Opening
KAREN GIBBS: I'm Karen Gibbs.
GEOFF COLVIN:And I'm Geoff Colvin. Welcome to Wall $treet Week with FORTUNE.
The White House said months ago President Bush had just two big items on his to-do list: get rid of Saddam Hussein's regime in Iraq and enact a major tax cut at home. This week the President crossed off the first item and threw every ounce of his new political capital at the second. The battle is shaping up as a classic Capitol Hill slugout, the outcome far from certain, and the stakes are high. I'll talk with the President's salesman in chief, Commerce Secretary Don Evans, who has been barnstorming the country promoting the plan against sometimes heavy opposition, even within his own party.
The week's biggest business story was American Airlines' parent company, AMR, coming within a whisker of bankruptcy, and its CEO, Don Carty, resigning. He had told American's labor unions the company would have to go Chapter 11 if they didn't take big cuts in pay and benefits but neglected to mention that his own large pension was guaranteed, even in bankruptcy. If the story gets you thinking about your own retirement prospects, that's good -- you can't do too much planning. But watch out: As Karen will discuss with three experts, just maybe everything you know about retirement planning is wrong.
Karen, everything you know about the markets this week is right -- what happened?
Market summary
GIBBS: Geoff, this week we saw some signs of life in the economy, but not enough to take it out of intensive care.
The economy didn't fall off the cliff in the first quarter as many had feared. First-quarter GDP grew at a tepid 1.6 percent, easing the double dip recession fears.
The earnings parade is two-thirds of the way through and it's been a better season than expected. And it seems investors are getting used to the corporate missteps, with scant market reaction to the Healthsouth
and American Airline debacles.
So while the market seem to be putting most of the bad news behind it, you can't expect it to go straight up.
The Dow (Jones Industrial Average) losing just 31 points this week, but still back underwater for the year. The Nasdaq up 9 points for the week and up over 7 percent year-to-date. And the S&P (500) adding 5 points this week, and up more than 2 percent year-to-date.
Morningstar style boxes show every investment style making money except large cap growth -- hurt by this week's downgrade of the chip sector.
All these market gyrations raise a very interesting question: Just how bad has this bear market been for long term investors?
The Wall Street Journal had an interesting perspective this week. The Dow rang out 1994 at 3834, ended last month at 7992. So what does that tell us? Despite the horrible bear mauling, the average gain for the market during this time is more than 9 percent a year -- the performance market historians preach we should expect over the long haul.
Stocks, bonds and retirement
GIBBS:But does that make you feel any better? Your nest egg is fried, your 401k has gone down the drain and your retirement dreams have become your worst nightmare. So what should you do?
First off, wake up and smell the coffee. Only 37 percent of american workers have tried to calculate how much money they will need to save to live comfortably in retirement. In fact, both workers and retirees say they spent more time in the past year planning for holidays and social events than planning for retirement.
Our roundtable guests will shake you out of that apathy. Zvi Bodie, Professor of Finance at Boston University says everything you've been told about saving for retirement is probably wrong. Judy Schub helps corporate pension managers stay on track. And by the way, only 39 of the S&P 500 companies offering traditional pension plans are adequately funded. And financial columnist and advisor Terry Savage is here to help us make sense of it all.
Well, let's get right to it, Zvi. You're on record, and I quote, "It's false that stocks are safe
in the long-term. You wouldn't find a single finance professor who would support that idea in
court."
That's some pretty serious stuff there.
 ZVI BODIE: Serious, indeed. Unfortunately, a lot of ordinary folks have bought into the idea that if you hold on to stocks long enough you're pretty much guaranteed to earn that expected return of 9, 10 percent per year, but it's not guaranteed. And in fact, it's quite risky. It's every bit as risky in the long run as in the short run. And it's quite interesting that there's this huge gap between what those of us who teach finance at universities and business schools around the country and what investment advisers, columnists and others have been saying to the public at large is at such loggerheads here.
GIBBS: Terry, what's your response to that?
