KAREN GIBBS: While the country was mourning a beloved
ex-president, there were lots of undercurrents moving through the markets.
Gas prices fell, giving temporary relief at the pump, but rising import
prices signal higher energy prices down the road. The group of eight industrialized
countries met off the coast of Georgia, but they might as well have been
playing golf for all the attention the meeting received. Fed chairman
Alan Greenspan warned of higher interest rates to combat inflation, and
a telecom ruling favoring regional bell companies could affect millions
of consumers. And a new study showed that being rich doesn't guarantee
you'll get lucky. But all of that took a back seat to the news of the
death of the 40th president of the United States.
No other president has an economic theory named after him. He left an
indelible imprint on government and Wall Street. John Rutledge was an
early architect of the Reagan economic plan. He now runs Rutledge Capital
and joins us from New York City. Steven Leuthold, chairman of Leuthold
Weeden Capital Management, credits Reagan for winning the Cold War but
fears the Reagan legacy of higher deficits. Steve joins us from Portland,
Well, John, let me ask you, the Reaganomics theories of increased defense,
reduced taxes, lower government spending, and deregulation are still with
us today. How do we grade Reaganomics?
JOHN RUTLEDGE: Well, you know, we should have called
him the Clipper instead of the Gipper, because he wanted lower taxes,
lower spending, lower regulations, and lower inflation. And his basic
idea was let's get the incentives right to get out of people's way and
let them run their lives and run their businesses. And I think it's done
very well today.
GIBBS: Well, Steven, it certainly has given the stock market, or at least he's being given credit for the longest bull run market, up since 1982 some 1,000 percent, but we still have the specter of deficit spending hanging over us. How do you look at that?
STEVEN LEUTHOLD: Well, back in Reagan's day in Reaganomics,
one of the ideas was that if Congress didn't have the money, they wouldn't
spend it. And unfortunately that proved to be wrong, because they still
continued to spend. They went out and borrowed more, and that's what created
the deficit. John, would you agree pretty much with that?
RUTLEDGE: Well, I think Congressmen love to spend money,
and it doesn't matter which uniform they're wearing. They all like to
spend. And today of course we've got a war, we've got terrorism, and we
had a recession, so it's really hard to make sense out of the short-term
LEUTHOLD: Oh, I think that's true.
RUTLEDGE: But, yeah, I think that's always going to
be a problem. When he was elected, inflation was 15 percent. Today it's
1 or 2. Interest rates were 21 percent. Today they're 1 or 2. Tax rates
were 70 percent, and today they're half of that, and lower than that on
capital gains. And the Soviet Union only exists in the history books today.
That's a pretty good scorecard by my way of counting.
LEUTHOLD: Oh, yeah. I wouldn't disagree with that, but I was not a great fan, being a deficit hawk, of Reaganomics back in the '80s, and one of the reasons was that I also didn't really believe in the Laffer curve in that if people took home more, they'd work harder, because most of the people I talk to, if they're taking home more, wanted more free time. But maybe it's the circle that I was running in.
GIBBS: John, do you think that investors are overreacting
to the fear of higher interest rates and higher energy prices?
RUTLEDGE: I really do. You know, the bump in inflation
in the first quarter, Karen, was caused by Chinese growth pushing up commodity
prices, by the dollar pushing up import prices, and by a one-time housing
price change driven by refinancing mortgages. Those are largely behind
us now. We're already seeing the numbers begin to soften up.
I think the Fed is going to be forced to back up and not to tighten as
much as they're giving us warning today. And that's because the job growth
isn't as strong as you'd like to see in a recovery. Costs are actually
under control. Profits are growing very strongly, which is good for the
market. But we do not have an inflation problem.
GIBBS: So you're saying that this is actually a very conducive environment for a continuation of the stock market rally, John.
RUTLEDGE: Well, yeah. You know three times in the last two years you had the opportunity to buy the stock market for 40 percent below its fair value. In the last 10 weeks, we've had another opportunity arise, because people were afraid of the Fed and afraid of the inflation numbers, so they sold the bond and the stock markets off. But unit profit growth is increasing 27 percent annual rate because of the productivity boom, and for another factor, all of the productivity growth we've seen so far has come from giving high-speed telecom to a group of large corporations in big cities. In the next five years, the small companies in the small towns are going to get it. Productivity drives costs down, inflation down, and profits up. That's great for stockowners.
GIBBS: John, and I should mention that not only are you a money manager, but you are doing some work on the telecom industry, is that correct?
RUTLEDGE: I am. I'm in the middle of doing a study of
telecom deregulation and its impact on the economy.
GIBBS: John, from your perspective, from an investor's perspective, who do you think are going to be the winners and losers in the telecom industry?
