Political roundtable
GEOFF COLVIN: As the Democratic primary race heats up, the candidates and the media may want to talk about Iraq and gay marriage -- but every poll shows the voters care much more about pocketbook issues. Will your Social Security benefits be cut, as Alan Greenspan says they may have to be? Will your job be the next one shipped overseas? Will your taxes be raised? The answers depend on who the next President is -- and with the Democratic field effectively down to two, it's time for a hard look at where John Kerry and John Edwards really stand.
Greg Valliere is managing director of the Schwab Washington Research Group. Peter Cohan runs his own management consulting and venture capital firm, and writes often on these issues. Viveca Novak is a Washington correspondent for Time magazine.
Well, topic A for a lot of people is Social Security and retirement. Here's what John Kerry said about that in the Democratic debate Thursday evening.
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JOHN KERRY: "Under no circumstances should we allow George Bush or others to pay for his tax cut by cutting Social Security benefits. We don't need to do that. That is not fair."
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COLVIN: And a couple of days ago after Alan Greenspan's testimony on this, John Edwards said this about cutting Social Security: "If I'm President, we're simply not going to do it. It was an outrage for him (Greenspan) to suggest that we should extend George Bush's tax cuts on unearned wealth while cutting Social Security benefits that working people earn."
Okay, Greg, first, did the senators frame the issue correctly? Is it a matter of financing Social Security cuts versus George Bush's tax cuts?
GREG VALLIERE: Not really, but it's an election year, and anything is fair in an election year, and there's going to be a lot of demagoguery on this issue for the next eight or nine months. I think the important, two important points I'd make.
Number one is, benefits are not going to be cut anytime soon. That just won't get through Congress. Alan Greenspan doesn't have to run for reelection.
The second point I'd make is that we're about to begin a serious national debate about some partial privatization for younger workers. That debate really will start in earnest about a year from now.
COLVIN: Right. So what's the real issue? Peter, what do you see it as?
PETER COHAN: I see the real issue as trying to secure the Republican base. What I think is going on here is that there's a group of Republicans who don't like unbalanced budgets, and so what they want to do is get Greenspan out there talking about how they're going to starve the beast, which is a very popular issue among a certain sector of the Republicans.
COLVIN: Viveca, how does this play out politically? Is any candidate going to say anything meaningful about Social Security reform between now and election day?
VIVECA NOVAK: Well, of course not. That's why it's called the third rail of politics. But I do think that the Democrats are very happy that Alan Greenspan in effect handed them this issue and framed it the way he did, talking about tax cuts and talking about cutting Social Security. And the Democrats can now say, you know, Bush cut your taxes and now Social Security is going to be suffering as a result.
COLVIN: And so how does the President respond most effectively to that?
NOVAK: Well, the President has to assure people that he is not going to cut their Social Security benefits. That is the overriding point he has to make between now and the election. He has to distance himself from that portion of what Alan Greenspan said.
COLVIN: Greg, as a practical matter, aren't benefits going to have to be cut eventually for somebody?
VALLIERE: "Eventually" has a lot of flexibility in it.
COLVIN: Yes, it does.
VALLIERE: I think (economist John Maynard) Keynes said, "In the long run, we're all dead." Does Social Security really go bankrupt in 2047 or 2050? Many people look at the assumptions of GDP growth, which are really exceptionally low, and ask will it really go bankrupt in 2050? I think at some point maybe people who are young now may see their retirement age go up a year or two, but any kind of big, draconian change is not imminent.
COLVIN: So it may be that politicians who don't want to touch this can avoid touching it for some time to come?
VALLIERE: I would say this though, Geoff. If Bush wins comfortably in November, a long way away, and if both houses stay Republican, I do think we begin a serious debate on some partial privatization.
COLVIN: Peter, who does this issue favor? The fact that it's out there in the air, people are talking about it, even if politicians want to avoid substantive comment, who does it favor?
COHAN: I think it definitely favors the Democrats, because I think there's a lot of Roosevelt-era programs that the Republicans would like to slowly whittle away at. And by opening up the possibility that this might be what's going to happen if Bush is reelected, I think it creates an opening to scare potential Democratic voters and people in the middle who are trying to decide.
COLVIN: Well, for a lot of voters the hottest hot-button issue right now is a different one, it's jobs going overseas. And so that makes it a matter of jobs and trade. Here's what John Edwards said about that in the Democratic debate.
