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Economic and Market Commentary

Still Crazy After All These Years

Long ago and not so far away in the land of Newport Beach, I had a family doctor – a general practioner as they used to call them. Nowadays, if he were still around, he’d go by the title of Doctor of Internal Medicine or something fancier and smancier than that, but back then he was just my “doctor.” Gene DiMaggio was his name, believe it or not. I used to always ask him how he felt when he grounded out on his last at bat in that 57th game of his hitting streak, but my comical query got a little stale as the years wore on. “I’m Gene, not Joe,” he would say and indeed he was - except he was “Crazy Gene” to me, for reasons that will soon become clear. Crazy Gene was actually a pretty good doctor, and I say that, I think, because I’m living proof. But he was a little chatty for my liking – primarily because he used to slobber when he talked, so bad that you’d wish he’d shut up, for reasons other than just the pleasure of his silence. “Close your mouth, Gene” I used to clairvoyantly pray, but it was a personal prayer – kept to myself to save him the embarrassment of realizing he resembled a six month old infant finishing his last gulp of Gerbers. I sometimes wished I could take a spoon and wipe the corners of his mouth just like I did with my own three bambinos, but perhaps I exaggerate a bit. At least his drool wasn’t the color of strained peaches or apricots – of that I’m sure.

In any case, his saliva was not the reason I used to refer to him as “crazy” Gene. He earned that title by telling me the story of why California was headed straight downhill and how he was prepared to deal with that reality. Our freeways and roads were so full of dangerous people, he claimed, that he carried a bicycle chain on his passenger seat in order to fend off potential attackers. Now I’d never considered myself to be naïve to the perils of the outside world, but he was going a bit too far in my judgment – especially for a man who had the pleasure of checking my prostate every other year. So I labeled him “Crazy Gene.” Despite these apparent eccentricities you could always count on Gene to be on time, conscientious, and concerned about me as an individual. “How is your sex life,” he would always ask. “Fine,” I would routinely sigh with the reflective knowledge of a 45 year-old male who had peaked 25 years earlier but was just then figuring it out. I’m sure he knew that though, as he nodded in silence with just a sliver of drool coming out of the side of his mouth.

What Gene didn’t know, though, and what he hadn’t counted on, is that medicine would change – that the paperwork, the declining income and the creeping advent of the HMO’s would force him to quit in his prime. “Crazy Gene” was 48 years old when he upped and moved to Boise, Idaho to become, of all things, a mortgage banker. He drove all the way up there by himself, bicycle chain at his side – little drops of saliva forming puddles in his lap.

Gene’s been gone for over ten years now and things have never been quite the same for me. Actually, I feel better now than I did then – it’s not a question of my health. My problem is that I’ve never found a replacement for good ol’ Gene. They don’t graduate many family doctors anymore and working my way through the hallowed halls of HMO land is almost not worth the frustration. The forms, the lines, the wasted hours of waiting are just too much for me – so bad that in the last few years I’ve begun going to the Newport walk-in clinic. The doctors there all look about 29 years old, and I presume they don’t know as much as the ones who work for HMO’s, but the service is lightning quick and I’m back at work within 30 minutes. Still, I can’t kick the sense that I, like “Crazy Gene,” have hit medical rock bottom. I feel sort of like a bum looking for cigarette butts along the side of the street, except this time I’m opening the door to a walk-in clinic. As I come out, I always pine a little for the days of my family doctor and I can’t help but hear in the back of my head that Simon and Garfunkel refrain – distorted a little bit to fit a different man and a different time: “Where have you gone, Gene DiMaggio, our nation turns its sickly eyes to you – woo, woo, woo. What’s that you say, Mrs. Robinson, “Crazy Gene” has left and gone away? – hey, hey, hey – hey, hey, hey.”

The last time I saw Crazy Gene, he was sitting at his desk bemoaning the advent of new age medicine. Holding his head in both hands, he swayed back and forth in his seat whispering “oh my God, I think I finally understand all this. I think I finally understand all this.” A similar light bulb went on in my head some time during the first few weeks of October as I was thinking about another new age phenomenon, the Internet. Never having understood it very well before, it’s difficult to pretend that I now have the key to cyberspace. I don’t. But I do have a few new age thoughts about the Net’s impact and influence on business and our financial markets. Cosmic, secular thinking has always provided one important link in PIMCO’s several decades long chain of market out-performance, so perhaps it’s not as crazy as it first appears for someone like me to be pontificating about something that personally is as foreign as an American tourist in France.

Actually, PIMCO has been at the forefront of this new wave for a number of years. Our 1995 Secular Forum was one of the first to address the Net and ponder its impact on growth, productivity and inflation. While it was never the primary ingredient in our Butler Creek scenario of range-bound inflation and interest rates, it was certainly one of our most important spices. Technology, and by extension – the Internet – we felt, would “bring good things to life,” leading companies not only to manufacture existing products in entirely new ways, but to create innovative methods of distribution that might eliminate middleman margins and therefore keep inflation low. We have been startled only by the swiftness of our prophecy’s fruition. The Net has multiplied geometrically and undoubtedly played a part in keeping inflation “contained” in the ninth year of a near record economic expansion. Companies lack pricing power because of globalization, to be sure, but the Net is now leading the charge towards even more intense global competition as international trade pacts and regulation have stalled out. A recent study by a national consulting group estimated that business cost savings through international use of e-commerce will rise from $17 billion in 1998 to $1.25 trillion in 2002. Wow – talk about disinflationary!

