Democracy and socialism have nothing in common but one word: equality. But notice the difference: while democracy seeks equality in liberty, socialism seeks equality in restraint and servitude.
-Alexis de Tocqueville

America's popular thinking and values are so entwined in this presidential campaign that, at times, TV and sports seem its only faithful mirrors. At NBC, the ratings for the 2000 Summer Olympics reached its lowest level in three decades. Perhaps it was because so many viewers chose instead to watch the thrust and parry of the US presidential candidates. But if that explained it all, why wasn't Olympic interest higher in the evenings, when The Veep and The Texas Governor broke from weighty conversations with Oprah and Regis? Perhaps the candidates turned to daytime talk shows because of their heavy evening schedules, Mr. Bush napping and Mr. Gore busily shaking the money tree among the Hollywood villains whom he skewers while the sun is up and the press awake. In early fall George W's fortunes turned for the better, at least temporarily, after he smooched Oprah and wore a decidedly hip, dark-colored shirt to schmooze with Regis. After a woeful three weeks of watching Gore ascend in the polls by promising all things to almost all people, Dubya leveled the playing field by learning the power of a kiss from the man who delivered THE KISS at the Democratic convention.

Perhaps Olympic viewership was down because so many of the "powerful" instead watched the nightly business reports and also surfed the Net. Their goal: to see how severe the stock losses for the malevolent corporations targeted by aspiring politicians for penance and retribution. The bigger the corporation, the better the target. It is a long list: oil companies, tobacco companies, pharmaceuticals, HMOs, hospitals, insurance companies, gun manufacturers, auto and tire manufacturers, cable-TV companies, telephones, airlines, credit-card issuers, banks, mining and forestry companies, trucking, railroads, brokers, and devious defense contractors. And do not forget the polluters, which would include just about all basic industries, especially chemicals, steel, aluminum, paper, and many electric utilities. Politicians also tried to scare investors by threatening powerful, recalcitrant corporations with the spectacle of breaking up the evil empire of Microsoft, a far-too-successful creator of jobs. Politics aside, perhaps so few people tuned into weightlifting and wrestling for a more practical reason. If played earlier in the summer, the Olympics might have drawn decently during those hot, lazy days and nights, but when summer vacations finish, most people return their focus to daily realities. Making a buck, soccer and high-school football, and the flux of new-school-year PTA activities probably drew away lots of eyeballs from TV. A first dose of reality probably noted by the studious: equity markets were not the most opportune place to be last quarter.

Four "E's" Bring Equity Markets an "F"

Most stocks struggled this year between March and the end of September, and the decline extended into October. The Nasdaq was particularly hard hit, as indicated on the accompanying table. The third quarter was marginally positive for the DJIA (+1.9%), but down for the S&P 500 (-1.2%) and the Nasdaq Composite (-7.4%). Year to date, all three averages and many others were below water; the total return of the Dow was –7.4%, the S&P 500 –2.2%, and the Nasdaq –9.7%. It has been a full decade since all three major US stock indices tallied an annual loss. Neither the S&P 500 nor the Nasdaq has posted a losing year since 1994. After a robust 1999, it will take a significant turnaround for the markets to offset their slump and register positive readings for the year. Even with a recovery, this year's return undoubtedly will be much less than the 20% to 30% that some investors have come to think normal.

For the remainder of the year, the four E's—energy, the euro, earnings, and the presidential and congressional elections—will continue to exert primary influence on the markets. The first three E's are very much interrelated, and the elections increase uncertainty across the board. Perhaps energy made the most dramatic headlines in the US recently. Dismissed for several months as only a minor inconvenience, the price of energy last quarter achieved major-problem status for both businesses and consumers at home and abroad. As energy prices escalated, so did political tensions in the US and the Middle East, and also in Europe, especially over gas taxes. Over the last several months, the euro declined in almost inverse proportion to the rising price of petroleum products. Oil now is almost universally denominated in US dollars. Already burdened with moribund, top-heavy regulatory hurdles, European industry and its consumers began paying high energy prices with a currency on a downhill slalom. For American corporations doing business in Europe, earnings have been hampered by both slowing European demand and negative currency translations. Denmark's recent election result—the Danes opted out of the euro system due largely to concerns that their womb-to-tomb welfare state would become less so—heightened the concerns of Europe's central bankers, who launched a defense of their new currency.

In the face of escalating energy prices and a reeling currency, economic growth in Europe has become problematic for American multinational companies. As corporations with significant overseas operations issued earnings warnings in recent weeks, aggressive money managers wielded the Damocles sword mercilessly. Recent victims include mammoths such as Eastman Kodak, Intel, Apple Computer, Lucent, and Dell Computer. On the last day of last quarter, Apple's market value was sliced in half as its stock price plummeted 52% from its previous day's close of $53.50, to $25.75.

