So let's flesh out those sectors mentioned in the last post with some actual stocks:

AA	Alcoa
PD	Phelps Dodge
XOM	Exxon Mobil
CVX	Chevron Texaco
GM	General Motors
F	Ford
ROK	Rockwell
APH	Amphenol
MSFT	Microsoft
ORCL	Oracle
ERTS	Electronic Arts
SFA	Scientific Atlanta
CMCSA	Comcast

Of these, the software group (MSFT, ORCL, ERTS) looks the best under my usual Buffettology ROI calculations. Since I already own these stocks, that doesn't help me much. Surprisingly GM and Amphenol also look good, and they are not stocks I would have thought of. These five all project out in the neighborhood of 20% return per year, but of course that doesn't always come to pass. Let's remember their prices as of today: MSFT 26, ORCL 12, ERTS 41, GM 48 and APH 61.

I've been thinking more about the prospects for inflation versus deflation, and I have to think inflation is what's coming. The Bush administration is running up a huge national debt. Even with interest rates as low as they are now, the interest payments are a large part of the federal budget. When rates rise, as they surely will some day, the budget will be totally out of whack. There is only so much the feds can borrow before creditors will demand higher and higher rates. Congress doesn't dare hike taxes a lot or cut benefits a lot, nor do they dare default on the debt. The only way out is for a nice rip roaring inflation to reduce the debt (in effect).

So what makes sense to invest in under this scenario? It's much like the 1970s, after Johnson's guns and butter binge. One thing is the Treasury's inflation protected bonds, which pay a rate that goes up with inflation. But what stocks? The Wall St. Journal recently (12/1) ran a piece by Ken Brown with some sector ideas:

• Mining and energy companies
• Auto makers
• Electrical equipment manufacturers
• Software makers with foreign competition
• Cable television companies and manufacturers

Sectors to avoid:

• Banks
• Service companies

The Wall Street Journal yesterday had a nice little sidebar about websites that offer free (and pay) information about insider trades. The sites are Thomson Financial and Vickers Stock Research. Insider buys are often a good indicator that a stock will go up. Insiders sells are less useful, as insiders frequently sell just to diversify their holdings, which is only prudent. Right now, I don't see any stocks with heavy insider buying that I like, but it's worth watching.

Mike Porter: Mistake to stock up on retailer because it's got a cool store
Some good points here about retailing being usually a poor business. But I think he misses the point about Lynch's suggestion to buy the stock of stores you like. The idea is to find a hot stock before it's hot, not like Krispy Kreme whose story is covered on the front page and the TV news. By that time, it is too late.

Back in the late 1980s, I worked for a company called Three D Graphics. They made presentation graphics software, starting with a program called Perspective, which uses (of course) 3-D graphics. The original code came from a couple of Macintosh fans who immigrated from Germany: Kai Krauss (who later became famous for Kai's Power Tools) and Martin Schmitt. Kai did the artistic stuff and Martin did the 3D math and the programming. A financial wizard named Elmer Easton invested in the company and became CEO. The company used to be based in Pacific Palisades, California but now is in the Century City part of Los Angeles. I wrote the first Windows version of Perspective, for Windows 2.11 (this is going back some!). I left the company in 1989 to take a job in the languages group at Microsoft.

From their website, it looks like Dan Weingart still works there, and maybe also Jon Henderson, who left to work at Microsoft for awhile and then returned to Three D Graphics. Other employees from the 1980s that I remember are fellow software developers Mark Riley and Keith Kiyohara, Vice President Tom Budlong and corporate secretary Celia Cushing-Brawley.

I received shares of common stock in the company, which is privately held. They were almost bought out by a public company in 1998 (which would have made my shares saleable), but the deal fell through. I've held these shares for 15 years now. I've been thinking of selling them to a friend for $1 so as to get a tax loss, but the company is still in business and who knows, it may yet be worth something. I talked to Elmer Easton a year ago and he urged me to hang onto them. Anyone else in a similar boat - got suggestions? Perhaps we could start a stockholders Yahoo! email group. Email me or leave a comment.

There was an interesting set of articles in yesterday's Wall Street Journal about the relevance of accounting as currently practiced (articles not online, at least not for free). Investors focus on EPS, yet earnings under GAAP do not count the cost of capital. Investors have a choice of companies to buy stock in, and expect a return of, say, 10%. Interest on loans is deducted as an expense, but the implied interest rate on equity is ignored. So a company can issue $1 million worth of stock, on which investors expect to make $100K per year, and then actually earn $50K a year, and it will show up under GAAP as a profitable company.

