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Gal^Stad
Investments Inc.

spacer October 2002
Commentary

Stocks are dead! Stocks are dead!! They have had their day, but it has passed, and investors are so turned off that they will stop buying stocks altogether. Please remember that you read it here first, on the Contra Web site, before Time, Newsweek, The Economist, or even MAD.

By using a complex blend of both fundamental and technical analysis, combined with the synergies of five psychologists locked in a closet together with only one chamber pot, the Contra Guys are not only willing to make the above statement conclusively, but we have ascertained that trading will gradually subside until, on November 31, investors will be so disgusted that no one will even place a buy order! At that time, a best-selling book will appear on bookstore shelves: Dow 36,000 ... If Trading Ever Resumes.

Having so concluded, we contemplated selling all our positions in a massive flurry, but since the media watches us so closely we deemed this a losing proposition; everyone would also be aware of what was about to happen, and because markets are perfectly efficient, a stampede for the exit would ensue. So, except for you, dear readers, no one knows what we know: yesterday, at exactly 2:22 a.m. (a time chosen based on the lunar alignment, which pointed to the old TV show Room 222), we shorted every single stock on every market in the world. With this windfall, we plan to buy first-class, 'round-the-world bus tickets. The Contra Guys, always thinking about fine travel.

However, before we embark on this magnificent voyage and lose touch with you completely, we felt it best to share a few additional thoughts. The public has lost its taste for the markets, optimism has dissipated, the bubble has been pricked and gone pftttt, and the dire search is now on for "The Bottom." New paradigms be damned; the established norms of human psychology and business cycles once again rule the day. Who'd a thunk it? Same old, same old. Again. Déjà new = old-style pessimism.

The question is, can future booms and busts be prevented? Dream on. Human psychology suggests that the way we react is too deeply ingrained. Our best hope is for a semblance of moderation, with lower crests and shallower troughs. How might this be achieved, short of reprogramming people's brains? (Something that isn't necessarily against our personal belief systems, but which others might find abhorrent -- hey, those are my stem cells!)

What is the primary means of regulating the economy today? Interest rates. Things getting too hot? Raise rates. The economy's cooling? Lower them. While this is definitely a powerful lever, an overemphasis on interest rates is simplistic. Here are a few other ideas, offered in no particular order.

Speculation must be curtailed. One way to achieve this is to force people to fork over more money for their purchases, increasing the margin requirements when people buy stocks. Perhaps, during periods of "irrational exuberance," no margin should be allowed.

Alan Greenspan, one of the more powerful voices in the world, recently said in a speech at Jackson Hole (no, that's not a pun on the state of the economy), that it was impossible to stop the bubble and that raising the margin requirement would not have made a difference. However, back in 1996 Mr. Greenspan said, "I recognize that there is a stock market bubble problem at this point ... We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it. My concern is that I'm not sure what else it will do."

Stricter margin requirements do dampen demand; they also reduce margin calls when stocks are weak, thereby creating less likelihood of an ensuing downward spiral. Unfortunately, the best time to do that passed with the mania, but graduated steps can be implemented now to phase this in before the next episode of what Warren Buffett calls a "mass hallucination."

We wonder, but don't have an answer, as to how much of the bubble can be blamed on efforts to contain nascent bears way back in the halcyon days: the Asian Contagion of 1997; the Russian default and LTC meltdown of 1998; or the crazy flush of liquidity that was let loose to pre-empt Y2K problems.

These events all figure in what we are experiencing today. The dramatic increases in the money supply to contain these episodes surely had a major impact on priming the bubble. Government must remain vigilant when using this mechanism, acting judiciously in the short term while maintaining a balanced focus on the long term when the economy is on an expansionary or contractionary kick.

Back on the subject of jerking knees, bankers tend to do this far too often. When do they adopt loosey-goosey policies and lend money like Niagara Falls? When times are good. When are they misers? When the twinkling is dire -- precisely when leniency is imperative. Somehow this mindset should be inverted, but it obviously is not easy to do. Maybe a course in "contrarian banking" should be made a mandatory part of MBA curricula.

