at the dividend-paying ability of the subsidiaries. When the subsidiaries are highly regulated and highly leveraged, it can get tough.

Q: Is this an environment in which you're finding a lot of safe and cheap stocks?
A:: We think most companies are in the wealth-creation business. They are not in the earnings-per-share business. That is Wall Street. That's not business. We can buy into an awful lot of well-financed high-quality companies that are selling at substantial discounts from readily ascertainable net asset values.
We recently acquired from the DuPont Trust a good-sized position of more than one million shares of St. Joe Co. We've been buying Toyota Industries, as a way to buy into Toyota Motor at a 30%-40% discount, Forest City Enterprises, Catellus Development, Brascan and Tejon Ranch.

Q: You like real estate.
A: It's easy for us. You talk about the macro perspective. Well, one of the things that impresses me is that the real-estate industry and the banking industry are better financed than they've been in my lifetime.
The loan-to-value ratio has been very conservative in the real-estate business. The banks have been relatively conservative corporate lenders, much more so than they have been historically. And they woke up to the fact that fee income is higher quality than spread income, and they've increased their fee income. The ability to securitize portfolios has reduced risk also. But we only buy financial institutions at a discount to adjusted book.

Q: Talk about St. Joe. That's had a nice run already.
A: A million acres in Florida. They seem like good guys. Any reasonable present value of the land they are developing puts the stock well into the 40s, versus about 33 currently. Most people aren't going to be interested because the present value is based on a 15-year outlook, not on next year. We are also the dominant shareholder in the Tejon Ranch, a large land developer in California..

Q: You've owned that for quite a while.
A: Yes. It has been a good investment. It's well-managed. But all our holdings have something wrong with them and the big thing that's wrong with the Tejon Ranch is that it's not located in Florida. What's wrong with Toyota Industries is that it is not incorporated in Delaware.

Q: Minor details. How do you feel about real-estate investment trusts?
A: We tend to be very anti-REIT.
Very few REITs are comfortably financed because of their dividend-paying requirements. It's as if they have a third mortgage.
We very much like companies that plow back cash. We don't like being held hostage to the capricious capital markets. The academic B.S. is that the present value of any common stock is the future dividends. Baloney. The present value is what kind of wealth a company can build. If we can get into a good real-estate company at a discount and, on average, they can increase adjusted book value 10% to 15% a year over the long term, boy, that's good enough for us.

Q: So how do you feel about the trend to start paying and raising dividends?
A: It's a very, very good thing, insofar as it will give companies better access to capital markets than they otherwise would have had. But we don't go there. We usually only buy companies that either don't need access to the capital markets, or if they do, they absolutely control the timing of when they are going to access the capital markets. That's a huge advantage.

Q: Generally, you are opposed to companies paying dividends?
A: We would rather not have them pay dividends. If they have a good reinvestment opportunity in the business, we'd rather have them put the money in the business. A company has three things it can do with its cash: expand productive assets, reduce liabilities or make distributions to stockholders. If paying dividends doesn't enhance your access to capital markets, which is true most of the time, payments to stockholders can only be a residual use of cash.
The first thing a company has to look at is expanding its productive assets and reducing its liabilities. If you are going to make distributions to stockholders, you can either pay dividends or buy back stock. On a long-term basis, you are much better off buying back stock than you are paying dividends.

Q: But what if a company you hold starts paying a dividend or boosts its dividend? Will you sell it?
A: No. American Power Conversion upped its dividend. The good news in that case, and in most of the cases, is the companies are cash-rich and cash-generative, so it certainly isn't life-threatening.
On the margin, it's not a terrible thing when you have plenty of cash to reinvest in the business. Generally, the companies we own are unleveraged, they don't have any debt, so there isn't a debt-service requirement.
We are very large shareholders, maybe the largest shareholder of Catellus, and we signed off on their plan to convert to a REIT. So we are not doctrinaire. Catellus still trades at a discount to its readily ascertainable net asset value. We think they can continue to grow net asset value, though obviously they will grow a little bit more slowly with this dividend requirement. Despite the recall [of Gov. Gray Davis] in California, we will hold it. We are offbeat. That's our style. We are not Graham & Dodd investors. We're not the efficient market.

