WBM, Mohan - Thank you for your encouragement... Abbey's complete speech on Feb. 15 to the Bay area council might interest everyone a little - <G> - so I've copied it below.
However, since I've taken this from the futurebluechip.com web site - I feel that I should thank them and that, perhaps, they are worth considering... Besides they ask so nicely.....
Chuzz might be a bit unhappy about the last bit of Abbey's speech though...<G>
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From...
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Bay Area Council Conference Jan. 15 1999
Abby Cohen, Partner, Goldman Sachs Inc.
When we do our forecasting for the stock market in many ways it is our secondary goal. We always begin with an outlook for the economy. Our
work is, as many of you know, based upon the fundamentals of what is happening in the economy- what is happening in terms of corporate
performance. And only once we have sorted that out do we begin to think about how the financial markets may respond.
And over the last 3 or 4 years as we have done our work we always put together a list of those critical variables, those items that will drive the
forecast and those items that might in fact, cause significant problems. At the top of our list since 1996 of things we have been concerned about
has been the global economy- with Japan being at the very top.
The whole concept of supertanker America is not that America would be immune from the global conditions but rather that the global economy
would be very treacherous, that there would be very rough weather out there and that the U.S. economy could not be properly forecasted without
recognizing what is happening elsewhere.
Our conclusion however is that the U.S. would be able to proceed the way a supertanker does...not necessarily very quickly, not necessarily with
a lot of style and panache- but steadily, reliably and would be very hard to knock off course. That clearly has been the case over the past couple
of years despite treacherous economic conditions among a number of trade partners and treacherous financial market conditions in many
countries, we have been able to perform well. Let me suggest to you that there are four separate but related reasons for that.
1.The U.S as many of you know is the world's largest importer. We are also the world's largest exporter: something that often surprises
many people. But it is very important to look at that within the context of the size of the overall economy. While exports as a percentage of
our total economic activity have doubled over the last decade or so, they now represent just 13% of our GDP. This is a proportion that is
about 1/3rd that seen in most other developed countries. Now it's true that if we add in foreign direct investment- the proportion would be
somewhat higher as it would be in other nations. But the point of this is that exports are important but the performance and health of our
core domestic economy is more important.
2.The second characteristic behind supertanker America involves a closer look at the sort of business we actually do overseas. One of the
observations for example is that among the nations that have been hard hit in particular in the past couple of years, many of them were
more important to the U.S. as a source of supply rather than as customers of our products. The other thing that is critically important here
is that the composition of our own trade portfolio has shifted over time. 10, 15, 20 years ago, the bulk of our exports from the U.S. to the
rest of the world involved commodities and other fungible items. It didn't really matter to the end user whether the wheat, polyetheline or
steel was produced in New Jersey or New Zealand. Over the last decade in particular, we have seen a dramatic shift in our trade portfolio.
The U.S. increasingly exports value added & proprietary items that are not easily reproduced and do not trade in global markets on the
basis of price or foreign exchange changes and so on. Enormous growth has come from your industry (the high tech industry), we have seen
for example that high technology product has been one the fastest growing categories and one in which the U.S. has an enormous trade
surplus. In addition computer software and computer service are also increasingly important. So are financial services, entertainment,
publishing and so on. As a consequence of that, even though U.S. exports have grown, these are not necessarily the sorts of products that
respond in knee jerk reaction to slower growth outside the United States. Many of these are items that will be consumed and used anyway,
not that there isn't some sensitivity to the pace of economic activity elsewhere or to changes in the dollar relative to other currencies, but
the degree of sensitivity has been dramatically reduced. For example we estimate that the trade portfolio of the U.S. is one quarter as
sensitive to changes in the currency as is the trade portfolio of Japan.
3.The third characteristic behind the concept of supertanker America has to do with the enormous strides taken in our domestic economy.
These are numerous…Let me focus on just a small number.
i.Consider the enormous improvement in the fiscal policy position of the U.S. In 1990, the annual budget deficit was approaching
$300 billion or 6% of GDP. This year and over the next few years we expect a surplus in the U.S. budget picture- and we are
one of the few nations on this planet to accomplish that.
ii.Secondarily and this is so important, the U.S. is one of the few nations that is demonstrating a domestic momentum toward
growth. Consider that we have grown even while the rest of the world has had difficulties. Since 1993, our job growth on a net
basis has been 15.1 million new jobs (there are still jobs being lost- but many more jobs having been created to a net gain of
15.1 million since ‘93) and two thirds of these new jobs pay above the median wage- not minimum wage. Most are in the fast
growing industries including high technology jobs. Now contrast this with the new European Community, "Euroland" with a
population somewhat greater than the U.S. Euroland has LOST 1 million jobs over the same time period since ‘93- AND during
the same time period Japan has lost millions of jobs, but in Japan it is hard to count because as you know in Japan when a job is
lost or done away with workers [often] remain on the payroll!
1.The fourth reason for supertanker America has to do with toughlove,
(a parenting tool) with regards to banking officials, Fed Reserve and accounting officials. Over the last 10 years for example, the
Finacial Accounting Standards Board, a formerly esoteric group in Norwalk CT- has made headlines by requiring more and better
corporate disclosure from the nation's companies. The quality of the information we now receive from companies in the U.S. is about
the best we have ever seen and it dramatically exceeds that of almost any other nation. We have also seen our bank regulators take
a pretty tough position: checking for example disclosure, encouraging our banks to enhance credit quality. Indeed over the last 2-3
years our bank research team reports that the quality of loans outstanding and the quality of credit card debt outstanding has risen
not declined. And when there was distress in the financial markets in August and September 1998 and for example when the
corporate bond market was not working particularly well, U.S. banks stood up and provided the money that U.S. corporations
required with a dramatic surge in lending for commercial and industrial loans.
