Brimmer Financial Newsletter
Second Quarter, 2002

The second quarter of the year was a grumpy time for investors. The downward direction of the stock market in the early months of the new year continued amid an incoming tide of negative news. Daily reports of corporate crimes as yet unpunished made headlines. There were more than a few stories about company executives who herded their corporations into bankruptcy. They collected millions of dollars in severance pay as their newly impoverished former employees counted their losses and looked for work. Islamist terrorists were still in hiding, no doubt plotting new destruction and delighting in our woes. Allegations of insider trading led a few nightly news broadcasts. The newspapers were full of gloomy forecasts, reports of catastrophes, the obituaries, and an occasional readable sports page. Wasn't there any good news to report? I believe there's a reason that most news reporting is about lying, cheating and stealing, war and pestilence. Bad news sells. A crowd is attracted to a calamity. When the mighty fall from grace, the crowd cheers. We're often reminded that whenever we buy a newspaper or listen to the news on radio or TV, we've just purchased a product called the BAD NEWS. It's apparently the only news fit to print. I guess the good stuff just doesn't sell.

In my opinion there is some good news to report. I feel strongly that this long siege of a bear market, now over 27 months old, is soon to end. Though no one can prove the future, this has the earmarks of the last days of past bear market attacks I've survived. Also, in this climate of guilty until proven innocent, most of our corporate bosses have NOT been accused of wrong- doing. There are thousands of public companies and millions of private ones. So far we've heard about only a few who played fast and loose with the rules. Their owner-shareholders and employees have paid a high price for the actions of a few decision makers and a handful of book-cooking accountants.

I truly hope that the bad apples are few and far between for the sake of our capitalist system and the many workers who labor in these organizations, as well as for the health of my clients, the owners. The injury inflicted on the thousands of blameless employees who lost their jobs and retirement plan assets has outraged the whole country, not just the investors who lost money when the stocks of their damaged corporations collapsed. So far as we know, this kind of immoral destruction has occurred at only a handful of well known companies.

When the wrongful deeds of corporate executives are uncovered, investors and short sellers punish the entire firm, not just the perpetrators, by selling their shares of stock, pushing down its price. If a company's stock falls too far, lending sources can dry up because the firm may no longer be considered creditworthy by its bankers or the bond rating agencies. This can drive a company to desperate measures, including filing for protection under the bankruptcy laws. If the firm emerges from bankruptcy it can then take years for the stock to recover. The market is unforgiving. They don't arrest the captain; they just torpedo the ship with all hands on board.

Out of this mess should come serious reform, overdue enforcement of existing laws, jail time and disgorgement of ill-gotten gains from those who committed fraud. And that's good news. President Bush delivered a speech in New York last week regarding these abuses. Lawmakers have heard from their constituents who are demanding justice and honesty. The SEC, the Justice Dept. and Congress are moving quickly to reassure investors that the system is self-correcting and sound. This isn't a failure of the system. It's a failure of a few crooks in the system. Also, this is not the first time we've had to deal with corruption and scandal. America survived worse than this and prospered. The 19th century was a time without the controls, laws and rules of market fair play that are in place today. Back then the order of the day was "laissez-faire" ('allow to do' or 'let it alone') both for the economy and stock market, meaning there was very little government regulation. Insider trading was an art form, not a crime. Deception was widely practiced. Corruption was pandemic. Each Monday morning the robber barons of the Gilded Age waged economic war on their high society Sunday dinner guests and their fellow robber barons. And somehow the country survived and thrived.

We will come out of this crisis of confidence when investors realize that America is financially sound; that we're out of recession and returning to broad-based profitability; that most companies are not organized criminal cartels. The free market needs a tune up. The executives need a reminder that they are fiduciaries, not princes of greed. They need to be reminded that they work for us, the shareholders, the owners. Forget the lessons? Then Go Directly to Jail. Do Not Pass Go. Do Not Collect $200. Breaking a sacred trust with the workers and owners of our great corporations is not unlike treason in time of war. Those few self-serving liars, and I hope there are only a few, gave aid and comfort to the enemy when they helped weaken investor confidence in our free market, capital-forming, wealth creating economy which had been weakened by the madmen of September 11th. I'm reminded often that markets thrive on confidence and falter on fear.

These events will, I trust, bring about a renewal of shareholder activism. All investors should be concentrating on reforming the system of rewarding both the corporate managers and the Wall Street analysts. Professional sports may have to face up to the compensation issue soon as well. If fans don't buy a ticket or watch the game on TV, who's going to pay $10 million a year to a star athlete? If the shareholders, especially the institutions (mutual funds, trust departments, pension plans, etc.), reassert their ownership of our public companies, then greedy deals, outrageous excessive pay and loans to managers and other boom-time abuses will not again easily take root. I believe that talent should be rewarded fairly. I'd be happy if the CEOs were paid a modest salary, not more than five times the pay of the lowest salaried full time employee, with performance bonuses paid in common stock if they help their company prosper. They could then sell their shares or hold them like the rest of us. If the company does poorly, NO bonus. Maybe NO job. It's called "identity of interests" with the owners. The years of the Dot.Com Mania, 1995-1999, was a time of "more money than brains" in too many corporate boardrooms. Hey, y'all, the boom's over. Time to get back to working for the greatest good for the greatest number. Remember free market democracy?