Q: What do you have against Graham and Dodd?
A: Everybody talks about Graham and Dodd. Nobody's read them. Graham and Dodd don't say what everybody says they say. For one thing, they knew zippo about credit analysis.

Q: But do they claim to know about it?
A: Yes. It's half the book. All they did was look at bonds from the point of view of a par lender.

Q: Meaning?
A: Meaning somebody who pays 100% on the dollar. Who in their right mind pays 100% on the dollar? Life-insurance companies might. Second, Graham and Dodd very much emphasize all the conventional stuff: the macro picture, the importance of dividends, the past earnings record. One of the last worthwhile editions of Graham and Dodd's Securities Analysis was in 1962. After the Securities Act amendments of 1964, there was a fantastic disclosure explosion. So much so, that outsiders can know an awful lot about a lot of companies, a lot of securities, just by reading the public record.
That kind of stuff was not available to Graham and Dodd. What they provided were really great caveats to follow if you didn't know much about a company because when they originally wrote Securities Analysis -- in the 'Thirties -- there was no way of knowing a lot about companies. But the public record got so good and no scholars picked up on their original research because they all went in for this efficient-market nonsense, which is predicated on the thesis no one can no anything because the market knows everything. Do you know how many efficient-market theorists it takes to change a light bulb?

Q: How many?
A: None. The market will take care of it!

Q: What else have you been investing in?
A: Sankyo, a Japanese pharmaceuticals company.

Q: What's attractive about it?
A: It's a matter of price.

Q: What are the short-term problems?
A: It has drugs coming off patent. But you never find a big pharmaceutical trading around book value, except in the case of Sankyo. And it has a strong balance sheet. It fits our style. We analyze securities very much like corporate control people. We're not like Wall Street research departments. Most of our exits come from our companies being taken over, one way or another. Control people tend not to pay as much as they think the business is worth to them. And lately, in certain deals, we find we are very much subject to "takeunders," only offered a premium to the market price.

Q: That's happening a lot lately.
A: We are a 5% shareholder in Mony Group. Their deal to be acquired by Axa Financial is being done basically to compensate management. Between management entrenchment and the distorted view of the Delaware courts of what valuations ought to be, outside shareholders are not on a level playing field. We are very disadvantaged versus management. One of the worst things that ever happened to the stockholder was the invention of the poison pill. How about Marty Lipton providing the principal guidance to the New York Stock Exchange when Richard Grasso was heading it? He was the same lawyer who invented the poison pill. That shows you deep down where the New York Stock Exchange has been and still is on investor protection.

Q: Shouldn't this new scrutiny of corporate governance bring about change?
A: Baloney. What scrutiny? It is all cosmetics. Let me tell you, for better or worse, the principal cop on the beat has been and will continue to be the private bar doing class-action lawsuits. The Securities and Exchange Commission and [New York Attorney General] Eliot Spitzer are drops in the bucket compared with the private bar. And Sarbanes-Oxley is just a full-employment act for accountants.

Q: Let's get back to stocks. Were you buying a lot of down-and-out Internet stocks that had a lot of cash?
A: We bought a lot of telecom-equipment securities last year. We bought the ones where cash exceeded liabilities and that were trading well under 10 times peak earnings. In many cases, we were buying them for the value of the cash or maybe just a little bit more. Ciena, Comverse Technology and Tellabs and Sycamore Networks.

Q: You own them for the long term?
A: We got in these at even better prices than if we were first-stage venture capitalists. I use the term venture capitalist very advisedly. We think the portfolio will work out okay, but we expect to have a pretty high strikeout ratio, just like venture capitalists. When it comes to doing technology, we generally do a basket. As long as the management teams are building value and not losing their competitive position and their balance sheets stay strong, we will stick around.

