For the last few weeks I've been reading "leaks" about the new PowerPC chip developed by a partnership featuring Apple [AAPL], IBM [IBM], and Motorola [MOT] and being used as the basis for an evolution in the Macintosh computer line. These new chips feature a RISC (Reduced-Instruction-Set-Computing) architecture -- a design approach stressing fewer, simpler, and shorter instructions. The design has already been successful in IBM work-stations, so it is not really untried.
The leaks promised a very impressive machine. Stories indicated about 99% of current Macintosh software (and essentially all commercial software) would run in the "emulation" mode with no problems while running at speeds within 20% of the current fastest Macs -- which could still beat most Macs in use. Programs designed from scratch or "re-compiled" to run in the native code would run 2 to 4 times faster than the fastest Intel (or Mac) processors. More importantly this chip is the low-end of a line of processors which should show increases in speed by a factor of 50 or more during its production lifetime.
The Intel [INTC] line is near the end of its useful life; they have done some work on RISC, butI would guess they are two years behind -- at least they haven't made any announcements. Intel has never been able to achieve timely introduction of its products, and they will have a difficult time financing a start-up without some major partners. They may have a large installed base of computers, but for computation-intensive applications, they are playing catch-up.; I see them losing market share although they will still grow.
In effect, Apple and Motorola (and to a lesser extent IBM) have said that if we market a powerful chip capable of running multiple operating systems on a personal computer, then the customer (or in computerese, "end user") can choose to use one or more operating systems as appropriate for his needs -- and the Apple-designed operating system is capable of overseeing the work. While IBM has designed and produced this first chip, subsequent chips in this series will be Motorola productions.
Apple is aggressively pricing these models; the low-end PowerMac 6100/60 with 8MB of RAM and 160MB of hard disk storage is being offered as low as $1599 without a monitor or keyboard (which can add roughly $400 to the cost). Early figures indicate Apple has orders for 150,000 of these machines. I now believe this is the machine any individual should consider first for a home or business purchase -- unless more computing power is needed. Most Macintosh software developers are expected to offer low-priced upgrades from Mac to PowerMac versions of their software, so investment in current versions should not be a waste of money. And as the technology develops these vendors are expected to "bundle" all versions of their programs on one "disk" and let the installer program choose which to load on the computer.
While thinking about the future I've also been thinking about the past.
Ever since IBM was included as part of the Dow-Jones Industrial Average the company has gone from being a "high flyer" to an also-ran "blue chip". The company which was a paradigm for all has followed GM and U.S. Steel (a.k.a. X) from being a company to emulate to a mature company with problems of their own. A company once viewed as a market leader -- not necessarily an innovator -- became one left behind.
IBM had a great run. But now that people have become somewhat disillusioned I am beginning to think the time has come to reconsider it as an investment. Their RISC design partnership with Apple and Motorola should be successful, and they have new leadership at the top.
What do I think about Apple? I've long been a fan of their computers (see my previous letter if you doubt this), but I have thought more than once that they were over-priced -- computers and stock. The key to their success will depend on the success they have in keeping their system software a leader -- this is where their leverage is. They put a lot of resources into delivering a great new computer on time. It will take at least six months before serious commitments are made to the new machine, so if they can get more developers to bring their products over to the new machine by making sure their operating system is still several years ahead of Microsoft [MSFT] they will be successful. The major products which have new versions for the PowerMac number about 35, and they are very impressive on the new machine.
What about Motorola? This probably is the company everybody believed IBM was. They are into the "information age" in ways most people don't appreciate. We know about their cellular phones, we know about their "success" gaining entry to the Japanese market, and you've read my opinions on their partnership with Apple and IBM. Try to remember if you've ever heard of "Iridium" -- this project will eventually have over sixty low-level satellites in a network providing communication with every point on the planet. Apple knows about it. George Gilder knows about it. He mentioned it in an interview in WIRED (1.4, available through AOL as I mentioned in my prior letter). I wish I had been writing this a year ago when the stock was around $50 -- I'd look so much wiser to you! At $108 or so I'm not real comfortable with the thought of investing here, but I like them and their leverage so much more than Intel -- perhaps a spread of long MOT and short INTC.
The PC/network is a tool for keeping information that is "bureaucratic" -- e.g., employee manuals, job descriptions, phone numbers -- current and accessible to all (or those who need to know).
Many corporations have had a difficult time understanding the Apple mystique. "The power to be your best" scares them; they want to be able to control how the computers are used and information is processed, and Apple has always played itself as "individualistic" (as in their classic "1984" commercial).
