BRIEFING BOOK. Data Information Knowledge WISDOM. KEN SAFIAN Location: Forbes, New York, New York. About Ken Safian...

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1 BRIEFING BOOK Data Information Knowledge WISDOM KEN SAFIAN Location: Forbes, New York, New York About Ken Safian... 2 Debriefing Safian 3 The Safian Interview

2 ABOUT KEN SAFIAN Intelligent Investing with Steve Forbes Ken Safian is the president of Safian Investment Research. Safian began his career at Dreyfus & Co. and had Jack Dreyfus as one of his early mentors. Safian was also mentored by Edward Johnson at Fidelity. Safian was a shareholder and investment policy director of the Regent Investor Services, which managed $3 billion and was sold in the early 1990s to Alliance Capital. Safian has served as a director of the New York Society of Security Analysts and as a member of the National Association of Business Economists. He is currently on the executive committee of Edward Jones and Co. Safian graduated from the Wharton School at the University of Pennsylvania

3 DEBRIEFING SAFIAN Intelligent Investing with Steve Forbes Interview conducted by Alexandra Zendrian October 8, 2010 Forbes: Regarding the newly released employment data, what did you make of it and how should investors use or not use that kind of data? Ken Safian: Employment data are extremely important and I do I think probably more work on the employment data than the vast majority of research firms do. I ll tell you what I see that I didn t hear when I was listening to the news and speaking to my clients today. I don t think people appreciate that the overtime hours this month were 3.9 hours. A year ago, they were 3.0. So you re up a lot and that s a relatively high number. So I think it s very clear that corporations and businesses generally are using part-time people. Wouldn t you do the same thing if you didn t know what the heck the rules were going to be because the new government coming in as far as the House and the Senate are concerned and if the House would gain control, wouldn t that be different if you were an employer, that you would say, Gee, wouldn t they do this differently? I m going to wait a while and not hire a full-time person and once I see how the new Congress is and I see what the trend is, then I can make decisions better. And if the Federal Reserve, they re finished really lowering rates, they can t do that anymore so all they can do is really buy bonds. That s all they can do. That s very different. And if the economy does do better, well goodness, I think they d be in there raising rates pretty quickly. So I think you have a great deal of uncertainty here and I think that therefore corporations are acting that way. I think that Congress people are saying, Why don t those guys build plants? Why should you build a plant when you don t know what the rules may be. So I think that we re faced with a terribly uncertain kind of environment here for the next two years. Obviously it could be more so in the event if this or that happens in the elections, but I think that no matter what, it s got to be a lot closer between the Democrats and the Republicans than it is today. I would think that this whole idea of getting higher and higher profits is a little bit skewed because they re not putting the investment in. And there s another thing about the investment that I have not heard anybody speak about. The Bush tax situation regarding corporations, there was one thing that expired in December 31 and that was the larger depreciation benefits. So if you and I had a corporation and we depreciated more, well our earnings would not be as high, would they? Because our depreciation charges would be bigger. Well in the first two quarters, our depreciation is less. So our earnings are more. Now I don t know one analyst who has told me that we should have lower price-to-earnings multiples because of the fact that we have higher depreciation. And that depreciation is a big number. The capital consumption adjustment in the first quarter from a year ago it was down $170 billion and in the second quarter it was down $171 billion. That s an awful lot of money. For example, in the fourth quarter it was $63 billion. So you re up about $100 billion in costs. So do you think they should higher P/E multiples for that? I don t think so. If - 3 -

