Insight on the News - National
Issue: 06/10/02
--------------------------------------------------------------------------------
Wall Street Paved Over With Worry
By Jamie Dettmer
The contrast is stark. While the overall economy is improving slowly but surely, no sustainable bull market has emerged. Wall Street is becalmed as if in the doldrums.
In early May, Treasury Secretary Paul O'Neill confidently told Congress that the U.S. economy had "regained its economic footing," predicting stronger global growth later this year as a consequence. His testimony came days before a series of economic indicators showed that his confidence wasn't misplaced.
The Commerce Department reported that U.S. retail sales surged 1.2 percent to $300.3 billion in April, led by strong sales of autos, gasoline and building materials, indicating that consumer spending remains healthy, albeit not exuberant. Economists had expected the increase to be on the order of a more anemic 0.6 percent. "It's Christmas in April," declared Richard Yamarone, chief economist at Argus Research, an independent equity-research firm.
And in May there was sensational news, with U.S. productivity posting its biggest gain in nearly two decades during the first quarter — potentially good for company profits as it allows businesses to raise wages without hiking prices. Analysts said the productivity gain at an annualized 8.6 percent rate confirmed the Federal Reserve Board's view that keeping interest rates at their 40-year-low for another month or so wouldn't risk aggravating inflation.
And they held out hope that the retail report in particular would hearten investors to more than just dip their toes in the markets. There was an immediate rally on the release of the retail figures, with stock prices jumping on the news and bond prices slumping. But only card-carrying optimists expected the rally to continue, and the markets soon returned to the doldrums, highlighting once again the disconnect between overall U.S. economic performance and Wall Street.
Market skeptics argue that hardly is surprising. Investors have not been resisting the allure of stocks for fear of a consumer slump, they say, but for other reasons, including concern at the 18-month plunge in capital spending and worry about poor corporate earnings.
But they also say the cheerlessness of the markets is a dark post-Enron counterpoint. They argue that the bearish markets are a continuing consequence of post-Enron nervousness among investors and mutual-fund managers, who remain cautious toward stocks generally and especially toward companies that have even a whiff of potential accounting problems or where there is any hint of a possible restatement of earnings.
Unfortunately, there are plenty in the latter group to stoke concerns about the accuracy and honesty of corporate bookkeeping. Even before Enron collapsed amid allegations of fictional auditing, crony capitalism, stupendous derivatives losses, massive hidden debt and outrageous overstatement of earnings, more than 100 major U.S. corporations had to restate their earnings last year.
That figure is set to increase dramatically this year. Companies realize that if they aren't totally open about their earnings and debts, they likely will see their share prices tumble or run afoul of more zealous regulatory authorities. Shareholders have suffered $200 billion in losses since 1997 after restatements, the Center for Quality Financial Reporting at Colorado State University has reported.
According to a new study by New York University's Stern School of Business, U.S. companies are filing financial restatements admitting false or faulty accounting at a record pace. Kroger Co., the biggest U.S. grocery chain; Restoration Hardware Inc., a home-furnishings retailer; and Homestore.com Inc., the nation's largest online real-estate service, all have restated their results since January 2001.
With each restatement investor confidence is knocked further, adding to market gloom. "The public's sensitivity to the risks from financial-reporting failures has become extraordinarily heightened," said Stephen Cutler, enforcement director at the Securities and Exchange Commission. "Each day seems to bring a new restatement, revelation or allegation that calls into doubt the accuracy or completeness of another company's financial statements."
Hidden-debt questions continue to dog dozens of companies, including Tyco International Ltd., Cendant Corp., Williams Co., Anadarko Petroleum Corp. and WorldCom Inc. A vicious cycle is under way, and it's eating into the trust and confidence that underpin healthy markets.
"This is looking like the year of the restatement," Jack Ehnes, chief executive of the California State Teachers Retirement System, told Bloomberg. "It's certainly disturbing for investors who expect financial statements to be accurate."
A new reporting standard has been implemented since Enron went bankrupt, though it was decided on before by the Financial Accounting Standards Board (FASB), an independent agency that sets America's financial-reporting rules. It not only has not helped to break the cycle, but has added to investor doubts about the health of U.S. companies.
The rule change concerns the way companies assess "goodwill" in past acquisitions. It also already has been largely responsible for AOL Time Warner's announcement in April that the company would take a $52 billion write-down in the first quarter, the largest quarterly loss in U.S. corporate history. And investment professionals tell Insight they fear the rule will result in further breathtaking write-downs. Ultimately it could lead to a stunning $1 trillion disappearing off the books, producing lower share prices and a deepening of post-Enron public disaffection with Wall Street.
"Goodwill" is the difference between what a company pays for an acquisition and the value of the assets being acquired. So, if a company pays $15 million to take over a rival with fixed assets of $12 million, the excess amount of $3 million is classified as goodwill. Under old accounting rules, companies could amortize their goodwill over decades, with 20 years being a typical period to charge off equal amounts against earnings each year.
But the FASB changed all that by ordering companies in January to assess the value of their goodwill each quarter and to take so-called "impaired goodwill" charges when the value of those intangible assets declines, turning what once was a predictable expense into an unpredictable one. The rule change is known as FASB 142.
Any company that ever has made an acquisition, even decades ago, may now have to announce abruptly an "impaired goodwill" charge. That in turn can shock investors and lead to lower share prices. That's what happened with AOL Time Warner, although most of the media failed to explain the arcane accounting reason for the huge write-down.
Some analysts have little sympathy for company complaints about the write-downs, maintaining that it was high time to make corporations come clean about how much they had overpaid for acquisitions in the heady 1990s. Others worry that it could not have come at a worse time for corporate America and the financial markets. "For some companies, it could become a vicious cycle," said fund manager Hal Eddins.
Companies that take write-downs in the first two quarters of 2002 are allowed to attribute them to a change in accounting rules and avoid affecting earnings. But later, businesses have to take the write-offs against continuing operations, thereby influencing earnings.
Some firms have decided the best long-term approach is to write off as much as they can in the first two quarters, thus getting the problem out of the way, but it is adding to market gloom and unnerving investors. Already the write-offs are piling up — $2.97 billion by Aetna Inc., $1.48 billion by Viacom Inc., $856 million by AT&T Corp., $708 million by Ford Motor Co.
The FASB planned the rule change back in the summer of 2001, and supporters of the new accounting standard say there are good reasons for it to be imposed. In the longer term it will be helpful for investors, who will better be able to look at companies on a comparable basis, they say. Freed from the burden of an annual goodwill expense, a company's profits should climb. And, according to Bill Stromberg, director of equity research for T. Rowe Price Group, ultimately the companies that have taken large write-downs will find themselves assessed in a more positive light.
But, with investors being spooked by their large losses in the last few months, will they factor that in and ignore the short-term misery?
Jamie Dettmer is a senior editor for Insight.
-------------------------------------------------------------------------------
insightmag.com |