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JOHN EDWARDS: "I voted against final fast track authority for this president. Senator Kerry voted for it. I voted against the Chilean trade agreement; he voted for it. I voted against the Singapore trade agreement; he voted for it. I voted against the African trade agreement; he voted for it. I voted against the Caribbean trade agreement; he voted for it. I wasn't in the Congress when NAFTA was passed; he voted for it. But when I campaigned for the Senate, I campaigned against it.
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COLVIN: Peter, on trade, Senator Edwards is trying real hard to differentiate himself from Senator Kerry. Are they that different?
COHAN: No, not really. I think what's going on here is he's demagoguing the issue. But when you look at what they're both planning on doing, one of the things that they both said they would do is go in and try to renegotiate certain provisions, the labor and the environmental provisions of NAFTA and some of these other agreements, and that's designed to attract the labor vote.
COLVIN: Right. But as far as undoing trade agreements or anything like that, is it going to happen?
COHAN: I don't think it's going to happen, and of course there are other parties to these agreements besides the candidates who might not like to change those agreements.
COLVIN: Yeah. Greg, the candidates do like to talk about jobs. As president, how much can they do about it?
VALLIERE: A little, at the margin, but not a lot. I think the most important thing is empathy, feeling your pain. Bill Clinton, who was the last person to defeat an incumbent president -- I think his last name was Bush, as well -- Bill Clinton felt people's pain and he could relate and he showed he was going to work hard. I think the style may be more important than the substance.
COLVIN: You know, it's a great point, and it actually makes me wonder, could we possibly see a repeat of 1992? Because there are a lot of parallels. We were coming out of a recession then, as we are now. The numbers looked pretty good. If you looked at GDP growth and unemployment, they were all improving, and yet voters didn't feel all that good. And the President, President Bush, as you said, was in the position of defending the status quo, which wasn't bad numerically, and yet Bill Clinton said "I feel your pain," and people responded to that and elected him. Viveca, could that scenario play out again?
NOVAK: It could very well. I mean John Edwards I think was the first one to make headway on this issue and to discover -- maybe accidentally, since he doesn't have a war record to run on -- that it's the economy, stupid all over again. That's what people care about. And now Kerry has taken a page from Edwards and they are both feeling the pain of voters.
COLVIN: They are. How is the President doing on this empathy issue?
NOVAK: The President is trying very hard I think to appear empathetic, but I think the key for him is to appear that he has an economic program that goes beyond making his tax cuts permanent.
COLVIN: We should take a look at some of the points the candidates have made.
Edwards on jobs and trade: NAFTA -- no. Meaning he says he would have voted against it if he'd been there. He wants a 10 percent tax cut to companies that keep jobs at home, and he wants to increase the minimum wage.
John Kerry: NAFTA -- yes, but. Meaning he voted in favor of it, but he's now sort of back pedaling and saying he would call for a review of it. He wants a tax credit to keep manufacturing jobs. He wants to stop countries from manipulating currency, which means actually stopping China from keeping its currency low, which is great for them and bad for us trade wise.
COLVIN: Both candidates, Edwards and Kerry, say they want tax incentives to keep jobs at home. How seriously, Peter, should we take that?
COHAN: I think it's a good idea not to try to stop outsourcing. I really feel very badly for those people both who have been outsourced and who have the fear of being outsourced. So I think that there should be public/private partnerships to help them find new jobs. But I also don't think we should stop outsourcing. Because I think what it does is it helps us become more competitive over time. And it's been a tradition in the economy to continue to improve and focus on what we do well. So I think it's a good thing to do, but I don't think we should assume that the market will blithely create new jobs for these people. Something has to be done proactively to make it happen.
COLVIN: Taxes are close to everybody's heart. Edwards on that issue has said he wants to keep the middle class tax cuts. He wants to repeal the tax cuts for those earning more than $200,000 a year. He wants to raise the capital gains tax for those earning more than $300,000 a year, and he wants a $5,000 tax credit for home down payments. John Kerry, same two top points. Keep the middle class tax cuts, repeal the tax cuts for those earning $200,000 or more. Could a President Kerry or a President Edwards actually get those tax cuts through Congress, Viveca?
NOVAK: Well, if Congress stays Republican, and indeed it appears that it probably will, I think it's going to be difficult. But I do think that Kerry and Edwards have both been smart in focusing on sort of small-bore things when it comes to jobs and trade and the economy. I think they haven't raised expectations too high, and they've been saying in their interviews with editorial boards, if not in their stump speeches, you know, we're not going to be able to stop the jobs from going overseas, we're not going to be able to change the economy radically. So some of their measures may indeed get through.
COLVIN: How strong an issue is taxes and the Bush tax cuts politically for Kerry and Edwards versus President Bush, Greg?
