IS THERE A BOTTOM IN STOCKS??
SPECIAL UPDATE #30
July 26, 2002
IN THIS ISSUE:
1. Stocks fall off a cliff; where's the bottom?
2. Stock losses estimated to be apprx. $7 trillion.
3. Will stocks' plunge cause a new recession?
4. The Blame Game - everyone's at fault.
5. New securities reform legislation - good or bad?
STOCKS CRASH: WHAT DOES IT MEAN?
Stocks had already declined precipitously when I wrote the last Special Update a week ago. But this last week has seen an even more accelerated crash, even though the markets rebounded strongly on Wednesday.
I'm not making any predictions since I am the first to admit that I don't know what lies ahead. From a strictly technical analysis, it should not have been surprising that the equity markets would have retested their post-911 lows at some point. Yet the post-911 lows seemed to be a strong support level, since nothing like 911 had ever happened before. But those lows were sliced through like hot butter!
So what is going on? Let me begin by saying that the collapse in the equities markets, in spite of clearly improving economic and financial conditions, means something serious! I'm not exactly sure what all the ramifications are just yet, but I will offer some thoughts and suggestions below.
ANOTHER 1987-LIKE CRASH?
Predictably, Wall Street is now saying that this move down will most likely be a re-make of the 1987 crash. In the 1987 crash, the market plunged in a sudden, unprecedented downward move as it has recently. Yet it rebounded almost as fast as it went down. Despite many predictions that the '87 crash was a signal that the economy was headed for a recession, there was no recession for more than two years after the plunge occurred.
The '87 crash was blamed on "program trading" by institutions and "derivatives trading" (futures, options, etc.) by speculators. As long-time clients will recall, I never bought that explanation. In fact, it was one very prominent futures trader - Paul Tudor Jones - who began BUYING huge amounts of stock index futures at the bottom on the worst day of the '87 crash, and was quietly credited with turning that crash around. So much for the derivatives theory.
From a market standpoint, the main result of the '87 crash is that securities and futures regulators instituted all sorts of market "circuit breakers" and "curbs" that they thought would slow trading when the market dropped certain amounts, or even close the exchanges for the day if losses reached certain levels. Again, long-time clients will remember I said at the time that these arbitrarily imposed "limits" would NOT prevent market plunges, and could even make things worse. I predicted that the markets would continue to become more and more volatile, despite the intentions of the regulators.
And they have. Limits, circuit breakers and curbs have not reduced market volatility. Market volatility has gone up and up and up. The intention was to limit market moves, or even shut down trading if necessary, so as to give investors hours or overnight to "cool-off" and, hopefully, stem the selling. Yet as I stated at the time, investors are not going to "cool-off" overnight if they are told they can't sell when they want to. When people finally decide to give-up, they want to get out NOW! Making them wait only makes matters worse.
THAT WAS THEN, THIS IS NOW
In 1987, public participation in the equity markets was miniscule as compared to today. The 1990s, and especially the last half of the '90s, lured millions of people into the stock markets. You've read my numerous articles about how many Baby Boomers (just to cite one age group) went into equities in the '90s, many for the first time, particularly in their retirement plans.
The public investment in equities today is enormous, compared to what it was in 1987. In 1987, there was not the plethora of "financial" programs on TV and cable that we all watch today. The growth in mutual fund assets has skyrocketed since 1987.
So what's the point? Here you go. The damage done by the 1987 crash is miniscule compared to what we have seen over the last year and a half and particularly the last two months. Millions more Americans are in the market now than in 1987. Millions of Americans have suffered catastrophic losses since the peak in 2000. And millions of Americans will not be able to retire as they had planned where the market is today.
Millions of Americans who are already retired are looking at their losses and realizing that they no longer have the income they counted on just a few months ago. Now they are trying to figure out what they will do to get along.
In June, the combined loss in equities was estimated at $5.5 trillion from the top in early 2000. Now, it is estimated at apprx. $7 trillion! Compare that number to the aggregate size of US Gross Domestic Product which was reported at $10.5 trillion in the 1Q.
ANOTHER RECESSION AHEAD?
As you know, my best sources, including The Bank Credit Analyst, have been forecasting an economic recovery since late last year. Those forecasts were more than realized when GDP grew at an annual rate of 6.2% in the 1Q. Most analysts are predicting GDP growth of 2.5-3.5% growth for the 2Q.