SAVAGE: That surprises me a lot. I just can't imagine where you'd come up with that.
You know, over the long run -- and I brought along, knowing that was your (Bodie's) quote, I said, 'Gee, let's bring back the Ibbotson chart that takes the stock market history back to 1925.' And the value of $1 invested in a diversified portfolio of large company stocks with dividends reinvested has had an average compound growth rate of 10.2 percent.
And beyond that, Ibbotson says there has never been a 20-year period where you would have lost money if you had invested in that large company, diversified portfolio reinvesting your dividends. Now, yeah, there have been 10-year periods. Go back to 1972. The Dow was over 1000, below 600 in '74, and then still below 800 in '82. So there have been some long periods where, you know, stocks weren't so attractive. But there's never been a 20-year period where you were a loser.
So I think if you have that long-term time horizon, don't forget, not only 20-somethings, 30-somethings, and those in their 40s saving for retirement, but people who are even in their 50s and will now live into their 90s need to have a portion of equities in their portfolio for that growth.
GIBBS: Zvi, what do you have to say to that?
BODIE: Well, I say that is a wonderful statement of the fallacy, and it is widely believed.
And there are a couple of ways to demonstrate or to try to demonstrate what's wrong with it. To me the most convincing way is to simply put the proposition to Terry, or better yet the next mutual fund salesman who comes around trying to convince you that stocks are not risky in the long run, and the proposition you should put to them is the following: Suppose I agree to let my money sit for 25 years. I'm going to take $100,000. You're telling me that I can be sure, virtually certain that that will be an investment say in 25-year Treasuries.
SAVAGE: Well, Zvi, only if America continues to grow along that trend line, that long-term trend line of stocks. And you know there have been plenty of times in history when we had reason to doubt. I have charts going back to what happened after Pearl Harbor, for instance, or when President Kennedy died. Surely there have been bear markets in times when you thought maybe it's all over for America, but what strikes you about that Ibbotson graph is that long upward slant which represents America.
SCHUB: The other thing is that people in institutions, all long-term investors, and I represent a committee of the Association for Financial Professionals, and it's the fiduciaries for many of the largest pension plans in the country. And they invest, manage the investment of over $1 trillion on behalf of 15 to 16 million participants. And they firmly believe in diversification because diversification over the long run reduces risk.
That's not to say you should put 100 percent into stocks. You shouldn't, but they would also say you shouldn't put 100 percent into bonds either, because bonds do not necessarily protect. They give you some protection on the downside, but you give up any upside. And the question is what's prudent risk? And a diversified portfolio for an institution or for an individual is a prudent way to go.
BODIE: Okay. Let me make the following point. What is the least risky way for me to -- let's say I'm just very, very risk-averse -- what is the least risky way for me to invest my money now and be guaranteed to beat inflation over the next 25 years?
SAVAGE: Well, you know, that's what I call chicken money.
BODIE: I'll answer the question.
SAVAGE: Chicken money.
BODIE: Chicken money. That's exactly my point.
SAVAGE: That's right, of which everyone should have some.
BODIE: Right. My contention is that only a handful, relatively speaking, of people in this country today know the correct answer to that question, and it's because they have not been informed by the financial press, by anybody for that matter, of the existence of Series I bonds issued by the U.S. Treasury, TIPS, which are Treasury Inflation Protected Securities. These are virtually unknown by the vast majority of Americans. Now I'm not saying that people like Terry -- Terry probably has written a column about these bonds.
SAVAGE: Well, sure I have. They have a place.
BODIE: Okay?
SAVAGE: I own some, yeah.
GIBBS: Is it risk/reward like kind of...
BODIE: Here's my point. These are truly risk-free investments.
GIBBS: But then there's very little reward.
SAVAGE: But the return, yes.
BODIE: You are guaranteed to beat inflation.
Now, let's say that you, someone like Terry comes along and says, 'All right, Zvi. You could invest in that. That's your chicken money, if you're a real chicken.'
