Wall Street Week With Fortune; 0141

US troops rolling toward Baghdad. Is that enough to get the markets moving again. Can a legendary stock picker be the guru of the index fund. So we put them both to the test and it's your fortune buried somewhere in the new list of Fortune 500 companies. How do you find out. That and more on Wall Street Week With fortune. Wall Street Week With fortune is made possible by contributions to your PBS station from viewers like you. Thank you. I'm Karen. And I'm Jeff called and welcome to Wall Street Week With fortune. Well in week three of the war better news from Iraq meant better news on Wall Street. Right now you'd think nothing else matters to the markets but of course much else will matter and I'll talk with two veteran forecasters about the possibility of a boom after the shooting

stops. And Karen we'll ask whether in this jittery market you should be picking individual stocks at all. Her guests hold decidedly differing views. While this week's war news was good for most stocks the war in general has been terrible for America's airlines which could lose over 10 billion dollars this year. Congress's efforts to help got stuck at the notion of subsidizing a failing industry that pays its top executives millions. Delta CEO Leo Mullin his compensation package was valued at thirty two million dollars last year. Yesterday he said he'd give up much of his pay this year but that apparently failed to clear Congress's sympathy hurdle. Both houses last night passed bills that aid the airlines and limit airline executives pay. The dramatic war news has made the latest corporate scandal easy to miss. But don't miss it. In just the past five days at HealthSouth America's largest chain of rehabilitation hospitals and clinics the board fired CEO Richard

Scrushy and the auditors. The company defaulted on an important bond payment and six employees pleaded guilty to criminal charges including conspiracy to inflate profits by up to two and a half billion dollars. This is WorldCom scale fraud as Simi a tale of greed as we have yet seen. And we'll keep an eye on it. The stock once $30 a share. Close the week at thirteen cents. And by the way one of its most ardent boosters was an analyst at UBS Warburg which happened to be health Souths investment banker. Not until after the fraud allegations came out. Did he finally change his rating on the stock from buy to reduce. Karen there was a bit more bargaining than reducing in the markets this week what happened. Well Jeff with investors preoccupied with over there there was a big doings over here this week while the war effort appears to be going just fine. The economy stinks. The unemployment rate held steady at

5.8 percent in March but the economy lost one hundred eight thousand jobs over one third of those losses in the travel related sectors. Not the kind of news on which to build a rally but rally the markets did as we quickly approach tax day. The mother of all tax preparers H&R Block said its office has handled fewer tax returns than they did at the same point last year prompting a downgrade from Goldman Sachs. Shares of Altria got smoked this week after its Philip Morris unit announced it cannot afford the 12 billion dollar bond required to appeal a recent court ruling. Not good news for cash strapped states that have become addicted to all that cigarette money flowing into their coffers. Since the 1998 tobacco settlement. And retailers are suffering from a war effect of sorts. Borders Books said traffic and sales have slowed as the nation focuses on the ongoing war. But in the typical What me worry fashion Wall Street charged ahead with all major averages moving into the plus column this

week. The Dow added 131 points on the week. The Nasdaq better by 14. The S&P picking up 15. Warning star style boxes give the edge to small cap value thanks to the airline industry's aid package. American Airlines parent a Amar soared 130 percent. But don't go cashing in those frequent flyer miles just yet. What happens to our economy and our investments when the war ends. Sudden boom. More tough slogging. The answer depends on much more than how the war goes well most of the public and the news media are transfixed by coverage from Iraq. Congress is about to enact a budget and tax cut package that could affect growth jobs and investments for years to come. The stakes are high here with insight into what's ahead is Kevin Hassett a resident scholar at the American Enterprise Institute who has advised President Bush on taxes and the economy. And William Dudley chief U.S. economist at Goldman Sachs for

