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Karen Gibbs and Geoff Colvin Geoff Colvin Karen Gibbs Karen Gibbs Geoff Colvin
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Air date: June 24, 2005
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Roundtable discussion

KAREN GIBBS: The first half of the year is drawing to a close, and the major stock market averages have gone nowhere. And no wonder. With record high energy prices, talk of a housing bubble, and emerging giants in Asia gobbling up resources and jobs, the economy is facing some major headwinds. These are tough issues for investors to navigate. And that's why we’ve called together a blue chip panel to help find some direction.

Howard "Pete" Colhoun, was one of the pioneering guests on the original Wall $treet Week program 35 years ago. He’s now a consultant to institutional investors. Peter Morici stays on top of economic trends at the University of Maryland’s Smith School of Business, and we’re also joined by money manager and contributor Michael Farr.

Well, Peter Morici, let me start with you. China has been in the news this week, not only for its hostile $18.5 billion bid for Unocal, a potential buyout of Maytag, and this on top of its already purchase of the IBM's PC division. Add to all of that flavor, it's on the cover of US News & World Report as well as Time magazine. Now there’s a lot of enthusiasm percolating about China. Peter, is it warranted?

PETER MORICI: Well, there's no doubt that China is going to create a great deal of disruption in the global economy. The question is can China learn to play with others and will China really be a hospitable place for investors. It's one thing to build a plant there and sell products there; it's another thing to get your capital out. How secure will your property be there? It's still an authoritarian government. China itself has said it's intent on changing the rules of the global economy as much as playing by them. Is it willing to play fair?

GIBBS: Well, it seems to have changed the rules. One of the tenets of investing that I've always learned is that free enterprise and democracy go hand in hand. This economic juggernaut is a Communist Party with absolutely no opposition and it appears to be forced enterprise rather than free enterprise.

MORICI: There's a certain element of that. It's one thing to throw a lot of inexpensive labor into textiles; it's another thing to build an automobile, to build a Lexus. The Chinese have not yet demonstrated that they can do innovative things and that they can coexist in advanced industrial markets for capital, for innovation, and so forth.

MICHAEL FARR: They also haven't demonstrated that they want to play by the rules of the rest of the world. They seem to like the rules to go their way, sort of on their terms, and when they don't like the rules, they're prepared to break them. And I don't think that we seem to have found a way in the U.S. to really hold their toes to the line and say "Here and no further."

GIBBS: Well, isn't it true that they say he who has the gold makes the rules, Pete Colhoun?

PETE COLHOUN: I think that China is an economic engine in the future. But the dilemma for the investor is, it's very difficult to invest directly, so I think you have to do it indirectly by investing in the natural resource companies that China is going to demand.

GIBBS: Like what?

COLHOUN: Well, there are two mutual funds that really feature this. One is the T. Rowe Price New Era Fund that is all based on resources, and the other is the Ivy Global Resource Fund that is owning nothing but companies that produce resources, including energy, but not exclusive to energy. And I think both of those no-load mutual funds are very good candidates for investors today that have an interest in a play on China.

GIBBS: What are your biggest concerns about investing in China?

COLHOUN: The rules, as my colleagues have said, the rules, they don't play by the rules, and so you may not have a possession of property, you don't have a very good recourse system, you don't have an open market. You don't have an SEC. They don't want you there, and that's not a good place to be. And I don't know how to do it through the peripheral countries as well as through the resources that they're buying.

GIBBS: Peter, do you echo those concerns?

MORICI: Yes. I do think that private property is not secure, especially that of a foreign investor in China. Selling to China: You know, there's an old story about who made money in the gold rush: the people who sold the shovels, not the people who mined the gold.

FARR: Well, how do we get to that right balance? Because I think in Congress both sides of the House are very comfortable not liking China right now, and I think there's that fine line, sort of all of a sudden waking up and saying we aren't doing enough to enforce our current trade rules with China, and then sort of swinging to the other side of sort of protectionism and xenophobia here. I mean I think there’s a real danger.