No Gas and Slipping Gears

Concerns over energy, the euro, and earnings are not the only albatross weighing on the markets. Valuation levels are ratcheting downward, eroding the price of many stocks, particularly those with recent nosebleed P/Es. With growing economic and political uncertainties in the last several months, and even without a recession or with simply a soft landing, the remaining high P/Es of many high-tech darlings eroded steadily. Between its peak on March 10 and September 29, the Nasdaq declined 27%, and the trend continued downward as October began. At the close of third quarter, computer-related shares of the tech-heavy Nasdaq traded at 94 times trailing earnings, leaving little room for earnings disappointments. Prior to its plunge, Apple traded at a P/E of 29. At quarter close, the stock's P/E was a more modest 15. One week earlier, Intel issued a profit-shortfall warning and saw its market value slashed by a world-record $91 billion in one day. Dell Computer, another former high-flyer, hit a new low at the end of September after declining 39% since the beginning of the year. Despite the havoc wreaked last spring among dot-com stocks and more recently among the leaders of both the Old and the New Economies, other market sectors have fared somewhat better: their valuations have been corrected after years of neglect by go-go growth managers who preached that growth at any price is king. Ironically, even as ultra high-valued tech stocks reel and still have above-average market risk, a large number of stocks from industries as diverse as energy, utilities, beverages, financials, and specialty pharmaceuticals creep upward. And continued merger and acquisition activity has highlighted numerous examples of undervaluation by Mister Market.

These trends probably will continue for some time, adjusting the prices of stocks still suspended in the stratosphere and allowing other stocks to continue upward or begin recovery. No longer the boogeyman, the Federal Reserve Board has started to increase the money supply but probably won't change interest rates until next year. The overall economy remains relatively sound even as the earnings growth of numerous former high flyers has slowed. To a very great degree, the negative impact of energy prices has been discounted or anticipated by many stocks. As pricing pressures dissipate from energy imbalances and as investor fears wane of a restrictive Fed, stocks whose P/Es are relatively low should continue to move upward. Overall, P/Es should continue to moderate while still-inflated high-tech stocks continue to mark time or slide.

People's concerns about energy and prices are understandable, particularly in view of recent Middle East turmoil, but we believe prices should moderate no later than early next year. Relatively high energy prices in the near future should not provoke a tight money policy from the Fed as in quarters past: inflation is relatively low and the economy has lost some of its earlier steam. Without question, high energy costs have hurt some companies and industries. However, these costs are far more mild than in earlier economic periods. Companies these days are much more efficient in using energy, and shocks in the system are absorbed better now than thirty years ago, when OPEC first flexed its muscles. The energy situation is not a crisis of too little oil. It is a partially contrived, government-induced series of bottlenecks that have impeded supply and refining capacity. Proven world crude oil reserves have been rising steadily for decades. Knowledgeable experts place current crude oil reserves at six trillion barrels. With current consumption running about 28 billion barrels annually, the world has enough crude oil to last at least 200 years! As in the past, government efforts to manipulate the price of energy and demonize the oil industry likely will prove counterproductive. Perhaps it is too much to expect that the government adopt a market-based energy policy. Regardless of government blundering, the long-term dynamics of oil are far less foreboding than many Cassandras would have us believe.

Short Nightmares, Long Delights

Thus, after a frustrating period in the equity markets that has perplexed both optimists and pessimists, we approach year's end in a somewhat positive position. Alan Greenspan and fellow gnomes at the Fed have taken the wind from the sails of boatloads of hapless speculators. At the same time, the Fed has moderated economic growth, which should alleviate some inflationary pressures. As 2001 unfolds, the Fed should be ready to metamorphose to a more benign, accommodating creature. In many cases, relative earnings growth will look better for pedestrian companies than tech companies. The worst part of the energy "crisis" probably is behind us. Less energy discomfit should take some pressure off the euro. The first three E's will turn from negative to neutral or positive factors.

