The Elephant in the Room

I'm working on putting together the next issue of the Forbes Growth Investor. I still have President Obama's State of the Union speech on my mind, so I asked Mark Stivers to draw this cartoon.

Hank Greenberg's Take

While Timothy Geithner was being grilled on Capital Hill today, former AIG CEO Maurice "Hank" Greenberg was delivering a talk at the Union League Club. He made several important points.

He said the legal system needs to be fixed. A politically ambitious attorney general (i.e., Eliot Spitzer) should not be allowed to destroy companies and reputations in order to reach higher office. Greenberg said AIG has already spent approximately $700-800 million in legal fees. Greenberg has spent almost as much himself. He asked, "For what?"

He pointed out that government officials played favorites by forcing AIG to pay Goldman Sachs 100 cents on the dollar. He said it didn't pass the smell test when former Treasury Secretary Henry Paulson fired AIG's then CEO Robert Willumstad and replaced him with Edward Liddy, who was on the board of directors at Goldman Sachs.

He said that when the government took an 80% stake in AIG, it should have immediately stated that the government's AAA credit rating also applied to AIG. However, government officials claimed they didn't have the authority to do such a thing. Greenberg found this explanation odd since the government did many things it did not previously have the authority to do. Yet it always managed to get the authority quickly whenever it wanted.

It turns out that Hank Greenberg is writing a book about all this. I can't wait to read it.

An Oldie, But a Goodie

Scott Brown's U.S. Senate victory in Massachusetts on Tuesday has certainly gotten the attention of all Democrats. Barney Frank, long-time protector of Fannie Mae and Freddie Mac, suddenly said today that these entities should be abolished in their current form. More importantly, a growing number of Senate Democrats now oppose the renomination of Ben Bernanke as Fed Chairman. I thought this would be a good time to revisit a cartoon we published in the July 2009 issue of the Forbes Growth Investor. It was in response to what seemed to me as a very lukewarm endorsement at the time by President Obama.

Pickens and Fracturing

When T. Boone Pickens tried to take over Phillips Petroleum in 1984, he was accused of not willing to make any concessions. He responded by saying he would move to Bartlesville, Oklahoma. Yesterday, I attended a luncheon at the Union League Club of New York City. Pickens was the guest speaker. Although he made his name as an oil man, more recently he has been trying to promote the use of natural gas in this country. During his talk, he was very critical of the failure of all presidential administrations to articulate a coherent energy plan.

Pickens says the United States is much too dependent on foreign oil--especially on oil imported from countries that are not particularly friendly to us. He pointed out that the U.S. has the world's largest natural gas reserves, and that we can easily decrease our reliance on imported oil by switching to natural gas for transportation purposes. He proposed mandating that all 18-wheelers (i.e., tractor-trailers) be forced to switch to natural gas over some period of time. His idea is to provide a $65,000 tax credit for the purchase of each of these vehicles. However, he did not address the safety concerns, how the trucks would be refueled, or if natural gas could even provide sufficient power to push a fully loaded semi up a mountain.

He also failed to make a strong case that drilling for natural gas would be environmentally friendly. While the available technology may be good enough to drill safely, the natural gas industry must do a better job of conveying this message. In fact, today's Wall Street Journal featured a front-page article about hydraulic fracturing, a process of using pressurized water mixed with certain chemicals to break rock formations in order to get at the gas. Opponents claim fracturing will pollute ground water. As the article pointed out, Exxon Mobil insisted on a clause that would allow it to back out of its proposed acquisition of XTO Energy if the government decides to outlaw fracturing.

How big a role natural gas plays in the future is uncertain, but one thing is becoming clear. Oil prices are too high. There is a big push to promote the use of alternative fuels. Society will remain dependent on oil for a long time, but natural gas, nuclear, wind, battery, and solar will all play bigger roles in the future. Unless global growth suddenly surges, demand for oil, which is already down, will continue to decline.

Stocks Sell Off on Good News

For the most part, there was good news in the markets today, so the strength of the sell-off caught many investors by surprise.

Today's housing numbers from the Commerce Department bode well for the home building industry. Even though housing starts in December fell 4% from November on a seasonally adjusted and annualized basis, they were flat compared to a year ago. Furthermore, building permits, an indicator of future activity, jumped 10.9% from November to December. They were up 15.8% from a year ago. However, don't get too excited about housing. It is still a very sick industry. Almost one in four homeowners with a mortgage are believed to be underwater, and foreclosure rates are still sky high. This will keep housing prices from heating up any time soon.

