PBS: Wall Street Week with FORTUNE
Michael K. Farr
President, Farr, Miller & Washington, LLC
Tuesday, January 11, 2005; 2:00 p.m. ET
How does the economy look for 2005? What have been the general investment trends of the past year and for the new year?
Wall $treet Week with FORTUNE is a PBS weekly half-hour financial news show. The series
provides an informative look at the world of investing and delivers relevant, topical content that illuminates the difference between an investment and a bet, as well as between journalism and infomercial. The show's anchors are financial journalists Geoff Colvin and Karen Gibbs.
Regular commentator Michael K. Farr will be online Tuesday, Jan. 11, at 2 p.m. ET to discuss the series and answer your general investment and economy questions. Please note that Farr will not be able to offer any specific stock or specific investment questions.
Submit your questions and comments before or during the discussion.
Farr is president and majority owner of Farr, Miller & Washington, LLC. He is a regular commentator and guest host for CNBC, CNN, Bloomberg, Reuters, and the Nightly Business Report. He is the regular Washington Commentator for PBS’s Wall $treet Week and is heard on Associated Press Radio, ABC Radio News, and National Public Radio. He is quoted regularly in the Wall Street Journal, Forbes, Fortune, Washington Post, USA Today, and many other publications. He currently is a weekly hour long guest economist on the Paul Berry Radio Show.
Editor's Note: washingtonpost.com moderators retain editorial control
over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.
Michael K. Farr: Good afternoon. Welcome to all of our viewers from Wall $treet Week with Fortune, and readers of The Washington Post. I am delighted to be with you today. I will do my best to answer as many questions as time permits. In general, I am constructive on the markets for the next few years, I think that interest rates will remain historically low. I think that corporate earnings will continue to grow. I believe that equity investors will outperform fixed income investors. Thank you for having me. Let's get to your questions.
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Olathe, Kan.:
Is efficient market theory true? Can an individual investor, by studying publicly available information and not by chance, consistently beat the professional money managers or the market? Michael K. Farr: I think that the efficient market theory is true. I believe that the public markets are exceptionally efficient pricing mechanisms. To suggest that studying publicly available information will allow any individual or professional to beat the broad market averages seems possible but in no way a foregone conclusion. And I'm not sure how it relates to the efficient market theory. I believe that individuals with a sound investment philosophy and a sound application of that philosophy can beat the broad averages over time. It's not easy, which is why so few individuals or professionals are able to do it consistently.
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Winchester, Va.:
What's your opinion on the current airline price wars, Delta in particular? What's the status of the airline industry in general?
Thank you.
Michael K. Farr: The airlines have always been poor businesses. They are heavily regulated, and sensitive to commodity and labor costs. External events like September 11 add another unexpected crisis that can hit at any time. The price wars work well for the consumer in the short term, but I wonder that as the industry shrinks that higher costs will not ultimately be borne by all consumers. There is certainly something Darwinian about the current travails among airlines. We can hope that those that most efficiently and effectively meet the markets' demands will survive and prosper. I think that they are very poor investments and would avoid them.
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Pittsburgh, Pa.:
Today (1/10) the Wall Street Journal's headlines say that stocks have "stumbled" out of the gate into 2005. Do you think this trend will continue?
Thanks.
Michael K. Farr: Stocks have paused at the beginning of 2005. This pause comes on the heels of a strong rally that began two weeks before the presidential elections. During the fourth quarter, the S&P 500 was up 9.23%, and the NASDAQ was up 14.87%. I give little credibility to the "first five days of January" predictor. I expect earnings to increase in excess of 8% over the course of the year, and I look for the market returns to be at or above 10%. Hang in there.
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Washington, D.C.:
Dear Mr. Farr,
If it is appropriate, I'd be interested in knowing what happened to Louis Rukuyser. He hasn't been on his show for a while now. (I understand that his is a different show.)
Thanks.
Michael K. Farr: Mr. Rukuyser is one of the deans of the financial media. His example continues to shine and set the standard for each of us in the financial industry that steps in front of a camera. Lou retired from CNBC, though I understand he will continue to write. He has given us all a great deal, and I offer him my gratitude for all that he has done, and my best wishes for this next stage in his career.
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Bethesda, Md.:
I just became a parent for the first time. Generally speaking in an economic climate like this -- what are some of the top things a new parent needs to take care of?
Michael K. Farr: Your biggest costs, presuming that you have health insurance and housing, will be education. You can't start saving early enough. The projected cost of a college tuition beginning in 2019 are staggering. 529 plans are wonderful vehicles for saving tax free tuition dollars. Most brokerage firms and banks can advise you on how to participate. If you begin with as little as 50 or 100 dollars and continue to contribute regularly, you should do it. The results will make you wish that you save more, and your child will be very grateful.
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East Lansing, Mich.:
Not a question, just a comment. When WSW underwent the change and all the drama, I must say I was very disappointed with the outcome.
Over time, I believe the show has really "upgraded" nicely and done a great job of having topics that relate to today's average consumer. It is definitely more "user friendly."
I look forward to watching WSW each Friday. Keep up the great programming.