MSFT is a company capable of "pre-emptive" strikes when threatened by new software/competition. They announce new products and features in response to almost any presence they sense as possible competition. To many observers they seldom get these products or features right the first time out. However, very dependent on the presence of Gates, and probably several other individuals. These companies are capitalized based on the mind/mental capital they are able to attract to working conditions as employees -- what if the best decide to leverage their abilities? One or two good software products could allow the developer(s) to "retire". And if one is truly explosive -- say a new "operating system" then MSFT, in particular, is in great trouble. And if this OS is not hardware-dependent (or can operate across hardware platforms), then Intel, in particular, is also vulnerable. The chips are already commodities; computers are becoming more like commodities; the software (through OOP (Object-Oriented-Programming)) is next. I'm not sure what their software technology (or vision) is ... other than perhaps world domination. Many Mac people (i.e., "users") think of this company as rather arrogant -- they've never been through a down market.
Or if a new chip with important technical changes appears, proprietary considerations could delay their entry into the market.
Will the software trend be like that in governments and corporations? Several powerful, huge, specific, finely-tuned, designed-to-order applications working alongside "objects" which interact with one another doing very specific small jobs (for which they are finely tuned) or small generic applications which are context-sensitive (and event-driven?) and allow much flexibility and power at a cost of speed, memory, and storage (relative to what is current). The trend toward being able to do virtually any job in the office (if not the plant) with the "right" software.
I warned you about WIRED ... and USA Today gave a positive mention 2/1/94.
Of course, I told you about a preliminary favorable view of Apple's Newton and the WSJ of 2/3/94 headlined "First Hand-Held Communicators Are Losers, but Makers Won't Give Up". Well, I for one, still like the idea, and I think the technology will be taking us in that direction. Apple has recently introduced both hardware and software upgrades while reducing the price of the basic Newton by $100. Increasingly I find myself wanting to jot down thoughts which might pertain to this letter or other things I'm working on. I really want a mini-micro portable word processor, spreadsheet with note-taking capabilities and other features. Rather than carrying around a number of cards or having to "write" the information twice, the Newton -- or this "mini micro" -- would allow for entry once and ....
All this reminds me of one the most thought-provoking, insightful books I've ever read. Martin Mayer, our premier writer on financial affairs (even when I don't agree with him), the author of books such as The Greatest Ever Bank Robbery, Stealing the Market, Money, and Markets, wrote a book over fifteen years ago called Today and Tomorrow in America. A friend of my father's sent it to him, referring to "the many nuggets in this little 200 page book." My father's thoughts on the book compelled me to read it ... and I have re-read it every year or two since then.
Some of his thoughts (briefly) on technology:
And an "unrelated" thought from Lee Simonson: "Any event, once it has occurred, can be made to appear inevitable by a competent historian."
In my first letter I mentioned my uneasiness over the current levels of the stock market. About that time Forbes magazine had an article which referred to Value Line's models for predicting stock performance and market levels. Value Line has been historically optimistic about earnings and per share price growth; the article said research had been performed which suggested that Value Line's five-year estimates of price appreciation were on average about 70 per cent higher than they turned out to be. At the time VL was projecting growth of 55 per cent for the next five years. If they are overly optimistic by the average 70 per cent, then we could be looking at a stock market 15 per cent lower in the next 3 to 5 years This is a loss of 4.8% to about 2.8% per year -- compounded. In the last several months the Dow Jones Industrial Average has increased in level by about 10 per cent. With the dividend yield on the market at about 2.6% I feel very uncomfortable with the idea of being long the market.
I'm equally uncomfortable with the idea of being long longer-term bonds. They might be yielding 6.5 to 7 per cent to maturity, but a 1 point rise in long-term rates will cause an approximate drop of 15 per cent in the value of the bonds. As I first wrote these thoughts the CME raised margins on S&P futures positions by 25 per cent and the Fed announced a raise in short-term rates -- from 3 to 3 1/4 per cent (an 8 1/3 per cent increase).
Within 24 hours two distinct bodies raised the cost of buying this market even higher than the record price levels we have seen. The market sold off quickly but not very far -- about 5 percent.
Few market observers will mention that this will push many "bullish" professionals to neutral and those who are neutral to "bearish". I'm not referring to prognosticators (like I am being in this opinion) but those who invest and trade for a living. These two actions have suddenly made it easier to justify selling or being short stocks (and bonds) or trading from the short side of the market. Broker-dealers will now get about 8 per cent more for holding cash or having short stock positions than they did recently. And when option price levels are low, it becomes very attractive to leverage a position or buy "insurance" -- and option prices were generally at historically low levels, although they have returned to normal or above normal.
Many market prognosticators still like to make a big deal out of the short interest figures. I think we may be on the verge of seeing a period when a truly large short interest (as a percentage of shares outstanding or trading volume) will be a bearish indicator -- especially if "covered" by long calls. This statement has tended to be true for individual stocks and is generally true in the futures markets (as these large positions tend to be taken by well-capitalized, knowledgeable traders and speculators).
