SEPTEMBER 3, 2001
Cereal Killer
By Alan Abelson
Who are "they"?
And where are "they"?
If you know, do us all a big, big favor and tell "them" to get off
their butts and do what they're supposed to, pronto.
Even if we're not sure who and where "they" are, we can say
with certainty that they're filthy rich and filled with noblesse
oblige (which is French for big tippers). We know that because
pundits by the ton have assured the world that "they" are poised
to come barreling to the rescue and keep the stock market from
pitching over the lip of disaster.
And, what's more, "they" are destined to do this right after
Labor Day (they paid their summer rental through August, which
is why they haven't shown up yet). For gosh sakes -- that's now!
There's no time to lose, as last Thursday's nosedive in the Dow
made clear. (Fridays don't count anymore because that's when
the shorts cover.) So, again, please, be sharp, be on the lookout
for them, it's important.
If you should chance to come across them, give them an elbow,
not too hard but not too gentle, either, and tell them to get with
it. Better yet, get out there and organize search parties. That all
of Wall Street's shifty eyes are fixed in the direction of the
Hamptons should give you a clue as to where to look.
We can't stress how urgent it is. Already, we've got all the
makings of a full-blown national emergency. The bear's claw
marks are visible in places remote from the stock market. We're
not just talking negative wealth effect here: The swoon in stocks
is having a negative mental health effect.
Nor is it merely dazed traders and busted brokers who are saying
funny (but not funny ha, ha) things and acting peculiarly. Take
Donald Rumsfeld, our widely respected Defense Secretary
(widely respected by the thousands of Pentagon employees who
are forced to salute every time they pass him in the cavernous
hallways). In the course of bemoaning his shrunken net worth,
Mr. Rumsfeld inadvertently disclosed that he has recused
himself from participating in any military decisions involving one
of his old outfits, Kellogg Co., the cereal maker.
What's shocking about that seemingly innocuous remark is that it
reveals one of the critical secrets of the Star Wars anti-missile
defense Mr. Rumsfeld has been advocating so vigorously.
Kellogg is the key supplier in the system, thanks to the discovery
that guided missiles of every description, no matter how simple
or sophisticated, veer instantly and unswervingly toward any
stray cereal box whirling about in space (the critical discovery
was made accidentally when a new missile being tested was
inexplicably drawn off course and unerringly zeroed in on an
empty box of All Bran that had been discarded by who knows
which careless astronaut).
The heart of Star Wars, friends and foes now know because of
Mr. Rumsfeld's astounding indiscretion, consists of hundreds of
thousands of boxes of Corn Flakes, Rice Krispies, Frosted
Miniwheats and, of course, our personal favorite and one that
North Korean missiles can't resist, either, Pop Tarts, floating
cheerfully in the heavens, waiting to distract anything our
enemies choose to send our way.
Which also explains why, despite disappointing earnings, Kellogg
stock has been doing so well in this putrid market.
Or consider the revelation last week by Alan Greenspan in a
speech to a gathering in Jackson Hole, Wyoming, that with the
economy and the market coming down around their ears, the
Federal Reserve was sparing no effort to develop a magic
formula that'll enable it to distinguish a housing bubble from a
stock-market bubble or, in his wonderful down-home and limpid
formulation: "developing balance-sheet disaggregations that
should help us infer the propensities to spend out of capital gains
across different classes of assets."
A startling example of strange behavior among civilians is
provided by a profession whose members are universally revered
for their undeviating rationality -- doctors, who also happen to be
inveterate investors in the stock market. Thus, the docs' trade
group, the American Medical Association, having decided to
launch a campaign warning its member physicians against
accepting gifts from those devils incarnate, the drug companies,
owned up to enlisting those very same drug companies to help
pay for the campaign!
Even though this is Labor Day, we don't want to labor the point.
Suffice it to say, the extended decline in stock values is seriously
affecting not only the financial well-being of Americans but
something even more precious -- their mental faculties.
So, however much it grieves us to admit, it does appear as if
"they" are the key to the fate of the stock market and the
prosperity and stability of our beloved country.
In other words, the future of the Free World depends on a small
group of privileged people who have spent the summer willfully
lolling on a pristine beach, gloriously inattentive to the quotidian
hubbub and oblivious to such matters of moment as whether the
Dow is headed for hell in a handbasket or some more
contemporary conveyance (like one of those dandy little scooters
that the kids use to clear the sidewalks of old folks with canes).
One can only pray the pundits are right. Or at least wish that,
even if "they" somehow neglect to do their duty, ordinary
investors, after recharging their bullishness over the long
weekend, will fill the breach. If nothing else, a market that went
up for two sessions in a row would be a nice change.
Maybe we're being just plain contrary (although this hasn't been
a bad year to be just plain contrary), but we suspect that three
whole days to ponder the state of their portfolios might just as
easily, if not more easily, inspire people to dump as to buy.