RUTLEDGE: Well, you know, this move the White House
made this week has essentially paved the way to free telecom up from the
regulatory burden that has made us number 11 in the world in terms of
network speed. India, China, Taiwan, Singapore, Korea all have speed of
light fiber optics running to their businesses. We do if you work in Los
Angeles or New York or a major city, but not in the small towns.
We've got to learn to outsource to our own small town companies, not
to small companies in India. Those changes are going to favor people who
have network, so the RBOCS who are going to do the fiber optic and wireless
investing are going to be favored relative to the MCIs, the AT&Ts and
the Sprints that are network users and renters. Within those users, you'd
rather own Sprint than AT&T or MCI because of their fiber backbone.
But the best gains are going to happen in equipment makers who sell the
little boxes and switches and fiber optic cable that's going to be used
to do about $100 billion worth of new capital spending. And the biggest
winners of all will be companies in towns that don't have broadband communications
now that will be able to compete with someone in Korea for the first time.
GIBBS: Let's talk about some of the demographic shifts we're seeing, particularly with the baby boomers really pushing this market. We have seen the economic recovery, focus on consumer confidence, and we've talked about the importance of unemployment and inflation. But health care now seems to be a really big push. John, can you give me your feelings on the health care sector?
RUTLEDGE: Absolutely. I'm an expert on health care,
because I'm the oldest baby boomer in America. And currently, if I start
at my head and work my way to my toes, nothing works and everything hurts.
So I think the baby boomers are not afraid of pharmaceutical intervention
to solve our problems. We were the children of the '60s remember?
Pharmaceutical companies I think have been sold too short because of
this cash flow squeeze, margin squeeze recession, and I think there's
very strong long-term fundamental demand. And as you bring more and more
of the third world into the growth part of the world, they're going to
begin thinking about health care, too. So health care is a very positive
sector I think, long term.
LEUTHOLD: I certainly would agree with John about that.
The big drug companies are under a big cloud, and I think it's creating
some of the best values for people that are courageous enough to be, to
go against the current political winds. But we think that companies that
are involved in containing health care costs, something we call our health
care cost containment theme, is really more timely. And I think you buy
the big drugs, but you put them away and be pretty patient.
GIBBS: You're also under weighting biotechnology. Tell
me why you don't like biotech right now.
LEUTHOLD: Well, we had liked biotech. It was a very
significant part of our portfolio, but again, when we're managing money
and we're selecting industry groups to be invested in, we do pay attention
to a very exacting type of quantitative model with 28 factors, and this
work has shifted to neutral with biotech. So we've moved out the biotech
stocks and we bought a package of life insurance stocks.
GIBBS: Let's talk about the life insurance stocks, because
it's part of the financial sector, Steve, that is sensitive to interest
rate movements. Why do you feel that life insurance is a better play?
LEUTHOLD: Well, Karen, you're certainly right about
that. Most of the financial groups are very sensitive to interest rates,
and rising interest rates is not a very good environment for most financial
groups. Now, I think life insurance is less immune to a rise in interest
rates than many of the other financial groups like banks, money center
banks, regional banks, and so on. And we look at them as being quite undervalued.
We look at the life insurance stocks, many of them as being candidates
for maybe acquisitions by others, and it just represents in our mind a
good value part of the market that is not terribly susceptible to rising
GIBBS: We're also seeing global growth really power
some of the industrial metals, but that also is going to ignite some inflationary
pressures, John. What do you think the market reaction will be to that?
RUTLEDGE: I think that's a head fake. I think that the
big push on the metals was last year, and that some of the measures taken
in China have taken the top off that. We had a tight market in scrap steel
and in nickel and in aluminum and copper and other things, but truth is
I think you're going to see those be modest increases or even decreases
coming up, likewise with oil.
China bought all the oil could deliver last year. They're trying to increase
their electricity capacity, but that push is mostly behind us at this
point. I'd much rather buy the ignored companies that are the branded
consumer products companies. You know, big margin companies, they get
hurt a lot during a recession when cash flow weakens, but when the economy
recovers, those gross margins lift their cash flow significantly.
GIBBS: Do you have any examples of those, John?
RUTLEDGE: I think, you know, the branded consumer product
names, the Procter & Gambles and the Unilevers and the like are companies
that have both brand equity that's going to gain from the recovery and
they also have significant business in China, which is really the epicenter
of world growth right now, Japan right behind it. Japan has really turned
the corner now and is doing good things.
