Crescenzi-Farr roundtable
GEOFF COLVIN: Welcome to Wall $treet Week with FORTUNE. I'm Geoff Colvin.
KAREN GIBBS: And I'm Karen Gibbs.
They came, they saw, they conquered. In a move that surprised absolutely no one, the Fed policymaking arm met this week and raised short-term interest rates for the first time in four years. That hike in rates was an admission by the Fed that the economy is on track, which should be a good thing for stocks. But higher rates are supposed to be bad for fixed-income securities -- government, corporate, and municipal bonds.
What should investors do with the trillions of dollars sitting in money market funds? Tony Crescenzi follows the bond market for Miller Tabak and says now is the time to be defensive. Tony joins us from New York. Wall $treet Week with FORTUNE contributor Michael Farr joins us, as well.
Well, Tony, if a hike in rates was signaling that the economy is strong, we got some numbers Friday morning that were a little disappointing: Nonfarm payroll job growth, 112,000, was half what was expected. Where do you see the economy going?
ANTHONY CRESCENZI: There's a moderation under way that's been quite apparent for a number of weeks now, and so I think it's probably largely priced into the market. We've seen weak car sales, or weaker car sales than we had seen, chain store sales from the major companies, major retailers have been softer in June, restaurants are seeing weakness and so on.
It seems pretty widespread right now. But it may be the type of pause that refreshes. The economy typically goes through ups and downs, and this is just part of that down part of it. But the fact is the fundamentals of the economy remain sound, and the best thing I can point to in that -- despite the job number for today, which did show a gain of 112,000 -- income growth year over year is near 6 percent. The historic number is 5 percent. Adding to that corporate profits up $300 billion in the last five quarters -- tremendous fuel for expansion. So I see a reigniting of growth in the next couple of months, a better stock market then and weaker bond market.
MICHAEL FARR: Tony, what were the chances that that growth, or the rate of that growth, becomes inflationary and perhaps an inflationary concern?
CRESCENZI: Well, luckily with Fed chairman Greenspan at the helm, the likelihood of the inflation acceleration that we've seen this year -- and we have seen the acceleration, the core CPI running at a 3.3 percent rate this year, triple the pace seen in January on a year-over-year basis, which is the lowest since 1965 -- although there has been an acceleration, Greenspan is likely to keep it in check.
GIBBS: Most consumers aren't thinking that inflation is here, they're finding it very painfully at the gas pump. When you couple higher gas prices as well as higher interest rates, doesn't that mean you might see demand by consumers slowing, and wouldn't that be negative on the stock market?
CRESCENZI: A few weeks ago we saw a downward direction to GDP, the gross domestic product, for the first quarter. Instead of a 4.3 percent pace of growth, it was revised down to 3.9 (percent). The reason? Because there was more inflation than thought during the first quarter. Inflation cuts into growth, it reduces the purchasing power of our dollars. Some slowing in the pace of consumer spending could actually be very good here.
GIBBS: Bringing it back home to the investor, in an inflationary environment, rising interest rate environment, what should investors be doing with the trillions of dollars sitting on the sidelines? Should we invest in treasuries? Should we go to corporates? In fact, the six-month Treasury is yielding 1.5 percent right now. Over two years, 2.5 percent. What should an investor be doing?
CRESCENZI: Well, of course, much depends on the investor's objectives.
If one is seeking capital gains, right now, the Treasury market is looking a bit overbought, if can you believe it. The yield on the 10-year has fallen to about 4.45 from 4.9 percent a few weeks ago, and that yield, I think, is low, relative to inflation. The inflation rate we know is running closer to 3 percent, maybe it will go down to about 2.5. But still, the premium in yield over inflation is very narrow. We want to see that closer to 2.5 to 3 percentage points over inflation during periods of vigorous economic growth. It averaged 3.5 over inflation in the 1990s, for example. So the 10-year note, I think, is a short, if you can play TLTs -- that's a symbol -- it's an exchange-traded fund. That's one suggestion for aggressive players.