MORICI: The problem in Congress is that it's reacting to the President's inaction. It's almost as if we're walking down a path of appeasement with China. I mean the administration seems reluctant to really confront China on a variety of issues, not just economic issues. The currency issue stands out. It's the most flagrant violation of the economic rules of the game. But look at intellectual property, look at China's lack of leadership on Korea, leaving it to us. Korea is in their backyard, not ours. They should be leading.

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GIBBS: China has also been behind the surging price of crude oil. Flirting with $60 a barrel this week, it has stymied a lot of the economic growth around the world. What do we do, Peter Morici, about the rising price of energy, and how is it going to affect the economy going to the second half of the year?

MORICI: We need to learn to use energy more efficiently, especially in the automobile sector. The technology is now available to us to greatly reduce the amount of gasoline we use to get around, without compromising the quality of our personal transportation. In the '70s we were telling everybody to get into Chevettes. Today we can take those large SUVs, make them hybrid for a couple of thousand dollars extra, $4,000 - $5,000 extra, and drive around on 40-50 percent less gasoline. It's absolutely a scandal that we don't have a coherent energy policy to make Americans more independent of these terribly rising petroleum prices, which have no place to go but up with China gobbling up so much oil because its industrialization process is so energy inefficient.

COLHOUN: I have two takeaways from the current energy situation. One is It's not the end of the world, because people will change their behavior as the price rises. As gasoline goes to $3 a gallon or higher, people will not drive these heavily-consuming vehicles and will change their behavior.

The second thing is the growth industry out of energy is nuclear power. President Bush said it yesterday. He is right. Investors should be looking for ways to invest in the nuclear power industry. It is not easy, but that's the growth industry of energy for the future.

GIBBS: Michael, this energy price is acting as a tax on individuals. Their discretionary income is crimped, they're not driving as much, they're not going out to spend as much. What are the implications for the economy going forward with these high gas prices?

FARR: I think it's very scary. And It's not so much the gas prices yet. The gas prices are higher. But as we've seen, you know, oil jump 10 bucks in the past week or two weeks here, I mean you haven't seen a corresponding 20 percent jump in gasoline prices at the pump. But these sort of higher prices, if we get to that $3 a gallon, and that happens on a global scale, I don't understand why, given what's happening in currencies and other issues, why that doesn’t really pose a serious threat of recession, not only in this country but on a global basis as well.

GIBBS: What do you think about that?

MORICI: Well, the U.S. economy is proving itself to be far more resilient to higher oil prices. It has to get up around $90 a barrel before It's at the highest levels we’ve been in the past. And the other thing is that because Americans are much wealthier than they used to be, they can absorb higher gasoline prices somewhat more easily.

And we also have to face the fact that Ford and General Motors are in deep trouble, and we really need to look to them for leadership in providing those vehicles for people to make the change. Unfortunately, for financial reasons, labor union reasons, and what have you, they're deeply wedded to outdated technologies.

GIBBS: How are we going to change that mindset then?

MORICI: I think it takes some federal initiative, some leadership, some leadership to say this is the right way to go. Also we’re going to have to learn to be very hospitable toward innovation from our Japanese transplants. The real future in the automobile industry is Toyota and Honda and Nissan, because they seem to be willing to make changes, to innovate, to do new things, and they're willing to do them here. My question is how do we get at that play?

COLHOUN: I think the agent of change will be the marketplace. Look at the price of General Motors and Ford. Look at their debt. It's rated junk today. Those market forces will bring pressures on the board of directors and the management to change the way they've been doing and bring on hybrids and bring on other cars. Nothing changes behavior like price. All the lectures in the world don't have the power of what it costs you to buy something.

FARR: Though if you took out the extra cost that GM and Ford as domestic producers have that the foreign producers don't have, would that level the playing field enough to make it competitive? And frankly I don't have the answer to this, so I haven't done this math. But if you take out that $1,500 per vehicle that they pay in medical care costs, if you take out the added cost and the burden of the unfunded pension and the huge liability that that represents with the unions, then don't you have much more of an apples-to-apples sort of a contest? And aren’t their products good enough? I mean a lot of people'seem to be buying them and driving them. they're just not making the money, right?

