- The Washington Times - Friday, June 28, 2002

''Phony earnings, inflated revenues, conflicted Wall Street analysts, directors asleep at the switch this isn't just a few bad apples we're talking about here. This, my friends, is a systemic breakdown. Nearly every known check on corporate behavior moral, regulatory, you name it fell by the wayside, replaced by the stupendous greed that marked the end of the [stock market] bubble. And that has created a crisis of investor confidence the likes of which hasn't been seen since well, since the Great Depression." So went the theme paragraph from the June 24 cover story, "System Failure," in Fortune magazine. How true it is.
Indisputably, this crisis of confidence has been an integral factor in fomenting the turmoil that has been afflicting the nation's markets. Indeed, the relentless battering that various indexes have sustained in recent months has been awesome to behold. The Dow Jones Industrial Average (DJIA) has declined 10 of the past 13 weeks, closing Tuesday at 9127. The DJIA is now down nearly 2,600 points (22 percent) from its January 2000 peak. The broader S&P; 500 has fallen five weeks in a row, eight weeks out of nine and 14 weeks out of 16. At Tuesday's close, the S&P; 500 was less than 11 points from its close on Sept. 21, its low point following the September 11 terrorist attacks.
The Nasdaq? As they might say on Wall Street, "Fooogitaboutit." At Tuesday's close, the Nasdaq composite (1424) was less than 1 point from its Sept. 21 low. Bubbles, anyone? Cumulatively, the Nasdaq was more than 3,600 points (or 72 percent) below its March 2000 peak of 5,048. The cascading Nasdaq 100, which includes the 100 biggest companies on the exchange and was once the market's hottest index, pierced the 1,000 level in after-hours trading Tuesday following the latest corporate accounting scandal. That was the announcement by embattled WorldCom that it had improperly accounted for nearly $4 billion in expenses for the past five quarters. (Naturally, see-no-evil Arthur Andersen, which a federal jury recently convicted of obstructing justice in the Enron debacle, professed to have performed all of its duties for WorldCom by the book.) On Tuesday, the Nasdaq 100 fell to 13 percent below its Sept. 21 level; it is now about 80 percent below its March 2000 peak. Meanwhile, WorldCom has just become one of nearly 1,000 corporations forced to restate their earnings since 1997. The market capitalization (the number of shares times the price per share) of once-high-flying WorldCom peaked at $115.3 billion; it is now below $1 billion.
As the Los Angeles Times noted the other day, if the market slide since March 2000, measured by the S&P; 500 and the Nasdaq, is viewed to be continuous, it will now be 27 months old, making it the longest bear market since the 1940s. And it may be not be over. As Frank Holmes, the chief investment officer of U.S. Global Funds, told the New York Times recently, the average Nasdaq stock currently trades at 80 times earnings, far above the Nasdaq's historical norm. Depending upon how "earnings" are defined. Are they pro forma? Are they "operating" earnings, exclusive of interest, taxes, depreciation and amortization expenses? Do they exclude so-called "one-time restructuring" charges? Do they include share options as an expense? The overall market's price-earnings (P/E) ratio, according to a recent analysis by the Economist, may range from the high teens to the low 40s (the more likely case). In either event, they are significantly higher than the market's historic average P/E ratio of 16. For the S&P; 500, which tracks the shares of the economy's 500 largest corporations, stocks are trading at 24 times expected earnings, substantially above that index's average P/E ratio of 15. Moreover, "expected earnings," as has been demonstrated far too frequently in the recent past, often occur only in the eye of the beholder. Indeed, as the Commerce Department recently reported, after-tax corporate profits, after falling more than 27 percent from their third-quarter 2000 peak, managed to increase by less than 1 percent during the first quarter, when economic growth increased by a relatively robust 5.6 percent annual rate.
With more than $6 trillion in investor wealth having disappeared since March 2000 and all stock-market indexes experiencing profound downward pressure amid a rash of corporate scandals, no wonder consumer confidence fell in June by its fastest pace since the September 11 attacks. The plunge in investor confidence has now reflected itself in a significant dip in consumer confidence, and the markets and the economy have now entered very dangerous territory. The Fortune article quoted Securities and Exchange (SEC) Commissioner Harvey Pitt from a recent speech at Stanford: "It would be hard to overstate the need to remedy the loss of [investor] confidence," Mr. Pitt said, adding, "Restoring public confidence is the No. 1 goal of [the SECs] agenda." Yes, and that goal cannot be achieved a moment too soon.

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