For those who are more modest about their strategies, I think right now, a defensive approach makes sense. If one must own and wants to own fixed-income securities, they want to own the shorter maturities, because even though they're yielding less with the T-bill rate so low, they are not as subject to the types of price losses that one can experience in longer maturities, which are much more sensitive, in terms of their price changes, to changes in interest rates.
GIBBS: What's your feeling on corporates or municipal bonds versus Treasury bonds, and where do CDs fall in this whole realm? When we look at a 2-year chart: A 2-year CD is at 2.05 percent, while a muni is just under 2 percent and the corporates are trading at 2.6 percent.
CRESCENZI: As I mentioned, I think cash flow is the story there. If corporate profits are improving, we're going to see more cash flow, is what that means, and so they become a bit less risky. But I do think, as the expansion progresses, corporates become less and less attractive; one wants to stay closer to the higher-rated instruments, and as far as Treasuries, which of course are triple A, the riskless securities. As the expansion matures, the risks of weakening and economic growth will increase, making these less attractive. So as the expansion goes on, reduce the degree of risk taking in certain assets.
GIBBS: Let's switch investments for a bit, because we saw the stock market the first half of the year pretty much tread water. The Dow was off approximately two-tenths of a percent, while the Nasdaq and S&P 500 are both better by a little more than 2 percent. Given the fact that the Fed has hiked rates and is expected to continue that, what changes are you making to your portfolio?
FARR: None. I continue to buy. I continue to put money to work. And I'm very happy with this environment.
It's strange that investors aren't coming into the market. I think it is a real reflection of sentiment, as we talked about last week with the Zogby poll. But there are plenty of opportunities within all sort of industry groups.
Bank of America. I love Bank of America.
GIBBS: In a rising rate environment?
FARR: In a rising rate environment.
GIBBS: Aren't financials supposed to be hurt?
FARR: Yes, financials will be hurt; I wouldn't own a mortgage company to save my soul. But Bank of America has a very diversified base. They have already been discounted. They're selling at 12 times earnings. Earnings are growing at 12 percent. Earnings for the S&P are growing at maybe 8 percent over the next five years, this is growing 12 percent. They just increased the dividend, 4.3 percent dividend. They're going to split the stock, they announced a 2-for-1 stock split.
GIBBS: Tony, I know you follow bonds, but looking at the stock market, are there any sectors, like the cyclical stocks, that are poised to do well in a rising rate environment?
CRESCENZI: Well, generally speaking one has to look at where we are in the interest rate cycle, and really, we're in the early stages. So I think certain industries that might be subject to risks related to interest rates are not going to be getting hurt just yet.
I think lately we've seen weakness in retail shares. My outlook on the consumer is pretty positive based on that 6 percent year-over-year income growth that we've seen, so I think some of that sector might fare well.
Basic material stocks -- I think that industry looks pretty good, because the amount of new supply coming to the market for commodities is still not all that great, making for good pricing power there.
Technology -- I really like the story there, because corporate profits now have picked up, and so they've got a lower P-E ratio than the market. Corporate profits are at $1.2 trillion; it's $300 billion more than five quarters ago. Corporate profits (now) exceed capital spending -- spending on equipment and so on -- by a little bit, so what this implies is that capital spending will be picking up as it has been for the last year, double-digit growth, will stay strong for the next year and a half, maybe two years, and I think that will help the technology shares pretty much.
GIBBS: But aren't technologies -- the companies, Mike -- usually heavily laden with debt, and doesn't that hurt them in the rising rate environment?
FARR: A lot of them are, particularly in the earlier-stage companies, they're highly leveraged. Others aren't. It really depends on the company, which I think makes this largely a stock picker's market. As I said, in the finances, I wouldn't own a mortgage, but I would own a big bank. They have investment banking.
In the tech sector, I like Nokia right now.
It's been beaten down. Stock's about $14 a share. They've got $3 a share in cash. You exclude that cash, and they're earning around 12 percent. I think it's really a cheap stock with a huge market share.
I think you can see other companies in different industry groups. APCC, American Power Conversion, they're around $19 (a share).
They make the power strips you plug your computer into and redundant backup battery supplies, they're the market leader. Trading around 19 times earnings, maybe 17 times after you exclude the $4 a share in cash. Management's excellent.