On the balance sheet, intangible assets are ignored, even though they form an estimated 80% of the assets of US corporations! Intangible assets are things like trademarks, computer software, etc. They are usually created by employees and their salaries are expensed. No assets appear on the books. Intangible assets should be capitalized and then depreciated over a period of years.

It makes you think and wonder when and where a clearer set of books will be found.

Business Week: Deflation
Declining interest rates and rising unemployment make me worry about deflation. Japan's been living with it for more than a decade. So what are the implications for investing in the stock market? First off, don't: Japanese stocks have been in a nose dive since 1989. For a business to survive deflation, it needs to keep debt low and avoid long term commitments to buy at a fixed price. Cheap restaurants, discounters, importers and providers of mental health services thrive.

The Big Chill, by Michael Brush
Global warming may cause the Gulf Stream to stop streaming. If this happened, much of Europe and the Northeast US would see much colder weather. Brush sees this as bullish for heating oil and gas companies, and those offering tours to warmer climates, bad for insurance firms, among other effects. It would be a startling development, yet it does sound plausible. Is the current cold winter in these areas an omen?

Economist Paul Krugman says interest rates are going up, maybe not in the next few months, but as a consequence of Bush's big deficits. It sounds, like in the 70s, stagflation may be upon us. The 70s were bad for stocks and bonds, but good for money market funds, real estate and precious metals, as I recall.

Warren Buffet's annual letter summarized in Fortune, full letter at Berkshire Hathaway.
Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us

And it's true that stocks are still overpriced by historical standards. Price-earnings ratios need to get down to 15 or so to match the historical average. Buffet would prefer even lower ones.

The baby boomer generation begins with those born at the end of World War II in 1945. The last of the boomer generation is a matter of opinion, but let's call it 20 years later, for those born in 1965. This generation reaches the traditional retirement age of 65 in 2010 to 2030. At that time they (OK, we) will depend on the smaller, younger generations to pay our social security, plus whatever savings we have accumulated while working. So one can envision a difficult period with a lot of older people needing support and not many of working age to do the supporting. From a stock market perspective, it doesn't look good for economic growth.

But lately it has occurred to me that this timetable actually happens earlier. Income starts declining around age 55, due to early retirement, age discrimination, or out-of-date skills and perhaps declining energy. At the other end of things, by 2020 the boomer generation will be reduced in size and importance. So the bad period may actually be 2000-2020.

The image I have is of boomers having had their peak earning years in the 1990s, working and saving hard for retirement. This period is now fading and may at least partially explain the three year bear market. And foreshadow 17 more bad years - yikes!

The bull market peak on the Dow was 11,720 in January 2000. For the S&P 500 the peak was 1,527 in March 2000. For the NASDAQ composite, it was 5,048 in March 2000. As of Friday, the Dow lies at 7,908 (off 32%), the S&P is 834 (off 45%), and the NASDAQ is 1,310 (off a whopping 74%).

Certainly we're in a bear market. If you dabbled in high-flying NASDAQ stocks back in the late 90s you've probably taken a real bath. The question now is: when do we reach bottom, or is there any hope of a revival in the averages?

The bullish argument:

• Interest rates are low, the lowest in decades, which is good for business because it makes it easy to borrow and reduces the payment burden of debt.
• Fiscal policy is stimulative, i.e. the federal government is running a big deficit, which according to Keynesian theory will stimulate the economy because the government is generating all this demand.
• Stock prices have come down to more reasonable levels, and unemployment has risen. Thus, there is some room for higher prices and a rise in production.

The bearish argument:

• Prices are still high. A long-term average price-earnings ratio is 15, but the averages are at nearly 30.
• The momentum is down, down, down. Check out the above chart of the NASDAQ composite.
• The mood is fearful. The market is worried about a war in Iraq. IPOs have virtually dried up. Everyone is hunkering down and waiting out the storm.

So, as always, it's unclear, but there's not much sign of an end to the bear market yet.

I used to post regular stock market newsletters back when the market was booming, but of course it became less fun when it turned bearish in 2000. The old letters are archived here. Now that we've had three years of down markets, I think it's time to take a new approach to these comments, and just make this a weblog that I will update whenever the spirit moves me. I've enabled comments on this blog, so feel free to post your thoughts, too.