Now of course I don't want to come across as a chicken. I'm very macho. So I'd say, 'All right, I'll tell you what, Terry. I'm willing to put my money into the stock market, but I hope you don't mind, since you're so sure that stocks are going to outperform, you give me a guarantee that if they underperform you'll make up the difference.'
How much would you charge me for that guarantee?
SAVAGE: You know something, you can find the premium for that guarantee by a long-term call option on a portfolio.
BODIE: A put option.
SAVAGE: Or a put option, I should say. Let me back up and say this is very exciting for me, because three years ago in 2000, and I wrote columns about Dow 35,000 and Dow 100,000 we knew -- I mean in hindsight and at the time I said -- we must be near the top of the market. Now we have an eminent professor coming and saying "Don't buy stocks, they're too risky, stick to Treasury bills or I bonds or TIPS," -- and so we must be near the bottom.
BODIE: I'm not saying don't buy stocks. I am not saying don't buy stocks. Let's be clear what I'm saying. I'm saying stocks are risky even in the long run.
SCHUB: And I don't think any of us are arguing with you that there is some risk, there's more risk in the equity markets than there is in TIPS.
BODIE: So, what do you advise someone who says, "Here's money I absolutely must have for retirement"?
GIBBS: Well, let's talk about the pension situation, too. I mean how bad is the crisis, Judy?
SCHUB: There is no crisis. There certainly are some issues of concern. But pension promises are long-term promises, and they're funded over the long term. The analogy I like to make is, it's how many people could pay off their mortgage tomorrow? Does that mean they're in trouble? Not necessarily. Now there certainly are some industries where pension funding is a big issue.
GIBBS: But there are a lot of companies, in fact we've got some that their pension liability is bigger than the value of the entire company.
SCHUB: And frankly some of those companies, their pension assets are bigger than the (companies' market caps) -- those are very big plans. They have a lot of assets.
You can see a big number. They owe $3 billion or they're "underfunded." And it's a lot a question of how we measure that. But they're underfunded by billions of dollars. And then you ask the next question, and how much assets do they have? They've got $30, $40, $50 billion dollars in assets.
This is certainly a serious issue, but we are facing what somebody said earlier is a perfect storm. We have the lowest interest rates in anyone's memory, and that affects the way in which pension plans measure their underfunding. We have a bear market going on for the third year, which is not a happy thought, and we have a relatively weak economy. Those things have combined to put pension plans in a certain position.
GIBBS: So what do we do about all of that, Terry?
 SAVAGE: Well, the exciting thing is that most workers today are not solely relying on a pension fund and probably shouldn't be.
I think we'll make it through this perfect storm, but we all have the opportunity to have IRA accounts, even if it's not deductible because you are covered by a pension plan or if you can have a Roth IRA because of the income limits, and this is your opportunity to be putting more money away and saving and investing for your future in addition to the promised pension benefits, and of course those promised Social Security benefits. I think given the crisis between Social Security and pension benefits, I'd rather bet on my pension than on Social Security being there.
GIBBS: And that's got to be the last word. Terry, Judy, Zvi, thank you so much for joining us.
Donald Evans interview
COLVIN: It may be the No. 1 question for the economy right now and it's certainly the hottest topic in Washington: How much of President Bush's tax proposal will be enacted? Will the result make you better off -- not somebody else, but you -- and if so, when? This is a huge proposal, the fight over it is already getting a little messy, and the man who's been out there selling the plan for the Administration is the Secretary of Commerce, Don Evans, who joins us now from the Commerce Department in Washington. Mr. Secretary, welcome.
DONALD EVANS: Thank you, Geoff. Good to be with you.
COLVIN: The latest figures suggest that the federal budget deficit this year could be up in the neighborhood of $300 billion. Is now the time to be cutting taxes?
EVANS: Now's the time to create more jobs in America, Geoff. We saw another indication of that today when the first quarter GDP number was released at 1.6 percent. We continue to have an economy that is growing but is underperforming and is a sluggish economy. The President has been focused on jobs, stays focused on jobs, knows the way to create more jobs in America is to cut taxes and stimulate economic growth. And so, yes, indeed, this is the time to be cutting taxes because you grow the economy by cutting taxes and controlling spending.