VALLIERE: I think it's very strong. It energizes the core. You play this class warfare game. But there is one tax issue that no one has talked about in the Democratic Party yet, that I think is the most important as everyone does their taxes in the next few weeks, and that's the AMT, the Alternative Minimum Tax, which is the ticking time bomb in the tax code. I don't hear anyone talking about that.
COLVIN: But it's going to ensnare millions more people in the next few years.
VALLIERE: That's right. Maybe it's later in the decade before we address it, but it has to be addressed.
COLVIN: Right, and that's because the provisions were never indexed for inflation, and so it was intended to go after high-income people, but more and more people are getting into those brackets sort of unknowingly.
VALLIERE: That's right.
COLVIN: Well, the bottom line on this for investors is what happens to the stocks and stock markets if, let's say, a Democrat is the next president.
COHAN: Well, I think one area that will win is Fannie Mae. Fannie Mae is under attack right now by the Republicans, and it's a fairly heavily Democratic company. And so I think that one would benefit. Another one that I think would benefit is say something in the biotechnology field like Amgen, because I know at least in the case of Kerry, he wants to encourage investment in that field, which I think will increase the value of that company.
COLVIN: Greg, sectors?
VALLIERE: Well, I vowed for Lent to give up making predictions about what's good for the economy and bad for the economy.
Quickly, I would say that there are two ways to look at the overall markets. For the bond market, Kerry might not be bad, because he talks about deficit reduction. I think for the overall stock market, to get to sectors, there would be a concern not if Kerry won about new legislation, because I agree there will be gridlock probably in Congress, I'd worry about the FDA, the FCC, the FTC, all of these regulatory agencies. And I think that the sector that would perhaps be the most vulnerable would be health care in general and drugs in particular.
COLVIN: Interesting. Greg Valliere, Viveca Novak, Peter Cohan, thanks so much.
Surmounting scandal
KAREN GIBBS: As recent corporate scandals move from boardroom to courtroom, savvy investors are buying disgraced companies in a big way -- and here's why. Since January of last year the S&P has returned a respectable gain of 30 percent. But an index of companies under investigation for possible wrongdoing has soared a shocking 58 percent. But how do you tell when a tarnished company is truly mending its ways?
Bill George is a former CEO, board member and management expert who knows the difference between a real turnaround and a short-term fix. David Katz loves to find out-of-favor stocks for his Matrix Advisors Value Fund which consistently beats the S&P. Well, Bill, how do you tell a turnaround company from a short-term fix?
BILL GEORGE: I think it depends on leadership, whether they have a leader that can transform the company from that vicious, downward spiral into a virtuous circle when they have all the employees pulling together and can get back on track and sustain that for the long-term. It doesn't do any good to do it for a year and then see it go back into the tank again. You need to find a leader that can sustain it for the long term.
GIBBS: Well, how do you evaluate leadership at a turnaround company?
GEORGE: Well, I think the same way you evaluate leadership anywhere. Can they bring people together and motivate them, can they focus on the customer needs, and can they get everyone pulling together to get real value to their customers in the marketplace? Quality products and services at a great price.
GIBBS: Well, investors have been burned and it's left a bad taste in their mouths. How do they come back and look at these companies with not so jaundiced eyes?
GEORGE: Well, I think they have to look at the governance of the company as well, and some of the companies we're looking at have really transformed their governance as well as put in transformative leaders, not just people that are playing it for the short term or trying to manipulate the company into getting a little stock market gain, but people that are really trying to build long term, lasting value.
GIBBS: David, how does an investor know when a company has truly turned around?
DAVID KATZ: We think the leaders are important, but you also want to make sure you have a good business. You want to make sure you have a good balance sheet and that the company has a competitive position. If those things are in place and the cash flow starts to do better, you can assume that a turnaround is taking place.
GIBBS: Bill, give me some examples of companies that you think have done a really good job of truly turning around.
GEORGE: Well, my favorite is Xerox under Anne Mulcahy. The company had a very heavy debt a few years ago before she took over. It had lost the confidence of its customers. That's all turned around, and she's doing I think a spectacular job in building that company for the long term. The stock has responded in the two and a half years she's been CEO, but I think it's got a long way to run as Xerox gets restored to its former greatness and can be a truly competitive force in the world.
GIBBS: Do you have another example?
GEORGE: I do. Tyco is another one. I think since Ed Breen took over -- this was a company in deep trouble under his predecessor -- he cleaned house, brought in a whole new board, a whole new management team. The first thing he did, he installed an ethics officer, Eric Pillmore, and Ed is really setting a standard of excellence. And he stopped focusing on acquiring companies and focusing now on building the business he's got. It's a $40 billion business. He's got some excellent businesses, but no one's running them. He's an operator and he's running them right.
