Bears lack spark as nerds get revenge

Kids are cruel. When I was in eighth grade, my friends and I were considered nerds. Every now and then we would be picked on. So finally, one of my friends, Mike Parker, made himself a home-made Taser. He took a stick, wrapped some wires around it, leaving them exposed at the end, and slapped on a battery. He then touched the exposed end of his Taser to Cliff Herzog’s braces. After Cliff flew about 20ft in the air, Parker, scientist extraordinaire, was suspended for the remainder of the school year and eventually went to private school. I, however, was stuck in public school for my remaining four years – trapped in the zoo.

That is how I feel when I read the average pundit talking about the US markets and economy. The cool kids love to be bearish. It allows them to be smug. Here are two of the arguments: “The subprime industry is taking down the economy” and “everyone borrowed money that they can’t repay so all the banks are going to go under”.

This ignores the fact that subprime loans are experiencing, at most, about 4 per cent defaults and the subprime industry is only about 20 per cent of all outstanding mortgages. So, in other words, less than 1 per cent of the outstanding loans are at risk because of the subprime mess. Which is why conservative banks such as Barclays are eager to buy subprime mortgages at 96 cents on the dollar.

Freemont General sold its entire subprime book at 96 cents on the dollar, leaving it with a commercial lending business that is experiencing less than 1 per cent defaults.

Some transactions have even gone as high as 97 cents on the dollar.

Another somewhat bearish argument popular in the media is that not everyone is experiencing the massive growth in average net worth. In fact, the argument goes, it is weighted to the upside. The gap between rich and poor is getting greater. People ignore the fantastic increases in productivity during the past 15 years that have driven this “wealth gap”.

Here is an example using two 16-year-olds: my kids’ baby-sitter and one of my interns. The babysitter makes $12 an hour. That is normal. It is the inflation- adjusted rate of what I made 23 years ago when I was a paperboy, which was the only job I could get back then that paid anything.

My intern, on the other hand, recently quit. I wouldn’t pay more than $12 an hour. Meanwhile, he makes about $200 a week for a few hours of work writing articles for various internet websites.

The gap between what he makes and what other kids make is so great because the internet has opened a world of opportunity to people of every age and class. Things are never so simple as to separate everybody into medieval categories of “serfs” and “landowners”.

My favourite bearish argument is that there is no longer any good use of capital and that is the only reason companies are now buying back stock by the truckload. In other words, companies realise we are about to go back into the Stone Age and nobody is going to be buying anything, so the only good use of capital, rather than to invest in new factories, among other things, is to buy shares on the open market to prop up prices.

I’ve written about this before in these pages. Companies such as Cigna have been spending billions of dollars buying back their stock on the open market. In effect, taking themselves private share-by-share. Cigna is not doing this because there are no factories to build (why would a healthcare benefits company want to build factories anyway?) but because it trades for only six times cash flows. That’s a cash flow yield of 18 per cent with interest rates at 6 per cent. Why not borrow as much as possible at 6 per cent and buy back shares yielding 18 per cent? That’s a pretty good use of money if you ask me.

Some other large cap stocks that are appealing for the same reasons are DuPont and Bank of America. They are spewing money to shareholders. DuPont bought back 5 per cent of itself, like a self- eating sewer monster, while at the same time yielding a 3 per cent dividend for shareholders. And Bank of America is at the tail end of a 200m share buy-back programme begun a year ago. Meanwhile, it is also giving out a 4.5 per cent dividend.

If, like the bears, you are worried that earnings might soon be a thing of the past, why not buy shares of the many companies that have had 10 years of consistent earnings growth? As long as there is a global economy, Expeditors International of Washington, a provider of global logistics services, will probably continue to increase earnings. Other companies with at least 10 straight years of earnings growth include Ross Stores, Harley-Davidson and Apollo Group, a provider of higher education to working adults.

Don’t let the bear bullies pick on you. Eventually they will be working the gas pump and filling your expensive cars. But their quality of life will continue to improve because it does for just about everybody every year.