March 2015

“As to Bell's talking telegraph, it only creates interest in scientific circles... its commercial values will be limited.”

- Elisha Gray, co-founder of Western Electric Manufacturing Company


Obviously, Mr. Gray was a “doubter” and did not see how the telephone would change, well, just about everything.  At the turn of the last century, America was growing fast and AT&T’s disruptive technology helped fuel the growth.  It was a heady time for men like Alexander Graham Bell and others--- like Thomas Edison and his brilliant apprentice Nicola Tesla.  Back then, Edison’s lamp and electric company (General Electric) was competing with Rockefeller’s Standard Oil for energy dominance.  Rockefeller’s competitive product vs. the light bulb was kerosene oil for lamps.  Oh, and a “useless” byproduct of kerosene production just happened to be gasoline.

So why the history lesson? 

Last Friday it was announced that AT&T (NYSE:T) will soon no longer be part of the Dow Jones Industrial Average (DJIA, or “the Dow”)   Of the original expanded 30 companies in the Dow, only GE and Exxon (the old Standard Oil) will remain.  Apple (AAPL) will replace AT&T (T). 

What this tells us at Talbot Financial is that the US economy was vibrant over 100 year ago and has not calcified today.  Corporate America is vibrant and evolving.  It also got us to thinking about more recent history….and the prevailing concern that the “market is too high.”  So rather than going back to the depression era to make an AAPLs to oranges (pun intended) comparison, we thought we’d go back to the dot com era and offer a more recent and relevant comparison:

Below are the top 10 stocks, Nasdaq Composite Index, then & now.

Source: Mauldin Economics

In 15 short years, only 2 of the top 10 remain the same.  But more importantly, look at the PE ratios.  Only Amazon and Facebook look “dot com-ish,” and certainly those two have revenue models that will eventually bring a lot earnings to their bottom lines.  We hope to find an entry point to buy these stocks at some time in the future.  The others are well within historical norms, and given today’s historically low interest rates (and rock solid balance sheets & cash balances), it would be difficult to call these “nosebleed” valuations.

Now imagine if 15 years ago we had told you that Cisco would eventually have a PE ratio of 13 and would be paying almost a 3% dividend; you would have said we had Cisco confused with an electric utility company.  And if we had told you Apple would have enough cash to buy many small countries, you would have spit out your coffee at the notion. 

So what were the earmarks that made these companies so profitable and successful today?  We would submit several characteristics.  First, they are always “fearful” of that someone is out-innovating them; so they have pursued and funded regeneration aggressively.  Secondly, they are driving sales worldwide with leveraged and innovative marketing plans involving many layers of distribution capability. 

And finally, and most recently, they have enjoyed virtually unlimited availability of extremely low-cost capital.  This has enabled them to “lock in” margins on the new and expanding product lines.  Essentially, they have disintermediated themselves to larger and larger market success.

These traits hold true across many sectors, but the tech world makes the point most vividly—and we’ll use an obvious example to make our point.  Look at this beauty below.

In the early 2000’s you could have bought this “state of the art, rear-projection TV” for around $3000.  It weighed almost as much as your car.  Today, you can hang on your wall a 50”, flat screen, hi-def TV with Internet interface and cloud-based gaming for under $1000. 

Think of all the things that are either far better and/or cheaper than they were 15 years ago.   Phones, computers, copy machines, blenders, waffle irons, crock pots, clothing, food, and even gas (!) are just a few of them we can all rattle off without thinking too hard.

In many ways, we have been conditioned.   We have come to expect that products will get better and cheaper.  Yet we find it hard to apply this same logic to the companies that make them. 

By almost any financial measure, Microsoft is better company than it was in 2000.  The stock is a lot cheaper, too.  Yet, we will gladly race to buy the latest upgrade (“Look at the deal I got!), but simultaneously have trepidation about buying shares of the improved and better-priced company.

The point is, there is fine line between skepticism and pessimism.  Skepticism forces you to do some homework, make sure the numbers are true, and ensure you are not investing in the next Enron.  Meanwhile, pessimism will paralyze you at best--- and force you into bad decisions at worst.

With all this said, we recognize there are economic/financial/monetary distortions (e.g. negative interest rates), possible black swans (too many to mention), and the potential for a double digit market correction.  The question is this:  What investments are best positioned to deal such events, and how will individual investors “feel” if/when this occurs?

By our reckoning, recent volatility in the bond market indicates disproportionate moves are already in the offing in the fixed income markets.  In the past six weeks, the interest rate on the 10-year US Treasury Note has moved from 1.64% to 2.12%.  That may not seem like much, but it is a 29% (!) rise---and that’s in an investment known for stability.  Of course, the price of the notes fell as the rate rose.   It has been a rough road so far for both the equity and fixed income sides in the month of March.

Turning specifically to stocks, we don’t doubt that, many times in the coming years, equity investors will feel like today’s bond investors.  When those days come, many will say, “I have seen this before.  I am diversified.  I will ride this one out as I have the other corrections.” 

Meanwhile, others will say, “This is my retirement.  This is all I have beyond social security.  I can’t absorb a big loss.”  For those in this category, a “cushion of cash” (15%-30%) often times can prevent pessimism from leaking into the decision making process.  The risk of that cash-cushion is, however, if the market continues to rise, then that cushion becomes and anchor to returns as it produces negative gains after inflation.

We at Talbot Financial understand both views and are happy to discuss both the metrics of our investments and the personal situations of our clients/friends.  We know the news can be dark and gloomy….and we know that the headline “Products are better and cheaper” doesn’t sell newspapers….or viewership on CNBC. 

Nonetheless, if history is any guide, optimism is the better investment philosophy.  That is something that Elisha Gray would likely humbly admit to today. 

Happy Investing. 


View older posts.