Letter - April 2002

 

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Enron... here  Enron... there   Enron ... everywhere!

Since the beginning of the year, the securities markets have been dominated by the ENRON/ANDERSON scandal and ensuing fallout. Fortunately, ENRON had never been on our buy list. Nonetheless, it cast a long shadow over the market. We are therefore pleased to note our average client’s account was up solidly in the first quarter even though the popular averages showed no gains at all.

For most investors, it is the shock rather than the financial damage which will be the lasting legacy of ENRON. Trust has disappeared from the stock market, replaced by suspicion. As never before, individual investors are finding they need all the professional help they can get. With the blessing of Arthur Andersen & Co., one of the country’s top five accounting firms, ENRON issued financial statements which disguised losses as profits and hid billions in debt. ENRON wasn’t the only one to give new meaning to the old Wall Street buzzword, “off the books.” Without informing stockholders, the president of ADELPHIA (fifth largest cable company) had the company guarantee a personal bank loan of $2.5 billion!!! When the news came out the stock collapsed. A number of other companies pleaded “mea culpa” to lesser offenses by restating past years’ financial statements. Not even the mighty have been spared. Both IBM and General Electric, when challenged on the way they reported financial results, could not come up with answers convincing enough to keep the price of their respective stocks from falling 20 percent in one week. ”Transparency” has thus become the name of the game. Companies are divulging everything from what the CEO has for breakfast to who supplies the paper clips.

All investors, not just those involved with miscreant companies, are suffering. A cloud of suspicion hovers over Wall Street. Brokerage house analysts stand accused of pushing stocks for the benefit of their investment banking departments. Company officers speak half-truths that often hide liabilities. Probably not the case with the majority of publicly held companies, but who can tell the good from the bad? As long as stock prices were going up, nobody cared. In a bull market, assets are what count; in a bear market, it is debt that matters. Today, the forward thinking investor must be concerned, not so much with potential profit as with potential loss. In regard to this, we are fortunate to have Mr. Sumner Gerard join our firm. Sumner spent 20 years as a corporate banker, so he knows where to look for skeletons. His understanding of the liability side of the balance sheet should help us continue to attain above average results.

While the bear market of the last two years seems to have ended, a bull market has yet to appear. Because stock prices are still historically high relative to fundamentals, the stock market will likely trade back and forth in a wide range. In addition, the prospect of rising interest rates will keep a lid on speculation. Consequently, we suspect that the period ahead may resemble that of the late sixties and seventies. In 1966, the Dow Jones Industrial Average broke up through 1000 for the first time, a level it did not exceed again until 1982! However, we do observe that the market is receptive to stocks that combine good results and reasonable valuations. In sum, we expect returns will accrue to good stock pickers, not because of a broadly rising market. Yet another reason why good advice and professional management should be key to investment success in the years ahead.

Philip Herzig


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