GIBBS: David, what does Tyco look like to you?
KATZ: We missed Tyco when it was down at about $15 or $20 because we had liquidity concerns. At this point they really have gotten their act together. The CEO has done a spectacular job. We think it's worth about $35, so it still has some upside. We just haven't stepped in at this point.
GIBBS: What did you step in to buy?
KATZ: One of our best scandal stock investments last year was Dollar General. It's got a great business franchise. They're a specialty retailer. They mint dollars. And they had a lot of accounting problems. They changed the CFO, they changed the CEO, and the company has returned to Wall Street favor and it's up about 100 percent. We would not be buying that here.
GIBBS: Any other ones that you did buy?
KATZ: We bought the brokerage stocks. We think they have mended their ways, and we still think they have a lot more to go. And Bristol-Myers is a drug company that had a lot of accounting problems. They have also fixed themselves and we think they're on the mend and should do a lot better.
GIBBS: Now how can you be sure, David, that these companies are actually out of the woods and that the accounting problems are over?
KATZ: Well, when you have these scandal stocks, one of the nicest things to see is when they change the whole CFO and all of his officers. After they've been in power for about three to six months, if no new things have come up, you can assume that the worst is behind the company. When they don't change the CFO, when they don't change the accounting staff, you still have to be suspect.
GIBBS: How do investors evaluate bad news as a good buying opportunity or just the tip of the iceberg of another scandal?
GEORGE: Well, I think they have to look beneath at the governance. Let's take MCI, a company that's in bankruptcy. Dick Breeden came in, former head of the SEC, and put a whole new governance structure in place, brought in Michael Capellas as the CEO. You can't buy the stock today. It's still in bankruptcy, but you will be able to, and I think Capellas is restoring that company, changed the name to MCI, got rid of the old WorldCom name, stopped acquisitions and started running the business. And both Capellas and Breeden and Mulcahy are all former chief operating officers. They know how to run businesses and they know how to build for the long term and restore customer confidence as well as investor confidence.
GIBBS: David, is MCI doing a good job of that?
KATZ: Capellas is a great CEO. He's doing a wonderful job of fixing the company. The problem is they're facing a fierce headwind. This is a bad industry, and even if you're the best in a bad industry, you're not going to do well.
Conseco brought in Gary Wendt a few years ago to fix the company. You could not have had a better leader, could not have had a better CEO, (but) it was a bad company with too much debt. They're not around anymore.
GIBBS: Okay, so we got rid of all the bad guys, but you still have a corporate culture that's there and you've got these seeds that have to be dug out. How do you know that this is the time to step in and take the risk.
KATZ: Well, you want to look at a company on a valuation basis. If you have a company that typically sells at 18 to 20 times earnings and all of a sudden it's at 12 times earnings and they have a balance sheet and they don't have too much debt, you can consider stepping in. You want to speak to the CEO, see if he has the right corporate culture, see if he's trying to enhance shareholder value, and if this is a good business over the longer term. You don't want to just step in because there's a scandal. Many companies that go down go down a whole lot further.
GIBBS: Well, there are some companies that may have weathered the internal storm but now are facing external pressures, and I'm thinking about Freddie Mac. You know, it's one of those government-sponsored enterprises that this week Fed Chairman Alan Greenspan put out a warning flare on. What do you think about that?
KATZ: Freddie Mac is a tough one. We have owned it for a number of years. We were appalled at what went on. The difference between this scandal and a number of others is they cooked the books by understating their earnings. But when you listen to the conference calls, in a lot of respects they didn't know what was going on. A lot of people who were supposed to know what was happening at the company didn't.
At this point we think a lot of their problems are behind them. They understand the balance sheet, they understand where their earnings are, and we think they're on the mend. In terms of the government re-regulating them or doing a lot more in regulation, we think it makes an enormous amount of sense. But at Freddie Mac you're talking about a company at nine and 10 times earnings. Even if their growth is a lot slower but their finances are a lot better, we still think it should sell at 14 times earnings and it should be a good investment.
GIBBS: Bill, I keep coming back to the fact that if the guys on the inside don't understand what's going on or don't have a handle on it, how are investors to get a handle on this?
GEORGE: Well, if the guys on the inside don't have a handle on it and they don't have a plan for the long term; you've got to change them out. A good example is Boeing, where Boeing had one scandal after another. Boeing is a great American icon. We can't afford to see Boeing go down, and Harry Stonecipher stepped in there three months ago, and he's putting a lot of things in place to restore the confidence of their major customer, the U.S. Government. They had lost that confidence. They had contracts coming away from them, being taken away, billions of dollars of contracts they're losing.