As Tony says, as you see this rebound in cap ex -- that we've been calling for years, we've been talking about looking for cap ex to return until we were blue in the face -- it's returning, and it looks like it's going to continue to return. Tech shares, tech shares with cash, tech shares with market share, leadership positions, I think are really are going to benefit. And on Nokia, you get paid 2.3 percent, so instead of getting your .8 percent in your money market account -- if you can stand it, own the Nokia, own General Electric, own B of A and make a little money while you wait.
GIBBS: Alright. One more question, Mike, and for you too, Tony: How many times do you think the Fed is going to hike rates this year and where will the market be at the end of the year?
FARR: I think the Fed has another two hikes, maybe three before the end of the year...
GIBBS: Each 1/4 percent?
FARR: Two more, I'm going to bet 1/4 percent each. Now that's really throwing darts. The market closes easily 10 percent higher than today.
CRESCENZI: Let's remember, when the Fed's raising rates, they're removing accommodation. They haven't raised interest rates in a way that's worrisome to investors; the 1 percent funds rate that we had recently was extraordinary. I think they'll probably do a few, we'll probably get at least three. There's a chance, if we have a strong holiday season, I think we might, because of strong consumer spending, that the Fed might be more aggressive soon around that period, around the holiday season or afterward.
But for the Dow, I think you're looking at thje second half better than the first. It's the opposite of what people thought at the start of the year. I think the market will find that the economy's entered the comfort zone: Not too strong, not too weak, great for stocks. And for bonds, rates might go up a little bit more, 10-year yield might go close to 5 percent perhaps, but the Fed is going to keep a lid on inflation. That's going to keep a lid on rates. A good environment for investors looking forward.
GIBBS: Tony Crescenzi, Michael Farr, thank you very much for joining us.
CRESCENZI: Thank you, Karen.
FARR: Thank you, Karen.
Investment scams
COLVIN: Everybody wants higher yields than bonds are offering, but could your hunger for higher returns make you easy prey for an investment scam? No way, right? Well, don't be so sure: Just this week the SEC shut down a bogus Web site that mimicked almost exactly the real Web site of Pax World mutual funds, except that it promised a guaranteed 657 percent annual return and asked for personal information that could be used to steal your identity.
Investment con artists never stop creating new and better ways to steal your money. So how can you protect yourself now? Gary Weiss is a journalist who's been covering investment scams for years; he's the author of Born to Steal: When the Mafia Hit Wall Street. Melanie Senter Lubin is the Maryland Securities Commissioner and plays a national role in fighting investor fraud. Gary, what's this latest scam that the SEC has just shut down?
GARY WEISS: Well, this scam is sort of a variation on a really sort of, venerable kind of...
COLVIN: They all are it seems.
WEISS: Oh, there's nothing really new under the sun. This is a variation of a couple of things. For quite some time there's been something called the private placement scam where basically the scamster will sell stock that doesn't exist, to reduce it to its essentials. In this case they were selling a mutual fund that doesn't exist. I must tell you, this is the first time I've heard of that happening, and I have to hand it to them.
COLVIN: There seems to be something that is called phishing, but fishing spelled phishing. What's that all about?
WEISS: Well, phishing, I think that's an Internet term, I do believe.
COLVIN: Yeah, it is.
WEISS: But you're really doing two things. It's really brilliant. You're stealing from people. You're stealing their money, because you're promising these ridiculous rates of returns, and you're also taking their information, and you can steal their identity. You steal their money, you steal their identity. I mean it's marvelous.
COLVIN: The latest statistics we have from the Gartner Research firm are that 57 million U.S. Internet users have received phishing e-mail. 1.8 million of them have divulged personal information, and reports of phishing attacks are going up 75 percent a month. It's really just incredible. Melanie, what can someone do if they think they have been victimized by something like this new Internet style of investment fraud?
MELANIE SENTER LUBIN: Well, I think with any investment fraud you need to get in touch with your regulators as soon as you think that...
COLVIN: Who are they?
LUBIN: You can get in touch with your state securities regulators, the state securities administrators in each state, or get in touch with the Securities and Exchange Commission. But it's really important that you notify somebody immediately, because the sooner we find out that there's a scam, the more likely it is that we can go in and freeze assets and try and get money to investors.