4 my earnings are up six cents per share or whatever, I don t think it should be higher. Well maybe that six cents better came from cost cutting. And if they re cutting employment as well, then that s going to be less. And if you re working people overtime, you re not paying these other benefits as much because you re paying them overtime and that s cheaper. It seemed like some investment advisors were saying that you should follow the unemployment number and the recovery and invest based on that that companies who could afford to hire were ones worth investing in. What do you make of that? I don t know because I think that if in a certain industry their labor costs could really go up a lot because they hired more people, why wouldn t they hire part-time people and wait to see what s going to happen with that situation with respect to labor costs dealing with health care. I mean, they ve got to do something here. So I don t know. It depends on the makeup of my firm as to how many employees they have, what kind of employees they have, do they have health care. Maybe I want to start hiring older people, where they re on Social Security and they can get cheap insurance through AARP. Maybe they would rather do that and then not have to pay them health care at all. It will be interesting to watch how the unemployment rate will be for older people. As someone who looks at sectors and rotates them, what sectors do you find enticing now and are there any that should be avoided? We were really the founders of sector analysis. I think the first person was Charles Dow and I don t think he s given enough credit. What he did when he started an industrial average, a utility average and a railroad average. And in my judgment, his utility average was really something based upon what the government would do, his industrial average was just a general industry and the railroad average was really based upon the unique factors in the railroad industry that were taking place. I don t think that you can really say how the whole market was doing and he back then saw these three categories and no one gave him credit for that. I think that no one followed his way. My associate and I, who unfortunately passed away several years ago, we started the growth/cyclical concept because we didn t think the Dow concept of industrials and rails and utilities was really the modern way of looking at the market. It was more growth and cyclical. We started this in 1961 and we began to put out stuff. What this meant to us was that our country was ending its World War II phase out of the rebuilding of the world. We were going to see more cyclicality within our country. So therefore we had to make a distinction between growth and cyclical. And we went back and we showed the disparities in earlier years. For example, you could have taken railroad and you could see how back in the 1800s you could see how the railroad industry was doing well because the government was putting rails in and then it was pulled back. So why shouldn t we have the same thing today? If you remember, we had a tremendous move in growth stocks, and back then they didn t call them technology, but companies like IBM were at a tremendous move at the same time the steel companies were bearish. And we had great disparity within our averages. For example, what happened in 1957, we had a cyclical average and a growth average. The cyclical average was down 20% and the growth average was up 15%

5 These are averages are fundamentally based because it s about what the economy s doing, what the tax aspect is doing. We do follow technical analysis; I don t belittle technical analysis. But I think you have to use the two groups together. What are some of the lagging sectors that investors should be watching out for now? This is watershed period. In July, 2009, we said that this was a new era that we were in. Not a new normal, because this is anything but normal. I wouldn t use the word normal at all. And I don t think things will be normal until we develop the new laws and everything else and then we ll see what normal is. Within a new era, you have to expect a lot of uncertainties and changes. So when you ask me what groups will do well, that s difficult for me because I don t know what the government s going to do. We had noticed that the technical pattern in the 30s as it was today. The percentage decline was exactly the same between the peak in 29 and coming down to the 1930s level as it was between what the peak was here and that period in March 2009 when the market was very weak. At that point, there were certain stocks that did exceptionally well in the 1933 period as you went up and those were all high-quality stocks that were primarily in the consumer-related area. Those would have been what we would have called growth stocks back then. Coca-Cola, Walgreen, the cigarette companies, they were all doing well. I mean, Coca-Cola was the stock of the century. It kept on going to new all-time highs. The growth stocks of today are no longer Coca-Cola. It s Apple, it s Amazon. Those stocks really did fly. Do you think they ll continue to fly? Probably so, but I don t think it ll be the same ones. As we go out in time, government regulations will change and therefore we will see other companies benefit from regulations, so other companies might do well. Certainly there are technology companies today that have had breakthroughs and I wouldn t see why those companies shouldn t do well. I think within technology, you re seeing a spread between those that are doing well and those that are doing not so well. I think it s clear that there s diversity there

6 THE SAFIAN INTERVIEW Intelligent Investing with Steve Forbes Sector Analysis Forbes: Ken, good to have you with us. Ken Safian: Thank you. Forbes: You're a long time observer of the market, but before we get into what lies ahead, you had a great insight in terms of sector analysis, of being in the right area even if you don't always pick the right stocks, if you get the right area, you're going to do fine. And you've made the point, heck, this is nothing new. Charles Dow did it from the beginning. We think of Dow Jones. But as you pointed out, you have industrials - this is going back a few years, to 1900 or 1996, you had industrials, you had railroads and you had utilities. Can you explain what gave you your insight into getting the right area? Safian: Sure. I think it was the beginning of when I first came into the business. I went to Wharton, and I didn't know anything about the stock market. I had a terrible teacher. Forbes: Even though you look like my son, when did you...? Safian: I graduated in '58, so I've been around for a long time. And then I started at Dreyfus and Company, and Jack Dreyfus was a big stock chart person and all. That's how I was introduced to watching the technical aspects of the stock market. And my other mentor, as a matter of fact, was Mr. Johnson at Fidelity. Forbes: You're right, you called him Mr. Johnson. Safian: I did call him Mr. Johnson, and I still do. And I called Mr. Dreyfus, Mr. Dreyfus, but everybody called him Jack. But I think that what you saw is different patterns developing in consumption, in the way stock prices acted, money flows; you really saw these different disparities. And I did go back to the '30s in my studies early on, and I realized that many of the popular stocks in the '30s disappeared and new companies came about. And it was interesting that we started a technology average back in the '60s. And I think maybe there are two stocks left in that technology average. All of them were taken over, went out of business, whatever. Some like Xerox are still in there, it's not considered a growth stock anymore. So, I think that the understanding, the transition takes place in the system, new technologies start. New growth sectors start. I think that you always have to update your indices and look at where these changes are taking place. And when we did that, in the early '60s, we clearly noticed that it was the first important recession period we were - 6 -

