No Market Rebound Until Companies Come Clean
washingtonpost.com
_____Investing Columns_____
• Investing
• Washington Investing
• The Color of Money
• Cash Flow
• The Week in Stocks
• Personal Finance Special Report
_____Previous Columns_____
• Supreme Court Ruling Upholds Powers of SEC (The Washington Post, Jun 10, 2002)
• Allied Capital Attracts a Feeding Frenzy as Ghost of Enron Spurs Sharks (The Washington Post, Jun 3, 2002)
• When There's Money in the Method, Strange Investment Schemes Can Sell (The Washington Post, May 27, 2002)
• Transparency Is in Firms' Best Interest (The Washington Post, May 20, 2002)
• United Defense Pays Off for Carlyle (The Washington Post, May 13, 2002)
• More Washington Investing Columns
By Jerry Knight
Monday, June 17, 2002; Page E01
Why does your 401(k) account keep dwindling even though you put money into it every paycheck?
Blame Enron. Blame Tyco International. Blame Adelphia. Blame Kmart. Blame ImClone. Blame Arthur Andersen and the whole darn accounting industry. Blame L. Dennis Kozlowski and the Rigas family, Samuel Waksal and his glue-gun girlfriend Martha Stewart.
Blame Wall Street. Blame all the analysts who touted Internet stocks because the companies happened to be their investment-banking clients. Blame the stockbroker who told you to get out of blue chips and into high tech.
Blame Washington. Blame Securities and Exchange Commission Chairman Harvey L. Pitt. Blame the lobbyists who are fighting reforms in corporate accounting and accountability and the lawmakers who are in league with them.
Your stocks keep sinking, your retirement plans fade, your college fund flunks out because investors are losing confidence in corporate America.
As Goldman Sachs Chairman Henry M. Paulson Jr. puts it, "In my lifetime, American business has never been under such scrutiny. And to be blunt, much of it is deserved."
The growing cynicism about corporate ethics could not hit Wall Street at a worse time. The economic fundamentals that drive the stock market are weak to begin with. Weak enough that you can make a case that after the longest, strongest bull market in history, Wall Street is destined to go through an extended down cycle -- or at least a prolonged plateau.
Economic statistics show that the country is, as expected, recovering very slowly from last year's mini-recession. The economy has grown less than 3 percent in the past year, its most anemic expansion in four decades.
This year corporate profits are coming back, but corporate revenue is not, notes James Paulson, chief investment strategist for Wells Capital Management, part of Walls Fargo Bank.
While roughly 60 percent of the companies in Standard & Poor's 500-stock index earned better profits than expected in the first quarter of this year, the same percentage also reported that sales were down from a year ago, Wells Fargo's Paulson calculated. Companies can go only so far at improving profits by cutting costs in the face of declining revenue, he cautioned. At some point, profit growth requires revenue growth.
Normally at this stage of the economic cycle -- when the nation is pulling out of a recession -- the stock market is rallying, playing its traditional role as a leading indicator for the entire system. Instead, stocks have been steadily retreating. All the major indexes have fallen for the past four weeks, and the Nasdaq and the S&P are close to their post-Sept. 11 lows.
The most negative interpretation of the market's decline is that the stock market is indeed a leading indicator; Wall Street is warning investors that a double-dip recession is ahead.
If that's what Wall Street is saying, not many economists are on the same page. Slow growth is not no growth, and the vast majority of economists believe there is little other evidence to support the double-dip recession theory. There is some danger, however, of feedback from Wall Street into the real world. Falling stock prices have the potential to drag the real economy down with them.
Well, if the stock market is not reflecting what's happening in the economy, why are stocks falling so relentlessly?
Because investors are scared.
Terrorist threats at home and abroad often correlate directly with daily moves of the market. A big rally a couple of weeks ago was attributed to rumors that Osama bin Laden had been killed or captured. Friday's drop in the Dow Jones industrial average was blamed on a car-bombing outside the U.S. consulate in Karachi, Pakistan, that killed 11 people.
Such an attack on U.S. soil would no doubt send the markets into a much deeper dive, but the terrorist factor seems to have an episodic effect on the market. Wall Street probably would quickly recover from anything short of a major domestic disaster.
But there is no quick cure for the other fear factor -- the fear that the widespread fraud and corruption exposed at Enron, Adelphia, ImClone, Tyco, Merrill Lynch and other companies are symptoms of metastasized corporate cancer.