Q: Do you do any shorting?
A: A few months ago, I woke up to the fact that there is a great business in shorting par bonds -- or bonds selling near the call price. There is no capital risk of the bond selling over the call price. And since there is a great chance of an increase in interest rates and corporate bonds would be subject to credit-rating downgrades, I thought we should short them. That's an investment idea we haven't executed yet. The staff and I have been through 20 or 30 of them, and we haven't pulled the trigger yet.

Q: Why not?
A: Shorting is difficult. If you short, you are not only making an investment decision, you are making a market decision. We are very good investment people. We're not good market people. We are sort of scared.

Q: Are you investing in European companies?
A: We are a big holder of Investor AB, the Swedish holding company controlled by the Wallenbergs that owns stakes in LM Ericsson and AstraZeneca. Their approach to investing matches our own. They are very long-term focused. We are also big holders of Hutchison Whampoa, partly because we don't think we are paying anything to speculate on 3G [third-generation wireless-telecommunications services], the same way owning Toyota Industries costs us nothing to see if Toyota Motors becomes the Wal-Mart of the automobile industry.

Q: You've changed how you communicate with your shareholders because of Sarbanes-Oxley provisions. What's the concern?
A: Our principal marketing tool is our shareholder letters. Because of Sarbanes-Oxley, we now send our stockholder letters as separate reports from the quarterly reports. They are two different documents. We are interested in informing our shareholders, but Sarbanes-Oxley says you have to sign off on the accuracy of things and "attest to the truth" of your statements. It's easy to sign off on objective numbers but it's different when it comes to our opinions and views about the future. I just did a quarterly letter entitled "The Unimportance and the Importance of Book Value." You think I'm going to sign off on that?

Q: You have a representative on Kmart's board. What do you think of the company's prospects?
A: The latest 10Q gives an accurate picture. Sales have lagged, but the profit margins have been super. I feel very good about the management team. The verdict isn't in, but so far, so good.

Q:: Thanks, Marty.

-- posted by Austrian

Top 468. Nov 10, 2003 10:44 AM

» MarketVVizard - Hussman

[By the way, I was going to post that Barron's Marty Whitman interview Austrian posted.]

From Hussman

November 10, 2003
The U.S. Productivity Miracle (Made in China)

The U.S. “productivity miracle” is almost entirely dependent on growth in U.S. imports and foreign labor outsourcing.

Market Climate

The Market Climate for stocks remains characterized by unusually unfavorable valuations and modestly favorable market action. Insider selling has eclipsed even the unusually high levels of recent weeks. The CBOE volatility index near 16% meanwhile suggests substantial complacency. As I've noted before, low VIX levels are not in themselves negative, but they do suggest that risk aversion has reached very low levels. When markets are richly priced, the greatest risk is an abrupt increase in risk aversion. We don't see evidence of that yet, but the possibility that such a shift could be abrupt already places us in a moderately defensive position in stocks, with about 50% of our stock holdings hedged against the impact of market fluctuations. The Market Climate for bonds remains characterized by modestly favorable valuations and modestly favorable market action.

The Hussman Funds paid their annual capital gains distributions last week. Details are on the Fund News section of our Home page.

Long-term productivity growth is not a large number

One of the most deeply held beliefs of investors is the notion that the U.S. has enjoyed a “productivity miracle” in recent years. Computers, the rise of the internet, and the spread of new inventory management techniques are credited for this revolution.

Two questions are worth asking. How much of a boom has U.S. measured productivity actually enjoyed? and, 2) How much of that measured productivity growth is real?