COLHOUN: Economic power will force a revision in the benefits that have been promised by the automotive companies. Economic power once again, you’re correct.

FARR: Or they're going to close, right?

COLHOUN: they're going to close. They’ll be like the steel industry.

MORICI: There'll be other changes there as well. Ford and General Motors are very inefficient in the design of cars. That's one of the reasons they have an inadequate inventory of engines. General Motors makes 50 percent more automobiles than Toyota does right now globally, yet they don't have the engines to offer us that Toyota does. They have a very bloated management, both companies do. they're very bureaucratic places, places where there is no responsibility. But, gee, you sound like the economist here. You’re absolutely right. Price will drive change. Sooner or later those guys will get the message. The question is, are they gone before they do it, or does someone else take over the companies the way it did the steel mills?

COLHOUN: It could be you drive the price of a company low enough, and someone else comes in with a takeover offer, and that's the way you bring about change.

MORICI: Absolutely.

GIBBS: Well, we've talked about one of the engines that drives the economy, no pun intended, the automobile industry. The housing industry is the other, and every time you pick up the newspaper, there are worries about a housing bubble. The housing market has been very resilient, as the U.S. economy has been, to rising interest rates. But, Peter, what do you think about the potential of a housing bubble?

MORICI: Well, there are two things driving higher housing prices on the two coasts. One is the things that people make in California and New York and Boston, the knowledge-based industries where people earn a lot more money, much higher multiples of ordinary people than they did before, they can afford to pay more for houses than they do.

On the other hand, we've had some very creative financial products and interest-only loans and negative amortization loans and things of that nature. Some of that has been driven, frankly, by Chinese investment, the Chinese government buying U.S. Treasuries, making credit readily available in the United States. The currency manipulation is playing a role. So I’d say It's 50 percent basic change in the economy that's permanent, and 50 percent bubble.

GIBBS: What about you, Michael? Because this also has a feeling of the function of highly-educated people, well-paid people, and it goes back to that outsourcing issue. What do you think about that?

FARR: Well, part of it does scare me. I mean the prices that we're seeing at these sort of interest rates, It's the adjustable rates that'scare me. Because I think the consumer that has gone for a lot of these cheaper products that Peter described could find themselves in a real bind in a couple of years if interest rates start to go up at a time, you know, perhaps when their earnings power is also being diminished by the inflation that's driving those interest rates up. So that concerns me.

Outsourcing in general doesn't bother me at all. Outsourcing is fine. That has a great role in a free market economy. The reason for the outsourcing bothers me a little bit, that we are hiring people in India and China, not necessarily because they're cheaper, but right now because largely they're better. they're better educated. We have CPAs and tax lawyers in India that you can hire now at a huge discount to those working in this country. If this sort of educational shift continues to occur where we can find these very high quality, educated people in other parts of the world at a discount on the dollar, the market’s going to drive those jobs there, and where is that going to leave our young people? I mean, there's a greater concern here for our economy in general, I think.

GIBBS: Peter, given all the uncertainty, where do you see the market at the end of the year?

MORICI: I see it at 1300. At the end of the year, I see the S&P at 1300. I think that right now real estate is over-bought, stocks are underbought.

COLHOUN: I'm in the same place. I would give you a guess that between now and the end of the year that the market, U.S. stock market broadly will be up 7 percent to 9 percent. We're flat year-to-date, and that's going to be a very good return for the next six months, and you have to buy things when they're out of favor, not when they're on the cover of Time magazine.

GIBBS: Mike?

FARR: I'm right there. I would hesitate to call any sort of near-term stop to your real estate investments, only because trends seem to last longer always than anybody ever thinks they're going to. But, yeah, I agree. The stock market, 7 to 9 percent by the end of the year seems very reasonable to me. Earnings power has been there. We've seen earnings continue to increase, we've seen price-to-earnings multiples contract. Dividends are strong. It's a very attractive place to have your money right now.

GIBBS: Michael, your best single piece of advice to give investors?

FARR: Stick with it for the long term and avoid your emotions. Emotions will lead you to the wrong decision every time. If you're scared, stick with it. If you’re ebullient, stick with it anyway. Just stick with it. It's people who have been consistent over time that have made money.