You know ethics have taken a hit when federal prosecutors are investigating Martha Stewart, the self-made symbol of mom, apple pie and domestic bliss. Martha is a buddy of Sam Waksal, the former ImClone chairman who took the Fifth last week when he was hauled before a congressional committee to answer questions about why he, his family and his friends sold millions of dollars' worth of ImClone stock just before problems with the company's cancer drug were revealed.
Martha, on the other hand, was eager to declare publicly that she was an interior decorator, not an inside trader. She said she sold almost 4,000 shares of ImClone just before it tanked because she had previously arranged to sell when the stock fell below a particular level.
Martha is now in the middle of two of the worst stories on Wall Street -- ImClone and Kmart, the bankrupt bargain barn that sells more than a billion dollars' worth of merchandise with Martha's name on it every year.
Shares of her company, Martha Stewart Living Omnimedia, started falling when Kmart filed for bankruptcy a few months ago and have dropped an additional 20 percent since the ImClone scandal broke.
Stewart, Waksal and ousted Tyco chairman L. Dennis Kozlowski are some of New York's beautiful people. If Andy Warhol were still alive he'd have painted portraits to illustrate their 15 minutes of infamy. There is Waksal being lead out of his chic SoHo loft in handcuffs. And Kozlowski going to court for allegedly scheming to avoid sales taxes on a Renoir for his boudoir and a few million dollars' worth of other art.
This is sleaze that People magazine's readers can relate to. They may not understand how Enron's Raptor subsidiary drained off millions or what kinds of games Tyco was playing with its accounting for acquisitions. But they get it when Kozlowski, who's taking home hundreds of millions in salary, bonuses and other incentive pay, is accused of getting sweetheart side deals and dodging taxes to boot.
That's why this scandal is resonating from Wall Street to Main Street, why newspaper columnists and editorial writers across the nation took note when Goldman Sachs's Paulson talked about the need for reform.
The Chicago Tribune, the San Diego Union, the Omaha World Herald, the Memphis Commercial Appeal, the Capital Times in Madison, Wis., and other papers too small to show up in databases endorsed his call for understandable accounting, full disclosure of stock option costs, independent boards of directors and greater accountability to shareholders.
Out there beyond the Beltway, who reads editorial pages? The very same people who buy stocks. Mostly it's older, educated, thoughtful, affluent people, a lot of them retired. (A lot of them are also Republicans who are expecting the people they sent to Washington to protect their interests.)
They've watched their portfolios shrink for 27 months. The Standard & Poor's 500-stock index, which represents the stocks most individual investors own, lost 9 percent in 2000 and 13 percent in 2001; it's off 12 percent more so far this year.
Those losses alone are enough to make investors -- whether they're in Memphis or Madison, San Diego or suburban Virginia -- wary of Wall Street. Add in daily doses of dirty linen and it's hard to imagine those folks flocking back to the stock market.
Investors need to have their faith in the integrity of the market restored. The call for action from Goldman Sachs's Paulson will help. So does Merrill Lynch's decision to simplify its stock rating and to pay analysts based on how well they pick stocks, not how well they attract investment-banking clients.
The New York Stock Exchange and the Nasdaq Stock Market both are promoting plans to make corporations more responsive to shareholders and to make corporate board members more independent.
Wall Street is getting out in front of this issue, because people there know they have to. They know more conflict-of-interest cases involving analysts are coming. They know that ImClone and Enron and Tyco are not the only places where bodies are buried. And they know that every new scandal scares away more investors.
Enlightened self-interest, alas, does not yet seem to have arrived in Washington. The city is understandably preoccupied with homeland security and foreign terrorist threats.
The Bush administration's ability to restore confidence in the market is hobbled because its frontman on the issue has to be SEC Chairman Pitt, who since he took office has been labeled as the accounting industry's defense attorney. Pitt is actually moving the SEC in the right direction. He has launched initiatives on important accounting and accountability issues. He has sicced the SEC's vaunted enforcement division on each new scandal that breaks, though they are rapidly running short of troops.
Pitt, however, still wears the scarlet letter -- A for "accounting" -- and he is facing a no-win decision on his future role in the corporate credibility crisis.
When he took office last year, Pitt followed the rules and recused himself for one year from having anything to do with issues involving his former clients. The year is almost up. There are calls for Pitt to extend his recusal indefinitely. If he doesn't, his participation in accounting investigations will be suspect. If he does, he will have to sit out the most important work on his agency's agenda.
© 2002 The Washington Post Company |
