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Opening thoughts
KAREN GIBBS: I'm Karen Gibbs.
GEOFF COLVIN: And I'm Geoff Colvin. Welcome to Wall $treet Week with FORTUNE.
The war ended this week about as officially at it's likely to end, with President Bush saying Saddam Hussein's regime "is no more," and the Pentagon announcing all major combat operations are over. To which many market watchers asked, "So where's the post-war rally?" They forgot the market never waits for official announcements - it had its post-war rally two weeks ago, when the swift American victory began to look likely. Now investors are facing the next reality: a weak economy, poor corporate profits, and the possibility that maybe a three-week war just didn't affect most companies' prospects much one way or the other.
And yet there's always opportunity. Karen will talk with a couple of global investing pros who see plenty of good buys for investors right now - though maybe not in the places you've been looking.
No trading on Wall Street today because of Good Friday, and it's Passover. If the season has you thinking about the moral side of your investments, you're far from alone. I'll talk with two leaders in the fast-growing business of investing based on values and beliefs. Don't scoff: You can do well by doing good.
Of course you can also do well by doing bad -- as we will see when we look at the shocking new numbers on CEO pay.
Karen, it was hard to do very well in the markets at all this week -- what happened?
Market summary
KAREN GIBBS:Geoff, now that the war is all but over, it's back to earnings as the single variable upon which investors' trade. In fact, all market issues took a back seat to stock specific issues.
Long-suffering financials rang the cash register this week with better than expected earnings from Citigroup, Bank of America and Fannie Mae.
But Safeway met its sell-by date after warning that efforts to fend off Wal-Mart spoiled first-quarter results.
Maytag went into a spin cycle as sales of pricey vacuums and washers went down the drain.
And Coca-Cola lost its fizz as it warned of weak growth. Altria saw its profits go up on smoke on weak cigarette sales.
But Microsoft and Intel saved the Dow helping it add over 134 points this week. That tech strength also had the Nasdaq better by 67, while the S&P found solace in Ford, accelerating 3 percent for the week, driving the index 25 points higher on the week.
In what could be the start of something big, the Morningstar style boxes show every investment style making money this week.
Roundtable discussion
GIBBS: What does that mean for markets here and around the world? And more importantly, what does it mean for your portfolio? Here to discuss the broader implications: David Malpass, Bear Stern's Chief Global Economist, and former advisor to the Reagan and Bush administrations, and Jeffery Everett, who scours the globe for bargains he can hold on for the long term in the funds he manages for Franklin Templeton.
Both gentlemen see blue skies and great opportunities ahead. Gentlemen, welcome. Great to see you.
Well, David, what's behind all this optimism?
DAVID MALPASS: We've had a change in the macro environment. In 1999 and 2000, we ran into some big problems. The dollar was getting way too strong and we had an oil price spike that didn't seem as if it was going to end. As we look at it now, we have the prospect of the dollar more fairly valued and a tax cut coming. So it completely changes the economic and the market outlook.
GIBBS: Well, now last week the IMF delivered a sharp review to the Bush administration's tax cut plan. Research director Kenneth Rogoff said that the timing of the tax package is awkward given the open-ended nature of potential costs stemming from the war in Iraq. He also cited concerns over the U.S. trade and budget deficits. How do you respond to that?
MALPASS: Yeah, I don't agree with that rationale. For one, I'd point out that the IMF has been part of the problem I think in world growth. Many of the countries that they work in are countries that end up going backward, so I really wouldn't want to take advice from that particular direction.
On the specific points, remember the tax cut that we're talking about is some $50 billion per year, depending on what size they actually come up with, versus an over $10 trillion economy. So it's simply not material in the outlook from the standpoint of the actual budget deficit.
What's going to matter is growth. And so if you can cut taxes in a way that actually stimulates growth or raises the value of stocks, then I think that's going to be a big plus for the economy. I think that's what the Bush proposal really is all about. They're talking about cutting the dividend tax rate. That is directly going to add to the value of equities. Remember in 1997 they cut the capital gains tax rate on houses, and what happened? People began buying more houses. The price of houses was going up, because you had less of a tax burden associated.