Are we concerned about factors roiling the markets and a large number of companies? Of course we are. But we also are aware of the tremendous opportunities that Mister Market recently presented, and still presents, to investors. The markets' consolidation over the past several months, plus the ratcheting downward of expectations, created a decidedly negative period during the last two quarters; stock prices fell to levels that terrified short-term investors but provided compelling investment opportunities for those with the long view. These market adjustments probably amplified the seasonal cycle of profit taking. Traditionally the period between November and April is a favorable time to be invested in US equity markets. For the last half-century, 90% of the profits from stocks have come in the six-month period of November through April, while only 10% of the market's total profits have been tallied between May through October. History continues to show the wisdom of the age-old adage, "It is time in the market, not timing the market, that determines success." Investors' confidence should return as they begin to look over the valley of waning problems to the prospect of a more accommodative Fed and still healthy earnings growth. Although it is unrealistic to expect a return of the supercharged and misplaced expectations of this year's first quarter, positive, less robust gains should be achievable through the end of the year. By focusing on corporations whose publicly-traded stock prices are at a significant discount to their intrinsic value, we at KING are confident of growing our clients' portfolio wealth over time.

An Election of Magnitude

And now the presidential election. While many think of the forthcoming election as a choice between Tweedledee and Tweedledum, in our opinion the election is one of great import. We recognize that politics, like religion and sex, is a sensitive subject. Yet we feel compelled to share some thoughts about the growing risk to property rights and individual liberty that is posed by growing demands for entitlements as a new class of rights. The implications for all of us, as citizen investors, will be both significant and long lasting.

Karl Marx remarked that religion is the opiate of the masses. Today the US seems to move inexorably toward an addiction to the opiate of entitlements. Each time an official injects a dose of government largess into the lifeblood of another special interest group, more of the citizenry becomes increasingly dependent on the government. Neither Democrats nor Republicans are blameless in the pursuit of special privilege. Dr. Walter E. Williams, chairman of the economics department of George Mason University and one of the nation's most honored and outspoken free-market economists, and an African American whose early adulthood overlapped LBJ's Great Society, excoriates both liberals and self-proclaimed conservatives who these days gorge at the public trough of entitlements:

Almost every group in the nation has come to feel that the government owes it a special privilege or favor. Manufacturers feel that the government owes them protective tariffs. Farmers feel that the government owes them crop subsidies. Unions feel that the government should keep their jobs protected from non-union competition. Residents of coastal areas feel that the government should give them funds for rivers and harbors. Intellectuals feel that the government should give them funds for research. The unemployed and the unemployable feel that the government owes them a living. Big business feels that the government should protect them from the rigors of market competition. Members of almost every occupation, profession, or trade feel that the government should use licensing requirements and other forms of regulation to protect their incomes from competition that would be caused by others entering the trade.

Conservatives . . . rail against food stamps, legal aid, and Aid to Families with Dependent Children, but they come out in favor of aid to dependent farmers, aid to dependent banks, and aid to dependent motorcycle companies. They don't have a moral leg to stand on. They merely prove to the nation that it is just a matter of whose ox is being gored. Conservatives as well as liberals validate H. L. Mencken's definition of an election: "government is a broker in pillage, and every election is a sort of advance auction of stolen goods." To the extent he was right, we must acknowledge that we, not the politicians, are the problem.

This year's presidential and congressional elections offer a fairly clear choice: vote either for a further diminution of individual liberty and economic freedom, or for a modest curbing of the government's growing, gargantuan appetite for taxes and restrictive regulation. Taxes are government claims on private property. The erosion of property rights—and by logical extension, the erosion of profit rights, too—moves all of us, individually and collectively, imperceptibly or more, toward socialism and involuntary servitude.

Examples are almost limitless of such government encroachments. Today as a percentage of Gross Domestic Product, taxes claim more of the productive labor of American consumers and businesses than at any time since World War II. The tax code has morphed from a source of revenue to a vehicle for social engineering larded with the spoils of redistribution. Over the past few years, the Federal government has used executive orders to execute a massive land grab of private property that would be considered extortion if conducted by private business or citizens. Daily at airports around the nation, how many thousands of potentially productive hours are wasted by besieged airline agents asking sheep-like passengers if they have been in control of their bags or approached by strangers to carry something? If you've built a house in the last few years, you probably know another small enslavement: federal regulations that require the installation of "water saving" toilets that, perversely, require excessive water to function. Our "representatives" in government do not have the backbone to flush away these and thousands of other examples of government overkill. Americans have become the subjects of rapacious politicians and unelected, unaccountable bureaucrats who, in effect, conduct a tyranny of the majority by the minority.

For a moment, let's overlook the fact that those who seek to "protect and care" for the masses have elitist convictions about their superior intelligence and knowledge of what's right for all of us. Let's even assume that these folks might have good intentions. What's most frightening is that these defenders of entitlements can achieve their goal only by curtailing rights to property and profits. In the end, supporters of entitlements stand against competition. Their agent for control is the government. They seek to replace individual market decisions with economic planning, higher taxes, and greater regulation and government control. They have good reasons for their goals but, as Williams asserts, "Every tyrant has what he calls a good reason for restricting the freedom of others."