GIBBS: Pete?

COLHOUN: People always try to buy what they should have bought three years ago, so the answer is buy straw hats in January. Buy what's out of favor, and don't chase what's just gone up. Know who you are, have a plan, and be consistent. don't be selling out at bottoms and buying in at tops. That's the answer.

GIBBS: Peter?

MORICI: You can't time the market. Have a long-term plan, be consistent. You've heard it here from my two fellow panelists. They give great advice.

GIBBS: Peter Morici, Pete Colhoun, Michael Farr, thanks very much for joining us.

Planning for retirement

GEOFF COLVIN: New evidence that America’s facing a retirement crisis -- a survey showing the typical household is on track to a retirement income that's only 59 percent of its pre-retirement income. That is just not enough to live comfortably. The experts say you should aim for 85 percent of your pre-retirement income -- yet only about one-sixth of households are on track to get there. What happens when tens of millions of baby boomers hit retirement age -- but find they can’t afford to retire? Could we be returning to the bad old days when millions of Americans were elderly and poor?

Ellyn McColgan runs the brokerage operation of Fidelity Investments, which conducted the new survey. She joins us from Boston.

Ellyn, your survey finds that most Americans, lots of Americans, are not saving nearly enough for retirement. Do you have any insight into why so many people are refusing to face reality?

ELLYN McCOLGAN: Well, yes. In fact, Geoff, our research shows us that 78 percent of Americans are going into their retirement years without a financial plan of any kind. They are hoping, I guess, that they're going to get through their retirement years with enough money.

And what we think we know is that basically people are, they're waiting too long to make the decision about saving for retirement, and they're spending their money in their younger years, underestimating how much they need to save, thinking that they don't have enough left to save for their retirement. And then facing the difficult years when they're at age 50 or 55 preparing for retirement and finding in fact that they do not have enough replacement of their pre-retirement income, and this is exactly the problem that we're trying to get in front of and help people address.

COLVIN: So you've cited a number of factors in fact. One is it sounds like it's sort of the culture or the society that people'simply are living for today. they're spending a lot, especially in their younger years, because they just, well, that's just what people do. Is that an element?

McCOLGAN: Well, I think that there are many things that people need to spend money on. They need to buy their homes and they need to put their kids through college. And I think by the time they're finished with those goals, they neglect to count their own retirement as one of their priorities.

COLVIN: Do they underestimate how long they're going to live or maybe how great their medical expenses will be?

McCOLGAN: Oh, absolutely. We know for sure that most people think that, underestimate how long they will live and live healthy lives. Many, many people will live healthy lives. And then of course health care expenses will be significantly higher for the next generation of people than they have been in the past, and people are not even beginning to save for that.

COLVIN: Your figures do show that people's numbers get better. Meaning the post-retirement income they're on track for gets a little higher as they get older. Is that because as they get older they freak out and realize they haven't been saving nearly enough and they try frantically to catch up?

McCOLGAN: Well, I think part of it is that people's expenses actually also go down after they retire, and so their post-retirement income actually, they adjust their lifestyle to fit the income that they think they will have. In fact what we think is that people continue to invest too conservatively even after they're retired, and they need much more of an equity component in their portfolio because they're going to live longer to make that post-retirement income continue for the rest of their lives.

COLVIN: Well, I'm glad you brought that up because it was the next thing I wanted to ask you about. Let's talk first about how people invest before they'retire. I mean the little that they do save, are they investing it wisely?

McCOLGAN: I think that the positive news here is that more and more investors, especially younger investors, are starting sooner, so there is positive momentum. I think that many 401(k) plans, for example, have introduced many millions of Americans to the equity markets, and so we are seeing some positive asset allocation at earlier ages. But it is true that far too many people take a passive approach to their investments. They stay in cash too long or they're in conservative investments for too long. And then what happens is at age 50 or 55 they do that rush to catch up, and of course by that time It's too late usually.

COLVIN: Well, and you mentioned this actually earlier. People get discouraged. I mean when they see the harsh reality at age 50 or 55, some of them seem to think, well, forget it. It's too late for me, I can’t do it, and they give up.