forecasting the economy is his job. Gentlemen welcome. Heaven I gather that you think there is at least a fair chance of a real boom in the economy and the markets when this war ends right. Yeah that's right you know we saw the beginning of the war when it looked like it wasn't going to go as bad as maybe some people feared. The markets really celebrated it. I think that the question is Is the market right now a little bit afraid that Saddam still has something really bad that he can do to either our troops or maybe to Kuwaiti oil fields that could interfere with the development of markets worldwide and I think that once we think that Saddam is finished you know maybe we don't actually have him you know in our custody but we don't think he can fire missiles at Kuwaiti oil fields and so on that we should expect to see another market celebration and it could be a significant one. And if it is significant then that's good news for the economy. So then the economy you think might follow as well because it's certainly in the doldrums now. Well if you look at last year it started in the beginning of the year to look like a typical recovery which was surprising I think to many of us. But then near the end of the year we really

slowed down sharply and I think we slowed down because as Chairman Greenspan said the geo political risk started to make people hold off on their big capital spending plans and the price of oil skyrocketed. So I think that if the geopolitical risk is out of the equation and the price of oil is back in the sort of $25 a barrel range then there's no reason why we couldn't end up above where we were headed last year which is 3 percent growth and that's a pretty darn good year. It's pretty good. Bill you're not so optimistic right. Well I think that the economy is suffering for more than just you know political risk I think the stock market bubble has burst and that's causing balance sheet adjustments by business households and state and local governments who are finding that they're faced with a very large operating budget deficit shortfalls. That adjustment process is underway which is good but we think it's not completed yet. Also if you think about monetary and fiscal policy we've got a lot of support to the economy last year from both less support this year because the tax cut package hasn't been passed yet. Now the monetary policy side most of the effects of already been felt. Housing is up. Autos are up. Mortgage

refinancing activity is up here not to get as much benefit from that going forward. How much stimulus do we get from the big drop in the price of oil that we've had these past few weeks. Well I think you definitely get some effect we use a sort of a rule of thumb for every $10 a drop in the barrel pro-oil it might add about a half percent to GDP growth. The drop we've had is less than that so it's definitely a positive. But I don't think it's a strong enough to generate a very strong robust economy quite yet. The tax package that you mention is before Congress now the House and Senate have passed differing versions most people seem to think they'll split the difference. Some people have said this tax package is of historic importance comparable to Reagan's tax cuts of 20 years ago. I want to ask both of you. Do you think it should be enacted. Why I think we definitely need near-term fiscal stimulus because that actually helps facilitate the balance sheet adjustment. Households want to save more because the stock market has been doing very well over the last few years if you give them tax cuts they can save more without cutting back on their spending. The real debate I think between the Democrats and the Republicans is this the right tax plan to stimulate the

economy in the near term. You know the dividend exclusion is quite controversial because it costs quite a bit of money and the effects are felt over the longer term rather than right in 2003 2004 when the economy really needs the help. Good point Kevin what do you think should be enacted. Yes I think definitely it should be enacted I think in particular the dividend part of the proposal. You know it's true the dividend tax reduction has benefits that are spread out over the long term but if markets are efficient it's good news for the market right now you know the price of a firm to be related to how much that firm can put in your pocket over time. And that's a price response that we could see immediately if the dividend tax proposal is passed. And so I would expect that if the dividend proposal does pass and I think something like the president's bill will pass then we'll see a celebration in the market and if that's time to coincide with the end of the war in Iraq it could really be quite a positive development. But now you say that you've said a couple times that if we get a celebration in the market it's good for the economy. But isn't it supposed to work the opposite way right if the economy is looking good then the market will respond.