LEUTHOLD: Well, I do disagree with John regarding the
industrial metal stocks. I think the whole problem there has been we've
gone through a decade from 1990 to 2000 of under investment in terms of
the metals industry because the pricing just wasn't there and it didn't
pay. There was I think about 2 percent per year was the investment growth
in the industrial metals area, all the way from smelters to the mines.And
at the same time, we were seeing demand growing at 3.5 to 4 percent per
year, so we're right now is some pretty slack inventories, pretty small
inventories, and I think that it's going to take quite a bit of time to
turn around and jack up the production of things like copper and zinc
And it's not like, well, Karen, back in your commodity days, you know,
if you ran short of corn, the farmers could plant a lot more the next
year. But in terms of copper, where it takes seven years, six years to
develop a new mine, and when you need major capital investment, I think
we're in for a period of short supply compared to the demand.
RUTLEDGE: Well, the prices, Steve, I think have been
tightened by exactly what you're describing. And last year China's industrial
capacity or production grew 17 percent, and that's not going to go away
either. But the sort of company we're talking about ends up doing capital
spending exactly at the moment when their cash flow comes on, which means
their free cash flow disappears. And over longer periods of time, they
have a hard time generating return on capital that beats the cost of their
money, which means I think they're mainly leveraged commodity price plays.
LEUTHOLD: But see, John, one of the things we've done
that's unusual is that we have not necessarily just bought the companies
that are benefiting from this; we've bought the actual physical industrial
metals as well. So we don't run any risk with those in terms of dumb management
decisions or accounting gimmicks or whatever.
RUTLEDGE: Well, good. Now we have a buyer and a seller,
so we have a market.
LEUTHOLD: That's right.
GIBBS: We also have a market in the rebuilding of Iraq.
I think you're on record as saying, John, that the rebuilding of Iraq
could mimic or rival the gold rush of 1849. Talk about that for me.
RUTLEDGE: I think maybe even a better example would
be the Oklahoma land rush, because on the borders of Iraq it's surrounded
by billionaires whose return on capital is the same as Steve's and mine,
which means single digits on fixed income investments and equities that
are a 10 at best. They have enormous incentives to invest in their own
region. They have experience in investing. So I think that the money that's
going to rebuild Iraq is going to be Kuwaiti money, Saudi money, Dubai,
Abu Dhabi, Qatar and the other Gulf oil producers.
GIBBS: Steve, what will be the impact then on the price
LEUTHOLD: I think we're temporarily up here around the
$40 mark and maybe you're going to see some kind of a setback here with
the normal cyclicality that we see with prices. But I still think you're
going to see oil averaging maybe above $30 a barrel, maybe $32 to $33.
In this country I think we overreact. I mean the fact is that a gallon
of gasoline right now takes about 7 minutes of labor by the average manufacturing
worker that's getting maybe $16 an hour, and back in 1980, when things
were really tight, it took like 11 or 12 minutes of labor with the base
salary at $7.40, $7.50. So and certainly if we compare prices with what
we see in Europe and in England where we're looking at $5.75 to $6.00
a gallon, our prices look pretty cheap.
GIBBS: Gentlemen, this has been a fascinating discussion.
John Rutledge, Steve Leuthold, thanks so much for joining us.
Dudas on gold
DUDAS: Gold continues to be a reserve asset for the
majority of the world's industrialized countries and even developing countries.
Gold is money. It's important to note that since the bottom of the gold
market back in 2001, gold prices have improved from $252 an ounce to a
high reached north of $430 an ounce earlier this year. I think when you
look at fear, you look at alternatives to financial assets. As this fear,
anxiety in the world, fear of a declining stock market, declining bond
market, concerns about currencies, whether policy related or geopolitical
related. People typically have looked towards gold as a place for a safe
And I think gold has reacted quite favorable towards the value of the
dollar declining, the fact that the world's economies are growing and
demand for commodities in general are improving. So I think it's a part
of the anxiety that's caused gold prices to move higher, but it's not
the overriding reason.
When the gold price increases 1 percent, typically equities that produce the gold improve anywhere from 2 to 4 percent. The top eight gold producing companies in the world control about 60 percent of the gold, so there's a limited large-cap universe.
We think that the equities themselves, as least the precious metal equities,
will outperform the general market over the next 6 to 12 months. I think
Newmont Mining manages their assets, their balance sheet, and their people
better than most other metal mining companies. I believe they have more
land than any other mining company to do exploration and testing on, that
they're in a very good position to replace the reserves that they're depleting
and actually grow their reserve base
You have to have the land, the capital, the access to people to grow
your business. And I think the bigger you are, to have more tools and
more ability to reinvest in yourself, the more advantage you'll have in
finding these precious metals. They're not, they're not plentiful. They're
very rare to find, and it takes many years to develop operations and to
add to growth. So I think the larger you are in this environment, you'll
have some more advantage to give good returns to shareholders.