And so I think we'd get a lot of long-term growth and a better capital structure out of some changes in tax, and this is a very good time to be putting those ideas forward.
GIBBS: Jeff, I see you nodding your head. I take it you agree with what David said.
JEFFREY EVERETT: I do. I think the world is facing a much more optimistic scenario than many pundits have put forward, and I think that's going to be a very healthy period for investors.
GIBBS: But he also mentioned the decline in the dollar. Now, foreign investors hold anywhere from 7 to 9 trillion dollars of our assets. If the dollar declines, won't that sorely test their faith?
EVERETT: It may. However, I think it's an arguably better reason for them to take some of those dollars and invest overseas at this time. By buying foreign stocks, you're essentially buying foreign currencies. Therefore, if you believe the dollar will go down, buying foreign stocks right
now is an even better reason to buy. However, we don't feel that the dollar is on a precipice ready to collapse. I know David doesn't as well, reading his work. I think it may trend down slightly,
but there are still some very fundamental reasons why it will remain strong, not the least of which
is the recent very quick success in Iraq.
GIBBS: Well, there are several countries that you think we should be investing in. You're talking China, South Korea, Germany, France and Mexico. Tell me why we should be putting our investments there.
EVERETT: I think the most important reason investors have failed to invest overseas is they think the risks over there are isolated to those markets and to those regions. And I think what they unfortunately are learning very quickly is that just because they avoid the risk doesn't mean,
that doesn't mean it's not going to impact their stocks here at home.
So if you already own some of that risk, why not own some of the opportunities? You're finding very good prices, very attractive companies, world class companies, at really low prices because there's no interest. And that is what we are all about at Templeton and what we are very excited about right now.
GIBBS: David, you talked about animal spirits. What is that?
MALPASS: Animal spirits is a concept that came out of John Maynard Keynes in 1936. He basically said you can try to quantify everything that people do, but when you come right down to it, it's when they want to take a risk. There's a point, a spark within the economy when you move from being cautious to being willing to take some risk. And I think we've been in a period since 1999 really where people were risk-averse, in part because the dollar kept getting stronger, which kept putting downward pressure on prices. We had a deflation.
As we come out of that, I think we'll be at a turning point where people are willing to take some more risk. For one, we've got interest rates very low, we've got inventory levels very low, within the U.S. and actually globally. Inventories are down worldwide. And so at some point, businesses will one by one decide that they can borrow a little money and put it to work and make some more profit, and that's animal spirits coming back. I think we're at that point where it should start. An important variable is going to be when oil prices actually come down another notch. That would help.
GIBBS: And they've already dropped about $10, acting as a little boost to the economy.
MALPASS: That's right, but they're still at $30 today, and that's just too high. And so one of the key issues here is when is Iraq's oil going to come out from under the UN sanctions, and that I think will be another, can trigger another stage in the optimism post-Iraq.
GIBBS: Jeff, you talked about the fact that investors, they already have some of the risk, so they need to start dealing with the opportunities. Can you talk about some of the opportunities and what we would miss if we don't invest overseas, like the largest durable goods companies or
the largest automobile companies, that sort of thing?
EVERETT: Sure. I think even common household name brands that people may not realize are foreign stocks that they can purchase. Bic, maker of razors, lighters and shavers, a fantastic company, a mid-cap company at that, but well run, family ownership, very high. And for years they've been generating very strong profits and growth. It's been a very strong stock.
Another one to venture to one of the hot spots, if you will, is Korea. Obviously people don't want to own Korea because of the North Korean risk, and certainly that has to be taken into account, but they're forgetting that Samsung Electronics, for instance, was the second most profitable technology company in the world last year after Microsoft. In fact, it earned almost twice as much as IBM in terms of net profit. It has shifted away from the commodity DRAM manufacturing. It has developed a very strong global brand name. The company has no debt, regular stock buy backs, better investor relations, and yet it sells for 7 times earnings. It's a perfect example of what we're speaking of when we say investors don't want to own these risks in these foreign markets. Unfortunately it's going to come back to hurt them. They're going to buy in later at higher prices.
