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Ethical Investing
from the February 09, 2004 edition
A look at the market - with an eye on values
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Watch out! That's the word from three values-investing panelists who came to share ideas with us recently in Boston. They piqued our interest with their thoughts about the stock markets (overvalued) and real estate (ditto). But what really caught our attention was the interplay of their social values with their unique approaches to investing. For example:
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Investors will have to move beyond traditional diversification to manage risk in new ways.
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Think commodities.
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Today's investing environment is a "row," a fundamental change from the '80s and '90s when it was a "sail."
Intrigued? Our panelists all managed to weather the market downturn with remarkable buoyancy. They are: Jerry Dodson, president of Parnassus, one of the world's first socially responsible mutual funds; Ed Easterling, who manages a family of hedge-fund portfolios called Crestmont Holdings; and Jane Siebels, who runs a values-based investment firm, Green Cay Asset Management. Here is an edited transcript:
The markets have roared back in the last few months. Can we breathe easily or have investors become too optimistic?
Jane Siebels: Euphoria is very hard to judge, but I think we're into the euphoric stage.
Jerry Dodson: It's a strange market. The bubble is going on in the technology and other more speculative stocks, but there's not a bubble in many of the basic economy stocks. Also, earnings are improving as the economy gets better. And, of course, when you talk about a P/E [price-to-earnings] ratio, and the E goes up, that means the ratio goes down. So I think that there are a lot of dangers out there. But I also think there are some areas where you can be relatively safe.
But if the economy is doing better, doesn't that mean better times ahead for stocks?
Ed Easterling: Most people don't realize that the economy and corporate earnings grew by almost the same amount during the period from the early '60s to the early '80s [and] from the early '80s to 2000. So in both of those nearly 20-year periods we had the economy and earnings basically go up threefold. It's just that in the first period, the stock market was flat, in the second period it went up 10-fold. And it's a function of interest rates and inflation. From where we sit today, we're in a period of very low inflation. So, from here, we either go back up into inflation, we go down into deflation, or we keep low inflation for a long period of time. But all of those mean that it's going to be hard to have a stock-market P/E expansion like what we had during the last 20 years.
You all sound rather gloomy. What should the average investor do?
Easterling: I would say that the most important decision for the average investor is to hire independent advice and above-average talent. In the '80s and '90s, when we had a generally rising [stock] valuation level, we had declining interest rates, and a confluence of other events that helped, ultimately, to create a bubble. It essentially was very much of what I call a "sail" environment. Because you just put your sail out, rode it, and, on a dip, opened the sail a little bit more. We've really moved to much more of a condition that I consider a "row" environment, like rowing a boat, which was like the '60s and '70s, where you had to actively manage investments, not just sail. And so for investors now, it means being much more adept, much more active, in the way that money is managed and to not have the expectations of the returns that were there in the '80s and '90s.
Siebels: I've had an incredible mentor in Sir John Templeton. And the biggest think I took from Sir John is that you can't do what everybody else is doing. You have to think independently, you have to - not be a contrarian [exactly], but look at stocks or look at the economy differently from everybody else in order to get the edge to outperform. Because if you do what everybody else is doing, you are going to perform exactly like everybody else.
Jane, you play both sides of the street: buying - going long - in areas you think will rise, and selling - going short - in areas you think will fall. Where are you looking now?
Siebels: There are areas that we find to be tremendously interesting, both on the long and the short side. On the long side are commodities. You have this tremendous economic powerhouse out there called China that is taking up so much of the world's iron ore, copper, aluminum. In the next five years, they're going to be big purchasers of oil, and so on and so forth. And these are stocks that, up until a few years ago, had been in a 20-year bear market. And there are only four firms that have global commodity analysts that are really calling commodity stocks around the world. And so, there's a tremendous opportunity there because no one's been looking at them for so long.
Now, on the other side, if you go to the cocktail parties, everyone is talking about - what? - how much money they've made on their house. [Then] you start looking at the demographics, you start looking at the possibility of interest rates actually rising, you look at the amount of money that's on adjustable rate mortgages now. And you can really see that there is a good chance that, at some point, real estate could be topping out.
And if you look at the United Kingdom and Australia, you can see that these things are even magnified further. You know this bubble is going to burst.
Next:
Jerry, you recently announced...
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