WASHINGTON, May 28 (UPI) -- The stock market has been somewhat weak since my second "Bear Food" article Dec. 24, down 6.3 percent to 1,075 on the Standard and Poor's 500 Index, and has showed recent signs of deteriorating further.
I thus thought it worthwhile to produce a third installment of "Bear Food" companies for negative-minded investors to munch on.
For new readers, I would explain that "Bear Food" companies are major companies whose stock can be expected to trade at 80 percent below its current price within three years of the recommendation.
In general, while the overall trend of the market since my first article in January 2001 has been satisfactorily ursine, with the S&P 500 Index down 20.4 percent from 1350 to 1075, the conditions I then anticipated, of serious recession with all the economic and market strains that produces, have not yet occurred.
By pumping money into the economy at a 12 percent annual rate in terms of M3, with eleven interest rate reductions from a federal funds rate of 6.5 percent (well, OK, already 6.0 percent when I wrote my first article) to 1.75 percent, Federal Reserve Board Chairman Alan Greenspan has certainly postponed the inevitable but not, as I have argued elsewhere, warded it off together.
My first "Bear Food" portfolio in January 2001 consisted of Marriott, Cisco and Goldman Sachs. Of these companies, Marriott has benefited from the continuing strength in real estate, and the recovery in hospitality after the Sept. 11 tragedy, so it has not really been a "Bear Food" success, dropping only 14 percent to $39.50 from its January 2001 price of $46.
My other two stocks, from a Bear viewpoint have performed much better. Cisco, then $34, is now $16.30, down 52 percent, and Goldman Sachs, then $105, is now $76.50, down 27 percent. In total, the three stocks are down 31 percent, satisfactorily outperforming (from a Bear viewpoint) the index's drop of 20.4 percent.
I would continue to recommend Bear positions in all three stocks, and expect at least two of the three (Marriott is the one of which I am currently least confident, given what is now a relatively short time frame, although I still think it will drop substantially) to trade at a price 80 percent below their January 2001 level, my Bear criterion, within three years of the recommendation. In other words, expect $9.20 (hesitantly) for Marriott, and, more confidently, $21 for Goldman Sachs and $6.80 for Cisco before January 2004.
My second Bear portfolio, of December 2001, has so far performed less well, dropping only moderately, mainly because the retail sector, on which all three stocks in it depend, has not yet experienced the sharp downturn which I fully expect. WalMart, Bear recommendation at $57, stands today at $51.30, down only 10 percent. Home Depot, Bear recommended at $50, today stands at $41.40, down 17 percent. E-Bay, Bear recommended at $65, is at $56, down 14 percent. Average drop, 13.7 percent, which is still not bad in only 5 months and handily beats the 6.3 percent drop in the index.
Again, I reiterate my Bear calls: Before December 2004, WalMart will trade below $11.40, Home Depot below $10 and E-Bay below $13.
My third "Bear Food" portfolio, includes two more companies that are dependent on the consumer, and one icon.
DaimlerChrysler, first, is generally touted as a recovery speculation. In the first quarter of 2002, the company achieved an operating profit of 1 billion euros ($930 million) after pretax losses of $1.3 billion in 2001 and $1.5 billion in 2000. The stock, at $50, is up around 15 percent on the year and double September 2001's low.
I have written that I thought that DaimlerChrysler was a badly run company, and I stick to that view. In the last six months, the Chrysler division has benefited from an enormous boom in U.S. automobile sales, aided by 0 percent customer financing, but the fact remains that its models are outdated and its position at No. 3 in the U.S. domestic market is unattractive in the case of a downturn.
Mitsubishi Motors, of which DaimlerChrysler owns 34 percent, lost large amounts of money in 2000, eked out a break-even performance in 2001, but has certainly seen none of the turnaround produced by Renault's Carlos Ghosn at Nissan. However, in past years, these problems have been hidden by the magnificent performance of DaimlerChrysler's flagship Mercedes brand, which produced operating profits of $2.6 billion in 2001, only to see these swamped by losses in Chrysler and elsewhere.