COLVIN: And what if you haven't been victimized, you're just suspicious?
LUBIN: I think if you're suspicious you should report it too, because the way we find out about our complaints and the way we're able to take action is by getting in early, and that's our best chance of getting money back to people.
COLVIN: It appears that in the past two years state regulators have filed nearly 3,000 enforcement actions against investment fraud. They assessed over $800 million of fines and penalties. They sentenced criminals to more than 700 years of jail. It sounds good. Any sense of whether we're getting most of the bad guys or just a few of them?
LUBIN: I think there are going to be bad guys out there no matter what's going on, and we're chasing after as many as we find out about. Anytime we get complaints and we can take action and try and shut somebody down, we're there and ready to do it.
COLVIN: Gary, the audacity of some of these frauds is just amazing, or at least it is to me, because a lot of these places are selling not bad investments; they're selling no investments. The money you send into them won't be invested in anything at all, right?
WEISS: Exactly. It's the classic scam. You know, you send them the money, and they keep it. That's actually, in many respects it's the easiest scam, because you don't really have to, you know, you don't have to deal with any actual stocks.
COLVIN: No, well, it certainly has a certain elegance and beauty to it.
WEISS: Oh, yes.
COLVIN: But I'm sure that, I mean I don't want to insult people who have been victims of these things because they've suffered a lot, but I'm sure everyone who's listening to you says how could anybody be so dumb as to send in money for something like this? How does it happen?
WEISS: People do it. People want, it really comes down to greed. You know, people are not satisfied with getting an S&P rate of return, which you can get by just buying into an index fund. They want to do better and, you know, it's understandable. So people are prone to all kinds of scams as a result of that.
COLVIN: Well, now a lot of this still takes place on the telephone, right?
WEISS: Oh, yes.
COLVIN: Good, old fashioned telephone, making cold calls to people and persuading them to send money.
WEISS: Yes, the boiler room scam, the old fashioned boiler room scam.
COLVIN: Exactly. Now I suspect a lot of people still just can't imagine that normal, intelligent people can be convinced to do this. Now you've talked to a lot of these scamsters, these con men. Let's suppose, for the moment, you're the con man, I'm the chump. I pick up the phone and say hello. What happens next?
WEISS: Well, usually they'll soften them up a little bit. You know, they might be what you call a lead call. Someone might call first and try to soften them up, maybe even sell them a legitimate investment, you know, to get the foot in the door. And then they'll come back at you, and they'll try to sell you the scam stock, either a real stock or a phony stock. That's when, you know, they'll come back at you and they'll say, "We want to sell you stock in Bear Paw Industries. This is guaranteed to do well." But they give you the hard sell and they make basically promises that aren't true. They're going to say "This thing is going up, and I happen to know, I've been in this business for 40 years and I've never seen a stock like this." You know, "They have a complete, they have a total dominance in their industry, and this industry will completely..." They just totally make up stuff, and a convincing con man can definitely convince you.
COLVIN: Well, and Melanie, you wonder who could be convinced by this, and you tend to suspect, well, it must be kind of poor, uneducated people, but I gather that's not the case.
LUBIN: It's not the case, and I'm very reluctant to blame the victims, because these con men, con women are good. They know what they're doing. They know the buzzwords. They know what to say to people in order to separate them from their money.
But there are things investors can do to protect themselves. They can get in touch with their state securities administrator. They can check out the person with whom they're dealing. They can ask us questions about the investment. They need to do their own due diligence. They need to understand that if this sounds too good to be true, it probably is. So even if you look at the SEC's Web site, people should wonder when something says it's going to pay 657 percent return. So there's always something in there that ought to raise the specter of suspicion.
COLVIN: Well, what are the buzzwords? I mean you know that these con men have worked hard to test concepts, to test words and stuff. What have they discovered really works?
LUBIN: I think what works is "guaranteed." You know, we're going to pay you a lot of money in a short amount of time, rates of return that don't make sense in relationship to what the market's paying, what bank accounts are paying. They con seniors by saying, you know, we know you're afraid you're going to outlive your investment, so these kinds of things will guarantee you the kinds of returns and preserve your principals. They hit all the words that people really want to hear to make them feel safe.
