It is often said that the stock market is driven by fear and
greed. If greed was the dominant psychology of the market's rise in 1999 and
2000, certainly fear is the watchword for the Panic of '02.
Fear of what? Well, for CEOs and CFOs, fear of a 20-year jail
term is a good place to start. New legislation now pending in Congress could
mandate a 20-year prison term for something as ambiguous as "artifice and
fraud," a legal penalty that could be as wide-bodied as a 350-pound
offensive lineman in the NFL.
A second fear factor for top corporate execs is the SEC's new
order that company financial statements must be certified for accuracy and
completeness. Harvey Pitt may be the most embattled SEC commissioner in our
lifetime. But with this move, he has trumped slow-moving congressional
legislation with one of the most draconian new regulations in history. Call
it Pitt's revenge.
Signed under oath, these new written statements must be filed on
or shortly after Aug. 14, 2002. They will require CEOs and financial chiefs
at 947 large companies to swear "to the best of my knowledge" that their
financial statements are accurate. Importantly, these execs could face
criminal as well as civil liability if regulators find any problems in their
statements. The SEC intends to make the certifications available to the
public on its website.
Most top business execs I know would prefer to stay out of jail.
So you can bet your bottom dollar -- or your last share of WorldCom -- that
our corporate leaders will err massively on the side of conservative
accounting and forecasting for all manner of revenues, expenses and profits.
Which brings us to a third fear: Investors are hyper-worried
that anticipated profits from a rising economy could evaporate because of
incredibly cautious accounting by under-the-gun executives. So, despite the
fact that industrial production has been climbing for six straight months,
verifying that the economy is definitely on the mend, now we're talking the
chance of zippo profits, or even profit declines. That's what the threat of
a jail term can do.
The odd part of this stock-market story is that profits in the
second quarter are actually up 8 percent over last year for 233 of the S&P
500 companies that have already reported. This suggests an average earnings
per share of $12.65, compared with last year's $11.23, for a rise of nearly
13 percent. But the stock market is off 29 percent from a year ago and 18
percent since the SEC's re-certification announcement of June 28. In other
words, nobody in the market believes the latest profit reports because they
are SEC non-certified.
While both Republican and Democratic senators keep calling for
his resignation, Harvey Pitt himself is determined to cleanse the corporate
mind of ethical breakdowns and prosecute any hint of dishonest accounting.
Therefore, the next truly credible profit report arrives Aug. 14. Meanwhile,
because of jail-time threats, investors will be worried over the prospect of
big downward profit revisions.
The famous disconnect between a rising economy and falling
stocks cannot possibly be resolved until we hear from the 950 or so firms
that will post their newly scrubbed results on the SEC website. And Aug. 14
is just the beginning -- company documents will dribble in for several weeks
after that date.
As we wait for the new results, it is worth remembering that
through 10 recessions and 10 bear markets since World War II, economic
recovery cycles have always delivered higher share prices. Over the
long-term, there is no disconnect between the economy and the market. From
1947 through mid-year 2002, a 55-year period, inflation-adjusted economic
growth in the United States registered a 3.4 percent average yearly gain.
Company profits increased by 3.1 percent a year in that time. And total
returns (including dividends) for the S&P 500 increased nearly 8.7 percent
annually. Your money doubles about every 10 years.
It's an important lesson. In a free economy such as ours, stock
markets are great wealth creators over the long run. Even now, with near
zero inflation, rock-bottom interest rates, falling taxes and surging
productivity, a double-dip profits recession is not likely.
Investors who can substitute faith for fear will be handsomely
rewarded by investing in stocks. Though the road directly ahead may be
filled with large bumps and deep potholes, Harvey Pitt's systemic corporate
cleansing may yet save the system from itself.