Most of the investment performance statistics we see each day portray the historical record as a series of identical twelve-month increments. But as we all know, the investment world doesn't always conform to the Gregorian calendar, and the annual numbers fail to adequately describe the daily ups and downs, or even the important shifts that seem to upset the trend every so often. So rather than wait until January 2001 to write the story of this particular year, we will break with convention to declare The Turn - a term we broached six months ago - in full bloom.

The year-to-date performance statistics hide the market's internal turmoil and remarkable shift from growth to value. Although January and February proved to be nothing more than the 13th and 14th months of a challenging 1999 for value investors, early March 2000 will be viewed by future market historians as an important inflection point. From that moment seven months ago, the previously unbeatable NASDAQ index is down more than 20%, the S&P 500 is up modestly while our managed portfolios and funds are up by a significantly greater amount. As usual, the change has not followed a straight line, but a preliminary review of our investment returns shows favorable comparisons versus the NASDAQ and S&P 500 in a clear majority of the monthly time periods. Don't worry: we haven't suddenly turned into momentum investors focused on short-term results; rather, we think it's simply worth noting that the market's internal shift appears to be more than a one-shot deal. That was our prediction six months ago, and we are sticking to it.

Well, now that we are clearly witnessing such a significant shift, it is time to determine "Why", or more to the point, the catalyst that triggered such a shift. Frankly, we have mixed feelings about these types of forensic exercises. On the one hand, we would all like to think we can discover valuable insights regarding the market's behavior. On the other hand, catalysts rarely appear in neon lights before they act upon the market. As we discussed last January, the Nifty Fifty (1973) simply ended one stock at a time - there was no particular trigger that ended one of the market's great runs (and ushered in one of its worst multi-year periods). So just remember: you were forewarned.

Based on valuation alone, the market's recent shift could have occurred quite some time ago, but it probably took a slowing economy -- and earnings -- to move the process along. The weak euro and $35 oil are raising all sorts of near-term problems for lots of companies. The big multinationals now find their products less competitive in world markets at the same time their European earnings translate into fewer U.S. dollars. The oil price rise adds additional problems: corporate operating/energy costs are rising while consumers will have less to spend on other items because of higher fuel bills. These issues present the market with the poorest macroeconomic context it has faced in several years. We certainly acknowledge these factors in our own work, and we have adjusted our models and estimates to account for these two challenges. But it is also worth noting that oil prices and the euro are likely experiencing cyclical, not secular changes, and thus the long-term impact from both factors may be quite small. Both oil prices and national currencies are subject to proven self-correcting mechanisms (remember: the world was drowning in $10 oil less than 18 months ago). So today's levels probably do not represent new equilibria.

While the weak euro and strong oil may represent key reasons why a larger-than-usual number of companies preannounced weaker third quarter earnings, from our perspective, these factors only tell part of the story. In the first place, the internal shift we have described started well before today's macro problems hit the radar screen. Second, the impact has been uneven and its greatest pain has been felt by the highest-valued areas of the market, like technology. Meanwhile, we have plenty of examples in our value-oriented portfolios of companies that face the same hostile macro environment yet have seen their stock prices rise.

The point of difference, in our opinion, is a renewed focus by investors on fundamental factors. Our commentaries in recent quarters have highlighted some important negative signals from the technology stocks, namely negative cash flows, the rising threat of bankruptcy among dozens of startups and, as further evidence, heavy insider selling. Well, it's now fairly clear to everyone (surprise!) that untested business models rely quite heavily on constant new cash from outside investors; when profitability and cash flow proved to be elusive, the capital markets window closed suddenly for nearly all of the players. Bankruptcy has become a real threat for many companies, and the outlook is for more distress: a recent analysis by Barron's identified 273 of 339 Internet firms currently bleeding cash. So, despite interesting new products, technologies and large potential market opportunities, the capital markets ultimately demand profitability - The Tribe Has Spoken!

But there is a related factor at work. Today's earnings disappointments appear to be somewhat greater than would be expected given price changes in oil and the euro. In our opinion, a key explanation is that many companies are running out of accounting tricks to boost their earnings. We have explored the poor quality of corporate earnings in previous commentaries: companies relying on one-time investment gains, questionable write-offs, option issuance and other distortions to improve reported earnings. For many of these tactics -- pension income, for example -- the rising stock market provided much of the fuel for the fire. But now that the market has reversed course, the decline in earnings may be larger than expected because companies can no longer count on investment gains or stock options (which substitute nicely for cash compensation) to boost reported results. How did reported profits become so distorted? Well, the incentive to boost earnings has never been greater -- thanks to the explosion in option issuance for corporate insiders -- and Wall Street analysts have been slow or unwilling to dissect reported results and hold management's feet to the fire. In any case, poor earnings quality creates another risk for both the offending companies and their shareholders.

At Harris Associates, our recipe for avoiding the risks associated with overstated corporate results is to focus our attention on free cash flow, not reported earnings. Our value philosophy is predicated on the strong belief that business value is driven by the amount of cash an enterprise can generate for its owners over the long-term, and so our research process is geared toward measuring, estimating and comparing this variable across our universe of holdings. There are a number of strong theoretical reasons why free cash flow makes perfect sense, but the most powerful reason today is that cash flow cannot be manipulated quite so easily by management. This gives us an additional sense of comfort during a period when accounting chicanery has proliferated and valuations provide small margin for errors or disappointments. Like Rocky the Squirrel, we always questioned whether Bullwinkle could pull rabbits out of his hat.

Six months ago, we presented a strong case for a resurgence of the value stocks, yet we admitted that our timing might be wrong. As it turns out, we were close to the mark, and recent investment results have been very encouraging. But new risks have clearly entered the picture: the energy shock in particular has a psychological aspect to it, so consumers are worried about their winter heating bills and may spend cautiously in coming months. Higher energy prices, the weak euro, plus the difficulty of further boosting reported profits present meaningful threats to corporate earnings as well as the general economy. By and large, we have been able to navigate these problems in the most recent period because we have remained focused on investment fundamentals and those stocks that offer the most compelling value (regardless of the economic trend). Our outlook today is mindful of the softening economic picture yet dominated by the opportunities we continue to identify in our work. If the recent past truly represents The Turn, then our portfolios remain well-positioned for just this type of environment.