COLVIN: Should you send money to anybody who calls you up rather than you having called them?
LUBIN: I think you hang up the phone when those people call. If you need investment advice, there are places where you can go. You can find legitimate investment advisors, legitimate stockbrokers. I've really yet to see anybody become rich overnight by investing in something where somebody calls them on the phone, says "I'm sending the courier over to pick up your check right away." Really, hang up the phone. You know, you want to gamble, go to Vegas.
COLVIN: Go to Vegas.
LUBIN: But you want to invest, know with whom you're dealing.
COLVIN: You mentioned sending the courier over. I gather the reason they like to send couriers is to avoid charges of mail fraud.
LUBIN: That might work. I don't know that that actually works, but they really want the immediacy. They call people and they say, "You need to invest right away." And in my 18 years of doing this, I haven't seen an investment that if it was a good deal you couldn't do it the next day. You didn't need to be sitting there waiting for the courier to ring your doorbell to pick up your check.
COLVIN: Gary, would you ever send money to someone who had cold-called you?
WEISS: No. The fundamental rule that an investor has to apply is that you just don't buy any investment over the phone, even by a legitimate firm. It just simply is not advisable. You want to be able to take some time, evaluate it, and do your own research.
COLVIN: Now, in your book you took some of the regulators to task. Are they doing enough to stop this?
WEISS: No, I don't think so. I think our regulators, I'm talking about the NASD and the SEC, who are the primary regulators of the over the counter and of the stock market, are being, I think they're too reactive. They're not proactive. It certainly isn't, they're not doing as lousy a job as they were doing, say, 10 years ago, but I don't feel that the regulators are proactive enough, getting out ahead of the investment scams.
COLVIN: Melanie, you prosecute some of these awful people when you find out about them, but how do you feel about the regulators that Gary is talking about?
LUBIN: I think we all have a lot of work to do, and I think we make attempts to do, you know, to address the issues, and a lot of times the issues of the day are the things you have to chase after. But what I've found is that really educating investors is what's important, because, you know, teach investors to have a healthy dose of skepticism. You know, it's trust but verify, you know, learn about the people with whom your dealing, learn about the products, and pay as much attention to your investments as you do to what toaster you're going to buy to replace the one that burned down your kitchen.
COLVIN: It's true. People sometimes do shockingly little research into huge amounts of money they're going to send.
LUBIN: Right, they'll just write a check for $100,000 without thinking about it a lot, but not want to spend $50 on a toaster without reading Consumer Reports.
COLVIN: Yeah, exactly. You know, one thing that a lot of people have got to wonder about, and that I wondered about for awhile, Gary, is where do the chop houses and boiler rooms get the lists of names to call? Because they don't just call randomly through the phone book.
WEISS: No, they buy lists themselves. These are known as leads in the business, and these leads are generated by legitimate firms, such as Dun & Bradstreet. The brokerage firms sell them to each other. There are list brokers, and in my book I deal with how they even stole leads. They would sometimes send a burglar in to steal leads from brokerage houses.
COLVIN: We're not talking about electronic theft. We're talking about good, old fashioned, physical breaking a window and going into an office and getting some papers.
WEISS: Absolutely, just like in Glengarry Glen Ross. It was exactly the main plot line of Glengarry Glen Ross.
COLVIN: Do you think that Internet shopping sites where we all buy so many things online have made us a little too casual and cavalier about giving credit card and other personal information online, Melanie?
LUBIN: I think people need to know where they're sending their information. I would never respond with that kind of information to an unsolicited e-mail. You know if your bank, your brokerage firm wants to get in touch with you or you're getting an e-mail that looks like it's coming from them, pick up the phone, call the branch. Find out are you, do you really need this information from me? Because the scam artists are just, are way ahead of the technology even with legitimate people, and they're going to use it to their advantage.
COLVIN: It's a good note on which to end. Melanie, Gary, thanks so much.
LUBIN: Thank you.
WEISS: Thank you.
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