7 seeing, and we saw bear markets and cyclical stocks, and bull markets in a stock like Polaroid and Xerox. And that's when we developed our thesis of looking for companies that were growing and looking at new ways of doing things and we saw these very different sectors. Another thing that we noticed is that when the government became more and more involved with things, and more taxes, it would hit one industry different from another industry. Or inflation would hit differently in another. Now, when we had wage and price control, you had capital goods stocks doing terribly when they had the wage and price control period, and the consumer stocks did well. But when they took off the wage and price controls, the consumer stocks did terribly and the capital goods stocks did very well. So, I think that it was the understanding of that that we just did more and more in this area, and I can see that as we've gone along, we've had so many different patterns, and all the businessmen were trying to move into another area where there was growth, that that was carrying the United States and more companies were becoming less productive, less profitable. No Such Thing As The Stock Market Forbes: So, you make the point there's no such thing as the stock market. Safian: I don't think there is. I think we can generalize, and you say that generally stocks are going up, but I think it's more what the general economy does than measuring the... Forbes: So, you really have to get into the innards of the market. Safian: I'll tell you, one series that is very good. We stopped all our series. I stopped managing money in June of I thought it was going to be a terrible time, and I phased it out. And I just decided to continue writing reports. I had sold one part of my business, then I sold another part of my business. And I just felt it was going to be a big, bad time. But even today, I think it's similar to the '30s because in the '30s there were plenty of stocks that did very well. I don't know if - you've read a lot and you know a lot - but if you take a company like Coca-Cola in the '30s, that was like the Apple of today. It just kept on going up and up and up. Forbes: Now, before we get to today, what happened in the middle of the decade that rang the alarm bells for you? First of all explain, how do you see recessions? Most people predict ten recessions for every three that happened. Your average is quite a bit different. Safian: Well, we have a leading economic series. We could always say, oh, it was right, but we only went when we were right from when we had it and going forward. And it picked three of the past three recessions, and it gave you a warning period. And we have - 7 -

8 five categories of leading indicators in there. And we make changes in the leading indicators as the economy changes. And it's been a good series. Forbes: So, what were the five indicators? Safian: Well, we have five sectors. We have about 26 series. But they're broken into five sectors. And the interesting thing is the sectors that dealt with the financial area were doing the best, and the other sectors were doing poorly because the government was pushing financial. And that was where our country led. I mean, it was clear. They didn't say this. Economists never said this. That was where we saw the leadership. We were the financiers of everything, do you see? We weren't getting the production. We were doing the production abroad. So, the bank stocks and the insurance stocks and real estate. Anything that dealt with finance, that was where your big bull market was taking place. And now, of course, that is changing big time, and I think our government now has to deal with how do we get the industrial sector of our economy going again. Sound Money? Forbes: Now, in terms of that, this gets to the Fed. The Fed was printing a lot of money. And if the Fed hadn't printed money, we wouldn't have had this disaster. Safian: You know, everything is political to some extent, and I think that, you know, if you or I were head of the Fed, I think we probably would have had to bend to those political pressures also. But I guess some people bend more than others, and certainly, with your background, you wouldn't have bent as much as some of the people who were head of the Fed did, you know, I'm sure. But you know, when a choo-choo train is coming, it's tough to get out of the way, you know? Forbes: Are you saying in a democracy, that it's really impossible to have sound money as we once thought of it? Safian: No, I'm not saying, I think our dollar is still sound because I think that we learned from mistakes. The dollar now is very weak, and we're intentionally bringing it down so that we can compete more. But I believe that we're going to make that turn. Don't ask me when, but I think we're going to make that turn. You know, there was the old expression when the United States sneezed, all the other countries got pneumonia. I think we got pneumonia and they sneezed this time. You know, this is very different. So, I think we need a very, very basic change in our structural system. And as I said before, we have to get the industrial area doing better, and the financial area being more conservative. Forbes: Now, in 2005 or so, you made the point if you take out real estate, you take out financials, the U.S. was stagnant