The first question is fairly simple to answer. Since 1947, productivity measured by output per worker has grown at a healthy rate of 2.0% annually. This overall growth rate masks a certain amount of variation. From 1950 to 1980, U.S. productivity grew by 2.1% annually. During the 1980's productivity growth slowed considerably, to a growth rate of just 1.3% annually. From 1990 through the third quarter of 2003, U.S. productivity has grown at a 2.2% annual rate, a full two-tenths of one percent over it's long-term average.

Wait. Didn't productivity grow by 8.1% last quarter alone? Well, yes and no. That 8.1% is quarterly growth at an annualized rate. The actual increase of just over 2% was significant, of course, but was the combined result of an enormous program of tax rebates, a blowoff in mortgage refinancings prompted by a brief plunge in long-term interest rates on deflation fears, and a contraction in the U.S. labor market. Since the economy enjoyed higher output with fewer workers, the quarterly productivity figure was extremely strong. Even occasionally large quarterly variations do very little to change the long-term average of about 2% annually.

To an economist, even changes of a fraction of 1% in productivity growth have enormous welfare implications over the long-term. A change from 2% U.S. productivity growth to 2.5% over the long-term would be tremendously welcome, but almost unthinkably optimistic. Unfortunately, the way that productivity growth is often discussed, investors appear to believe that long-term productivity growth in the U.S. has accelerated by several percent, with similar implications for long-term earnings growth. That simply isn't the case.

So even though the implications of the recent “productivity miracle” for long-term earnings growth are marginal at best, 2.2% growth since 1990 is not bad from the standpoint of long-term economic health and social welfare. That is, assuming that this acceleration in measured productivity is both real and sustainable.

Is the increase in productivity growth real?

Productivity is measured as output per worker. Essentially, productivity is the total output of the U.S. (GDP) divided by the number of workers required to produce that output. Increases in output, or decreases in the required labor, both increase measured productivity.

Economists know that increasing the amount of capital that workers have at their disposal (“capital deepening”) tends to increase labor productivity. So it is not surprising to see productivity increase as a result of the capital spending boom of the 1990's. The difficulty here is that much of that capital spending boom relied on massive inflows of foreign savings. The unpleasant arithmetic of the “savings investment identity” ensures that foreign savings have to bridge any gap between the amount the U.S. invests (factories, housing, capital spending) and the amount it saves. The amount of savings we import from foreigners is measured by our “current account deficit,” which is presently the deepest in history.

Wait. Doesn't the current account deficit essentially measure how much our imports exceed our exports? Yes, but here's how that works. If we import $100 worth of stuff, we have to pay for it by exporting $100 worth of stuff. Suppose we import $100 of goods and services, but only export $70 of goods and services. In that case, we've got to export $30 of something else to foreigners, and that something is U.S. securities. So that $30 gap measures both our current account deficit, as well as the amount of savings we import from foreigners (through the sale of securities) in order to finance our economic activity.

In short, if the U.S. savings rate is very low, it is difficult to run a sustained investment boom unless we import savings from foreigners, which essentially means running the current account to negative levels. Not surprisingly, every sustained economic expansion in U.S. history has begun with a current account surplus, which quickly moved to a deficit as investment boomed. With the U.S. current account already at the deepest deficit in U.S. history, the flexibility to run even deeper deficits is limited. As a result, our ability to run a sustained investment boom (with associated productivity growth) is also limited.

As I've noted before, I expect that any surge in U.S. capital spending will likely be financed through a reduction in U.S. housing investment. Given that the mortgage refinancing index peaked several months ago, it is likely that the housing market is in the process of peaking as well. In other words, we may very well see increases in some areas of U.S. investment, but they will be accompanied by decreases in other areas. As a result, we're likely to see relatively flat growth in gross domestic investment, rather than the broad increase in gross investment that typically emerges in strong and sustained economic expansions.

The investment boom of the past decade does help to explain the faster U.S. productivity growth since 1990, but again, the actual acceleration is only a few tenths of a percent above the long-term 2% trend for U.S. productivity growth, and the nation's deep current account deficit puts the sustainability of capital spending growth in question.