The Net has also played a significant role in stimulating economic growth and may be a primary reason why U.S. equity markets have done so much better than their European and Japanese counterparts. Of course, their list of non-U.S. Microsoft, Dell, and AOL look-alikes is a shorter one, but our stock market’s magic carpet-ride reflects much more than Net stock performance: it’s more a case of Net commerce influence . Of that $1.25 trillion in cost savings predicted for 2002, U.S. companies are expected to reap over half of the long-term benefits, primarily because our companies have been the quickest to innovate. In comparison to other industrialized countries, U.S. per capita income is now 31% higher on average as compared to 1991 when the gap was only 10%.

In addition, because of Net stocks and their influence, the S&P 500 has had a number of sterling double-digit performance years. Without them, the performance would be desultory indeed. Take a look at the following two charts. The top one shows New Age America via the Net. The bottom one displays smokestack America of yesteryear. These industrial cyclical stocks are actually down 35% over the past few years on a relative basis when compared to all S&P 500 issues, while Internet-related issues are up 138%. Quite a disparity.

Figure 1 is a line graph showing the percentage rise of internet-related stock issues in the S&P 500 index, from January 1997 to September 1999. By September 1999, internet stocks are around 240, up from an index level of 100 in January 1997. The metric is around 100 in September 1998, after which it soars upward, reaching a peak of around 240 in March of 1999, then drops to around 180 by July, before resuming its upward path. Internet stocks on the chart show a bottom of around 70 in April of 1997, and trade in a horizontal zone before the third quarter of 1998.
Figure 1
Source: ISI Daily Economic Report, October 7th, 1999

Industrial Cyclicals Relative To S&P 500
Figure 2 is a line graph showing the decline of industrial cyclicals as a percentage of issues in the S&P 500, from January 1997 to September 1999. By September 1999, industrials are around 65, down from an indexed level of 100 in January 1997. Industrial cyclicals bottom around 55 in March of 1999, then rise to April to a range of 65 to 70, where it trades through September.
Source: ISI Daily Economic Report, October 7th, 1999

There’s little doubt that despite what I believe to be a bubble market in U.S. stocks, that because of the Net, higher U.S. market P/Es are justified when compared to Europe, Japan, or even our own levels in the 70s, 80s and early 90s.

Now don’t go thinking I’ve gone soft on the stock market, just when it looks like it may be cooling off. I haven’t and just to prove it, here’s one giant frightening Net-related thought that bodes poorly for almost all corporate profits over the longer term. The Internet, as the past few years have proven, is one giant leap forward for placing information and indeed power in the hands of individuals. Trading stocks via the Net is just one visible example: instead of calling up your broker as was the prior modus operandi, the small guy can bypass Wall Street’s bureaucracy at a fraction of the price. The Internet, then, in example after example, whether it be buying an airplane ticket, or looking for the best deal on a new car, allows the user to shop for himself and eat into corporate profit margins in the process. Gary Hamel, chairman of a management consulting firm, was quoted recently in BusinessWeek as saying that “for many companies, consumer ignorance used to be a profit center.” Those days are rapidly disappearing because the Net turns unsophisticated shoppers reliant on local newspaper ads into global raconteurs eating into profits like a swarm of Egyptian locusts munching through a wheat field. It’s another way of saying corporations increasingly lack pricing power. Sooner or later, this transfer of control from corporation to consumer may eat so far into margins that the term “profitless prosperity” may take on new meaning. Stockholders beware: the consumer via the Net may turn out to be your worst enemy instead of your best friend .

These Internet-related influences on global economics and markets should resemble a host of other historical trends throughout the years that have inevitably surprised participants and observers both on the up and the downside. When Crazy Gene finally understood the ramifications of HMO medicine, he realized his job as family doctor was gone forever, and he was off to Idaho a few months later. A downer for Gene – an upper for patients and corporations looking to control their health care costs. Likewise, the Internet is no one-eyed Jack – there are two sides to its face. On one of its cheeks are displayed the benefits of low inflation and burgeoning U.S. economic leadership. On the other, an astute observer can glimpse a developing blemish of narrowing corporate profit margins resulting from a transfer of purchasing information and power to the end consumer. Whatever the result, my ex-family doctor up in Idaho and all the rest of us around the world will soon feel the Net’s mighty sword. Where have those simpler days gone, Gene DiMaggio? They’re even crazier after all these years. Woo,woo,woo – hey, hey, hey.

William H. Gross
Managing Director


No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.
This article contains the current opinions of the author but not necessarily Pacific Investment Management Company, and does not represent a recommendation of any particular security, strategy or investment product. 
The author's opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.
This article is distributed for educational purposes and should not be considered as investment advice or an offer of any security for sale. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Copyright ©1999-2003 Pacific Investment Management Company LLC. All rights reserved.

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