Three trends seem very likely to cause a reversal in even Mercedes' fortunes, and consequently a second and more prolonged downturn in those of DaimlerChrysler.
First, the up-market automobile segment grows ever more competitive, and has been identified as the primary target by all the giants of the industry; coming from a high cost manufacturing base in Germany it will thus be impossible for even Mercedes' profit margins to be maintained.
Second, the dollar, which has been strong against European currencies since 1995, which weakness has enormously benefited Mercedes (which manufactures in Europe and whose most profitable market is the United States.) This strength has now gone into reverse, with the euro today trading at 93 cents, up from 82 cents at the bottom. Because of the U.S. balance of payments deficit, currently $400 billion per annum and climbing, I expect dollar weakness to continue and worsen for a number of years.
Finally, the key demographic that has benefited Mercedes and other luxury car makers in the U.S. has of course been the increasing inequalities of income, and the bubble stock market profits that have accompanied them. U.S. inequality is at historically high, if not record levels (certainly the highest since 1929) and there seems no likelihood that this situation will remain.
With the federal government running deficits (and taxes thus likely to increase) the stock market going nowhere, excessive stock options under attack and financial sector bonuses likely to be sharply depressed for the next few years, the purchasing power of Mercedes consumers will be sharply curtailed. Without Mercedes' protection, the weaknesses in DaimlerChrysler's other operations will be clear to see. Automobile companies historically suffer severe share price drops in economic downturns; expect DaimlerChrysler to trade below $10 before May 2005.
Fannie Mae, the leading provider of U.S. housing finance, had a spectacular year in 2001, with profits and revenues more than doubled in four years from the already booming levels of 1997. Its share price, at $78.75, is close to its all time high and double its 1997 levels.
Its leverage has sharply increased, with equity down since 1997 from 3.6 percent of total assets in 1997 to 2.3 percent in 2001, while its return on assets has declined slightly from 0.81 percent to 0.78 percent.
In short, it is a classical cyclical stock at the peak of its cycle. In addition, as has been extensively featured in the press, it is heavily exposed to the derivatives market, through transactions about which its disclosure is very limited, and it is subject to significant political and funding risk, since its cheap funding and AAA credit rating rely on an implicit but not explicit U.S. government guarantee. Fannie Mae's book value (before deducting any intangible items) is $17.55 per share. An 80 percent share price drop from current levels, to $15.75, would represent only a 10 percent discount from this book value.
Finally, the icon. Warren Buffett is probably the greatest investor of the past 50 years (he began his professional investment career in 1951.) However, he is also 72 years old, and his holding company, Berkshire Hathaway, is trading at $77,000, more than twice book value of $37,920, and on a price-earnings ratio of 106.6 times. Buffett's investment record over the past few years has been less than stellar; in the three years 1999-2001 Berkshire Hathaway shareholders equity increased by only 0.3 percent, admittedly in a period when the S&P 500 Index dropped 3.1 percent.
If, as I expect, the S&P 500 Index drops 25 percent from the end of 2001, to around the 860 level, then Berkshire Hathaway's book value can be expected to drop considerably more, since the company's liabilities at $103 billion are nearly twice its shareholders equity of $57 billion.
If Berkshire Hathaway's book shareholders equity were to halve, to $19,000 per share, and then the shares were to sell at a normal closed end mutual fund bear market discount of around 20 percent, then Berkshire Hathaway A shares would trade at $15,200 per share, more than 80 percent below their current level. In addition, Buffett's track record is not what it was in terms of sector picking; his insurance operations do not seem particularly attractive in the present climate and such investments as the Salomon Brothers participation, taken at the peak of the 1987 bull market, suggest that even Buffett is by no means infallible.
Berkshire Hathaway is an investment icon to many, but to me it is Bear Food.
(The Bear's Lair is a weekly column which is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the last 10 years, the proportion of "sell" recommendations put out by Wall Street houses has declined from 9 percent of all research reports to 1 percent. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
