Leuthold interview
KAREN GIBBS: For an insider's look, we're calling on a former potato farmer and rock star Steve Leuthold, money manger for many major institutions and a regular here on Wall $treet Week with FORTUNE. He joins us from Tucson, Arizona.
Steve, there was a lot of pressure on the markets this week, particularly from energy prices. I filled up my gas tank and oh, boy -- Now the Department of Energy is warning that a gallon of gas could cost more than $1.80 around the country next month. Ouch.
STEVE LEUTHOLD: You're looking at gasoline at $5 a gallon in England and in Scotland with the taxes that are put into it. I mean, comparatively, U.S. gasoline prices are very, very cheap compared to the rest of the world.
GIBBS: Now you are bullish on some alternative energy companies. In fact, Plug Power, Fuel Cell Energy, and Syntroleum are all in your portfolio. What's the play there?
LEUTHOLD: Well, the play is that ultimately we are going to need some replacement energy sources. And it's a historical thing. You saw whale oil getting replaced by kerosene, you saw wood being replaced by coal. When things get too expensive then you develop alternative sources, and I think, ultimately, a lot of these energy sources are going to become major, major contributors to our energy supply, and we kind of want to be on the leading edge of this. It's a long-term play, but it's also a play on short-term movements in the price of oil, because as the price of oil goes up, interest in alternatives also goes up.
GIBBS: Well, some people are saying that this recovering economy is going to swell the coffers with more tax receipts and that might kind of blunt this burgeoning deficit. Now you've got an interesting strategy. You're buying utilities, particularly electric utilities as a bond play. Explain that.
LEUTHOLD: Well, Karen, for the first time in 30 years I don't own any bonds. I can't see -- I think the risk in almost every kind of bond, the risk comes from interest rates going up is greater than the potential of reward for the coupon over the next six to 12 months. And so we've been trying to find some place to invest money where we get some kind of descent income and we've come down to public utility common stocks, mostly electrics, but buying ones where there are good dividend coverage and they yield about 5 percent. After all, a 5 percent yield is a lot better than the 3.7 percent on a 10-year treasury, and I don't think you've got as much risk of loss in a utility common stock as you do in a treasury bond.
GIBBS: And some of your holdings, and there are A.E.S. Corp, DPL, and Reliant Resources. Now, you're holding on to them partially for the dividend play, but also because of the long-term prospects?
LEUTHOLD: Well, I wish we'd never bought DPL. They've gotten in a little trouble lately. But, yeah, they are growth companies because energy is a growth area in this country. And whether it's going to be oil and gas, or whether it's electric, or whatever, we know that we're going to consume more and more energy as the population grows and the demands become greater. So, we view electric utilities as a long-term, slow growth industry, but in addition, a pretty good return, and without much downside risk.
GIBBS: You've been advising your clients, Steve, to look out for a correction in the stock market. Why?
LEUTHOLD: Well, it was overdue, we had a move of over 50 percent from the lows, without even a 5 percent correction, and based on past market dynamics, it was just about time to have something like that. And we've seen it now. I mean the Nasdaq fell from its high in February to its low here this month, about 10 percent. We saw the Dow down close to 7 (percent). The S&P not quite down 5 (percent). So, I think we put some money in the sidelines and we're starting to commit again that we'd had park there to use.
GIBBS: For the rest of the year is your outlook still rather positive?
LEUTHOLD: Well, I am positive, I'd say, for the next three or four months. I think we really have to stand back and take a look at things come summer because I would imagine we're going to see an increasingly divisive political campaign going, and you're probably going to see a pick up in inflation, and I would guess that the Federal deficit is going to become a bigger and bigger political issue. But at least for the time being I think we're ready for a pretty good rebound the cyclical bull market is still with us.
GIBBS: What's your biggest concern about the economy? What keeps you pacing the floor at night when you should be sleeping?
LEUTHOLD: Well, I keep thinking, how are my grandkids ever going to be getting any kind of retirement benefits or any type of Social Security when the current generation has been eating up all the assets? That's what keeps me awake at night.
GIBBS: What is your solution to solving the Social Security problem.