What if you like the stocks in your portfolio? I am going to suggest several possible ways of hedging -- none may be appropriate for you, but you must talk to your accountant and tax advisers, because using puts, calls, and futures can have various tax consequences which vary from investor to investor. The IRS has made some truly strange arguments and decisions about profits and losses with respect to certain trades; the only logic seems to be providing more revenue to the IRS regardless of the logic of the economics used to reach their decision (and thereby increasing effective tax rates).
You should also talk to your broker. If one or more of my suggestions makes sense to you, you might find it necessary to find another brokerage firm to handle your business, because many of the larger broker-dealers have high commissions on these trades and less knowledgeable people than some of the smaller firms which specialize in handling these orders and more fully understand hedging and the margining required. Also many brokers seem to look at options as something to be bought or sold rather than bought and sold or sold and bought.
Each of these suggestions should give you some measure of protection if the market falls.
Before the Fed's discount rate hike option premium levels were fairly low . They have since moved higher which might change the attractiveness of each strategy.
The strategies I mention can be applied to individual stocks or to your whole portfolio. Anything you do to hedge an individual stock will lessen whatever hedging is necessary for your portfolio. If you are trying to hedge your overall portfolio, you will have determine which index options and futures are most appropriate for your portfolio. You may also have to determine whether you will over- or under-hedge, because most portfolio strategies are based on dollar values (usually in $25,000 multiples); these dollar values are in turn weighted by factors -- usually called "beta" -- which are estimates of how each individual stock will react to a certain percentage move in the overall market (in theory a stock with a beta of 1.0 will have "identical" percentage changes in its price when compared with the change in the market -- most betas are positive, but you may see estimates range from slightly negative to perhaps as high as 1.5 to 1.8). Because these are "guesstimates" any portfolio strategy can have a less certain degree of success depending on the quality of stocks in your portfolio and the diversification of that portfolio.
The basic hedging strategy most stock investors know is selling 1 call for every 100 shares of stock owned. This is called a "covered write", because every option written (sold) is "covered" by 100 shares of stock (which is delivered if the call is exercised by a buyer and "assigned" to the seller). If you are still somewhat bullish, you might look for an option that is 5 to 10 percent out-of-the-money (i.e., having an exercise price 5 to 10 percent greater than the current price). Depending on the volatility of the stock, you could make an annualized yield of 20 to 40 percent or more for a three-month option if you get assigned. This position will hedge perhaps 20-25% of your exposure.
A more aggressive posture can be taken by selling the above call and buying a put approximately the same amount out-of-the-money. Depending on market circumstances this could be done at very little cost (other than commissions) -- perhaps even a credit. This position could provide a hedge of perhaps 40-50% of your exposure.
The most aggressive position I will suggest (I could suggest some much more so, but I'm trying to give you some realistic possibilities without undue risk) involves doubling the last suggestion -- that is, sell 2 calls and buy 2 puts. A price rise to the call's strike price could leave you short 100 shares of stock (you could buy a call one strike price farther out-of-the-money if this worries you, but this is an aggressive strategy). This hedge has the most variability; you could be marginally long to moderately short (say +20% to -40%) compared to your current position,
All hedge estimates are approximate because the figures change over the life of the option as the underlying price changes. The reason I told you options are bought and sold is because the hedge ratios do change -- even if nothing happens.
If you write an at-the-money option you will increase the effective return from this strategy for sideways or down markets, but will be more likely to lose any dividends and price appreciation.
Two observations from the Chicago Sun-Times, Tuesday, February 15, 1994:
"Fans who are enticed by the Gold Star Sardine Bar's unusual free admission policy should take note of the $15 cover on Julie Wilson's shows. ... Why the change? "We're defraying expenses," said co-owner Susan Anderson. Things will return to normal for most attractions, but a cover will be instituted for the more expensive ones.
"Actually, we had a good response with Bobby [Short]," she said. "People liked it, because it meant we were limiting the number of people we let in, so it was less of a mob scene." -- p. 23."
from Kup:
"The Mercantile Exchange's Jack Sandner's recent statement that the Merc is "cash rich" and may establish a profit-sharing plan caught the eyes of congressmen who feel if the Merc is doing so well, why not finally impose a transaction tax? The two exchanges long have argued that such a tax could drive the business to London and Tokyo. "
I want to add my voice to the "chorus" which is calling this the year of the CD-ROM and multi-media. Of course, some of these people have been saying this for several years. I've become convinced that the explosive growth will become apparent this year, because the pricing of CD-ROM players is more aggressive, and new "publications" such as Metacom's (META: Nasdaq) NautilusCD are truly impressive.
Nautilus will send you a free copy of a current (or recent) issue for the price of a phone call to (800) 448-2323. They publish both a Mac format disk and Windows format disk on a monthly basis -- some articles are particular to the format.
Date created: March 1994 Last modified: August 1, 1997 Copyright © 1994, 1997, Greg Cramer, O.M.S. Maintained by: Greg Cramer optionsms@earthlink.net