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8/25/02


 

WALL STREET TREACHERY

Part Four: THE WALL STREET SWINDLE CONTINUES 

By David Podvin 

One of the reasons being given for the current bear market rally is the August 14 deadline that required Chief Executive Officers of America’s biggest corporations to personally vouch under penalty of perjury for the accuracy of their companies’ reported earnings. The premise is that, with executives knowing there will be criminal consequences for continuing to lie to their investors, corporate financial statements will no longer be deceptive. 

The premise is a sucker play. The first clause of the Securities and Exchange Commission disclosure document reveals the procedure to be an election year charade. It begins: “To the best of my knowledge …”  

Not:  “I assert under penalty of perjury that the following is true…”  

Just: “To the best of my knowledge…” 

The careful wording of the SEC form insures that “I didn’t know” is an exonerating defense. In this case, professed ignorance will set you free. No executive is ever going to spend a second in prison based on a legal document that starts with a hole large enough to drive Linda Tripp through, and they are aware of it. So the swindle continues. 

Investors who are buying in the belief that things have changed are being conned again. As of August 23, 2002, the blue chip companies that comprise the S&P 500 index were collectively reporting earnings of $39.86 per share by using the creative accounting method that is called "pro forma". Applying the traditional accounting standard known as GAAP - Generally Accepted Accounting Principals - S&P 500 earnings are collectively $25.29 per share. This means that America's biggest and most respected companies are still overstating their earnings by 60%. When traditional accounting techniques are used, the price to earnings ratio of the S&P 500 is over 37, compared to an average of ten at bear market lows. 

Simply put, the market is still extraordinarily expensive, and the average large publicly held corporation in America is still lying to the public – BIG TIME – in an attempt to inflate its stock price.

It is likely that more business scandals are on the way. The New York Post is reporting that top executives at AOL/Time Warner are in danger of being implicated in an insider trading case. Pension funds of companies like IBM and General Electric were heavily invested in stocks at the top in 2000, and are now teetering on the brink of being underfunded. Companies that allegedly have understated health care costs when calculating pension fund liability include General Motors, Ford, and Phillip Morris. The next round of unseemly revelations involving corporate malfeasance is probably going to include some of America’s highest profile companies.

Meanwhile, the Wall Street hucksters are imploring the investing public to buy stocks in this “undervalued” market. These are the same brokerage firms that were selling stocks short at the top in 2000 while imploring the public to buy because the market was “undervalued” then. In January, when stocks were much higher than they are today, a Gallup Poll of more than 1,000 investors revealed that the respondents planned to put off their retirements by an average of four and a half years as a result of stock market related losses. Yet the grifters on Wall Street continue to lure the average American into the House of Pain.

For a long-term perspective, the chart above is the price to earnings ratio of the Dow Jones Industrial Average spanning the twentieth century.

At the bear market low in 1921, the Dow P/E was 5. That was an undervalued market that represented a long term buying opportunity.

At the bear market low in 1932, the Dow P/E was 9. That was an undervalued market that represented a long term buying opportunity.

At the bear market low in 1982, the Dow P/E was 7. That was an undervalued market that represented a long term buying opportunity.

The vast majority of bear markets have ended with the Dow P/E below 10.

There has never been a bear market that ended with the Dow P/E above 14.

As of August 23, 2002, the Dow P/E was 24.

The current Dow P/E is higher than it was at the bull market top in 1987. Buying then was an opportunity to have your stocks decline by 38%.

The current Dow P/E is right where it was at the bull market top in 1966. Buying then was an opportunity to have your stocks decline by 43%.

Even after a brutal two and a half year bear market, the current Dow P/E is close to where it was at the top in 1929. Buying then was an opportunity to become destitute.


Sources: Marcin Asset Management, MSIM

There is a way to measure the value of the market without dealing with real or imagined earnings. The chart above depicts the stock price of companies in the S&P 400 divided by the sales generated by those companies. The S&P 400 has traded at approximately 140% of sales at bull market highs and approximately 40% of sales at bear market lows. The exception was the hysterical mania that ended in 2000, when the index reached 235% of sales. Today, the S&P 400 still trades at 125% of sales. Historically, this level has occurred near major bull market tops - not near major bear market bottoms.

Investors must decide whether to be guided by the habitual liars on Wall Street or the objective historical norms of the stock market. Will most Americans continue to trust the corporate executives and brokerage analysts whose venal deceit has inflicted such ruin to portfolios across the land?

Most Americans continue to trust George W. Bush in spite of overwhelming evidence that he is compulsively dishonest, so the process by which the majority decides whom to trust does not appear to be entirely rational. For the knowledgeable few who are willing to confront reality rather than pacifying themselves by conforming to the herd mentality, the current stock market and the current inhabitant of the White House both appear to be highly overvalued. The only times the American stock market has been this expensive - as measured by price/earnings and price/sales ratios - were the major highs of the twentieth century that occurred in 1929 and 1966. In each case, stocks fell hard, and the incumbent president lost his job.

Wall Street Treachery Series

Podvin, the Series

 


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