Michael K. Farr: Thank you very much for your kind remarks. Larry Moscow, our executive producer, Karen Gibbs and Jeff Colvin, our hosts, do an outstanding job. We are always trying to make the show better for you. Please continue to give us feedback and please keep watching.
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Larchmont, N.Y.:
Is Google $194 a bet or an investment ?
Michael K. Farr: In general, when a share price bears little relation to its underlying earnings, those shares qualify as a bet. When the share price reflects higher earnings expectations in the future, those shares qualify as a bet. The real question is, are they a good bet? The answer is, ask me in five years. There are a lot of dot-com's that looked good in the late 90's that no longer exist. I think Google is here to stay. I don't know what it's worth.
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New York, N.Y.:
What do you think was the biggest surprise in the markets in 2004? What's the biggest thing looming for 2005? '06?
Michael K. Farr: The biggest surprise in '04 was the lack of discernible movement. At the beginning of the year, I predicted economic growth, earnings growth, and market gains. Until around October 15, I was right on everything but the market gains. I called for a 10% return for the S&P 500 for the year and was disappointed until well into the fourth quarter. I'm pleased that it returned 10.88%, but it tested my nerves. I think that the biggest surprise for 2005 and 2006 will be the lack of dramatic change. I think that the trend in energy prices and interest rates will persist longer than most people expect. This moderate growth scenario will be good for investors, but very tough for the media that have to report on it. The patient, disciplined investor will make money.
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Glover Park, Washington, D.C.:
Dear Mr. Farr,
Is all the hype about the dollar's crumble against the Euro justified? As a person with a casual interest in economics, it seems like this issue has received massive amounts of press and air only recently. How concerned should we be?
Michael K. Farr: The dollar is a hot, misunderstood topic, much in the media.
• Federal budget deficits should continue to rise due to the war in Iraq, tax cuts, and the costs of aging baby boomers.
• The yearly deficit in itself may not look alarming (historically, the deficit as a % of GDP has been much higher), but the size of outstanding federal DEBT is becoming a huge problem.
• Over the past several decades ownership of US government debt has overwhelmingly shifted to foreign entities, largely the Chinese and Japanese central banks (The Japanese and Chinese are funding the US government's deficit spending).
• Since the US went from the budget surplus to a budget deficit in 3Q01, the dollar has been weakening.
• Therefore, the Japanese and Chinese have been losing money on their investments in US government debt as the dollar has lost value; the Japanese and Chinese are willing to accept less return on US debt because if demand falls for Treasuries (dollar denominated assets), then the value of the dollar will likely fall, and the trade surpluses, with the US, enjoyed by China and Japan will be in jeopardy. A weaker dollar makes US exports more competitive. By the same token, a stronger yen (versus the dollar) makes Japanese exports to the US less competitive.
• The fear is that the Japanese and Chinese at some point will get spooked by the sheer size of our debt and start to worry about getting paid back on all the Treasuries they own.
• If the Japanese and Chinese do stop buying US debt, or even worse, start selling in large quantities, the dollar would probably plunge in value, and interest rates would spike in order to attract buyers for our debt.
• Bottom line: The losses being absorbed by the Japanese and Chinese on their Treasury positions offset the benefits they enjoy from their trade surpluses with the US.
So when people say they would ideally like to see an "orderly" decline in the dollar, they mean that a weaker dollar would help our manufacturers become more competitive, but a sharp decline in the dollar might worry the Chinese and Japanese and keep them from funding our huge budget deficits. As the dollar slowly weakens, the hope is that our increased competitiveness will start to result in more balanced trade deficits. Over time our "twin" deficits, budget and trade, should begin to come into balance.
The outlook may be bright but to be bright requires a confluence of a measured decline in currency, a measured increase in corporate growth, and a reasonably stable geo-political environment. Our fingers are crossed. Most important, our assets are invested with great discipline to be both defensive and opportunistic as the investment landscape unfolds.
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Boston, Mass.:
I heard a figure close to 2.2 million jobs were added last year. Is this still a jobless recovery; what are your expectations for 05?
Thank you.
Michael K. Farr: If this is a jobless recovery, don't tell the 2.2 million that found employment in 2004. Expectations are that over 2 million jobs will be added in 2005. A recent report from monsterjobs.com found that an increase in new ads were heavily weighted towards jobs in sales positions, which indicates corporate growth and expansion. Some are suggesting that this turnaround was caused by tax cuts and monetary stimulus. There's no way to prove clear cause and effect, but it is clear that monetary and fiscal stimulus were provided during a recession, and an economic recovery followed.
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Culpeper, Va.:
My Vanguard mutual fund has finally gotten back into the black since I opened it in 2000, apparently at the height of the market bubble.
I'm tempted to get my $5,000 back out and try some other investment ideas: any advice for a 20-something whose gotten burned?
Thank you!
Michael K. Farr: Don't be the guy that buys at the top, rides through the worst, and sells before he can benefit from the long-term upward bias of the stock market. If you believe that corporate America will continue to prosper and grow over the next ten years, then stay invested. Keep the faith!