The question now is whether the stock market plunge will erode consumer confidence so much that it sends us back into a recession over the next several months. There is no question that the latest crash in the market will have a dampening affect on the economy. But will it be enough to send the economy into negative territory?
That depends, of course, on whether the stock markets stabilize or continue to move lower. Obviously, no one knows for sure what will happen just ahead in the equity markets. If the markets stabilize at or above the lows seen this week, and begin a slow recovery, then I would expect we will avoid another recession. Yet if this equity dive continues, it could very well throw us back into a recession by late in the year.
If this were to occur, it greatly increases the odds for a "debt deflation." I discussed the issue of a debt deflation at length in my July issue of Forecasts & Trends which you can read on our website: www.forecastsandtrends.com. wWhat happens next in the equity markets deserves our closest attention. With consumer spending accounting for over two-thirds of GDP, this economy could head south in a hurry if the market plunge continues.
THE BLAME GAME
Almost every day now, we hear of another corporate accounting scandal. Finger-pointing has been going on ever since Enron imploded last year, but with the latest spat of scandals and the market crash, the blame game has moved into high gear. The Democrats, of course, are blaming the Republicans, but the truth is, there's plenty of blame to go around.
The Democrats are trying to blame President Bush, but that doesn't hold water. Bush has only been in office for 18 months, and we have learned that this accounting hanky-panky has been going on for several years, apparently getting worse and worse over time. Despite that fact, the Dems are trying their best to get the public to believe that the accounting scandals and the plunge in the stock markets are the fault of Bush/Cheney and the Republicans in general.
As I wrote last week, the Dems are getting some traction on this. Bush's approval ratings have slipped a little, down to 65% in one poll. Still, most Americans realize that the seeds of the growing corporate accounting problems were sown well before George W. got to Washington.
Knowing the public might not fall for this, the Democrats have also tried to pin the blame on Harvey Pitt, the chairman of the Securities and Exchange Commission (SEC). The SEC must have been asleep at the switch, or worse, complicit with Arthur Andersen, et.al. Perhaps, but Harvey Pitt has only been the head of the SEC for a short time, and like Bush, he had this scandal dropped on his head as a result of mishandling in the past.
[This, by the way, is why Bush has stood steadfastly behind Pitt during this firestorm. I would venture to say that had the same circumstances occurred in the previous administration, Clinton would have axed his SEC chairman in a heartbeat to keep his own approval ratings high.]
The Republicans, of course, are also pointing their fingers at the Democrats. They would have us believe that the current mess is the result of eight years of botched regulation and corporate greed fostered by Clinton and his amoral cronies.
As usual, the truth is somewhere in between, and no one in Washington wants to talk about it. But I will.
In 1995, a securities bill was passed by both houses of Congress that substantially limited the liability of accounting firms, brokerage firms and other investment professionals in cases of fraud. Under this new law, these entities were no longer "jointly liable" for the entire fraud; rather they were only "proportionately liable." The bill passed with both Republican and Democrat support.
In one of the rare cases when he did something right, Clinton vetoed the bill. Yes, I know that plenty of things happened on Bill Clinton's watch that may have contributed to the current malaise of accounting scandals and the stock market blowout, but this was not one of them. [Even I can give Clinton credit for one of the few things he did right.]
The bill was championed by Senator Chris Dodd (D-CT), who had earlier been the chairman of the DNC. Not willing to see his bill go down in flames, Dodd organized the votes to override Clinton's veto. The Senate voted 68-30 to overturn Clinton's veto. The bill became law to the delight of accounting firms and, apparently, a good number of corporate CEOs.
Dodd, of course, had very close ties to - guess who, drum roll - Arthur Andersen! In fact, Dodd and Phil Gramm (R-TX) received more money from Andersen than did any other Senators. So do we blame Chris Dodd? Yes. But not just him. We also blame the 68 men and women, Democrat and Republican, who voted to override Clinton's veto.
Yet the Democrats would now have us believe that the accounting scandals and the market meltdown are all the fault of the Bush administration. They know most Americans have no clue about the legislation discussed above, or that the Democrats pushed it through, including overriding Clinton's veto.
The Dems also don't want you to know that several members of their party played direct roles in some of the recent corporate scandals. I'll give you a couple of examples.
New Jersey Democrat Senator Jon Corzine was the chairman of Goldman Sachs when it was hotly touting Enron stock. When Corzine retired from Goldman in 1999, he spent $60 million of his personal fortune to buy. . . I mean win. . . his Senate seat in 2000.