LEUTHOLD: I think there is a lot of things that have to be done, but the thing is, we have to realize, people in this county have to realize, Social Security is a tax, it's not an entitlement. And when FDR, and back in the days when it was first created, it was meant to be a safety net for people who had nothing in retirement. And it wasn't intended to be entitlement. And I think we have to go back to that original purpose of Social Security, and therefore, I think it doesn't make much sense for people that have $200,000 of income, or more, to still be getting a social security check from the government. In other words, I think there's part of the answer, and it's not the whole answer, but part of it should be some form of means testing for Social Security. And that does not make me a lot of friends in Tucson, Arizona with all the retirement people.
GIBBS: But it does give you food for thought. Steve, thanks very much for talking with us.
Water roundtable
GEOFF COLVIN: Oil is the world's biggest industry, followed by electricity, but what's third? The answer is the ultimate necessity, water -- a global business growing so fast that some analysts say it's the coming century's oil. In the developing world, dirty water is the planet's worst health problem. In developed countries, demand is rocketing while the water infrastructure is crumbling. Giant corporations are suddenly interested: When General Electric recently identified a handful of industries likely to grow twice as fast as the economy for years to come, water was prominent among them, and GE has jumped into the business. Should you?
Debra Coy is the leading investment analyst covering the water industry; she's with the Charles Schwab Washington Research Group. And John Dickerson is one of the world's leading water-industry investors. He joins us from San Diego.
Debra, here in the U.S. most people get their water from water utilities. Most of these are not investor owned, not publicly traded. The prices are regulated. Where's the investment opportunity?
DEBRA COY: Well, even those that are not investor owned have to buy a lot of pumps and valves and filtration equipment. Their pipes are falling apart. We've got to work on that. So there's certainly a lot of investment that the non-investor-owned water utilities are making. And because it's often difficult for particularly some small cities to meet all those requirements, new environmental standards, upgrade of treatment systems, they're turning to the private sector in some cases to help them manage or even to take over ownership of their small utility systems, so that's an opportunity as well.
COLVIN: It is a big trend, privatization of water utilities. Now where is this whole vast world water industry are the best opportunities for profit now?
JOHN DICKERSON: Well, as Debra said, they're in the industrial side of the water industry, the pumps, pipes, valves, filters. We have the same amount of water today on the planet that we had a million years ago, but we have 6 billion people now competing for that asset. At the same time, we're not only competing for the asset, we're more and more increasingly polluting the other, the remaining water, if you will, both ground water, MTBE, and the like.
COLVIN: And that's where we get into purification, which both of you have talked about as a big opportunity, and in fact some big companies now are getting into this. It used to be a small business kind of industry. Now big companies, including General Electric, are getting into it in a big way. And in fact they have been running a commercial on television very heavily promoting their involvement.
(video clip begins)
COMMERCIAL: Each year GE technology helps industry purify billions of gallons of water to a standard even higher than drinking water, because pure water just performs better.
(video clip ends)
COLVIN: And of course the classical music aficionados recognize that as the "Water Music" by George Friedrich Handel. But what is the significance of GE, Debra, being in this business now?
COY: Well, I think GE has figured out, as they started looking around their portfolio of businesses, that they wanted to be in some higher growth businesses. They didn't want to be an old industrial company. They want to be a new industrial company. And water certainly has the prospect of growing at about twice the rate of the overall economy, as they have said, as I have seen, because of the need for investment, both for industrial treatment and for municipal infrastructure upgrades
COLVIN: We haven't seen all the gains yet?
COY: No, I don't think so. I mean I think we're really at the very early stages. I look at this sometimes like the early stages of growth and consolidation in the telecom industry. We're seeing technology development. We're seeing consolidation. There are literally hundreds of little companies out there that GE and some of the others are looking to buy. We're going to see larger companies develop I think.
COLVIN: Debra, I don't know if you remember a reality series recently called Rich Girls, but oddly enough they had something to say about water.
(video clip begins)
CLIP FROM RICH GIRLS: You know what I find is weird kind of, Allie? People pay money for clothes, okay? But shouldn't it be like a free necessity like water because you need it?
(video clip ends)
COLVIN: Now she thinks water is free, and apparently a lot of other people do, too.
COY: A lot of people do, but it's not. Water may fall from the sky, but it doesn't get to your, doesn't get to your tap for free. And that's the thing that people forget because it is a very, very cheap utility, and people aren't used to thinking about their water bills, so it's only just beginning to become apparent to them how much effort it takes to get the water from here to there.