COLVIN: One of the big concerns is the affect on the deficit and the larger government debt. The Congressional Budget Office suggests that if the plan is enacted the deficit would total $1.8 trillion over 10 years. Now that's a daunting figure.
 EVANS: Well, Geoff, the size of our economy over that 10 years is about $150 trillion. And so when you put it in perspective, you realize that that debt level is a very manageable level. It's a very affordable level. Right now the debt level in our country is below where it has been over the last 50 years as it relates to the gross domestic product of this country. Our forecasts indicate with the President's full package passed and implemented the debt level will remain below what it has averaged as it relates to GDP for the foreseeable future. So the question is, "Is it a manageable and affordable level of debt or deficit?" And the answer to that question is clearly a "Yes."
COLVIN: The opposition to the program comes not only from those you might expect, Democrats on the other side of the President, but also from some Republicans, including some such as Senators Voinovich in Ohio and Olympia Snowe in Maine. How tough a fight is this going to be in the Senate?
EVANS: Well, Geoff, we're going to continue to sell the President's plan very aggressively. We want to see that all elements of the President's plan are enacted into law. We want to, right now we want at least $550 billion of tax cuts over the next 10 years. We've already established in Congress, both on the House side and the Senate side, that we agree that if we cut taxes we'll be creating more jobs. So it certainly makes sense to me that we ought to cut even more taxes. Why use a low number if that's fewer jobs? Let's cut taxes at a much higher level.
COLVIN: Right, and the question is then going to be what number do you end up with, $550 billion, $350 billion? How low do you expect this to go?
EVANS: Well, you know, it's going to be, we're fighting for at least $550 billion, fighting for all elements of the President's plan, the acceleration of the rate cuts, the marginal rate cuts, the elimination of double taxation on dividends, the increasing of expensing for small business owners across America, acceleration of the marriage tax penalty.
COLVIN: Another thing that's going on that affects taxpayers a lot is the large budget deficits at the state level. And of course states, unlike the federal government, are required to make up their deficits, to run balanced budgets year to year. So even if we cut taxes at the federal level, a lot of people may either be facing rising taxes at the state level or benefit cuts at the state level. Are we robbing Peter to pay Paul?
EVANS: Not at all, Geoff. In fact, that's one of the great benefits of economic growth. If you grow the economy, it means there's more for everybody. There's more for the citizens, there's more for local governments, there's more for state governments, and indeed there's more for federal governments. All the economic models that we have looked at and we have seen indicate to me that this will be a benefit to state governments and a benefit to local governments because of the increased economic growth that will result.
COLVIN: One of the things you mentioned was the dividend tax exclusion, a big part of this proposal, accounting for about half of the total cut in taxation. This has provoked a fair amount of opposition. Can you give us some idea of how important it is or how hard you're going to fight for this as opposed to the other elements?
EVANS: We're going to fight for all the elements, Geoff. They are all, you know, the president has looked at this very carefully for the last 7 or 8 months. And what the president has been focused on, what can we do to create more jobs and stimulate more job growth in America? And these were the top four or five policy changes that his economic advisors suggested to him. These are the ones he selected. And so we're going to fight for all of them very hard. And the elimination of double taxation on dividends is one of the important ones.
COLVIN: Would you take a partial exclusion or a phased-in exclusion?
EVANS: Well, listen, I mean we're going to continue to fight for the elements of the plan, and it's too early to say what we'll do or what we won't do other than fight for the president's plan. We want at least $550 billion in tax cuts and we're going to continue to fight for that.
COLVIN: Secretary of Commerce, Don Evans, thanks so much for your views.
EVANS: Thank you, Geoff.
Where have all the scoundrels gone?
