Update--January 14, 2002

Today's Realities & Tomorrow's Headlines

I was once asked why I share Sir John Templeton's perspective so often. I replied that I had never found anyone else who could see tomorrow's headlines as reliably as John. As I've mentioned, my first published article in the early 1980's ended with John disputing the best-selling prophets of economic doom and predicting the Dow might triple from the 1000 level during the eighties. When that happened, he again challenged the gloomy majority and predicted the federal debt would not even slow the rate of economic growth in America; that we were headed for a period of prosperity unprecedented in the history of the world; and that the U.S. stock market would soar. As the nineties ended, we read all that in the headlines.

Still, some of my more skeptical clients assumed John was simply a Polly Anna whose constant optimism coincided nicely with a two-decade economic expansion. But as regular readers of this Update know--and the rest of us can affirm at www.spiritualinvesting.com--in 1999, John told a reporter friend that anyone investing in the very popular S&P 500 Index Funds might simply break even in ten years. That seemed shocking at the time as a Paine Webber survey said investors expected 18% annual returns over this decade. (While stocks as a percentage of household financial assets have dropped from 46% to 33%, a recent Vanguard study said the majority of those still in are still expecting 15% this decade!) More importantly, John said the technology bubble was the most dangerous in all of financial history. That didn't keep investors from flooding into the tech-heavy mutual funds, like Janus, that were dominating the magazine covers and fund rankings. Yet the January 11th Wall Street Journal said the seldom mentioned Templeton Growth fund returned 8.5% per year the past three years while the comparable and nearly twice as large, though now shrinking, Janus Worldwide fund returned exactly 0.0%!

More prophetically, John went on to predict that 90% of the soaring Internet stocks would end up in bankruptcy. So despite his decades long love affair with U.S. stocks, he encouraged us to switch to bonds, the inexpensive stocks of small non-technology companies and very carefully selected international stocks. He even suggested that aggressive investors might consider a hedge fund that would "short" Internet stocks, or profit from their return to economic reality. A Forbes headline recently said that last strategy alone profited Sir John tens of millions as many investors lost billions and many good nights of sleep.

As I've done in these Updates, I discussed those predictions at seminars for our clients in Naples, Florida during the past two years. I returned this week to update them on John's current thinking, which can be found in the January edition of Louis Rukeyser's Wall Street newsletter. A lady asked how Sir John always seems to know tomorrow's headlines. I replied that he sees a different reality today than most of us do. I used John's favorite example to demonstrate by tapping on a table and asking how many saw it as solid, motionless and enduring. Of course, everyone did. I then explained that a quantum physicist could see that at a deeper level it is mostly space within and between atoms that are constantly moving and rapidly, in quantum terms anyway, passing away.

I then explained that my clients essentially see financial reality in three ways: 1) Most see what seems obvious. 2) A few have the insight to see deeper realities. And 3) A very, very few see as mystics and realize that even those deeper realities may not be all that important in the scheme of things. Again, let's use the federal debt as an example. During the early nineties, most investors thought it obvious that the debt was a major problem. But a few economists, like Robert Bartley, the editor of The Wall Street Journal, had the insight to know why the debt was largely political illusion. He explained so in a less than best-selling book that could have enriched millions had they been willing to look beyond the obvious. But John knew that federal debts--indeed nations--come and go. So despite predicting a bull market, he sold his funds as he wanted to create spiritual riches for Americans who were prosperous but less than happy.

All that remains most relevant to today's headlines. For example, the January 6th New York Times Mutual Funds Report featured a story on best-selling financial author Suze Orman, whose spirituality is reportedly Eastern mysticism. The Times said, "in the nation that has done more than any other to secularize the spiritual, Ms. Orman has completed the circle, turning the pursuit of the secular--namely money--into a spiritual quest" with such new age teachings as, "So put your heart into your money and your money into your heart." That sort of new age spirituality obviously appeals to our money culture, even if the deeper reality is that putting the age old love of God and neighbor in our hearts might still be more enriching.