Lies, damned lies, and statistics

Unfortunately, the “productivity miracle” is also partly a statistical quirk. A significant portion of what we “import” from foreign countries actually represents intermediate goods produced by foreign subsidiaries of U.S. companies, or companies formed by direct U.S. investment into those countries. Think about this for a second. We import the same goods we would have manufactured at home, but at cheaper prices, and end up with a greater amount of finished output. Yet when we turn around to calculate productivity, we don't count the foreign jobs used to produce that output. In other words, foreign outsourcing has the effect of artificially raising productivity figures because the foreign labor used to produce this output is not counted, yet the denominator (U.S. jobs) declines.

The net effect of all this is that the U.S. “productivity miracle” is almost entirely dependent on growth in U.S. imports and foreign labor outsourcing.

I had a lot of fun putting the following chart together (any use of this should include “Source: Hussman Funds”, thanks). Since productivity is cyclical, I used the 5-year growth rate of non-farm productivity, which smooths out short-term fluctuations. To get at the idea of import growth over and above the growth in overall consumption, the other line is the 5-year U.S. import growth rate over and above the growth rate of personal consumption expenditures.

Very simply, import growth captures both the “true” part of productivity growth (since increased capital investment typically requires an expanding current account deficit) as well as the illusory part of productivity growth (resulting from the failure to account for foreign labor input in the productivity numbers). In both cases, it is misplaced optimism to expect rapid and sustained growth in U.S. productivity when the U.S. current account is already at a record deficit.

No Lucy, you can't do the show

One of the most famous arguments for free trade was developed over a century ago by David Ricardo. Right. David. I always get that wrong. Ricky was the one on “I Love Lucy.”

Consider two countries. In TVland, an hour of work can make 3 TVs or 6 loaves of bread. In Doughnia, an hour of work can make just 1 TV or just 4 loaves of bread. Clearly, TVland has “absolute advantage” in both TVs and bread. But notice that by giving up 1 TV, TVland can produce only 2 loaves of bread, while Doughnia can give up 1 TV and produce 4 loaves of bread. So though Doughnia has no absolute advantages, it does have a “comparative advantage” in making bread.

Ricardo's solution was to encourage each country to specialize their production to those goods in which they had comparative advantage. So TVland focuses only on TVs, producing 3 for each hour of work. Meanwhile, Doughnia focuses only on bread, and produces 4 loaves.

Now here's the neat part. As long as the “terms of trade” are somewhere between what the countries could produce without trade (i.e. between TVland's 1 TV for 2 loaves and Doughnia's 1 TV for 4 loaves), everybody benefits from trade.

So suppose TVland trades 1 of its TVs for 3 of Doughnia's loaves. After this trade, TVland has 2 TVs and 3 loaves of bread, which is better than it could have done by producing both. Meanwhile, Doughnia has 1 TV and 1 loaf of bread, which is also better than it could have done on its own.

That's the standard argument for free trade. It does, however, assume a few things. First, notice that all the bread bakers in TVland have become unemployed, and now have to learn how to weld transistors. Meanwhile, Doughnian tech workers now have to learn baking. In the real world, these dislocations are painful. While there are various theorems in economics that assure that it is always possible to compensate the losers from free trade in a way that the nation still benefits, in practice, that compensation often does not occur.

Messing with the terms of trade

Let's take this to the U.S. economy. There is no question that the U.S., and especially its consumers, benefit from the availability of inexpensive imports. But there is also a cost in terms of displaced manufacturing jobs. This is not an argument against free trade, but it is an argument against taking these displacements glibly or without other policies to address them.

A second issue is the terms of trade. One of the arguments against free trade is that it will tend to drive U.S. manufacturing wages down to the impoverished levels of China, Mexico and India. Clearly, this overlooks the distinction between comparative advantage and absolute advantage. Free trade benefits both countries even if one country is at a profound disadvantage in absolute terms. There is no reason for wages to converge if the absolute productivity of workers differs across countries.