GIBBS: Talk about Germany and France very quickly.
EVERETT: Germany and France, different stories. Again, we like the stocks in these countries more than we like the macro picture in these countries.
But take a stock in Germany, Volkswagen, a very good example of a stock that can do very well even if the economy's not doing well. Aventis, actually the merger of a French and German company, one of the leading pharmaceutical companies in the world, has done very well, very, very cheap for investors.
GIBBS: All right, we've got to leave it there. Jeff, David, thank you very much for joining us.
CEO compensation
COLVIN: Last year, of all years, would corporate boards dare to pay their CEOs more? After a third straight year of withering stock values and 18 months of incredible scandals, could directors possibly give CEOs a raise? You bet they could.
CEO median compensation last year rose 14 percent to $13.2 million, even though most shareholders got dramatically poorer. Some companies performed even worse than the market, yet still paid their CEOs like heroes.
Exhibit A is Dennis Kozlowski, who got fired as Tyco's CEO last year and is accused of looting the company, and got paid $82 million, though the stock fell 71 percent. Steve Jobs at Apple Computer got $78 million while the stock was down 38 percent. Jeff Barbakow was paid $35 million for a year in which the stock fell 58 percent. And Scott McNealy, long-time CEO of Sun, received $32 million with the stock falling 75 percent.
Joining me to talk about what's going on is my FORTUNE colleague, senior writer, Jerry Useem. You've just written a cover story about this. It seems almost incredible. How could this happen?
JERRY USEEM: Well, I would say it's shocking and also not surprising in another sense, in that if history has shown anything, it's that CEO pay heads only one direction and that is up, regardless of what is happening in the world.
If you look beneath the numbers, what you'll see is a decrease in the use of stock options, which you could say is preparation for the fact that they will likely have to be expensed in the future, (but) I think the more likely explanation is they're no longer the route to quick wealth they once were.
So instead what we're seeing is a shift towards all other -- every other kind of compensation imaginable, whether it's cash, restricted stock, or most troubling of all, is sort of the stealth wealth, a kind of compensation that doesn't even necessarily show up on a company's proxy statement.
COLVIN: Well, CEOs and those that defend them say, look, this is supply and demand. The demand for good CEOs has gone up, the supply of them is shrinking. In any situation like that, the price is going to go up, is that valid?
USEEM: That's a total myth. There's supply, there's more talent out there than ever before. Every year the business schools are cranking out more business executives. In terms of demand there's been this huge merger consolidation, so if anything, the pay should be shrinking, but yet it continues to go up. So I think there definitely is a different dynamic than that at work.
COLVIN: The dynamic is a big, big question. There was a law passed in 1993 that wanted to limit the pay. It said to the extent a CEO's income exceeds $1 million, they can't take a tax deduction. And this would force companies to scale back CEO pay.
USEEM:That resulted in the Law of Unintended Compensation, as I call it. Any effort to block the rise of CEO pay perversely ends up increasing it. So basically everyone rose their CEO's pay to that $1 million limit and then started finding new ways to reward them, mostly with stock options. So you have sort of ever more troughs from which the average executive is feeding, to use a crude barnyard analogy there.
COLVIN: And I gather that an awful lot of CEOs nowadays have contracts, whereas they didn't used to. What did you find when you looked into those?
USEEM: Well, the contracts are quite remarkable documents in themselves. A lot hinges on whether you get fired for, quote, "cause." If you're not fired for cause, you stand to collect a huge, typically-guaranteed, huge lump sum of money.
And the definition of cause, however, is not what you might think. It (job performance) can include screwing up in any sort of way (and still not be cause for termination). You can even commit a felony so long as it's not a crime of moral turpitude and sort of meets several conditions. In essence, it's impossible to get fired for cause these days.
COLVIN: the situation does seem more incredible every day, Jerry. Thanks very much for your insights.
USEEM: Thank you.