Perhaps indicating the inverse relationship between the popularity and helpfulness of financial books remains intact, the Times cautioned readers that: "Some of her advice can probably do more damage than good, like this Money Card maxim: 'When it comes to every financial decision you will make for the rest of your life, you will choose correctly if you go with your first instinctual response. That answer will always be the right one for you, the one that will empower you to make money for yourself.' Which helps explain why most individual investors have their clocks cleaned in the stock market, and why portfolio turnover among mutual fund investors is so depressingly high. Acting on your first instinctual response is more certainly the road to ruin than the road to wealth."

During their interview, Rukeyser asked if Sir John relies on such instinct. John replied, "I try to avoid instinct, because my instincts and most other people's instincts are the opposite of what is likely to happen. Instinct is the opposite of wisdom in investing." The August 15, 2001 Update described how instinctually responding to best-selling books, magazine covers and mutual fund rankings, such as those that had investors flooding into the Janus funds at all the wrong time, is similar to running at the roar of a lion, which turns portfolios into dead meat. It added that old jungle guides know to stand still until a clear head calms the racing heart. And while most investors still see it as obvious that such spirituality and ethics have to cost an investor, Sir John's decades of experience have proven to him that both can enrich us.

So what do we need to clearly know today? First, despite the instinctual response of investors after the 9/11 plunge, U.S. stocks aren't as cheap as they obviously appear. The January 12th edition of The Economist contains an article headlined, "Plenty Of Bull: A Whiff Of Irrational Exuberance, Bubble Trouble." It says the P/E ratio of the S&P 500 is now higher than it was at the peak in 2000 as corporate earnings have fallen more quickly than stock prices (earnings are down 16% this year.) It argues that the markets have soared since 9/11 as the Federal Reserve has again flooded the banking system with cash, as it did during Y2K. Many analysts believe that cash fueled NASDAQ's assent to the 5000 level but once the Fed drained it out the NASDAQ collapsed. If so, we should keep a very wary eye on the Fed--and the market--again.

Should the Fed not tighten, the crucial question is where that cash might go. My guess, in ascending order of probabilities, though hardly certainties: It might drive our stock market to bubble levels. People might spend it, resulting in higher inflation and making real estate investment trusts more attractive. It might go to foreign markets. Or people might be frightened enough to stop speculating and spending and pay down debt. That might keep a lid on inflation and interest rates and make some bonds attractive.

So with headlines saying U.S. investors are now charging to get into the profitable small-cap value funds, I think I'll lighten up on those we've bought during the past couple of years. To fill that more aggressive portion of our portfolio, I'm buying some medium-grade corporate bonds for the first time in years. (Just so you don't think Sir John is the only guru I listen to, I looked at them at the recommendation of Bill Gross, the highly regarded head of fixed-income at Pimco.) Investors threw the baby out with the bath water after 9/11 and sold the decent grade bonds as frantically as the riskier, lowest-rated junk bonds. Some fairly good bonds now pay 9% interest and may appreciate if the economy doesn't fall apart. My favorite mutual fund of such bonds has averaged over 15% annual returns over the past three years, proving that such bonds can be as rewarding as stocks, particularly if Sir John remains correct and stocks are flat this decade. And the January issue of Money has just echoed John's past caution by reminding its readers that from 1966 to 1982, the Dow rewarded investors with a -1.6% annual return.

Fortune's Investor's Guide 2002 said the legendary Warren Buffett opined that the best gauge of stock values--the total value of a nation's stocks as a percentage of its gross domestic product--shows our market is still 33% higher than it was at its previous peak, in 1929. The better news is that he said equity investors might "perhaps" make 6% annual returns, which is still less than the interest payments of solid corporate bonds.

The good news is that after 9/11, even new age spiritualists seem to be realizing it's more important for our hearts to love our neighbors than money. At the risk of stating the obvious, God may still work in strange ways.

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