Yeah that's right I mean basically they're simultaneously determined and I think right now if we look at the fundamentals of the economy the negative effects of the decline in the stock market from a couple of years ago. Have abated that the capital overhang measures seem to be saying that there's not as big an overhang anymore and so that the drags can reverse themselves and economy could really take off and so therefore the stock market thing could sort of be the scientists right. And that was some economist speak but what it means is that businesses may have to start capital spending which really could help the economy move. Yes. The real problem I think is our business is going to start spending capital investment before they see the increases in demand have a little bit of a chicken egg problem. Do you invest before you see the demand or do you wait for the demand if you wait for the demand then it's hard for the economy to really cycle up. Another problem the economy has is the economy would really be depending on mortgage refinancing activity people borrowing money from their house. That's an automatic brake on the economy once the economy starts to strengthen. Because one consequence of a stronger economy the higher interest rates you'll turn off that mortgage refinancing engine. How much of a window do we have left for that particular activity.

Yeah. I think it's very important for our listeners to check because the odds are it's still a good time to refinance for people who haven't refinanced in the last six months. What do you think. Well I think the mortgage refinancing is still helping but I think it's going to be less powerful going forward for the fact that you know once you refinance once there's less money to pull your home the second time and the third time. And two I think home prices are starting to go up more slowly around the country. We have seen that. Kevin I want to focus for just one more minute on the dividend tax exclusion because that does seem to be the hot button in the president's tax proposal. I know you've spoken to the White House and the president about this. There's going to be some horse trading between Congress and the White House before this becomes law. How committed do you think the president is to the dividend tax exclusion. I think that the president has said on the record and he certainly said to a group of economists met with him including me in the White House a while ago that he's 100 percent committed to having the whole thing or nothing. And you know the fact is that Washington being Washington you have to sort of read between the lines and is that really what he means is he not going to horse trade when he can have something but not the whole

thing. And you know my guess is from talking to all the principals around town that they're looking at some kind of compromise that might involve cutting in in half or so. And so if we had to guess what's going to happen I think that might be a good forecast right now. Good to know Bill Things don't always go right. We've been talking so far mostly about the upbeat scenario but you've looked into other scenarios what could go wrong and what can we worry about. Well a couple of things that could go wrong was one we win the war with Iraq but maybe the peace is difficult to win the war with Iraq in. But that doesn't eliminate the geo political risk. We have plenty of political risks with respect to North Korea. Maybe Iran has some talk about Syria so the geo political risk may stay with us even with a victory over Iraq very shortly now. Final question you both at earlier points in your careers were economists with the Federal Reserve now based on that experience plus everything else you know. Do you think the Fed will cut rates on May the 6th. I think there's a very good chance of it I think that there's a lot of speculation about the Fed moving in or meeting

before May 6 I don't think they're going to move that quickly because they want to be patient. They think that it is mostly geo political risk restraining the economy. But if the economic news stay stays as bad as it's been it's going to be hard for them to resist when they sit down on May 6. Kevin what do you think. I think that Chairman Greenspan has conveyed to the market he's concerned that the celebration over the end of the war with Iraq could get us into something that gets carried away growth gets too high maybe inflation starts to take off. I think that's one reason why they sort of held back right now and they've been holding back despite the fact that as Bill says the data have just been awful. And so I think that it's quite likely that if the war with Iraq has resolved itself and we don't see the amazing celebration that we began our segment talking about that they will reduce rates again. Kevin Bill thanks so much for your views. Thank you. Well our colleagues at Fortune this week released the brand new Fortune 500 ranking and as always it contains fascinating insights for investors whose biggest Wal-Mart by a mile followed by General Motors and ExxonMobil the former title

holders than Ford and General Electric one of the most interesting findings is that not all five hundreds are the same the Fortune 500 collectively has been a better investment than the S&P 500 over the past year. And over the past 10 years the very best investments in the Fortune 500 last year were Crown holdings of maker of cans and packaging tentacle automotive Providian Financial a credit card issuer Pacificare health systems and believe it or not a dot com. Amazon Dot com. Several famous companies finally grew big enough to join the 500 of them Ace Hardware Starbucks And at number 500 Neiman-Marcus another newcomer is less well-known but that may change soon. The cars on America's roads are getting older and that's good news for Advance Auto Parts. The Virginia based retailer has been doing more than selling car parts in recent years.

