[A-List] Enron "profits" and the dismal science

[Sabri Oncu <soncu@xxxxxxxxxxx>]

Seth/Charles wrote:

> And kill off unproductive capital, creatively
> or otherwise, no?
>
> Seth
>
>
> From: "Charles Brown" <CharlesB@xxxxxxxxxxxxxxxxxxxxx>
> Reply-To: a-list@xxxxxxxxxxxxxxxxxxx
> To: <a-list@xxxxxxxxxxxxxxxxxxx>
> Subject: Re: [A-List] Enron "profits" and the dismal science
> Date: Mon, 18 Feb 2002 12:56:15 -0500
>
> Won't this squeeze investment and make recovery
> more difficult ?
>
> Charles

> A New Credit Crunch
> Business Week; New York; February 18, 2002; Rich Miller
> in Washington and Heather Timmons in New York,


I think both of you are right.

By the way, it is nice to have Henry on this list. I suspect that
we will start to hear about GE more often. We will see.

Sabri

++++++++++++++++++

FEBRUARY 22, 2002

SOUND MONEY
By Christopher Farrell
Business Week Online


The Dawn of a Golden Age for Bonds

Many signs are pointing to returns on bonds that could be
competitive with equities over the next several -- even 20 --
years
The Enron virus is working its way through the stock market.
Investors are punishing companies with opaque financing or
questionable accounting -- and not just upstart telecom companies
but also blue-chip stalwarts such as IBM and General Electric.
Management is getting the message. GE is the latest to publicly
embrace greater financial openness by promising to provide
investors with more detailed numbers than ever before on its 26
businesses.

The stock market will regain its footing as investors eventually
become confident again in the quality of corporate earnings and
as the economy strengthens. Still, equity investors are likely to
be disappointed with the returns they'll earn over the next
several years.

They could find solace in bonds, however, which should offer very
competitive returns with equities. Even though stocks have bested
bonds for all 20-year time windows over the past 160 years, the
global fixed-income research group at Deutsche Bank assigns a
mere 37% probability that equities will outperform bonds over the
coming 20 years.

HISTORY LESSONS.  The outlook for the stock market appears bleak
when compared with its sizzling performance of the past two
decades. The dividend yield is a traditional measure used for
forecasting long-term stock market returns. On the Standard &
Poor's 500-stock index, the dividend yield has averaged 3.5% over
the past half-century. But the great bull market of the 1990s
drove equity valuations into the stratosphere, pulling the
dividend yield lower. It now hovers around 1.3%.

The historical record shows that eras of low dividend yields are
typically followed by a period of anemic returns, and vice versa.
The low dividend yields of the mid-1960s preceded the poor
returns of the 1970s, and high dividend yields in the 1970s paved
the way for the 1980s boom. The stock market could stumble along
until the dividend yield returns to a level closer to its
historic norm.

Another way to predict the course of equities that has worked in
the past is to combine the average dividend yield with the
average growth rate of the economy. That gives you a reasonable
estimate for inflation-adjusted returns for equities. The U.S.
economy has averaged an inflation-adjusted growth rate of 3.4% a
year over the past half-century. Going forward, economists at the
Federal Reserve Board calculate the speed limit of the U.S.
economy (growth as strong as it can be without igniting
inflation) is a comparable 3.5% to 3.75%. Adding together a 1.3%
dividend yield and a 3.4% real growth rate suggests a reasonable
forecast for real stock returns is around 5%.

DEFLATIONARY FORCES.  Of course, that's well below the average
12.57% annual inflation-adjusted return from 1981 to 2000. A
number of factors came together to create that stellar
performance, ranging from the end of the Cold War to the rise of
the Information Age to a sound mix of monetary and fiscal
policies. Most important was a secular decline in inflation from
double-digit territory to low-single figures. The consumer price
index, the broadest measure of inflation, is up a mere 1.1%
year-over-year so far in 2002, the slowest pace in 15 years.

Competition continues to heat up throughout the economy, thanks
to the spread of capitalism around the globe. With deflationary
forces gathering momentum -- from Silicon Valley to Shanghai --
companies will find it well nigh impossible to raise prices.
"Inflation rates in G7 nations [the world's seven largest
industrialized countries] are at levels that are unlikely to fall
much farther in the future," according to "The Bond Is Back:
Bonds, Stocks, and the Price of Risk," a Deutsche Bank report.

At some point, that low inflation begins to erode the ability of
companies to increase earnings. "What's more, it is far from
clear that additional disinflationary pressure from here would
enhance equity returns, as the associated margin pressure would
likely eat into earnings," the report says.

RELATIVELY ATTRACTIVE.  As a rule, bonds do well when inflation
is tame. Investors can currently lock in a 3.5% return on a U.S.
Treasury inflation-protected security that matures in 2029.
That's a hefty return with no credit or inflation risk. Blue-chip
corporate bonds are also relatively attractive these days when
compared with equities.

Sure, stocks beat out bonds by some six percentage points over
the past half-century. But over the next few years, investors
might want to ease up on their stock holdings and put that money
to work in the bond market. It's reasonable to expect that
returns for stocks and bonds should run neck and neck in the
first decade of the 21st century.