That said, it is quite possible to skew the terms of trade so that U.S. workers lose jobs and yet foreign workers enjoy little benefit. This is particularly true in the case of China. Part of the flap over the Chinese yuan is that it is currently undervalued (while I think a gradual adjustment would be useful, an abrupt adjustment would be near-catastrophic). A cheap yuan encourages companies to substitute U.S. labor with foreign labor.

Unfortunately, the often repressive conditions in China also make it possible that Chinese workers get very little of the benefit from free trade. So while free trade has clear gains for U.S. consumers, and also benefits companies that shift jobs overseas, there is a strong possibility that unskilled workers in both countries receive an inequitable share of these gains.

Labor Ethics 101

Case in point is a recent proxy we received from Sun Microsystems. Among the items was a strikingly modest proposal regarding rights of workers in China. This is an interesting issue, of course, since the U.S. has an enormous trade deficit with China, and has lost a great deal of manufacturing jobs there. While trade in itself has the potential to benefit both countries – to the U.S. through greater access of consumers to inexpensive imports and to China through employment for their impoverished people – the actual conduct of American companies in China has a great deal to do with whether these benefits actually arise. There is a difference between inexpensive labor and exploitation, and the distinction is not particularly subtle.

The elements of the proposal in Sun's proxy are summarized below:

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• No goods produced by the company or its suppliers shall be produced by bonded labor, forced labor or within prison camps.

• Wage and hour guidelines should adhere at least to those provided by China's national labor laws.

• Facilities and suppliers shall prohibit the use of corporal punishment and physical, sexual or verbal abuse.

• Facilities and suppliers shall use production methods that do not endanger workers safety or health.

• Facilities and suppliers shall not call on police or military to enter their premises to suppress workers rights.

• Employees shall have the freedom of association, assembly, of forming unions and bargaining collectively, of expression, and freedom from arbitrary arrest or detention. (This sort of clause always has to be read carefully, because sometimes human rights proposals are really mandatory unionization proposals in drag. It's completely appropriate for employees to have the right to unionize and bargain collectively, so long as a company is not prohibited from hiring non-union workers if reasonable agreements can't be negotiated. There's no mandatory unionization in this policy).

• Employees shall not face discrimination on the basis of age, gender, marital status, political or religious activity, or arrest for peaceful protest.

• Facilities and suppliers shall use environmentally responsible methods of production.

• Facilities and suppliers shall prohibit child labor, or at a minimum comply with guidelines on minimum age for employment within China's national labor laws. (Again, this one is not as obvious as it might seem. The absence of child labor is in some sense a luxury of prosperity, and in many underdeveloped countries, child labor is a factor in the survival of the family, as it was during the early agricultural development of the United States. Even so, child labor is largely the result of the unavailability of living wages for adult workers. American companies should not allow this situation within the scope of their foreign operations).

• The company will not provide products in China that can be used to commit human rights violations.

• The company will issue annual statements detailing its efforts to uphold these principles.

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Here is Sun's recommendation to shareholders:

Our Board unanimously recommends a vote ‘AGAINST' the proposal for the following reasons:

• More than eighty-five percent of shares voted on a substantially identical proposal at our last two annual meetings were voted against the proposal. (Well, shame on them.)

• It would limit Sun's ability to manage complex and sensitive issues related to our operations in China.

• Compliance would be difficult to measure, time-consuming, and costly, and would result in a diversion of resources from other equally important issues.

The proxy goes on to discuss Sun's commitment to the general intent of these principles, and the belief that management, rather than “broad and sweeping” policies, are best suited to address these issues.