So we put these 4 characteristics together: 1)That U.S. exports accounts for only 13% of our GDP. 2)A greater number of value
added and proprietary items in our exports, making them less sensitive to difficult conditions abroad; 3)strong domestic core
economy, and 4) increased financial accountancy standards.
[These four elements add up to a result]
Think of the result as E.V.A. An acronym for the phrase Economic Value Added- which is basic common sense and any of you who
run businesses have probably implicitly understood this. Under E.V.A. you measure costs of inputs and the measure the return of
those inputs and then you're trying to maximize the spread between return and cost of these inputs.
We have an analysis of the S&P industrials index- we are trying to contrast the return on capital versus the cost of capital, what is
important here is the spread, the E.V.A., that is, what they are generating by using that capital. Something rather interesting is the
following:
i.Spread in the U.S. is not just high, but it has been high for an extended period of time. Investment theory would say that should
be associated with long term, sustainable increases in stock prices- and indeed it has been. The second point is that this good
spread has been related not so much to the cost of capital, but to the surge in the return on capital that we have enjoyed over
the last several years in the U.S.
We have seen this improvement in market value in the stock market because companies are performing better. Profit margins in the U.S. have
risen dramatically and are now higher than they've been in 25 years. Return on equity is now the highest we have seen it, and it is important to
recognize that there have been two phases over the last decade in which this has occurred. Phase 1: Latter part of 1980's: restructuring, a
euphemism often times, for shutting down businesses and laying off workers. At the end of the 1980's many U.S. companies recognized that they
have lost their competitive edge in some global markets and recognized that they have not been as attentive as they needed to be to this spread:
whether they were really making money in this business and some of this was attributable to poor accounting- inflation got in the way and we
couldn't measure things properly and so on. And so we began, as a nation, to restructure.
And in the first phase of restructuring, national assets were taken away from under performing projects, enterprises, businesses, industries and
these national assets were not just capital, they were also people. BUT WHAT HAS TRULY DISTINGUISHED this economic cycle, was the
second phase of the restructuring. In the second phase, financial assets were transferred from under performing enterprises, projects, businesses
and industries to enterprises, businesses projects and industries that can generate excellent returns.
As a result of this the composition of the U.S. economy today is not what it was, our trade portfolio has changed as I mentioned before, and our
composition of GDP has changed as well. Technology as a percentage of our GDP has tripled over the past 7 years. Not just spending on
technology but technology as a percentage of a growing economy has tripled during this period of time.
We have also seen that in other areas the U.S. has a commanding proprietary advantage: we can do things better, we have higher value added
perhaps than the other competitors do. These are categories that have grown tremendously. As a result, as a nation we have created significant
value added and the stock market has responded.
By contrast, similar accounting analysis for Japan, the EVA spread has not been just smaller than the U.S. but rather it has been negative.
Investment theory would indicate that when there is negative EVA, when economic value added is destroyed, stock prices should head lower and
indeed that is what has happened in Japan. LET ME DRAMATICALLY point out that Japan's spread has been lower than the U.S. not because
cost of capital is higher- [in fact the cost of capital has been lower!] but because the return on capital has not been very good. They did not have
the same TOUGH LOVE we had in the U.S. companies. They did not have the same higher standards of excellence imposed on them by tough
accounting standards and appropriate bank regulation. And in a way, the low cost of capital available to Japan during the 80's and various points
in the ‘90's has not been just a mixed blessing but in a way, not a blessing to Japan at all. A good deal of the inexpensive capital was misallocated
to real estate, corporate spending that didn't need to be done and so on.
Conclusion:
Our outlook for the U.S. Financial Markets is keyed off our view of the U.S. economy. I agree that '99 will be yet another year of economic
growth in the U.S. and for the S&P 500 another year of profit gains. As we have seen, over the past 2-3 years, those averages, while interesting,
don't tell the whole story. The real story of the U.S. economy has been happening beneath the surface- there has been such wide differences in
performance, one economic sector vs. another, one industry vs. another. That's where the real information is. We continue to believe that some of
those categories in which we excel as a nation, technology as an important part, will continue to enjoy above average growth, not just in unit
volumes but also in earnings and this is a very important part of our positive view of the stock market.
Over the next several weeks, we will introduce our forecast for 2000 and at this point I do not expect there to be any significant problem
developing either in terms of growth, or inflation or interest rates. That being the case, yes, we are still bullish on the U.S. stock market.
Question: When do you, Abby Cohen, think that common sense will prevail in the valuation of internet stocks?
Answer: We've seen this thing before, in biotechnology in the early 90's, semiconductors in the 70's and and in the 50's household
appliances….We think the valuation models based on market share and projected revenues do make sense and we think that as is the case in
most new, fast growing industries, a focus on current earnings and cash flow usually doesn't give you the right answer.
Abby J. Cohen
Goldman Sachs Inc. Jan. 15th, 1999
San Jose, CA
For more see: cnbc.com
or goldmansachs.com
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