COLVIN: Most of us still don't pay very much for water. We don't even notice how much we pay for water, for the most part. How big is the water problem facing the United States?
COY: Well, certainly a lot of people lately are looking at an EPA study that they came out with about a year and a half ago, their so-called gap analysis, which was the gap between what's being spent on water infrastructure and what needs to be spent. The number that they came up with, and this came from surveying cities all around the country, was a half a trillion dollars is the shortfall in terms of what needs to be spent to upgrade water infrastructure across the U.S. So that's a big number. Even in Washington they notice those kinds of numbers.
COLVIN: Yes, you would notice that. And that means what? Rates are going to have to go up, right? Bottom line.
COY: That means rates are going to have to go up. And that is certainly, investors say, well, water's been a problem for a long time, why do you think that finally this investment is going to start taking place? And I think because of contamination problems and water main breaks, people are noticing. And when they start to look at it, they complain about their water rates going up, but their water rates are cheap. The average water bill in this country is about $16, $17 a month. Relative to cable and electric and cell phone, it's cheap.
COLVIN: There's a Charles Schwab Water index.
COY: Yes.
COLVIN: Which since January 2001 is up 34 percent, a period over which the S&P is down 14 percent.
COY: Correct.
COLVIN: Nobody thinks of water as a growth industry, right? As something that would outperform the S&P.
COY: I do.
COLVIN: You do, but this is the battle you're fighting, right?
COY: The truth is that water utilities, relative to electric and gas utilities, are already faster growing because of the capital investment and return on that and because of the consolidation that's taking place. But then there's these other treatment equipment technology firms which are growing again through a combination of demand and also consolidation, so we have earnings growth rates in some of these companies that's certainly in growth rate territory in the fifteenish percent kind of range, which does.
DICKERSON: Geoff, could I say something on that?
COLVIN: Sure.
DICKERSON: I have some numbers I brought along on Aqua America. It used to be named Philadelphia Suburban. I lot of people know it by that name. But for the 10 years just ended at the end of January, Aqua America had a 10-year compound growth rate of 20.5 percent. It exceeded the growth rate, total return, of companies like Johnson & Johnson, General Electric, Wal-Mart, Home Depot, Procter & Gamble, Merck, it goes on. In other words, the stocks have been exceedingly good performers for a very long time, and nobody knows it. Nobody pays attention.
COLVIN: Nobody pays attention, and that company is not even in the technology or the filtration or any of that. Those are utilities.
COY: That's a utility.
DICKERSON: They have grown very heavily by acquisition and they're able to by these little utilities from very much a buyer's market. These little utilities don't have access to capital markets, cannot upgrade their systems to meet regulatory standards. And a Philly Suburban and many of the other investor owned utilities are able to buy the Mom & Pop utility at a return on capital or a return on equity that rivals any business in the land.
COLVIN: Now who do you like? I mean the companies that you think are most promising.
COY: Pentair is a company that was a diversified industrial manufacturer and has recently announced that they're divesting their tools business and acquiring a water company, one that's more in the pipes and pumps and valves and pool and spa treatment business, and they're turning themselves into a water company. It's an interesting opportunity. We've certainly already seen some response in the stock price. And there are some of the small filtration companies that aren't Wall Street household names, but have performed very well over time, including in the filtration side Cuno would come to mind. Cuno is a top filtration manufacturer of both the kind of small, the small cartridges that go into refrigerators that give you clean water out of your refrigerator, all the way up to industrial and pharmaceutical manufacturing.
COLVIN: A fast-growing industry where most people least expect to find it. John Dickerson, Debra Coy, thank you very much.
Wine investing
COLVIN: Maybe there's something about investments you can drink. Not only has water beaten the S&P 500, so also has wine -- fine wines in general up 22 percent over the past five years, some of them up much, much more, while the S&P is down 15 percent. So should you be investing in wine? How does the market work? And if you're not an expert, how do you choose the right wines?
FORTUNE senior writer David Rynecki has been selflessly researching this topic and joins us from New York. David, lots of people like wine, but what kind of person should invest in wine?
DAVID RYNECKI: Well, I think that for the average person who's interested in this, first they have to have just a natural interest in wine. You don't have to be an expert, but you want to be a little bit more interested in wine than, say, your Two Buck Chucks.