It's been doing some shopping of its own buying up a handful of competitors and multiplying its stores and sales advance is now the nation's second largest auto parts retailer behind auto zone its newfound status among the Fortune 500 puts it a long way from its 1932 roots as a tiny local chain. And when our people first heard that we were in the Fortune 500 We were listed at four hundred sixty six on the Fortune 500 list they were very excited. You know the first thing they're asking is how do we get to be 400 on the last Advance Auto Parts went public in November 2001 at a time when Wall Street believed auto part retailing was a good recession play. Consumers would keep their old cars longer Street logic went and do their own repairs instead of paying a mechanic Advance Auto Parts. Stock is up nearly 19 percent since its IPO. The S&P 500 is down 22 percent in the same period. Simply put our customer base just doesn't consider a dud battery a discretionary purchase.

In a recent research note Solomon Smith Barney says advance is still an excellent way to play the retail market without significant exposure to volatile consumer spending. In fact some consumer trends are expected to help say. Last year more vehicles sold in the United States were made up of the vehicle population of white pickup trucks and VS and that's very important to us because the parts on those vehicles the replacement parts go for an average ticket price that's considerably greater than a passenger vehicle. Equity analysts say Advance Auto Parts should have no trouble meeting its 25 percent earnings growth targets this year. In fact I think the stock is undervalued. Still there are risks at Vannes took on a hefty load of debt to finance its growth and some of its acquisitions could take longer to integrate into the chain than expected. But neither managing debt nor converting stores is new to the company despite the same challenges last year it managed to rank in the top 20 on another Fortune list fastest growth in profits while more Fortune 500 factoid.

Of all the companies that were on the first five hundred in one thousand fifty five and are still on it today the very best performing stock was Altria formerly Philip Morris with a return of eighteen point six percent a year over the past forty eight years. The S&P 500 even a casual observer of the markets hears and reach those words dozens of times a week. The benchmark by which most investments are measured. But now fund giant Vanguard the company that practically invented index funds is changing the rules and the benchmarks. Saddam is not only runs the all the index fund He's also about to become the key decision maker on how Vanguard invest 400 billion dollars between stocks bonds and index funds. Marty Whitman the legendary chairman of the Third Avenue Value Fund says Forget index funds. If you buy cheap safe stocks investors will make money. He especially likes taking big

chances on distressed companies that others have soured on. Marty joins us from New York. Gentleman welcome. Well Gus let me start with you. Why the change in the benchmark. Well over the last 10 years or within my group we've identified characteristics that we think constitute the ideal characteristics for an index. About a year ago MSCI Morgan Stanley Capital International. Came out with a new index or announced a new index. They would be coming out with. We looked at the construction methodology and determined that in fact they met most of the criteria that we have identified as being ideal characteristics for an index. When they finally started producing some data this year we analyzed the data and we were very impressed with the style integrity. In other words the indexes really measure the segments of the market they're designed to measure. The large cap index is a very good measurement of what's happening in large cap stocks the small cap value index for instance. Turns out to be a very good measurement standard for what's going on

in small cap value market. And the other factor is they tend to have lower turnover than many of the commercially available indexes. All of that sounds very good but what does it mean for the individual investor. Well it means that if they're investing in let's say a large cap growth stock they're going to get a return that really reflects what's going on in the large cap growth portion of the market. The worst thing to happen is to invest in a segment of the market and have it be the segment that does outperform but not really being reflected in your index fund. So the no that they're going to get the performance of the segment of the market that they select. Marty what do you think about index. Indexes. But I'm on a theory that the market knows more. Than you as an investor can possibly know. For us that's arrogant nonsense we would never invest in a. Security unless we know a lot more. Than the market did in terms of what's important. I think indexes grew

