May 2007

Only the names have changed...

The current stock market cycle has avoided, so far, the normal pullback one would expect given its unyielding performance. The surge to new highs in the indices is in part due to liquidity (easy capital) and is being orchestrated by massive hedge fund and private equity buyouts. Record amounts are being paid for companies by these power-brokers with seemingly unlimited access to capital. Given the prices paid, the question remains: How much shareholder equity will be created from these efforts?

Today, the markets appear to be riding high on the tide of excess liquidity here and abroad. We remain cautious to the current speculative market environment, given the slowdown in domestic economic growth, modest capital spending, and the probability of continued weakness in housing market as credit tightens with ever higher interest rates. To offset some of the market uncertainties, investors should remain conservative by not chasing the market, accumulate blue-chip companies with solid balance sheets on notable price pullbacks, remain fully diversified in their investment allocations, and have a long-term perspective in the accumulation of wealth. Capital preservation should be an increasing focus to investors.

Not to throw water on the fire of todays frothy markets, but we would be remiss if we ignored lessons from the past. Lessons that should, at least, give pause. “Mergers of industrial corporations and of banks were taking place with greater frequency than ever before, prompted not merely by the desire to reduce overhead expenses and avoid the rigors of cut-throat competition, but often by sheer corporate megalomania. And every rumor of a merger or a split-up or an issue of rights was the automatic signal for a leap in the prices of the stocks affected – until it became altogether too tempting to the managers of many a concern to arrange a split-up or a merger or an issue rights not without a canny eye to their own speculative fortunes.” “One could indulge in all manner of dubious financial practices with an unruffled conscience so long as prices rose. The Big Bull Market covered a multitude of sins. It was a golden day for the promoter, and his name was legion.” These quotes could be written of today but these observations are taken out of Frederick Lewis Allen’s 1931 book “Only Yesterday” about the 1929 stock market crash. Today, only the names seem to have changed, i.e., hedge funds, private equity and leveraged buyouts.

We hear day-in-and-day-out from the talking heads on major financial newscasts of the “goldilocks economy”, how all is well, and that we have very little to worry about. Remembering, “Is Everybody in Yet?” And, this is precisely why one should begin to worry. Still, the vast amount of liquidity in the world makes one wonder how far on the upside can we overshoot without a significant market correction. Only time will tell.