COLVIN: Okay, so you don't have to be the kind of person who can identify 1982 Chateau Margaux blindfolded.
RYNECKI: No, you don't have to be that person at all. Because what's simple about it, and this is what makes wine investing beautiful compared to stock investing, in stock investing you have 7,000, 8,000 public companies and just as many mutual funds. It's impossible to actually figure out what will do well. In wine investing, you're really talking about 20 to 25 blue chip wines, and they primarily come from the Bordeaux region of France.
COLVIN: Well, some of them have done fabulously. I mean if we look at some of the returns, just over almost 5 years, a little less than 5 years, Chateau Lafite-Rothschild, up 875 percent; Le Pin, up 700 percent; Chateau Petrus, 531 percent. Those are fabulous returns for 5 years.
RYNECKI: Exactly. And what's remarkable here is it's not like Chateau Latour was an IPO in 1998 or 1999. These are wineries that have been around for hundreds of years in some cases. And we know that every couple of years they come out with a new wine that will be spectacular. This spring the wine shops and different wine aficionados will be going over to France and tasting the first of the 2003 Bordeaux, that's last year's Bordeaux. It won't actually arrive in stores until 2006, but people can start ordering it now.
COLVIN: Right. Well, now where should you order it from? Should you wait until it's in a store and buy it there? Should you buy it from the producer, or what?
RYNECKI: You can wait, but, if you want to take a bet, if you feel like Chateau Margaux or Chateau Latour, which are extremely sought-after wines, if you feel like over time those will do well, then what you can do is find out about what are called futures. You can go to a service such as Wine-searcher.com, which is obviously an Internet site. And most cities have at least one or two shops that will offer these wines.
COLVIN: As an investment, you know stocks and bonds don't care if the room is too hot or too cold, and if you drop them you can pick them up again. Isn't keeping wine a little bit of a pain?
RYNECKI: Well, that's one of the funny things. In fact one of the biggest warnings you have to give people is keep this away from your relatives. I have a friend who had a very special bottle of Italian wine, a Barolo, it was quite old and just very valuable and also personally valuable. He had some relatives come to town and they drank it.
So you've got that issue. You don't want to store it near a heater. So one of the things you have to make sure is that you have a place to keep it. There's also a patience factor here. You've go to wait five years, 10 years, 15 years before the wine is actually worth a lot of money. So in that time you have to figure out what's going to happen, well, think of it this way. Okay, there are 500 cases of a certain wine made each year. Now every time someone opens a bottle of that wine, there is less supply. And even if the demand stays the same, the supply going down is going to increase the value of the wine
COLVIN: These great Bordeauxs that you're talking about generally sell for hundreds of dollars a bottle even when they're brand new. Do you need a lot of money to get started with this?
RYNECKI: Not really. There's a service called Winebid.com that allows you to buy special wines just one bottle at a time and you can do that. I know some people who each year as a gift to each other will buy a bottle, or in some cases a case if it's more affordable, and hold on to it and watch it mature, and that will become their investment over time. If you can buy it by the case it's going to be much easier, because certain wine shops will require that you buy a case if it's of a future of Bordeaux.
COLVIN: And in some cases I gather buying a whole case and keeping it intact makes it more valuable when the time comes to sell it. Now this is going to sound like a stupid joke question, but it's really not. When it's time to sell wine, how liquid is the market?
RYNECKI: Well, that's going to depend on the economy, and there will be moments when the wine is not sought after. But when you take wines like Petrus and Margaux, Latour, Haut-Brion, these wines always have a market, and that's why if someone is going to do this, in order to minimize the risk as much as possible, they want to stick to those blue chips of Bordeaux where there's always going to be a market. The price will fluctuate, but if they hold on for time, then they will probably see a nice return.
COLVIN: Well, and there's another point to be made, and you have made it in the past, which is there is a worst-case scenario that's not so bad when you own great wine, right?
RYNECKI: Sure, you can drink it.
COLVIN: David Rynecki, thank you very much.
RYNECKI: Thanks, Geoff.
Next week
GIBBS: If only the nation's most vexing financial problems had such an elegant solution. Rarely does an economic issue generate as much noise and outrage as the outsourcing of jobs ... next week we'll bring you a surprising take on this hot button topic.
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