COLVIN: We've updated you continually on the unfolding scandals involving Wall Street firms. This week a major development: The first criminal charges against a prominent Wall Street figure. Frank Quattrone, former star banker at CSFB, was charged with obstruction of justice and witness tampering. He says he's innocent. If you're keeping score at home, here's where other one-time high-fliers stand:
- Jack Grubman, former telecom analyst at Salomon Smith Barney, agreed to pay $15 million and be barred from the securities industry for life. He's said to be considering a new career in consulting.
- Henry Blodget, once the king of Internet analysts at Merrill Lynch, has been told by the NASD to expect regulatory charges against him. He's writing a book.
- Mary Meeker is still analyzing infotech companies for Morgan Stanley. The SEC and New York attorney general Eliot Spitzer say they won't charge her.
Just for perspective, remember that after the last rash of Wall Street scandals, in the 80s, lots of people not only faced criminal charges but did time in the big house.
- Michael Milken paid a $500 million fine, surrendered his toupee, and served two years for market manipulation. He now runs the Milken Institute, an economic think tank, and CapCure, which seeks a cure for prostate cancer, a disease he has.
- Ivan Boesky, who famously said "Greed is good," paid $100 million, served 22 months, and won a $20-million divorce settlement from his wife. He has disappeared from public life.
Investor spotlight: Private market investing
GIBBS: One investment style that never left public life, the art of picking stocks based on the value of the entire company. It's called private market value investing. FORTUNE's David Rynecki has been tracking some of the grizzled investors who are snapping up some good stocks on the cheap. He joins us now from New York.
Hey, David good to see you. What is private market value investing and who's doing it?
DAVID RYNECKI: Well, Karen, a lot of times you'll hear investors, like Warren Buffett talk about how they don't buy stocks they buy companies. But what does that mean? Private market values are an answer to that. What they do is, they look at the assets of a company and then the figure out what would the company be worth if it was sold today by comparing that company's valuation to other acquisitions in the sector.
GIBBS: So we know who's doing it's guys like Warren Buffett but what are they buying?
RYNECKI: Well, that's right, if Warren Buffett is doing it, I guess we should all be doing it. I recently talked to some folks -- I didn't talk to Warren Buffett -- but I talked to some folks who might be almost as good.
Out in Wisconsin, at a firm called Rinehart & Mahoney, what they're buying right now is Kroger to start with. That's one of their favorite stocks. Kroger is a supermarket chain. It's been going up head-to-head against Wal-Mart which is as you might know has been trying to get into the supermarket business. Unlike so many other supermarket chains, Safeway for an example; Kroger has actually taken on Wal-Mart and has been winning the battle. The stock is about 40 percent below what the company is worth. So that might be something to look for. You have to find some catalyst out there, one of them is that Kroger has been doing some major cost-cutting by $500 million. That's going to really translate into some bottom-line
performance.
GIBBS: What's another company that comes up on the radar screen?
 RYNECKI: Let's take a look at Kimberly-Clark. Kimberly-Clark makes some major household products including Huggies. The major competitor for Kimberly-Clark is Proctor & Gamble. A few years ago no one wanted to own Proctor & Gamble now everyone wants to own it and the reason is that Proctor & Gamble has become much more cost conscious. It's done a number of sales discounts that have made it harder for Kimberly-Clark to compete. Now the good news for Kimberly-Clark, not necessarily for consumers, is the P&G is less interested in those discounts. At the same time Kimberly-Clark is coming out with some new products some new sort of variations on diapers for example that should help it and it's doing some of its own cost cutting to sort of clean up its act a little bit.
GIBBS: That always sounds good but where's the pitfall, what's the catch?
RYNECKI: Sure, I wonder why there's always has to be a catch but it certainly does. The catch is that one, private market value analysis primarily works with mid-sized companies that's because they're just easier to understand, they've got less moving parts. The second one is, that even when you know what those moving parts are doing, you can't always be certain at what's going to happen in the future. So when you talk to the best in the business about private market value analysis, even they say if they are right two out of three times, they're headed for the Hall of Fame.
GIBBS: Alright David, it's always a pleasure. Thanks for joining us tonight.
RYNECKI: Thank you.
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