Derivatives, as we have cautioned before, are a disaster in waiting. Already they have taken their pound of flesh, but this is nothing compared to the major munch that is yet to come. While these instruments supposedly smooth the waters, they are too often abused by little boys in suspenders who have only a limited understanding of their dynamics. Many who trade in this field are not doing so to create stability, but solely to increase profits, often at tremendous risk. Some banks and major corporations face the peril of being wiped out as these bets are flung back in their face. Get ready to count the job losses, along with the associated economic straitjacket.

Next? A June column in The Globe and Mail's Focus section said, "Twenty years ago, senior executives earned about 45 times as much as an ordinary employee. By 1997, the factor was 305 times as much. And between 1997 and 2000, when profits grew little, the multiple reached a jaw-dropping 458." Heck, 305 times seems jaw-dropping enough for us, but what do we know?

We are aware of the trickle-down effect, whereby money works its way through the system from the top down. But this is far from an optimal method of distribution. We propose the "spread-the-wealth-around effect." We bristle when guys like John Roth receive payouts of $145 million or so. It's not that we don't like Mr. Roth, or Mr. Stronach or their ilk; we just think that a wider range of snouts should be allowed to nuzzle their way into the trough.

Think of it this way: an individual like Roth can only spend so much money on his own. There's a limit to how much he can fire the economy with his $145 million. But spread that same money amongst 10,000 people, giving each a cheque for $14,500, and a lot of cars and dishwashers and brooms and other neato stuff will be purchased. But, you say, Big Bad John got the $145 mil as an incentive/performance bonus. When you look at his already fat salary, how much extra performance could Nortel really hope to induce? Now, if you dangle a $14,500 carrot in front of 10,000 souls, we'll bet that the aggregate performance boost is a heck of a lot higher.

Let's do some math. An executive who makes about 100 times the minimum wage, or $700 per hour, will -- based on an 80-hour work week 52 weeks a year -- earn about $3 million a year. Let's be even more generous and ratchet that up to 200 times -- that works out to a cool $6 million. That's enough for anyone to earn in one year, isn't it? Let's cap the compensation there and either return the excess to the corporation or tax it away.

Let's face it: the business cycle, with its ebbs and flows, is a staple of life. This is unlikely ever to change. However, we can deal with it better than in the past, thereby creating a more stable economy that will function more smoothly and allow a recalibration of the highs and lows.




Our guiding philosophies appear elsewhere on our website and are published every January in the print edition of Contra. Here are a few other simple rules and concepts that guide the day.

A question that we are regularly asked is: Given the sell-off in some stocks and their penny status, how low can they go? The answer remains the same as ever: zero. It is important to remember that $10,000 invested in a stock at $124 a share is the same as $10,000 invested at 82 cents, if the firm goes under. A stock trading at a low price is not necessarily cheap. There is no point in making an investment based on a stock price that seems low if the fundamentals do not suggest that a turnaround is realistically in the cards. We know that stocks in general are better buys with the Dow at 7,500 than at 12,000. This also applies to the TSE -- er, TSX.

We know that, if we are choosing a fantasy baseball team of no fewer than three batters, and the goal is to assemble a team of hitters who average the most home runs per player, we would not put the entire league on our roster. We would likely pick A-Rod, Bonds and Sosa. The same rationale applies to cherry-picking individual stocks instead of backing indexes.

We know that telecom and high-tech stocks are more likely to perform well over the next five years than oil and gas. We also know that, at this particular time, more people will invest in the latter than the former. We know that real estate remains hot at the same time that tons of economic thermometers are chilling, and that this is normally a harbinger of worse things to come in this sector.

We know that a $28 billion court judgement is ludicrous and makes a mockery of both the judicial system and money.

We know that the Kyoto accord cannot be all bad; it will certainly cost jobs, but new ones will be created, too.

Before departing this quarter's commentary, we should mention, for those who have some free time, there are still some seats available on the bus reserved for our subscribers. The vehicle happens to be one of Laidlaw's finest, although in the interests of full disclosure, we must reveal that it doesn't have a toilet; we lent that to the psychologists. However, it does have a big "11" on the side for easy identification. Please come and join us on this magical excursion. It should be a hoot.

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