Wholesale purchasing prices were up just 0.2%, and there was no change in core figure. Although I have argued that the Fed needs to begin its exit strategy, today's PPI data means it is more likely to stick to its policy of keeping rates low.

Finally, Scott Brown's victory in Massachusetts means Congress will have to take a more moderate approach to health care reform. In fact, Amedisys (AMED), a home health care stock we recommended back in September in the Forbes Special Situation Survey added to its gains today.

The sell-off in the overall market is being blamed on China's decision to reduce lending. This stoked fears that global growth might fall short of prior expectations. This kind of thinking could drive stock prices even lower.

Jobs Report Dampens Workers' Hopes

By Vahan Janjigian - Today's announcement by the Bureau of Labor Statistics that nonfarm payrolls dropped by 85,000 in December is a big disappointment, especially to the many investors who were betting that the economy was on the mend. While the headline number is bad enough, the figures down below are worse. For example, although the number of officially unemployed people fell slightly to 15.267 million, the number of employed people dropped by 589,000 because the labor force shrank. In fact, 2.5 million people are no longer considered a part of the labor force even though they want to work and they sought work during the past 12 months. They are excluded because they did not look for work during the past four weeks. In addition, 9.2 million people are working part time, not by choice, but because they can't find full time employment.

One bright spot of the labor report is that temporary jobs increased by 47,000. This is considered good news because corporations often hire temporary workers as business conditions improve before making a commitment to take on permanent employees. In fact, in recent months, at least a couple of equity analysts raised their outlook on Manpower (MAN), a leading temporary employment agency. The stock is up about 30% since November and has more than doubled since the March 9, 2009 low.

Disclosure: The author has an ownership interest in Manpower (MAN) shares.

FGI Gains 35% in 2009

The following commentary appeared in the January issue of the Forbes Growth Investor.

By Vahan Janjigian - When I was in graduate school, a marketing professor told me that investing was easy. He said,“All you need to do is buy low and sell high.” However, many investors did exactly the opposite last year. They threw in the towel at precisely the wrong time. As stocks sold off in March and the Dow dipped below 6,600, they decided stocks were too risky, so they got out of the market. They did not understand that stocks are actually less risky after that kind of selloff. Instead of selling in March, they should have been buying. Even if they had to wait a few years, chances are the returns they would have realized from stocks would have exceeded the returns generated from safer assets such as cash.

As it turns out, however, those who did buy in March did not have to wait long at all. Stocks went straight up after the selloff in the beginning of the year. The Dow finished 2009 with a 19% gain, the S&P 500 rallied 23%, and the Nasdaq Composite surged 44%. Our Forbes Growth Investor Top 40 climbed 35%. While it did not outpace the tech-laden Nasdaq, it did exhibit less volatility. Since inception (Oct. 6, 2000), our stock picks have gained 75%. The three major indexes lost ground during the same period. The Dow fell 2%, the S&P plunged 21%, and the Nasdaq plummeted 32%.

However, the higher stock prices go, the more cautious I become. Investor sentiment may drive stocks higher in the short term, but fundamentals are more important over the long term. As I see it, the fundamentals are not particularly good.

While the worst of the financial crisis is probably over, the economy is still troubled. The unemployment rate may have peaked, but it will probably remain elevated for years. Housing prices may have bottomed, but they will likely remain depressed for quite some time. Retail sales during the holiday season were better than expected, but that trend will probably fade in 2010. Corporations are producing profits not by selling more goods, but by cutting expenses. In addition to all this, capacity utilization is near all-time lows, new home sales are at a standstill, government debt has surged to almost unfathomable levels, consumer credit is falling, and savings rates are rising at precisely the wrong time. A particularly worrisome trend is the growing role government is playing in the economy. It is the nation’s largest employer, it has become the largest shareholder in a number of previously blue-chip companies, and it is about to take over the healthcare system.

Given this backdrop, there are a number of things to watch for in 2010. We may have emerged from the recession, but a double dip is possible. However, a second recession, if it does indeed occur, should be less severe than the first. Gold prices could fall significantly. They have not risen to current levels because of strong demand or a lack of supply. Gold prices have climbed because of the Fed’s easy monetary policy and the resulting weak dollar. Similarly, oil prices should go lower. The recession has reduced demand for gasoline and other refined products. The big push toward alternative energy is also having an impact on the demand for fossil fuels. As for stocks, they could sell off again. A retest of the March 2009 lows is unlikely, but the Dow could easily shed a thousand points or so. If that happens, it will be time to start thinking about buying once again.