I have no information as to whether Sun or its suppliers have had any direct or indirect involvement in these activities at all, and these comments should not be taken as any suggestion otherwise. But my view is simple. Some practices are so clearly unethical that they should be rejected out of hand, and ruled out formally, vocally, and without shades of grey, even if that rejection might increase the costs or reduce the business of a company. Sun offered no firm alternative policy for vote on these issues, just a statement that the issues were “complex and sensitive.” Had Sun responded with some sort of clear, even reduced alternative, a no vote might have been reasonable. Sun did not provide this choice. We voted in favor of the proposal, though with little expectation of seeing it adopted.

In many cases, we believe that it can be useful to hold shares in an otherwise strong company and attempt to induce changes from within. This is not true for companies that are are already marginal holdings for us. In Sun's case, we observe competitive pressures from the Windows/Intel platform, and increasing adoption of open systems such as Linux.

Personal Investments in the Hussman Funds

Speaking of rejecting certain practices formally, vocally, and without shades of grey, the following is a complete record of my personal investments (dollar amounts excluded) in the Hussman Funds. As I noted last week, my investments in the Funds are made automatically at the beginning of each month. There is a small number of months when I did not make investments due to tax or charitable contributions. Otherwise, I really do practice what I encourage for shareholders. Save first, not last. Invest regularly. Don't attempt to time the Funds. Figure out a set of actions that you believe will make a difference in your life if you follow them regularly. Then follow them regularly.

Strategic Growth Fund

Date Description NAV
6/20/2000 Initial Subscription $10.00
12/1/2000 Additional Subscription $10.88
1/2/2001 Additional Subscription $11.54
2/5/2001 Additional Subscription $11.47
3/1/2001 Additional Subscription $12.05
4/2/2001 Additional Subscription $12.56
5/2/2001 Additional Subscription $12.11
7/5/2001 Additional Subscription $12.30
8/2/2001 Additional Subscription $12.32
10/31/2001 Capital Gain Reinvestment $11.42
1/7/2002 Additional Subscription $11.96
2/5/2002 Additional Subscription $12.37
3/4/2002 Additional Subscription $12.45
4/4/2002 Additional Subscription $12.97
5/6/2002 Additional Subscription $13.20
6/5/2002 Additional Subscription $13.53
7/3/2002 Additional Subscription $13.36
8/1/2002 Additional Subscription $13.67
9/3/2002 Additional Subscription $13.71
10/2/2002 Additional Subscription $13.40
11/4/2002 Additional Subscription $13.23
11/22/2002 Capital Gain Reinvestment $12.27
12/4/2002 Additional Subscription $12.46
2/4/2003 Additional Subscription $12.64
3/5/2003 Additional Subscription $12.29
4/2/2003 Additional Subscription $12.32
5/6/2003 Additional Subscription $12.93
6/4/2003 Additional Subscription $13.82
7/1/2003 Additional Subscription $13.94
8/6/2003 Additional Subscription $14.05
9/5/2003 Additional Subscription $14.60
10/8/2003 Additional Subscription $14.50
11/6/2003 Additional Subscription $14.74
11/7/2003 Capital Gain Reinvestment $14.76

Strategic Total Return Fund

Date Description NAV
10/2/2002 Initial Subscription $9.92
11/4/2002 Additional Subscription $9.88
12/4/2002 Additional Subscription $9.86
12/31/2002 Income Reinvestment $10.19
2/4/2003 Additional Subscription $10.29
3/5/2003 Additional Subscription $10.21
3/31/2003 Income Reinvestment $10.11
4/2/2003 Additional Subscription $10.02
5/6/2003 Additional Subscription $10.23
6/4/2003 Additional Subscription $10.61
6/30/2003 Income Reinvestment $10.54
7/1/2003 Additional Subscription $10.57
8/6/2003 Additional Subscription $10.36
9/5/2003 Additional Subscription $10.57
9/30/2003 Income Reinvestment $10.77
10/8/2003 Additional Subscription $10.63
11/6/2003 Additional Subscription $10.70
11/7/2003 Capital Gain Reinvestment $10.33

-- posted by MarketVVizard