Berserking

I have been exploring the idea of collective thinking, popular sensations and mob action. The purpose, of course, was to understand how the Nasdaq got to more than 200 times earnings. Only a form of collective madness makes sense out of it.

Collective madness is useful, of course, in some circumstances. In a charge of heavy cavalry, the more the men act in unison…the fewer second thoughts and divided hearts they have…the wilder and more reckless their charge – the more likely they are to succeed.

The momentum of the charge – captured so vividly in the paintings at the Musee d’Orsay – was intended to break-up the enemy formations and cause havoc, and perhaps panic, in the ranks. The cavalryman had to plunge himself and his horse directly into the enemy line…forgetting his personal safety, surrendering himself to the collective will.

The word ‘berserk’ comes from ancient Norse. The Vikings would go ‘berserking’ – attacking an enemy with such wild fury that no reasonable man would want to be in their way.

Collective thinking dominated the politics of the 20th century. Now, the mob has turned to economics. “Today, with the world at peace,” wrote David Ignatius, executive editor of the Washington Post, “the Armageddons that people worry about are financial ones.” Today, people go berserk over stocks.

There is a deep point there, waiting to be grasped. We are on the verge of a breakthrough in our understanding of the way the human brain works…and the way human society progresses. And you, dear reader, will be among the first to have it.

The idea came to me while reading an article about Carl Icahn, the corporate raider of 1980s fame. Icahn was in the news last week because he attempted to force GM to sell its stake in Hughes Electronics – in order to ‘unlock shareholder value.’

The basic facts of the GM situation are worth recalling. I reported them in an earlier Daily Reckoning as an example of a ‘darned cheap stock.’ It is also an example of how collective thinking in the stock market rallies round some preposterously overpriced stocks – such as Cisco or Amazon – and completely deserts other investments, making them conspicuous bargains. GM, I guess I don’t need to tell you, is an example of the latter.

GM had more sales, in dollar terms, than any other company in the world – $177 billion worth. It earned a profit of $6 billion. Not only are the earnings low – 3% of sales – the other news is not good. GM is losing market share and its unionized workers seem ready to revolt.

But GM also has a few things going for it. Even in today’s world, $6 billion is a lot of money. Plus, GM has $10 billion in cash. Its pension plan is over-funded by $9 billion. And it owns a stake in Hughes that is worth $15 billion.

Icahn’s idea was obvious – so obvious that I think I may have even suggested it in last year’s note on GM. He would buy a big enough block of GM stock to be able to force the company to sell the Hughes shares.

The entire company – at today’s stock price – has a value of about $36 billion. Here is where non-collective thinking comes into play. Imagine that you, personally, could buy the company. For $36 billion you would get a company with $10 billion in the cash register. So, you’d only really be $26 billion out of pocket. And then, you could sell the Hughes holding for $15 billion…so the rest of the company would really only cost you $11 billion.

This gives you the world’s biggest company…producing cars, trucks, and other things you can put your hands on… Heck, there’s probably a spare ’66 Corvette in a garage somewhere that you could drive around. Factories, real estate, giant machinery…you get it all. Plus, you’d earn about $6 billion each year. Expressed in conventional terms – the operating part of the world’s largest company has a p/e of just 1.83. From your point of view, as owner, you’d get your investment money back in about 20 months…and earn about $6 billion every year after that.

Thinking collectively – using the slogans and feeble- minded dicta of the financial media – you might want to avoid it. GM is ‘old economy.’ It’s a has-been company that can’t seem to get its act together. Owning GM is definitely not cool.

Carl Icahn doesn’t worry about being cool. I discovered in the N.Y. Times article that he has a Ph.D. in philosophy from Princeton. In his thesis, he developed the idea that collective thinking is invalid: “Knowledge is based only on what you observe. You talk to me about something, you must relate it to something that’s observable.”

(Icahn, an analog man, must not read the editorial pages of the N.Y.Times. They are a waste of time, except as an observation point, like an overlook at the zoo, for watching the herd animals.)

GM’s way of making money is observable. Its products are operable. Its results are a matter of record for anyone who wants to look at them.

By contrast, looking at Amazon.com – the River of No Returns – all we can observe is abstractions, ideas, hopes, and losses.

GM may have the world’s largest sales figures. But Amazon’s ambitions go even further. It says it is “the planet’s” largest virtual store. It has 23 million registered customers and Jeff Bezos says it will continue getting bigger and bigger – growing at a compound rate of 50% for the next 10 years.

Hmmm…that will give it more than 1.3 billion customers by the year 2010. Wow. And sales should hit more than $100 billion. Soon it will be the biggest virtual store in the whole blooming galaxy. What madness! It could happen, of course. But so could the Second Coming.

Bezos did not reveal, at last week’s presentation to investors, just how the company would reach its targets without going broke first. What one can observe at Amazon is that the company has earnings of negative $3.37 per share. Even this may understate its losses. Amazon books the stock it receives from its commerce partners as though it were real income. “They should not be recording these deals as revenues. Period.” said an analyst with the Center for Financial Research & Analysis quoted by Barrons.

But imagine that you had never heard of Amazon nor of the New Economy. Imagine that Jeff Bezos came up to you and offered you his company. It has $2.1 billion in revenue. Assets of uncertain value. Billions in debt. And it loses more than $1 billion a year. He wants $14 billion for the company. What is your reaction? Would you pay $14 billion for the privilege of losing $1 billion per year (which would have to come out of your pocket)? Or would you suppress a laugh…and politely show him the door?