And it would be just great were they to decide to unload in a
hurry and all together. For one of the troublesome things about
this decline has been its languorous nature, which, however
typical of a bear market, is not the traditional springboard for a
serious rebound. Rather, to get a decent move upward, we first
need a spasm of climactic selling on heavy volume, the kind of
cathartic action that has been conspicuously absent from this
market, for all its slipping and sliding.
That would set the stage for the bulls' last romp. And that
sequence -- a shuddering sell-off followed by a big bounce --
could happen sooner than later.
It would provide the investing masses with a chance to get out,
though alas, they'll likely view it as a chance to get back in. The
"alas" is inserted because after the rally runs its course, the bear
will be back, bigger and uglier than ever. Much uglier, we're
afraid.
That chart directly to the
right is one of the reasons
we're skeptical that the worst
is over for the stock market.
As the little credit line
indicates, it's the creation of
Sanford C. Bernstein & Co.,
whose research is often more
interesting than the
run-of-the-mill Street stuff.
And what it narrates is the
story of operating margins for the S&P 400 from 1976 through
last year, as reported and as adjusted for nonrecurring items and
the effect of stock options and pension plans.
Once those adjustments are made, "the exceptional
performance," to quote Bernstein, of profit margins in the
second half of the 1990s "disappears entirely." Glance at the
chart again for a moment and note the divergence between
reported margins and adjusted -- or what we've dubbed "real" --
margins, as depicted by the spread between the light and dark
lines, and you can see the "improvement" vanish before your
very eyes.
Using the same adjustments, Bernstein surmises that there
wasn't any growth in earnings per share from '95 through 2001
(it cautions that perhaps not all options were exercised, so there
could have been a minuscule gain, but it's a distinction without a
difference).
In other words, shorn of gimmicks, the vaunted growth of both
profit margins and earnings in the boom years of the 'Nineties
goes up in smoke.
It now emerges, moreover, that the famed productivity miracle
of the 1990s that Mr. Greenspan puts so much store by, and that
was presumed to be the very bona fides of the New Economy,
wasn't all that much of a miracle.
Revisions by the Bureau of Labor Statistics pared the rate of
gain in the 1996-2000 stretch from 2.9% to 2.6%, but, as Jeff
Madrick pointed out in an excellent column in the New York
Times last Thursday, the downward adjustments were
particularly severe in the years 1999 and 2000, when the
reported rise in productivity was greatest. Most notably, last
year's stunning 4.3% rise was sliced to 3%.
In brief, Wall Street's main talking points in the liftoff stage of
the late, great bull market -- exploding earnings, expanding profit
margins and surging productivity -- were pretty much hot air.
The monster investment those myths fostered, however, has by
no means been fully washed out of this market. What that says
to us, simply, is that until it is, any rally will prove merely an
interruption to the market's melancholy downward trek.
The best piece of analysis we've seen in a long while comes
not from one of your million-dollar babies at a heavyweight firm,
but from the CEO of a company called Retractable
Technologies, a chap named Thomas Shaw. And the critique,
which took the form of a letter to shareholders, is of a
competitor called Med-Design Corp.
Med-Design has been something of a wow in the stock market
(its range over the past year is roughly 10 to 40 plus, and it
closed Friday at 23 and change). By contrast, it has been
something of a blank in the marketplace, with red ink and a
modicum of sales. For their part, Retractable shares are selling a
hair under 5, quite a piece below their high of nearly 15. It, too,
has been losing money, but sales are growing rapidly.
Mr. Shaw's letter, dated July 26, is aimed at explaining why Wall
Street has treated the two companies, which specialize in
medical needles, in such different and what he considers quixotic
fashion.
A big reason, according to Mr. Shaw, has been all the noise over
MedDesign's Becton Dickinson connection -- it has licensed
sundry patents for automated retraction technology to the latter.
He evinces skepticism as to the ease with which that connection
will turn into a marketable product.
But, he shrugs, suppose Becton does bring a Med-Design
retractable syringe to market. He reminds that it normally takes
about 18 months after FDA approval to work out the assembly
bugs, so that leaves 3½ years of the 17-year patent life on the
device for Med-Design to collect royalties.
Well, even a very aggressive production schedule, calling for
output of two billion units over the 3-1/2-year stretch, with
Med-Design's 2.75% royalty and end-user pricing of 50 cents
per unit, would generate total royalty revenues, he reckons, of
only $27.5 million over the patent's remaining life.
As Mr. Shaw comments, that $27.5 million hardly squares with
the July 26 market cap of $446 million for Med-Design, a
number more consonant with a valuation accorded
"manufacturers with continued high profit margins rather than
patent holders."
And that statement seems just as true for a patent holder with a
market value of $303 million, which happens to be
Med-Design's current market cap. If Mr. Shaw ever tires of the
medical device game, Wall Street beckons. |