McCOLGAN: Right, and you know what we’re trying, what Fidelity is trying to say to people at this point is, look, there are three or four easy things that you can do. So you've had a wonderful life, you've done lots of things, you've accomplished a lot. You've built a home, you've had a career. You've built a family. Now you have to do this one last thing. You've got to get your retirement taken care of. And so what we suggest to people is that they may have to work a little longer than they thought they were going to. They may have to spend a little less in their retirement, and they probably have to stay in a growth or an equity environment a little bit longer than they thought.

COLVIN: Can you expand on that point a little bit more? Because I think an awful lot of people figure, well, by the time I'm 62 or 65, I should be all in fixed income investments, bonds or one thing or another, play it safe; play for income. You're saying no.

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McCOLGAN: Right. I think when people, when life expectancy was significantly less than it is today, it made a lot of sense for people to move into fixed income securities. But look at what we're looking at. People start to save money in their 30s and they work until they're about 65, so they've got 30 years of working.

Now in the environment we live in now, many, many people are going to live into their mid-90s, which means that that income has to last 30 years. So it took them 30 years to save it and 30 years that they're going to have to live on it. It's unrealistic to expect that you should be in a fixed portfolio for all that time. So I think people just have to start to adjust what their traditional expectations are of investments.

COLVIN: One of the great social trends of the past 50 years has been that old people on the whole are much better off financially than they used to be. Could we see a return to the old days with millions of people, many more old people poor, even on welfare?

McCOLGAN: Well, I don't think our research supports that and I don't think that we are as pessimistic about investors' resiliency. Our experience has been that the American people are very responsive when a problem or a crisis is pointed out, and I think we have plenty of time to get at this. And as I said, I think there are three or four easy things that people can do. I think the Congress is ready to also help in this regard and maybe help us on some tax legislation and so on that will make it easier for people, because no one wants to return to the days when elderly people are not well taken care of. So I think getting out in front of it while the baby boomers are still in their late 40s and early 50s, being able to start to prepare for that'sooner is going to help a lot.

COLVIN: What do you want to see Congress do in the way of tax legislation?

McCOLGAN: Well, you know we would love to see a simplification of the retirement options that are available to people.

COLVIN: When you say simplification of choices, what do you mean? What are you talking about?

McCOLGAN: Well, we currently have 401(k)s, 403(b)s, 457s. We have IRAs, we have Roth IRAs, we have simple IRAs. We have a whole variety of choices available to people, all of which have different income limits, have different contribution limits, different sunset provisions in them. We’d like to see some of that'simplified simply so that more Americans can save more, sooner in their working lives in a tax-protected vehicle.

COLVIN: How about just unlimited IRAs as some people have advocated? You could put as much into it as you want. You pay no tax on it until you take it out.

McCOLGAN: Well, I think that's certainly one of the options that should be on the table. Of course that has to be balanced against the revenue projections of what that does for the government. But anything that's simpler and allows people to save more we think would be a good thing.

COLVIN: And have you taken a position on Social Security reform?

McCOLGAN: We have not. We believe that Social Security is a critical part of the income equation for most retirees. There's no proposal currently out there for us to respond to, and so we have not responded.

COLVIN: Well, your overall message is save more, invest more aggressively, start earlier. Is that fair?

McCOLGAN: Yeah, I think that's fair. Act now, do it now, save more, and invest wisely.

COLVIN: That's a good message. Thank you, Ellyn.

McCOLGAN: Thank you, Geoff.

Goodbye

GIBBS: Well, there was no growth in those retirement accounts this week. The Dow tumbled over 325 points, the Nasdaq fell almost 37 points while the S&P slipped 25 1/3.

COLVIN: Well, that's our program. We won't be seeing you next week because Wall $treet Week with FORTUNE is retiring. We can't possibly thank all the people we'd like to, but we must thank our faithful underwriter, Nuveen Investments, for its long-running support, and we most deeply thank you for yours. We've enormously enjoyed being with you these past three years. So long, we'll see you around.

GIBBS: Goodbye.

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