The Barnard Observer

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Home  Picks  Figures  Great Investors  Vault  OpEd Contact   c2003-04 Thomas Barnard

The Japanese market rose from 12,000 in August to around 16,000 today, a rise of 33%.  In the same period, the Dow has gone exactly nowhere.  I was looking for a yearend rally but it didn't materialized.  It looked like we might get a January rally, then it looked like we wouldn't get one, and now it looks like we might get something. 

There are two huge industries in America.  The automobile industry and the housing industry.  The auto industry is in deep trouble.  Years of ignoring consumer tastes, agreeing to onerous labor contracts, and ignoring the essential issue of quality.  How long has it been since the Ford ad campaign with the slogan "Quality is Job #1" and the attention to Sigma Six?  Years and years.

A sort of Peter Principle applies to labor contracts.  Labor had enormous bargaining power, which they applied liberally to automakers.  With this power they ultimately obtained wages and benefits that are not sustainable.

Labor contracts involved two serious problems.  Health insurance, the costs of which have gone out of sight, and the huge problem of defined benefit pension plans.  But someone had to agree to those terms, and so we save our real scorn for management.  They ignored the compact market in the 1970s, building horrible cars like the Pinto and the Vega.  I know, I had one.  Meanwhile, the Japanese made attractive smaller cars with standard amenities like power windows.  Could GM and Ford learn nothing from Toyota?  You would think they would be learning the Japanese practice of incremental improvement.  But it doesn't look like it from here.

General Motors has been a drag on the Dow, and a drag on the nation.  From where I'm standing, the actions that GM has taken so far fall short of what is needed to turn their fortunes around.  GM is not out of the woods by any measure.  Kirk Kerkorian jazzed up the stock price for a while with his bid for 10% of the company.  But later on, he sold some of his position and the stock fell off a good 30%.  Ford appears to be taking serious reckoning of their problems, and they will still be around, but perhaps a smaller operation even than they are today.

Taking a Peak at Housing

Today it was announced that existing home sales fell 5.7% in December from November.  Median price for existing homes fell from $215,000 in November to $211,000 in December.  Inventories of homes are increasing right along.  The inventory of unsold condos jumped 8% last month.

It looks like the new Fed chairman, Ben Bernanke, is a smart fellow with a good program of inflation targeting.  Nevertheless, coming off the huge following of Greenspan, we expect a rough year ahead.  Gold is telling us interest rates had better be headed higher, but this will be bad news for the economy, and specifically, bad news for housing.

The Underlying Problem

There exists a serious underlying problem for the U.S. stock market, and that is, it is over-valued.  Yale professor, Robert Shiller, who called the market downturn in 2000, says that stock market values are simply too high.  As quoted in Fortune, December 26, 2005, "The trailing P/E ratio for the S&P is still around 25, vs. a long-term average of 15." 

It's a huge difference, and the problem with that is an average of 15 means that there are also a bunch of years below 15, with P/Es of 10 or less.

When you look at the Japanese market, and its rise, you have to remember that market was in a long term decline from 1989 to 2003.  If we suffer a similar decline, that would mean that the final decline for our market wouldn't be until 2013.  I often remind people that the stock market top in the Dow of 313 of 1929 was not equaled again until 1952.  That's 23 years.

Some of the stocks that powered up the 1990s like Microsoft and Intel have been flat for years, and as my dear old Dad says, "those stocks may have a particular good product that does very well, but those results get lost because the company is so big."  Cisco that I liked in my last report, is a little above where I recommended it, and I'm out.  I expected a better yearend or January market and recognition of the fact that bandwidth will grow no matter what.  Nothing happened.  Maybe Cisco is suffering from being in middle aged company like Microsoft and Intel.

Intel's report just came out and it was something of a disappointment.  Margins are down somewhat.  Inventories up half a billion, accounts receivable up a billion.  If they're having trouble keeping up with demand, then why the lousy balance sheet?

Microsoft has been living off its laurels for years.  Microsoft Office has been a money-maker as has Windows.  The new version of Windows does not appear to be a major improvement.  Moreover, Google's idea of doing your computing online makes an operating system less and less important.  If you can edit your documents and spreadsheets online and save them to a master computer, what do you need other than a browser?  Well, we'll see how that all pans out.

What's Left?

Energy.  Gold.  Exceptional growth companies.  We have liked Suncor, but it's a little high at the moment.  We'll have to research this out.  I am stepping back to watch for a while, and reconnoitering.

The Junkers

I'm out of the junkers.  The finally tally is charted below.  A mixed bag.  I'm forecasting a flat or declining market, and these companies may have trouble staying afloat.  Lucent recently disappointed and they're bringing in new management.  Gateway has a manager I like in Wayne Inouye, but its founder keeps selling.  Sun Micro disappointed.  These companies have prospects, but I think I'd rather deploy my soldiers elsewhere.

                Recommended Price    Current Price    Incr/Dcr

Lucent                 3.06                        2.52             -18%

Gateway              2.71                        2.82            +4%

JDSU                  2.06                        3.01            +46%

Nortel                 3.31                        2.97            -11%

Sun Micro           3.89                        4.44            +14%

January 27, 2006