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Issue XXI

October 1999


Sharp Investing


Y2K
Prepare or Panic?

The Y2K problem (for those that have been living in a cave for the last four years) is the result of computer programmers attempting to save valuable memory space thirty years ago by using the abbreviation "00" in code rather than the full date "2000". A 600 billion dollar industry has sprung up to correct problems associated with this shortcut. While much testing, time and money has gone into trying to minimize the potential problems, the fact is that no one really knows what kind of impact the Y2K problem will have on systems, society, the economy, and the government. 9/9/99 recently passed without much of a problem (programmers used to use 9999 at the end of programs as a stop flag), but this problem is thought to be much less pervasive than Y2K.

So called "Y2K experts" predict everything from total global recession and a breakdown of society to business as usual as Y2K turns out to be a big deal about nothing. Part of the problem is in trying to determine what a problem on such a micro-level will do on a macro-basis. Programmers and software experts can understand the problem, but politicians

and CEOs are the people implementing policy decisions about how to handle
these problems and how much money to allocate to various systems.

So where things stand right now is that some companies and government agencies have thrown more money at the problem than others, just as some countries have thrown more money at the problem than other countries. Still, two
big unknowns remain:

1) What systems will be affected and
to what degree?

2) How will people, society, and countries react to any problems?


I think that most of the systems that might be most impacted by the problem (utilities, financial institutions, public systems, and
other data-intensive areas) have probably reduced their exposure to a few isolated problems and the chance of catastrophic breakdown is limited. However, there may be systems that haven't been looked at as closely that may experience more severe breakdowns, but I think the problems will be temporary in nature.

So far people's reactions to Y2K are like a bell-shaped curve, with one end stocking their concrete bunkers in the wilderness, and the other end making travel plans for New Year's Eve 1999. The vast majority of people are somewhere in the middle - aware, slightly concerned, and planning for the worst while hoping for the best. Recent polls have determined that 1 in 3 Americans are doing "something" about Y2K, from storing a little extra water and cash to checking the hardware on their PC's.

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Y2K and Investments

Given the unknowns outlined to this point, what can investors expect from Y2K?
There are three main areas that need to be addressed; systems, economic impact, and financial markets.

Systems - My first suggestion would be to have two weeks worth of cash available before the end of the year. It is within the realm of possibility that credit/debit cards and/or checks may not work for a couple of days within certain systems. Secondly, for the first month or two after the turn of the century, I would look over bills very closely
to make sure you are being billed correctly, and make sure the companies that you
pay your bills to are properly crediting
your payments. You may even want to make copies of your proof of payment for
a couple of months.

Finally, I would suggest very carefully scrutinizing your bank and brokerage statements, and make sure that there is continuity from your November to December to January statements (your December statements will be generated after the first of the year). Keep hard copies of all financial transactions during this timeframe in case electronic records are destroyed. The SEC has been very carefully reviewing Y2K compliance
among brokers and while the chance of lost or botched records is slim, I think the possibility is greater with many of the very small brokers as compared to the national names.

Economic impact - Make no mistake about it, Y2K will have an impact on some corporations, there are millions of businesses in the United States alone, and even if 99% of all companies have no problems there can still be tens of thousands of companies with serious Y2K problems. Most publicly-traded companies have a Y2K policy, have done testing and repair, and are likely better prepared than virtually any other organizations in the world. If you contact the public companies that you hold stock in, they will all tell the same story - they have mostly completed their Y2K testing, are not aware of any further problems, but won't know until the event happens exactly how they might be impacted. Even if a company has no problems, they could experience problems due to vendors, suppliers, or customers that have their own

Y2K problems. There is just no way to assure that any company will be 100% glitch-free. As a rule of thumb, giant companies have much more that can go wrong (more mainframe computers, older imbedded systems, etc.) but also have greater resources to prevent problems and more in-house expertise. Smaller companies may be less likely to have problems, but also can be more severely impacted economically by a disruption in business. The same concept applies to countries. The United States is much more prepared than many countries, but is also much more reliant on the type of systems that may experience problems.

Companies with a lot of debt to service, with extensive foreign operations, or with sizeable accounts receivable, could find it hard to make ends meet if they suddenly found their revenue stream were temporarily interrupted. However, I believe it will be a fairly rare case in which a company is permanently impacted by Y2K problems.

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On a broader economic scale, there is the possibility that Y2K issues would be disruptive enough to the economy to throw the U.S., and even the whole world, into recession. However, the Federal Reserve has calculated that Y2K issues are very unlikely to take more than one tenth of one percent off of GDP. In other words, the Federal Reserve expects that Y2K could slow economic growth from say, 4.0% to 3.9%. On the other end is Ed Yardeni, a respected economist and forecaster that puts the chances of worldwide recession due to Y2K at 70%! My feeling is that if Y2K is bad enough to throw this strong economy into recession, I am probably going to be more worried about survival than about how my investments are holding up.

Financial Markets - The first law of investing (and human nature) is that markets hate uncertainty. The second law of investing is that most investors think with a single brain, i.e. herd mentality. To this point financial markets have been completely unfazed by dire Y2K predictions. However, I think that there is a good chance that sometime between now and the end of the year there will be a Y2K panic as the herd decides it is time to stampede in that direction together. Of course, at that point no one will have any idea of whether there is an economic impact behind the panic, because it won't have happened yet! The thing to keep in mind is that any Y2K panic that starts before the turn of the century is purely psychological, as nothing more will be known about the problem then than now - we will just be closer to it and it may get the herd's attention. Logically, if investors aren't worried about Y2K now, they shouldn't be in December, but realistically, as the event draws close some investors may panic.

Corporate Y2K problems are likely to be of the nagging, temporary variety rather than of the "complete destruction of the

business" variety. So most of these problems won't even be apparent to the investing public until the companies report first quarter 2000 earnings months after the event. Therefore, I believe it will be worth the risk to pick up a good company at a panic price (if it occurs) and then wait for the first quarter results to clear the good name of the company purchased. The other thing to keep in mind is that any correction in the market for anything other than changes in economic conditions is usually very short. So unless Y2K problems are so bad that they send the economy into recession, it is a good bet that panic prices won't be around long.
Y2K is a funny thing. It's like knowing exactly when an earthquake is going to happen, but not knowing how big it is going to be. I expect that there will be some sort of market-related Y2K panic at some point late in the year, but I view it as a potential opportunity rather than a reason to throw in the towel. I am planning on making purchases if the panic throws out the good with the bad indiscriminately.

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Therefore my bottom line strategy for long-term investors is the following:

  • While it may be completely unnecessary, taking precautions with cash, bills, and statements is cheap insurance in case you run into system problems.

  • The chance of a severe economic impact from Y2K is low, so buying during a pre-Y2K panic is a good bet.

  • Selling during a pre-Y2K panic is herd mentality and is not a good bet. No more will be known during the panic than is known at this time. Delay any selling decisions until the truth is known after the actual event.

  • If there is economic impact from Y2K, either to the economy or individual holdings, try to determine how long the impact will last versus your own patience and make portfolio decisions based on facts - not speculation.

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