9 Safian: Yes, it was. Forbes: In terms of profits and growth. Safian: It was. Forbes: And that was the signal to you? Safian: That was the signal, right. That was, and it got progressively worse. Forbes: And so, you did warn, Get out of financials. Safian: Yeah, we did. We did. And it was too early because they still did well. Forbes: Well, that's the problem with a bubble, you never know when it's gonna, you know, burst. Safian: You never know when the bubble's going to break. I admit my mistakes, that's one thing I do. Hanging It Up Forbes: But so, what are you looking at now? Why did you decide, for example, in the summer of 2008, before the biggest decline we had in our lifetime? Safian: Well, I decided before that because there was planning, so it was before that. Forbes: But that this was the time to hang it up, at least for a moment? Safian: Well, I saw that the political system - I do go down to Washington frequently, and have been going down since the '70s, and I could see that it was very difficult to make any progress in the direction that we had to go. And that had to change first. And I had no idea how it was going to change, but it certainly seems that with this coming election, we're going to see a change. The degree of it, we don't know. And I think that we're going to be forced to have more and more changes. And I think those changes will be good. I'll give you one example. And everybody I speak to, they don't even pay attention to it and say oh, that's crazy. But if we have too much debt in the system, why shouldn't we have the interest on debt not be totally deductible? And keep the dividends at a relatively lower tax, so that you would encourage more equity financing than debt financing, and you would get the debt to equity ratio in better shape, right? And that would make sense, but I have a couple of people now that are listening. But doesn't that make sense to do something like that, and try to come up with ways that you would have to make less use of debt? So, I think it's thinking like that that has to change, and we have to have some creative thinkers

10 Present Indicators Forbes: What are the things you're looking at now, indicators, and what do they tell you? Safian: I think we hit a very good bottom back in the late 2008, early 2009 period, and I think that bottom is going to stay. I don't think we're going to have an important double dip. But I do think we're going to continue to see diversity in the system. I think that the public has a mess of cash. So, I think it's very difficult to see an important stock market decline here. But certainly, you can see more of this doing well and that not doing so well. And more money could be funneled into certain areas or into certain stocks. Forbes: So, what are the Coca-Cola's today? What sectors do you think, based on the numbers you look at, say okay, this is a sector like the '30s that can grow even in the kind of environment we have now? Safian: You ask a good question, and I think a lot of that will be determined by what the government does. And part of the reason that I made this decision to downsize my business, and I just write reports now, was because I really had no feel, and I still don't have a strong feel as to what the government is going to do. But if they do do the right things, number one, technology should be very good. And it is. I mean, you see, but it's mixed, some are doing it, some aren't doing it. But that is a good area. And I think that we do have to do something also about education. Unfortunately, these education stocks that exist, you know, they have bad financing, they have problems. But I think the real changes I think that are going to take place are not so much in the graduate schools and all, I think it's going to be more in the very lower grades, when they're going to use the computers, and they're going to be the new, you know, dynamos and the good employees and everything else. And I think we have to relearn a lot in here. And I think that it's going to take time. But we're a very viable people. And I think that we will do it. Employment Numbers Forbes: Some examples of your ability to look at the innards of things, for example, employment numbers, what do you see that others aren't picking up on things like overtime? And then, in terms of profits, depreciation and the like? Walk us through those two. Safian: Okay. Well, I think as far as employment is concerned, we did see, for some time, that employment was deteriorating. And one of the things that we use that was a very good series was full-time employment, and full-time employment was deteriorating. And businesses were using more and more of part-time employment in trying to save money, et cetera. So, we saw that

11 So, I think that as far as employment is concerned, again, the government has to think of a way that you do want to have full-time employment. You don't want to have part-time people. If a part-time person wants to work part-time, fine, that's a different story. But if a part-time person wants to work full-time, and he or she is willing to work hard, why shouldn't they be able to work full-time, you know? Forbes: Does that mean we repeal Obamacare? Safian: Well, that would be one thing, I think, that a good way of doing this was. It very honestly, has taken the medical industry, and sticking only to the medical industry, say, that there would be a limit to liability if a drug company came up with, you know, a drug that hurt people, and yet, they really didn't think it. I'm not talking about if they're doing something intentionally wrong, throw them in jail. But I mean, if there's just an error because of, you know, an obvious error that was made not intentionally, why should that drug company have to pay, you know, zillions of dollars in insurance for that? Or why should a hospital have to pay? Or why should a doctor have to? Why can't that be limited to reasonable amounts, and make the if someone is intentionally doing something wrong, you know, put the guy away. I mean, really, nail him, you see. So, I think that that would really help, I think, in having healthcare be more affordable if you wouldn't have that. If a doctor, for example, wouldn't have to pay that kind of thing. So, I think it would be thinking along those lines, and whether it be Democrat or Republican, I don't think that should matter that much in something like this. You're just sticking it to healthcare, you're not putting it in a lot of different industries. So, I think you have to be more creative in saying how do we get these healthcare costs down? Does that make sense? Forbes: Yeah. I'm for reform of healthcare, positive reform. Safian: Right. Forbes: So, what does the employment picture tell you today when you look at the numbers? Safian: Well, I think that there's still a sluggishness, a desire rather to put a plant outside the United States than put it inside the United States. The flow of funds data that just came out that we just did a report on, it showed that cash flow is up there, but the capital expenditures are being held back. So, I think that we have to encourage investment in some way, in the United States. The question is how do we do that? Do we give more tax benefits and things of that sort? I would think so. Encouragement Through Corporate Taxes Forbes: Cutting the corporate tax rate