Icahn had the right idea. He sold the dot.coms short in 1998 and 1999. At one point he had a paper loss of more than $60 million on his shorts. “He said he was certain that the stocks would never be able to earn enough money to justify their valuations,” says the Times article. Now, with the Internets off 80% and more from their highs, his shorts have turned “highly profitable.”

More…more…and still more…to come.

Bill Bonner,

enjoying a gorgeous day in the City of Light. September 27, 2000

*** Heating oil inventories are now 26 million barrels below last year at this time. Analysts say U.S. distillates need to rise 4 to 5 million barrels per week to avoid a supply problem this winter.

*** “Inventory management is now very sophisticated,” wrote new era groupie Paul Erdman on August 17th. “Our capitalistic system has always been plagued by inventory cycles. [But] with the information that computers instantly provide managers today, and with just-in-time systems in place, major upswings and downswings in inventories leading to similar swings in our economy and in unemployment rates are, for the first time, preventable.”

*** And yet, a huge inventory shortfall seems to have developed in the world’s most important and most carefully-watched commodity. “Oil Creeps up as U.S. Supplies Dwindle” the Reuters headline tells us.

*** Despite opening the Strategic reserve, oil prices rose yesterday, to close just below $32. And OPEC announced that if the price fell too much, it would shut down some of its pumps.

*** The Information Age has produced a deluge of information. Data. Entertainment. You name it. Want to know how to spell ‘compos mentis’? It’s right there on the Internet. But that does nothing to overcome the tendency of people to over-react and under-react. Nobody wants to invest in refineries when the price of gasoline is cheap. And nobody wants to think about inventories when supplies seem abundant.

*** “In this information age,” wrote Erdman, “we live in a new world in which decision makers are immeasurably better informed than ever before…” They certainly have access to more information. Too much information. So much that they cannot hope to analyze it. Instead, they look for validation and confirmation in collective thinking. Yes, more below.

*** The latest focus of earnings disappointment was Kodak – whose stock fell $14 yesterday. Earnings, Energy, the Economy and the Euro – they’re still worrying Mr. Market.

*** The Dow fell 176 points yesterday – led by Kodak. The Nasdaq dropped 51.

*** Advancing stocks fell behind those declining for the 11th time in 13 sessions. There were 1250 issues making forward progress on the NYSE yesterday, while 1599 dropped back.

*** Intel lost another couple of bucks. It closed at $43.40…after losing 30% of its value since last week.

*** In Japan, stocks fell 286 points…led by the techs.

*** “There’s a lot of fear around,” said one analyst quoted by Reuters. But just a few lines down we discover that “Consumers [are] Upbeat.” Fear has not yet broken out on Wall Street. The consumer confidence index rose in September to 141.9 from 140.8 in August. Researchers studied 5000 households. 53% of those surveyed believe jobs are plentiful, with only 10.7% responding that it is “hard to get” a job.

*** The euro may be climbing a wall of worry. All the press on Europe and the euro is negative. Yet, the currency rose to 88.57 cents yesterday. The dollar index fell to 113. Gold did not move.

*** Europe, by the way, has not been a bad place to invest. According to Morgan Stanley Capital International, European equities have compounded at 18.2% annually since January of 1983, versus about 16% in the U.S.

*** Olympic athletes sometimes use drugs to pump up their performance. The Bureau of Labor Statistics, as I have mentioned often, uses ‘hedonics.’ But Barron’s columnist, Gene Epstein, claims that hedonics don’t give the performance boost that Kurt Richebacher, Jim Grant, the Bundesbank, two Harvard economists – Medoff and Harliss – and I have reported. According to Epstein, a ‘dumb arithmetical error’ leads to a gross misunderstanding of hedonic measurements. Stay tuned.

*** Also in this week’s Barrons, editor Alan Abelson mentions one of Lynn Carpenter’s recommendations – Centex. The stock – one of our ‘darned cheap’ collection – is expected to earn $5 per share next year…and is selling for less than $30. That gives it a forward p/e of only 6.

*** Lynn updates us: “Centex is still great. Do you realize you can get this stock for a PEG of 0.5 and price to sales of 0.24, P/E 7.4? [Based on this year’s earnings.] It’s still a bargain, even though FSL is up 21.8% on this stock as of today. We bought it in April, so that’s a week shy of a six-month return.”

“Centex is also a good example of our contention that the hi-tech sector isn’t the only place to look for good technology. It’s what you do with technology that counts. InformationWeek magazine named Centex one of the 500 best users of information technology. Earlier, Salomon Smith Barney noted Centex was one of the ‘most innovative and Internet-savvy companies in the market.’ SSB included Centex on its list of the five best Old Economy stocks…”

*** The violence “…is not what I came for,” a Birmingham schoolteacher told a reporter from the International Herald Tribune. She was speaking of demonstrations that turned into a cobble-stone hurling, fire-bomb tossing melee in Prague yesterday. A peaceful schoolmarm traveled across Europe – 24 hours by train – to reach Prague because “her son often woke up in the middle of the night, frightened about global warming.” She continued: “I wanted to tell my son I was doing something about it.”

*** It’s another beautiful day here in Paris: Blue skies, warm temperatures…the smell of fresh baked croissants and expresso coming up from Le Paradis caf?…prostitutes close to retirement age in the doorways of the rue des Lombards…the bells of St. Merry’s ringing the hour. Wish you were here.