Now they're getting them back. They're going finally, hopefully, to go after Airbus and get their market share back because they lost the leadership to Airbus, and they've got to get it back. They've got this new 7E7 that he's investing in. So I think you see in Stonecipher a very senior guy, but who's had a lot of experience, hopefully will restore that company to its former greatness.
GIBBS: David, there's a company that's in the news this week, Martha Stewart Living Omnimedia. Is it damaged goods?
KATZ: Well, part of that whole company is the CEO or the old CEO, and she is damaged goods, so that we think that the company is damaged goods, and this is one that we would stay away from.
GIBBS: I want to ask both of you a question. Have you ever had a CEO look you in the eye and lie? Bill?
GEORGE: Well, I've had CEOs I couldn't trust. One of them was the former CEO at Tyco, and the things he said to me I could just not trust. I don't think he lied to me, but the head of U.S. Surgical did. He told me he had an offer for his company at 58 which he had turned down, and then a month later accepted an offer for 43. He was not telling the truth.
GIBBS: How about you, David?
KATZ: Over the years we've had a number of CEOs and CFOs that have looked us in the eyes and told flat-out lies, and then when they were asked about them a month and three months later, acted like it never happened.
GIBBS: David, do you still think there's some bad apples out there?
KATZ: There are some bad apples, but there are a lot less bad apples. Corporate America is probably the cleanest it has been in a long time, simply because the problems were so pronounced and they came to light and a lot of people are going to prison. So we think Corporate America is very much on the mend.
GIBBS: Bill, do you feel the same way?
GEORGE: I think we're getting there. I want to see the sustainability and not just checking boxes with Sarbanes-Oxley. I want to see the long-term, sustainable growth and people staying with it. But this new generation of CEOs has the message, and I think they're going to do a lot better than the previous generation.
GIBBS: All right. David Katz, Bill George, thanks very much for joining us.
Hollywood stock exchange
GIBBS: Need a break from all the market intrigue? How about investing in movie stocks and star bonds just in time to get your money down on this year's Academy Awards nominees. The Hollywood Stock Exchange's Michael O'Rorke joins us from Los Angeles. Tell me about the Hollywood Stock Exchange. How does it work?
MICHAEL O'RORKE: Well, the Hollywood Stock Exchange is an online entertainment destination where we run a virtual stock market at HSX.com. You go to that site, and basically it's free to play. It's a trading game where registered users sign up, it costs nothing, we give you two million, what we call Hollywood Dollars, which you then use to buy and sell securities. Now, whereas the New York Stock Exchange is companies and firms and mutual funds, and things like that, we offer stock in movies and stars, and in this particular time of the year, Oscar nominees as well.
GIBBS: Well, since it's Oscar time and the Academy Award coming up, could you walk us through a trade, particularly say in the Best Actor category.
O'RORKE: It looks like there's about three strong contenders on our site, and as well in the public consciousness. But, basically, at this point in time, on our market, Sean Penn is the slight favorite ahead of Johnny Depp with Bill Murray trailing a close third.
GIBBS: Well, walk me through what's going on right now in the Best Actress category.
O'RORKE: Most of the smart money at this point seems to be on Charlize Theron for Monster.
GIBBS: Well, all the buzz, of course, circulates around the Best Movie. What is your trading system saying who's going to win Best Movie?
O'RORKE: Well, I'd love to tell you we've got a shocking revelation that it's going to be something other than Lord of the Rings: The Return of the King, but I think our market is bearing out pretty much what everyone else around town is saying as well.
GIBBS: Well, although this movie is not in the Oscars, it made a big splash this week. I'm talking about Mel Gibson's Passion of the Christ. What's going on there?
O'RORKE: Well, it is definitely trading extremely high numbers on our Hollywood Stock Exchange. I think it's a very unusual film and that just as little as six months ago people sort of viewed it as kind of an art house gamble by Mel Gibson to put up all this money to make the movie himself. Our market is trading over $120 Hollywood Dollars, which indicates that our traders feel like it's going to earn around $120 million in the first four weeks of release.
GIBBS: I would think that Hollywood executives would be very interested in the type of information that you generate. What could they glean from this?
O'RORKE: We're basically a giant well-attuned focus group. Certainly, far more, far reaching, than your typical market research groups. It's a new, modern way of looking at things. But it's one that we've found to be very successful.
GIBBS: Michael O'Rorke, thanks very much for joining us.
O'RORKE: Thank you.
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