12 Safian: Absolutely, why not? Why not? If you do something. If you don't do anything, then you don't. I think it shouldn't just be cut the corporate profits tax. I think it should be make it more that you get an investment tax credit, bigger time, if you make that investment, or if you hire more people. Make your taxes lower if you're doing something to achieve what the United States has to achieve so that we don't have lawyers figuring out tricky ways just so you can get lower taxes, do you see? I think that it's not just cutting the tax rates, it's the way you cut the tax rates to encourage something better. And I don't think that's what we've been doing. Forbes: Now, on corporate profits, do we have a paradox here that if companies started to invest and take depreciation, that might put a hit on their profits but actually make them healthier? Safian: Well, firstly, I think there's a very big difference between the corporate profits in the financial sector and the corporate profits in the non-financial sector. As I said before, the financial sector was doing very well, and the non-financial sector, relatively, was going down. So now, we're beginning to see that shift, aren't we? So, I think that we do have to encourage the areas, you know, that we need to grow, and where we would get our better exports, et cetera. I think this is the trend that we have to go on. And we have to become more efficient, I mean, whether having better railroads and it doesn't take someone as long to get to their job, and you increase productivity that way because a person can get to their job faster, and they don't come in a half hour late or whatever it be, you know, there's a lot of different answers to increasing productivity. Being Picky About Investments Forbes: So, are you investing now? Or are you just sitting on the sidelines? Safian: Well, I'm being very picky. And I think that a lot of where I would like to invest, unfortunately, it's cloudy as to what the government's going to do. I mean, I think one of the best areas to invest in is still technology because the government doesn't have very much to say about technology in the new stuff because they don't understand it yet, so you can't pass a law against A, B or C, right? So, technology makes sense. But I think in other areas, where the United States can be more creative, you see, that is where I would be looking. And I think that I'll give you an example. I think we're very good in producing food. And we have a lot of land. Forbes: Some of us would agree, yes. Safian: We have a lot of land in the United States. So, I think that the food area, the agricultural area, if China's going to develop its lower class, or rather, India is going to develop, there's going to be a tremendous increase in the demand for food in the world

13 So, I would say that in that food production area, do you see, our government should encourage that. And so, we got a lot of land in the United States. I have a second house up in Massachusetts, gee, there are farms beginning to open there where before, there was nothing there but farmland, but no, they weren't using it for producing. Now, they're starting to use it, so the prices are going up. The Unusual Jack Dreyfus Forbes: Question about Jack Dreyfus. Unusual man. Is it true that in the afternoon, he would sometimes go out to the park? Safian: Feed the pigeons? Forbes: Sit with bare feet and just feed the pigeons and look at his toes? Safian: Well, I never saw him do that. But I did see him go down. He was a very odd man in certain ways, but a very good human being in other ways. And I'll tell you, I first came there from Wharton, and my first job at Dreyfus and Company was putting in the reinforcements on Mr. Dreyfus's charts, you know, and these things. You needed, you know, a Wharton degree for this. But I did the job right outside his office, you know, so I could hear everything that was going on, so I would be able to learn something. So, even though I was sticking on those reinforcements, you know, I didn't mind. And he took me under his wing, and he was very good to me to explain things and I think he was a very bright man, very, very, very bright man. And I respected what he did because he had a mutual fund, and he also had his brokerage business. And he felt that it wasn't right what the government and the S.E.C. was saying, to keep those two together. So, he voluntarily and early on split to two companies up. Now, you won't find many people doing something like that in business today. So, I think his ethics were very high as well. Forbes: Ken, thank you. Safian: My pleasure. Thank you