Robert Rubin, who served as Treasury secretary during the Clinton administration, had an even more direct connection. Citigroup, which he has headed since 1999, played a central role in concealing Enron's growing debts from investors and regulators. Last November, Rubin phoned Peter Fisher, a Treasury undersecretary, and asked him to intervene with credit-rating agencies that were about to downgrade Enron's status.
John Diaz, a managing director of Moody's Investors Service, says Rubin also contacted him about getting a higher credit rating for Enron. Both men rebuffed Rubin's requests, which struck them as highly unusual.
These are just two of the many examples that the Democrats don't want to talk about. I could go on and on with examples where both Democrats and Republicans had a role in fostering the accounting scandals. The fact is, both parties are responsible.
This is precisely why both houses of Congress swung into high gear the last few weeks and passed strident new legislation intended to stop the corporate accounting scandals. Never before can I remember Congress acting this fast! It's amazing how efficient they can be when everyone's butt is on the line!!
NEW CORPORATE FRAUD LEGISLATION
Yesterday, Congress overwhelmingly passed new legislation to crack down on corporate fraud. The new legislation includes the following:
* Creates criminal penalties and prison terms for business fraud and shredding of documents.
* Forms an independent, private-sector board with subpoena power to oversee the accounting industry.
* Restricts accounting firms doing consulting for corporations whose books they audit.
* Bans personal loans from companies to executives and directors.
* Adds rules to prevent conflicts of interest for financial analysts.
* Extends the time in which investors may sue companies for fraud, counteracting GOP reform several years ago to stem a flood of frivolous shareholder suits.
* Creates for defrauded investors a federal account including all payments from corporate wrongdoers.
This new bill passed 99-0 in the Senate and 423-3 in the House! Even Phil Gramm who steadfastly opposed the bill voted for it in the end. Maybe I can find one, but I can't recall any bill in recent history that passed with such overwhelming support on both sides.
Why? Because all these politicians have been in bed with big business! They are all responsible for the accounting scandals, in one way or another! They all know the American people are hopping mad over the stock market meltdown! And most importantly, they all need to be able to go home in August and be able to say:
"Look, at least we have done something to make sure this never happens again."
Just in case you are wondering, here's who voted against the new bill: Reps. Michael Collins of Georgia, Jeff Flake of Arizona and Ron Paul of Texas. In the Senate, Jesse Helms (R-N.C), who is recovering at home, did not vote.
WILL THE PENDULUM SWING TOO FAR ??
Whenever conservative Rep. Ron Paul (R-TX) votes for or against something, you know there is a good reason why. While I don't agree with every single position Ron Paul takes, I consider him to be the most honest and principled person serving in Washington today. While Paul has not posted his reasons for voting against the securities reform bill on his website yet, I'll bet I can tell you why he voted no.
First of all, Ron Paul knows that another huge government bureaucracy is not the solution for Wall Street's problems. Paul is very much a "free market" guy who believes bigger government is more likely to make things worse than better.
Second, while the provisions of the new bill probably sound good to most investors, guess what mysteriously dropped out of the new law at the last moment? Can you say STOCK OPTIONS? The rampant abuse of stock options (and the accounting for same) is just as much of the problem as hiding expenses. Yet the provisions in the new securities bill to deal with stock options were quietly dropped altogether. Hmmm.
Third, this new law will result in enormous new expenses for corporations. Out of fear of going to jail, corporate executives and their accountants will quickly begin to reduce profit and earnings forecasts, recategorize expenses, and all of this - while sounding good in principal - may result in the stock market falling even further.
I totally agree that corporate executives who defraud their shareholders and investors should go to jail. Yet we already have laws on the books to deal with securities fraud.
As noted earlier, politicians in both parties have been in bed with big business for years. Now, virtually all of them want to jump on this "fix it" bandwagon, just so they can beat their chests in front of constituents. What they won't be saying is that they looked the other way, once again, on the issue of stock options. Isn't that special??
Maybe the new securities laws are a good thing, but I have my doubts. But whether they are, or they aren't, the end result may well be that the pendulum swings too far in the other direction, and that could make the stock markets go even lower.
It will be interesting to see if President Bush signs it. With 522 votes for it, and only three against, what do you think? I'll bet you a Diet Coke he signs it, pronto!
Have a great weekend!!
Gary D. Halbert
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