GEOFF COLVIN: The prisoner-abuse scandal at the Abu Ghraib prison in Iraq has highlighted the often-overlooked role of private contractors in government-run prisons. That role is not always scandal-tainted -- publicly traded companies have been running prisons here in the U.S. for years. And because the prison population is rising while government budgets are tightening, at least one of those private prison companies may be a good investment to think about now. Wall $treet Week with FORTUNE contributor Michael Farr has been looking into this trend.
Michael, what are the trends that make things good for somebody in the private prison business now?
MICHAEL FARR: There are about 2 million to 2.1 million people incarcerated in our country right now. That number is growing at about 2 and three-quarter percent per year. So we get two and three quarter to 3 percent more prison population.
COLVIN: That's faster than the population overall is growing I'd say.
FARR: I believe it is faster than the overall population, so that's a good thing if you are providing prison services I guess.
COLVIN: Right. And as well, governments don't want to pay for this, right?
FARR: Governments want to pay for it their way. And they like this pay as you go pay out of cash flow, pay out of current accounts, as opposed to let's build a new prison, let's commit a couple hundred million dollars and issue bonds. That part they don't like.
COLVIN: You actually went to visit one of these privately run prisons to see what it was like, and you spoke with the CEO of Corrections Corporation.
(Video clip begins)
JOHN FERGUSON: We are the sixth largest correctional system in the country. That means we are bigger than 45 states. We had some 63,600 inmates give or take a few. We do business with the United States Marshals Service, the Immigration and Customs Enforcement, as well as the Federal Bureau of Prisons.
FARR: As a taxpayer, the state or government will pay you $50 a day per inmate. You have to provide the same level of services, food, etc, in your facilities. You do that for that $50 a day and your company still makes a profit. Why can't the government do this less expensively and as efficiently as you can?
FERGUSON: We have some benefits that the public sector doesn't have. We are not constrained by procurement laws. Procurement laws actually add to the costs. We can go out and negotiate things down. We can pick what we know is the best provider, for that reason we can do things much more quickly. If we can build a 1,500 bed prison in 18 months, and it takes the federal government almost six years or seven years because of the procurement constraints they have, then you can imagine the benefit that we have.
FARR: Of all the inmates in the U.S., what percentage is outsourced to private prison management companies like yours?
FERGUSON: Approximately 6 percent.
FARR: 6 percent of the total population?
FERGUSON: Of the 2 million inmates that are incarcerated either at state, federal and local, our industry has roughly 130,000 of those.
FARR: My quick math says 50 percent.
FARR: How does a company like yours grow?
FERGUSON: There are some 30,000 to 40,000 additional beds that will be needed by the public sector every year. They've got to provide those beds some way. If you look at all the states combined, they are at 101 percent of their highest capacity. Highest capacity means they are utilizing space they ideally would not like to utilize. The Federal Bureau of Prisons is running 132 percent of their current capacity. So as these inmates are arrested, convicted and incarcerated, it generates that requirement for new beds. We have the beds to meet that demand.
FARR: We see movies like Shawshank Redemption. We hear horror stories about how dangerous it is to be in a prison environment, how violent it is. Is it accurate?
FERGUSON: Not accurate, at least not accurate in the CCA facilities. Now that doesn't say that when you have 63,600 individuals who have 24 hours a day to figure out how to do mischief that we don't have some situations, but as far as a continuing presence of violence, that just does not happen.
(video clip ends)
COLVIN: I'm assuming you don't have a whole lot of experience with prisons… how did the place strike you?
FARR: I don't have a whole lot of experience with prisons.
See, Mom, I said it, and she's going to be worried. I can just tell Mom's
watching. This wasn't as bad as I thought a prison would be at all yet
this was not a place I'd choose to spend time.
COLVIN: Let's talk for a minute about Corrections Corporation
as an investment. It's a growing company with a lot of good trends behind
it. If you look at the stock chart, it's been a pretty steady rise over
the past two or three years. High priced today - what do you think of
FARR: I think it is high priced today. It looks like a very full price to me. Any stock that goes up -- it was up over 50 percent last year, it's up about 30 percent, 35 percent year to date -- anytime I see that I always take pause. And earnings are forecast to be lower next year. That gave me pause. The reason that they're going to be lower next year is all of a sudden they're going to have to start paying taxes. They had a tax loss carry forward. The share price over the long term ought to do well. I think I would look for a little bit of weakness to buy this stock. I like management very much. I like the company. A little weaker price would make me feel better.
COLVIN: Michael Farr, it's always a pleasure. Thanks for being with us.
FARR: Thank you, Geoff.