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April, 2003


As we have entered the Easter season, "spring is bursting out all over," and organized resistance to U.S.-led forces in Iraq has collapsed, hope is rising for a time of resurrection. Those who do not find solace in the next world may at least look for a lifting of their fortunes in this one.

Analysts using a comparison between the 10-year U.S. government bond yield and a U.S. average equity earnings yield (average per share earnings divided by average per share price) are now often pointing to the latter, at roughly twice the former, as evidence that this is an excellent time to be investing in stocks.

Others suggest that, with the most expensive phase of the Iraq war winding down, extra government spending, signs of at least modestly increased consumer purchasing, the lowest interest and mortgage rates in about forty years, a Federal Reserve intent on assuring stimulus to the economy, and falling gold and oil prices, a return to significant industrial growth and surging share prices is assured before year's end.

On the other hand, many red flags remain. Stock prices as a percentage of gross national product, a macroeconomic indicator favored by Warren Buffett, remain surprisingly high, about where they were just before the severe bear markets that began in 1929 and 1973. Buffett is, according to his letter recently published in the Berkshire Hathaway 2002 Annual Report, understandably not interested in purchasing new equities now, saying his company can find few if any good buys.

He adds that the extent, complexity, and interdependence of derivatives now likely exceed the highly leveraged margin buying excesses immediately before the Great Depression, and represent a "time bomb" threatening America's financial health as much as significant potential acts of terrorism.

In a recent issue of "Scientific American," the April, 2003, issue ("Defining Poverty," by Rodger Doyle, p. 31), it is pointed out that our nation's official poverty threshold (currently about 12%) criteria are outdated. Likely for political and bureaucratic reasons, an updating of the threshold factors has not been done since the early 1960s.

The magazine suggests that accurate criteria, taking into account working mothers' child care costs, higher Social Security and other taxes levied on the working poor, cost of living differences in various parts of the country, savings needed to cover short-term emergencies, actual liquid wealth (cash and other liquid assets less debts), and other factors, would show a much more bleak picture of our country's capacity for robust growth and readily bouncing back from recession, with 40-45% of households either now in poverty or significantly at risk of being unable to get along without charitable or welfare assistance.

Economists report that the average U.S. consumer's debt vs. annual income level has never been higher.

And then there's SARS (severe acute respiratory syndrome), already a tremendous damper on commerce and tourism in Asia. It seems likely we have not yet seen the worst effects of this disease.

Nor is the current stock earnings yield to government bond yield ratio all it's cracked up to be. Earnings projections turn out to be routinely inflated. Buffett indicates that aggregate earnings increases cannot for long be sustained above the growth level of the gross domestic product. Yet forecast earnings average about 150% or more of GDP growth.

Val and I have no real confidence in a short-term forecast, though we are mildly optimistic of a continuation for awhile of the recent rise of equity prices. But, for the long-term, if a more accurate assessment of corporate earnings were used for the stock vs. bond valuation model, these asset classes should probably be given about equal weight in one's portfolio.

Of course, if for safety you have been keeping almost all your liquid holdings in reserves or short-term bonds, even the adjusted stocks vs. bond yield ratio would suggest an increased exposure to equities' growth potential (and risk) is now appropriate. Even Berkshire Hathaway has tens of billions of dollars invested in stocks, from prior purchases.

But given that U.S. stock securities now appear to have relatively low upside vs. downside prospects and that Buffett and others see our markets as still needing to offset the binge of "extravagant exuberance" in the 1990s, a return to dramatic and prolonged bullish behavior soon seems unlikely. We have a better chance of experiencing a trading range, above and below a mean, than a new, extended run-up of stock prices year after year.

This is an investment environment that rewards the establishment and maintenance of fixed allocation percentages. For instance, select a target threshold, say, 5%, above or below which you'll sell or buy, respectively. Then begin with 50% of your liquid assets in Vanguard Short-term Bond Index Fund (VBISX) and 50% in a variety of stocks or stock mutual funds. When it is noticed that stocks have increased to more than 5% higher, the excess (over 5%) would be sold and the net proceeds invested in additional short-term bond fund shares. As equities over a few months might continue to "head north," the target threshold would dictate that more of the stock side of the portfolio is sold off and more of the bond shares purchased.

Thus, if one begins with a total liquid portfolio of $400,000, $200,000 each in short-term bond mutual fund shares and equities, and the latter go up to $215,000 ($5000 above the $10,000 [5%] target threshold), $5000 in equity shares would be sold and the net proceeds invested in short-term bond fund shares.

The same would apply in reverse for bonds, if they have gone up relative to one's stock holdings.

This is a fairly simple, low-risk way to enjoy a portfolio that retains some growth potential but protection against loss of principal for either asset class viewed separately.

One probably should not hope for superlative returns with this approach. But now may not be the best time to bet the farm on another bull market either.

To get better bang for the equity side of your investment buck, though, this could be a good moment to look at European dogs. Similar to the "Dogs of the Dow," these old world mutts or "profitable pooches" and "Euro Dogs," as they are called in the 4/7/03 issue of "Barron's" (under "A Breed Apart," by Vito J. Racanelli, p. 18), now have generally lower price to earnings ratios and higher dividends than their U.S. counterparts. What is more, they'll benefit relative to Dow stocks if the dollar continues to trend lower. "Euro Dogs" are a little harder to purchase than American breeds, but could be well worth the extra trouble.

Please note that, we understand, the foreign asset dividends are subject to a 10% tax, paid for investors automatically by their brokerages.

A good sector selection of these European canines follows:

DCXAuto Mfr.€
HSBC Hldgs.HSBABanking£682.115.54.8%
SuezSZEElectric Util.€13.3811.75.3%


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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