at of. Biden capital theory which really is very very sloppy scholarship. Basically the theory behind an efficient market. Is that an investor. Can outperform on a risk adjusted benchmark in terms of total. Return. Consistently. That's what the theory said. And you ought to know that consistently is a dirty word. It really means all the time. I would agree with that. I would think of index funds as superior. To people who think they can beat the market on day to day trading. But there is really such a small minority of all investing. And basically investing. If you want to do well has to be grounded. In fundamentals where you

know more. Than the market about what's important. And things that are important are a lot more and I'm predicting next quarter's earnings. Well Gus Let's talk about that because a lot of people pick investment styles based on where they think the economy is going. And you say that you shouldn't look at the economic outlook or forecast into determining investment stock. Isn't that a contradiction. Well not really we think investors really should establish an asset allocation or an investment program based on their own personal needs regardless of what is going on in the economy. So someone investing today should come up with the same investment program that they might have come up with three years ago regardless of the fact that the market is way off. We think that a rational investor should allocate some of their money to stocks some to bonds and some of the money markets depending on their own personal situation and not try to guess which which type of investment will outperform or which segment of the market. If you're talking about just stocks of whether it's large cap or small cap.

You're going to be taking over like 400 dollars a day at that and what are you going to tell of the fasters index actively battered bonds or bombs. I think that there's a place for both index funds and actively managed funds index funds are great core holdings. They tend to outperform the majority of active managers. So for investors that don't want to take additional risk manager risk if you will an index fund could represent a portion of their portfolio or all of it. On the other hand investors that want to take a risk on an on and manager trying to outperform the index then they can invest maybe some in indexing some inactive managers in so far as stocks versus bonds for instance as an example bonds can also be indexed and purchased that way but that the allocation between stocks and bonds should be a personal decision for some people. It's 20 percent stocks 80 percent bonds for other people it's the other way around 80 20. Is it too late to jump on the buyout bond bandwagon you're looking at very low interest rates in our previous panel think we might even see the Fed go lower and right but it's not so much work that they can move.

Well the large part of the upside is behind this but that doesn't necessarily mean the bonds will go back up. I think that investors still should have some bonds because the stability to a portfolio. Martin you've made millions investing in distressed backs and bonds and particularly you're one of the largest creditors of Kmart. What's going on there. Well we don't advise distressed stocks. Any time a company is in distress our investments are as a creditor. Well talk about OK Mark let's talk about OK Mark and I were in the group that is going to take control of Kmart and then all equity reorganization. And the funds were putting in gives reorganization to value valued at KMart of approximately a billion dollars. For that. We get a very nice revenue. Base annual revenue of approximately 25 billion or a little better and we also get an awful lot of cheap attractive real estate.

If the thing works it works extremely well. There are I think there are three factors that will determine whether or not this Kmart investment is a home run. I would hope it would be and those three factors management management management. I think we have the right. Well I I have confidence to you today that you know we have the right CEO and we'll see how the thing plays out. You're also looking at some utilities and real estate yourself which I think tell industries as well as quickly. Why. While. I mean I have a long background in utilities I don't know a regulated utility that's never not made its bondholders whole. Since I started in 1979 when I was financial advisor.

To the president's commission on the accident Three Mile Island and Pacific Gas Electric we bought the first mortgages at a 25 and a half percent yield to maturity. OK. And I figured they never missed a payment because we bought a kilo. Dad and I react got to wrap it up here yeah. Oh thank you for talking with us. Guys thank you for joining us here. Thank you guys. We love to hear from your writers of Wall Street Week With Fortune Owings Mills Maryland 2 1 1 1 7 or email us WSW at PBS dot org. Next week we'll take an in-depth look at the food industry and you may even find out how to fatten your wallet while slimming your ways. And we'll also hear from one of the nation's top strategist Tom McManus from back America. He's ready to buy. Coming up next on many of these PPF stations now with Bill Moyers. Good night. We'll see you next week. To learn more about this program visit PBS online at PBS dot org America Online keyword PBS for a transcript of this program.

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