More good news: The economic recession is also over. It was neither deep nor long-lasting. In fact this recent business slowdown was mild. Except for telecommunications, the airlines and certain sectors of the technology group, our country's economic life is healthy. The home building and home buying markets have been very strong over the last several quarters. Consumer spending, which represents about two-thirds of our economy, continues to hold up. The unemployment numbers are improving. Most people who want to work can find a job. There are an estimated 10 to12 million illegal immigrants in America. Some of them may have beaten the system and are here receiving tax-free benefits, but most are here to work. They aren't counted in the employment numbers. So there are really more folks actually working than are reported.

U.S. worker productivity (output per hour worked) continues to improve. In manufacturing, factory utilization is increasing. Based on the revised numbers from the government, the economy grew by 6.1% in the first quarter of the year. That's the best quarterly growth since 1999. The second quarter saw the economy grow at a slower rate, perhaps 3% or so. That's half of the 6% from the first quarter, but it's still a good number. Congress is increasing spending for defense and security to fund the war on international terror-criminals. Airlines are reporting a steady increase in passenger miles flown. Yes, the world has changed since 9-11, but we're getting back to something like normal despite all the worries.

Interest rates are at 40-year lows. Inflation is likewise at a multi-decade low. Every day, tens of thousands of American scientists, engineers and researchers create improved medicines, products and systems that enhance and extend our lives. You'd think someone would say something uplifting. But no. The media chant a dreary repetition of the litany of wrongs. Like sharks in a feeding frenzy, news people feast on the negative news. Day after day they pound out pages of
pessimistic prose. What they don't do, in my opinion, is report a balanced view of actual conditions, in other words, reality. Many pages are filled with partial stories, innuendo and bias. So we read, hear and watch only what's depressing, disheartening and disconcerting. Any wonder so many are eager to sell?

In my opinion, what's going on this time is a stock market-driven event, not an economy-driven event. By that I mean that the country is in good shape. Main Street is healthy. It's Wall Street that's sick. The problem is investor psychology. Optimism is definitely out. Fear is in. What did FDR say? "The only thing to fear... is FEAR itself." Markets go up or down based on perception, not necessarily on fact. The facts aren't all bad. Most of the facts about the economy are pretty good. The perception is bad, and that's what's driving this market.

Most investors have never lived through a long drawn-out bear market like this one, now over two years old. This kind of painful experience is a 30 to 40 year event. We've only had two other similar nasty bear markets in over 75 years. The first was the 1929-1932 Great Depression Market. The second severe bear market occurred during 1973-1974, which dropped for 22 months before recovering. The problem in the 1930's was depression. The problem in the 1970's was inflation. Now, the market's down, but the economy is healthy. That's why I think this is a market-only event.

A generation of 1990's stock market day traders and speculators may have sold most of their shares by now. They helped drive up prices during the boom. They have, no doubt, contributed to the recent sharp decline in prices. Some may have joined the ranks of the short-sellers and are keeping pressure on prices for the time being. Short sellers are speculators who sell borrowed
stock, hoping to buy it back cheaper after the price drops (due in part to their selling). I believe the "shorts" are a powerful negative force in this down cycle. Selling is how they make their money. It may not be patriotic, but it's legal and very risky. Their time may soon be passing. The NASDAQ index has already revisited its Sept. 21, 2001 lows. Several of the other major market indexes have gone back down to their Sept. 2001 levels. As I write this, the Dow Jones Industrials are nearing a revisit to the low point reached on September 21, 2001. Market technicians, those who follow the charts and patterns formed by the price movements of individual stocks and the major market indexes, hold that the market must "test the lows" of the recent past before it can resume its long-term upward bias. We're now taking those tests, hoping to pass so we can graduate up to the next bull market. A review of market history reminds us that these negative trends are usually short-lived. The general rule of thumb is that the market goes up two-thirds of the time and down or sideways one-third of the time. The average bear market over the last 75 years or so is about 18 months. This one has lasted, so far, 27 months. We're now way overdue for a course correction. This time it will be up. The repetitive cycles of up and down markets create a mirror image of themselves when their gyrations are charted. Just as the boom cycle of the late 1990's went up too far, this market bust has gone down too low. Most bear markets end with a flood of selling called the capitulation. It seems we're in such a selling wave now. No one rings a bell when the bear market is over and the new growth phase has begun. So we won't know for a while that the market is improving because some stocks will keep dropping while others begin to climb. Eventually, the majority join in the upward march. It's gradual. In time the movement will become obvious.

I'm in the process of assessing each portfolio, each stock, bond and mutual fund. Some of you have already received a letter from me suggesting one or more positioning moves. In the cases of those stocks and funds that have held up well during the bear cycle, I may simply recommend adding now to increase the number of shares you own. In other cases, I may feel that a change may be warranted, based on my belief that certain sectors of the market should outperform during the recovery phase. Our managed accounts have already been repositioned to take advantage of the market recovery. In all cases, tax considerations are part of the decision, but not the primary motivation.

I'm reminded of a story about my investment hero, Sir John Templeton, who, during the later years of the Great Depression bought 100 shares of every stock he could find on the New York Stock Exchange that was trading for $1.00 or less. Starting with about $10,000, which, as the story goes, he borrowed from his boss, he stayed with the portfolio for four years until it had grown to around $40,000. He sold enough to pay back his boss and never borrowed money again. The end of the 1973-'74 bear market was the best time to buy bargain-priced stocks in the last 28 years. Will the second half of 2002 be the best time to have bought bargain-priced stocks over the next 28 years? I don't have this answer, but I do have confidence in our future.

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