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Spartanburg, S.C.:
Is the health care industry (diagnosis, retirement communities of various sorts, pharmaceuticals) likely to be another "bubble" like the dot-coms, or is it likely to have legs because of the demographics of the next 20 years?
Michael K. Farr: For their to be a bubble in health care, we would have to see prices appreciate. Health care has been one of the most depressed industry groups of the past three years. While biotechs have found new life in recent months, the larger health care companies and pharmaceuticals have languished. Many represent compelling value at current prices. Because of the rising costs of health care, this sector will probably remain under pressure for the next several years, as law makers try to establish cost controls. Over the long term, I believe that demographics, and a fundamental need for these services and products will prevail. We maintain exposure to this sector in our managed portfolios.
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Charlotte, N.C.:
Two reasons lead me to believe that we are near a "top" in the stock market. Bullish sentiment on the part of letter writers is near record levels, and Jeremy Grantham points out that asset valuations are at levels he has not seen in his career, making it very hard to find a place to put one's money. I know there are many other indicators out there, but don't these two at least point out high risk in the market?
Thanks.
Michael K. Farr: There are always risks in the market. There are always respected letter writers who look at the same data and draw opposite conclusions. At the end of the bull market of the 1990's, the majority were calling for continued gains based on "the new paradigm". A few were calling it a bubble; I suggested that the dot-com craze was easier to access than a trip to Vegas, but just as dangerous, and withouth the free drinks. During the bear market, I heard seven strategists whom I respect call the market bottom at different points. My point is that very few people have been able to make money guessing market tops or bottoms. The investors who have done best over time have stayed invested over time and have owned high quality companies with consistent earnings growth. If you have a long time horizon, ignore the short-term noise. If you don't have a long term horizon, you should not be invested in stocks. Look for good value from companies you can understand, and hold them for the long term. Time and quality mitigate risk.
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Falls Church, Va.:
Last W$W program looked at commodity investing. How should individual investors approach this field?
Michael K. Farr: This is a dangerous area for individual investors. It is an inappropriate asset class for most individual investors. If you believe it is appropriate for you, and you feel compelled to participate in this sector, I would encourage you to look at funds and e-shares. Limit your exposure, and if possible, benefit from a professional fund manager.
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Laurel, Md.:
Portfolio-construction question, not about stocks.
Except for government issues, almost no individual investor would buy bonds except through a mutual fund. No less mutual fund experts than Peter Lynch and John Bogle have said that the fees on bond funds eat up too much of the profit to be worthwhile as investments.
Looking at the rates of investment-grade bonds (A+), they're really no better than the interest on CD's at online banks. So should most investors just forget bonds and buy the highest rate (insured) CD's available?
Michael K. Farr: Bond funds should be judged on their own individual merits. The records of some bond managers, like the records of some stock managers, are superior to others. All funds should be compared on their net total return. And there are some good ones available. I agree that for short-term taxable investors, CD's present a viable alternative. The 18 month treasury note now yields 3.17% and should be considered, in my opinion, by most fixed income investors.
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Park Fairfax, Va.:
Dear Michael,
Can you speak to President Bush's plans to allow people to privately invest part of the Social Security money?
Michael K. Farr: This is not an easy issue. Government employees have had access to large government-run mutual funds for many years. They have done well. Higher rates of return, or higher taxes, are neccesary for social security to survive. Because the Bush administration is tax-averse, they opt for the higher growth solution. The complexity of establishing an investment program on a national scale is overwhelming. The terrain for a national social security investment program is fraught with peril. For example, could the national social security investment fund own tobacco stocks while the attorney general is bringing suit against the tobacco industry and thereby diminishing share value? Could share holders of social security funds bring suit to the government for interfering with their retirement plan?
This is a thorny issue begging for a solution. The government has to do something. I hope they get it right.
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Vancouver, Canada:
Hello Michael;
I'm reading and hearing from several sources that stock and bond markets in the U.S. and Canada may underperform for the next year or two, and it's time to not only invest in foreign and emerging markets, but also to try new investment arenas such as commodities.
Where would you be looking outside the U.S. and Canadian stock and bond markets?
Thanks.
Michael K. Farr: I believe that there are opportunities in every market, at all times. I think that responsible investing requires a period of years. Because my forecast and goals go well beyond the next 12 or 18 months, I don't find it difficult to find opportunity in North American markets. If the U.S. GDP continues to grow at a 3% or better rate over the next 3 - 5 years, equity investors will benefit handsomely. When done best, investing is a fairly boring process.
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Michael K. Farr: Thank you all very much for joining me for this hour of chat courtesy of The Washington Post and Wall $treet Week with Fortune on PBS. I appreciate the outstanding questions. Please stay tuned to Wall $treet Week with Fortune and The Washington Post.com. 2005 will be a decent year, but that's not important to long-term investors. Important is that investors will be rewarded over the next 3, 5, or 7 years if they are disciplined and patient. If there are ways we can better help you, please let us know. In the next few days, I will publish my quarterly newsletter free on our website: www.farrmiller.com. Thanks for your questions. Thanks for watching. Happy 2005!
Warmly,
Michael K. Farr
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