The Bears' Club, Part 2

Barton Biggs, Jim Grant and Alan Abelson grouse about how to stay bearish in an era of unbridled optimism.
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Editor's Note: Part 1 of this three-part conversation with the three bears ran yesterday. The cast includes Barton Biggs, Morgan Stanley's chief global strategist; James Grant, editor of Grant's Interest Rate Observer; and Alan Abelson, the editor of Barron's; and they are joined by Henry Blodget, the Merrill Lynch Internet analyst known for his ebullient price targets. Nick Paumgarten is a senior editor at The New York Observer, where this article first appeared.

Valuations Are Wacky

Grant:

It's the irrelevance of valuation in general. It's not just that no known model of valuation seems relevant to the Internet. It's that the old-economy stocks are also immune to valuation. There are increasing numbers of stocks with decent balance sheets and fine prospects for profitability that are selling for just four, five, six times earnings.

Biggs:

But the question is, do they really have fine prospects of profitability? I think the Internet is changing the world and that its impact on the profitability of industrial America is going to be staggering. I don't think anyone has any idea what the Internet is going to do, but you know that it's very deflationary, and that it is crushing the profits in a lot of sectors in the economy.

Grant:

It's crushing profits particularly in the Internet sector, don't you think?

laughter

Biggs:

Yeah, it's crushing profits in both sectors.

Ford

(F) - Get Report

announced they're going to take $3 billion out of their costs by buying parts through the Internet, and that the entire automobile industry is gonna take out some incredible number, like $60 billion or $80 billion. That's coming out of someone else's profits, out of businesses that already exist. And that's why an auto parts supplier like

Federal-Mogul

(FMO) - Get Report

that looks incredibly cheap, a really good company selling at a discount to book value -- that's why valuing it is all irrelevant, because you have no idea what Federal-Mogul's profitability is going to be.

Grant:

So how can you invest not knowing anything about valuation?

Biggs:

It's hard.

Grant:

You just described the perfect case for Treasury bills.

Biggs:

Mmm.

Abelson:

If we extrapolate from what Barton said, there's not going to be an economy, and that isn't going to work very well.

Biggs:

Of course there's going to be an economy. How is there not going to be an economy?

Abelson:

If you kill profit margins through all production, I don't see how you're going to sustain an economy.

Biggs:

You may not kill Ford and

General Motors

(GM) - Get Report

.

Abelson:

Just the people that supply them, yes.

Biggs:

It's creative destruction. You're just taking out an inefficient layer of infrastructure.

Abelson:

Inefficiency is in the eye of the beholder.

Asking Henry

Grant:

In the case of an

Amazon

(AMZN) - Get Report

, Henry, how do you know how high is too high? Given the uncharted waters of valuation, what is the right price for Amazon?

Blodget:

I don't know. I think in valuing these stocks, you can only come to very vague, fuzzy conclusions. You have to go out several years and ask yourself what is the real opportunity here? Usually the mistake is in being too conservative.

Abelson:

You want a recent analogy for this market? Go to Japan in the late '80s. The same arguments were made then as are made now: that it's

different

.

Blodget:

I don't necessarily think this is different. But I do think it's always important to ask whether it

might

be different. If you're paid to manage large sums of money, if you decide that right now it is no different and we are five days away from becoming another Japan --

Abelson:

I'd say

three

days.

Blodget:

Well, if we are in fact three

years

away from that, in those three years it won't matter, because if you're on the sidelines when the market triples, you will have lost your job before you are proven right.

Grant:

It's always different. If it weren't, the historians would have all the money, whereas in fact they have so little of it. And yet there are aspects to every market that are eternal because markets are all about people in crowds, and people in crowds tend to repeat patterns of behavior.

Blodget:

And they tend to go too far both ways.

Abelson:

If you manage money, you have to take a different attitude. If someone calls a plumber in, the plumber may not like the architecture, but he has to fix the leak. People pay Barton and Henry to manage their money. Jim and I aren't restrained by having someone else's pot of money.

The Observer:

Then, do you feel restrained, Barton?

Biggs:

No, not really. But look at

Warren Buffett

. Buffett's just as bearish as we are, so he tries to be amusing about it.

Abelson:

It's the last refuge of scoundrels.

Biggs:

It's a defense mechanism.

Tomorrow, read the third and final installment of "The Bears' Club."

Nick Paumgarten writes for the New York Observer. He welcomes your feedback at

npaumgarten@observer.com.