COLVIN: We should point out that a few companies did pay their CEOs more than fairly last year. Warren Buffet was one of your best buy CEOs, getting only $296,000. And Richard Fairbanks of Capital One received a company car and perks valued at $97,000 in all. And Tom Siebel -- Siebel Systems had a tough year like many software companies, but hard to say he was overpaid.
He received exactly $1.
Investor spotlight: Socially responsible funds
COLVIN: Proxy season and CEO pay are not the only reasons investors think especially hard about what's right and what's wrong at this time of year. It's Easter time and Passover, for millions a time of reconnecting to deepest beliefs, and for a fast-growing number of investors that means changing the way they invest. Mutual funds that choose stocks and bonds based on social or religious values have been attracting new money at a time when most funds are not.
This is an important trend, and two leaders at the forefront of it are with us now. Barbara Krumsiek is CEO of Calvert Group, offering America's largest family of socially-responsible mutual funds. John Liechty is president of MMA Praxis Mutual Funds, which are managed in accordance with the beliefs of the Mennonite Church.
Welcome to both of you. I want to start off by reading you a famous quote from Milton Friedman, winner of the Nobel Prize in economics. He says there is only one social responsibility of business: to use its resources and engage in activities designed to increase its profits without deception or fraud. Barbara, was he wrong?
BARBARA KRUMSIEK: He wasn't wrong. What's missing from that is over what time period, and if you just look at the numbers, you're only looking at one short-term aspect of performance. We at Calvert really believe that what we're looking at -- in looking at other criteria, like environmental performance, workplace practices, human rights practices at overseas factories -- is long-term performance. And that doesn't show up in everyday stock prices, but we think shows up over the long term in the results of the companies we invest in.
COLVIN: Well, you both invest according to broad principles, some of which are actually similar between the two funds, environmental practices, human rights, don't invest in defense contractors. But doesn't this put you at a fundamental, and most of these other funds, at a fundamental disadvantage because it narrows the universe of stocks from which you may
choose? John, is it true?
JOHN LIECHTY: No, it's not true. As a matter of fact, the Domini 400 Social Index has outperformed the S&P 500 over the last 10, five and one year time periods.
COLVIN: In fact, we have the numbers on that, and you're absolutely right. Over the past 12 months that index is down about 20.7 percent, which ain't great, but it does beat the market, which was down 22 percent.
LIECHTY: Yes, and if you think about it, by excluding companies that engage in pollution, violate EPA laws, practice poor labor relations with their employees, by excluding those kinds of companies from your universe, intuitively one can make the case that you actually will avoid
some costs that are associated with these types of businesses and enhance your performance.
COLVIN: Well, your own fund, the MMA Praxis Core Stock Fund, in 2002 was down 18.2 percent, which again beat the market, which was down 22. And Barbara, your principal fund, the Calvert Large-Cap Growth, was down 20.8, but again, not down as much as the market was down. I'd like to ask both of you for some specific stocks. Who do you like now, and very briefly, why?
KRUMSIEK: Well, I'm going to start off with Dell Computer, which as been a strong performer over one year and five years, the last three years have suffered from the bubble. But we're very impressed with some of their practices. And most recently, Dell is one of the first computer companies to step up and commit to developing a recycling program for computers, which has not been the case to this point. So we're pleased to see that positive environmental step, which we think is good for Dell and good for the industry in the long run.
COLVIN: Who else?
KRUMSIEK: We like Avon, very positive workplace practices. And Wells Fargo, an excellent diversity program, very outstanding record of women and minorities in senior management and on their board, and this is in addition to being an outstanding banking operation and great franchise and great results.
COLVIN: John, how about you?
LIECHTY: Sysco Foods, not to be confused with Cisco in technology.
COLVIN: Not Cisco, okay. The "Sysco" Sysco.
LIECHTY: That's correct. A remarkable record of earnings growth, 27 consecutive years of earnings increases, a very profitable company, a 20 percent return on invested capital. They have a stellar record for recycling their packaged goods that are used in the food processing, a very aggressive recycling program and a company we like, both for social and financial reasons.