President Bill Clinton said, "The era of Big Government is over." It is not, nor will it be, regardless of whether Al Gore or George W. Bush is elected. With each passing year, the sclerosis of Big Government brings great dangers to capitalism and its blessings—however imperfect that tree and fruit might sometimes appear—and reduces individual liberty. We would do well to heed some of Williams' conclusions—which, in a lighter vein, might have been anticipated by the old cartoon character, Pogo, when he noted that "we have met the enemy and he is us":

The elites' assault on the principles of freedom would have been less devastating had not Americans from all walks of life, whether they realized it or not, demonstrated a deep and abiding contempt for private property rights and economic freedom that stemmed primarily from their desire for government to do good. They decided that government should care for the poor, the disadvantaged, the elderly, failing businesses, college students, and many other "deserving" segments of our society. It's nice to do those things, but we have to recognize that government has no resources of its own. Congressmen and senators are not spending their own money for these programs. Furthermore, there is no Tooth Fairy or Santa Claus who gives them the resources. The only way the government can give one American one dollar is to confiscate it first, under intimidation, threats, and coercion, from another American. . . . If a private person were to do the things that government does, he would be condemned as a common thief. The only difference is legality, and legality alone is no talisman for moral people. This reasoning explains why socialism . . . uses bad means (coercion) to achieve what are seen as good ends (helping people).

Williams explains why, for many people, successful capitalism is the Achilles' heel of this society:

In spite of the tax burden, capitalism has been so successful in eliminating disease, pestilence, hunger, and gross poverty that other human problems now appear both unbearable and inexcusable. Free enterprise thus is threatened today not because of [capitalism's] failure but, somewhat ironically, because of its success. Although the rise of capitalism brought better treatment to women, racial minorities, the handicapped, criminals, and the insane, social reformers assert that "it doesn't work" and "is dehumanizing." In the name of ideals such as income equality, sex and race balance, affordable housing and medical care, orderly markets, consumer protection, and energy conservation, to name just a few, we have imposed widespread government controls that have subordinated us to a point at which considerations of personal freedom are but secondary or tertiary matters. If you take any steps toward a goal, one day you will get there, and the ultimate end of this process is totalitarianism, which is no more than a reduced form of servitude. As David Hume said, "It is seldom that liberty of any kind is lost all at once."

Beyond November

At KING, we ponder the long-term effect of the presidential election on individual liberty and economic affairs. We are apprehensive about both Mr. Gore and Mr. Bush. Mr. Gore is a man of THE STATE, whereas Mr. Bush is a man of the state. By this we mean that the Vice President has an abiding faith in both the wisdom and the ability of GOVERNMENT to solve problems. Mr. Bush, who appears to be less of an ideologue, calls for an extension of government functions. For some, the consolation is that Bush wants this extension at a significantly slower pace than Gore, and without overtly threatening to transfer wealth from the producers of economic growth to those who would demand economic resources as entitlements. Seven decades after the New Deal and the introduction of Social Security, and almost four decades after the introduction of Medicare and Medicaid, is it too much to ask now that this country adhere to Thomas Jefferson's famous prescript, "That government is best which governs least"? Or at least to hope that the electorate will make political choices based on factors more meaningful than puckered lips and a "free lunch"?

Having vented our political frustration with the state of America and the body politic, let us add that this is a great country. We hope that Americans of all political parties will awaken to the need to right their ship before it runs aground. This awakening might take longer than we would like but, as always, we believe that individual self-interest will work for the common good, especially when that is threatened. More immediately, the markets will survive the election of either Mr. Gore or Mr. Bush, plus any shift in congressional power, although the rules of engagement will be very different depending on who wins. With Gore, we will learn the impact of investing within THE STATE, which will take on many enfeebling characteristics of Europe's socialized nations; with Bush, we will experience investing within a state in which capitalism with a small "c" coexists with the appendages of liberalism with a small "l." Either way, investors will continue to be badgered by a host of concerns including taxation policy, government regulations, merger and acquisition oversight, and judicial rulings on commerce issues.

Above all, this year's presidential election, however irritating and inefficient, invites thoughtful investor enthusiasm for the ever-evolving American state. At KING we remain optimistic about the long-term future. In a world of change, we hold course with the Business Valuation Approach to investing. We continue to scrutinize the economic and political climate and to embrace the future in whatever form it presents, all to capture promising investment opportunities. In short, we are eager and ready to expand our clients' portfolio wealth. No matter who wins in November, we feel confident that our clients will prosper in the years ahead.

Roger E. King
Chairman and President

Other Contributors to this issue:
Leah Friday, Ruth Laseski, Michele Thompson and Marcey Whitney