COLVIN: Who else?
LIECHTY: We also like Protective Life. Protective Life is one of the smaller companies that we hold in our portfolio, about a $2 billion market cap company. Historically they've been a regional insurance company in the Southeast. They've now expanded to the national market. An extremely well managed company. They have a very competitive array of life and annuity products. And they also has a management that has promoted a strong ethical culture at the company. In fact, they've recently adopted the corporate slogan "Doing the right thing is smart business."
COLVIN: Now the criteria you use are not always the same. Let me pose a hypothetical question to you. Would you have any problem with, let us suppose, a casino company with great labor relations and a great environmental record? Barbara?
KRUMSIEK: Well, we have a screen where we will not invest in companies engaged in gaming, so that scenario leaves us out on that basis.
COLVIN: John, how about you?
LIECHTY: The same situation with MMA Praxis.
COLVIN: Same deal. It is worth pointing out that, especially in the religious fund area, there are a wide variety of funds available with all kinds of different criteria. A few to mention, there's the Aquinas Fund, Catholic-oriented; the Timothy Plan, who are conservative evangelical-oriented; Thrivant Financial, Lutheran-oriented; the Amana Fund, Islamic-oriented, and they have been growing at a remarkable rate also.
Just a few years ago in 1999 there were 34 such funds, today 75. I need to ask both of you, has the rash of corporate scandals brought you new business do you think?
KRUMSIEK: Absolutely. I think the fact that social investment firms look at the way a company does business, not just the numbers -- and those are important, very important to have the right financial outlook -- means that we've been looking at things that other investment firms are now just waking up to, that corporate practices matter. And the governance scandals have
actually drawn more attention to what we do, and Calvert, for example, was the 11th-fastest growing mutual fund company last year.
COLVIN: Do you try to change the companies that you own? Most mutual funds are not very active. What about you?
LIECHTY: If a company moves in an area that we find objectionable, we have concerns about the direction management is taking the company, we will attempt to sit down with them and engage them in dialogue about our concerns. If that is not productive, we will occasionally bring shareholder resolutions to try and effect change that way, and as an ultimate step, we would
divest ourselves from the holding if we weren't getting any progress.
COLVIN: Bottom line, what do you think is behind the growth in your types of funds? What is bringing people to you?
KRUMSIEK: I do think strong performance attracts attention, and social funds have outperformed, and I think that's the beginning. Then when people spend a little time learning what we do and how we do it, it's very attractive in this environment where superficial analysis has not helped. You have to look below the numbers. You have to look at corporate practices.
COLVIN: John?
LIECHTY: For us it's a matter of trust. We do customer satisfaction surveys, and we find that the number one reason that our shareholders do business with us is because they trust us. And I think in this day and age investors are hungry for institutions that they can trust.
COLVIN: For sure. For more information on this topic, you can start with our web site, pbs.org/wsw. Barbara, John, thanks so much.
KRUMSIEK: Thank you, Geoff.
Jordan paean
GIBBS: Basketball legend extraordinaire Michael Jordan retired from the court this week. Now, we know number 23 has had a vast impact on the court, but we decided to take an unscientific look at his effect off the court.
In 1985, His Airness was Rookie of the Year . The Dow gained more than 27 percent.
Five times, Jordan was named the NBA's Most Valuable Player. In each of those years, the Dow rose.
The Dow also rose every year he was named MVP of the NBA Finals.
It's been five years since Jordan won a major award, and the market….Well, it's certainly seen better times. All we can say is, we'll miss you.
Well, that's our program for tonight. We do love to hear from you. Please write us at Wall $treet Week with FORTUNE, Owings Mills, Maryland, 21117 or email us at wsw@pbs.org
Next week: Commerce Secretary Don Evans -- the administration's tax-cut salesman in- chief -- will discuss president bush's plan to salvage the sinking tax-cut ship.
COLVIN: Also, is your pension at risk? As the stock market sags, companies across America are trying to slash more than $1 trillion dollars in benefits they owe to current and future retirees. Find out if you're one of them.
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