By Amey Stone
With the Dow Jones industrial average down nearly 750 points in the past week, economists and market strategists are puzzling over why a buyer's strike is occurring at a time when the economy and corporate profits are showing improvement. Attributing the free fall to the crisis in confidence in Corporate America or the still-high valuations of U.S. stocks in relation to their moderate earnings may be accurate -- but it doesn't quite do justice to the magnitude of the decline.
So here's a new way to get your arms around the problems plaguing stocks: Compare what's happening on Wall Street with the dynamics of the used-car market.
WHO TO BLAME?
I came up with this notion while discussing with colleagues the growing public perception that there's too little accountability in the corporate world. Check out the latest boardroom scandals, and it seems that no one is responsible for the financial shenanigans that are felling what used to be respected companies -- not CEOs, not auditors, not analysts, not investment bankers.
It's reminiscent of the fix that used-car buyers find themselves in when they purchase a lemon. Is it the car manufacturer's fault? The previous owner's? The mechanic's, or the dealer's? Maybe it's the buyer's fault for not realizing that a deal that seemed too good to be true really was.
If you're old enough (as a few people around BusinessWeek Online's offices are), you might have seen the situation dramatized in Robert Zemeckis' 1980 movie Used Cars, in which Kurt Russell plays a, shall we say, less than ethical car salesman with a heart of gold who's trying to finance his bid for the state senate (a related occupation, let's face it) by expertly plying all the tricks of his trade.
SMELLS LIKE MONEY.
I rented the cult classic to see for myself -- and sure enough, the parallels run deep between the few-but-very-visible bad apples in Corporate America and the much larger percentage of slick operators who inhabit the used-car business. Here are a few similarities that are worth noting -- and that help explain why a stock-crazy public has turned at least temporarily skeptical:
Like a specific corporate-accounting firm and a generous sampling of its clients, used-car sellers (at least, as portrayed in the movie) use a wide assortment of artifices to make a car seem like a better deal than it is. In the opening scene of Used Cars, a fresh-faced Russell prepares the lot's inventory for the coming business day. First, he turns back the odometer on one 99,000-mile dog to a respectable 33,000 miles. Then he inflates another aging hulk's flat tire with the help of a can of "Flat Fixer." Another car's fender falls off, and he reattaches it with a piece of bubble gum.
My personal favorite: Russell climbs inside one freshly painted jalopy and gives the interior a few spritzes of "That New Car Smell." Later in the movie, an ambivalent buyer is told that the taxi-cab yellow that shows through a new coat of paint is really "yellow primer."
GUMMING THE WORKS.
It doesn't take much imagination, unfortunately, to see how the people who dressed up some rotten-at-the-core companies with creative accounting could work on the same lot as Russell's character. Whether they were hiding expenses, pumping up earnings, or manufacturing revenues, they were plying the same trade: Prettying up the company on the outside while hiding the ugly reality of its inner workings.
A used car has to run well -- at least for a short time. For the dealer to make a sale (and the salesman to earn a commission), the car basically has to survive a test drive and a journey of a few hundred miles from the lot. Let's face it: The movie was engaging in hyperbole when the gum Russell stuck on the fender came off as the customer hit a pothole on the way out the lot. In the real world of corporate shenanigans, that gum should have lasted at least a month.
Russell's character had one thing in common with some of today's high-priced execs, though: Pay packages at many companies have been structured so that senior management has little incentive to care about the business's reputation or its long-term viability. Instead of aligning the interests of CEOs and stakeholders, multi-million-dollar stock-option packages create an irresistible temptation for some managements to pump up the stock price -- and try any trick to keep the price aloft until they can cash in.
Of course, it's true that many salespeople succeed only because they can play on the fear and greed of their customers. If used-car buyers weren't so eager for a good deal, they wouldn't be so easy to fool. In one hilarious scene from the movie, Russell baits a fishing rod with a $10 bill and uses it to lure a customer from the neighboring lot. Likewise, many individual investors were baited into getting into the stock market by the oversize returns of the dot-com heyday. Their dreams of becoming rich overnight made them easy prey for Wall Street's hype machine.
Russell and his colleagues also badgered customers into buying by playing on their fears that someone else would steal the bargain that only they knew about. In the same way, many conservative investors were lured by marketing campaigns that made them feel like they were fools if they didn't climb aboard the stock market band wagon. The logic behind one line from a salesman in Used Cars is echoed by several current mutual-fund and brokerage ads: "You can't afford this car? You can't afford not to buy this car!"
People buy used cars -- and run the risk of getting rooked -- for one reason: Used cars are a lot cheaper than new cars.
That gets at the heart of why stocks may still have further to fall. For buyers to return in droves to the market, given their heightened concern over the reliability of financial reporting, they may need to feel that they're getting such a good buy that it's worth taking a risk that a stock could blow up. Either that, or they need to be so confident that they have reliable information about a company's financial strength (or a used-car's history) that they're willing to pay a fair price.
ONE BAD LEMON.
Financial reform is building momentum, but the kind of confidence repairing that's now required will take time -- especially considering that by many measures, stocks are still expensive. Phil Toews, president of Toews Funds, thinks the real problem with the market is overvaluation. With the trailing price-earnings ratio of stocks still at a historic high, he says, "I think we still have a long way to go in this decline."
Could be, and yet plenty of good deals can be had today -- both on car lots and in the market. Millions of people buy used cars all the time for a good price, and end up perfectly happy with their purchase. Likewise, the great majority of stocks will recover from this bear market and go on to reach higher prices in years to come.
The problem for the used-car biz is that enough lemons are sold, and enough sleazy salespeople are selling them, that the entire business is colored by the actions of the disreputable few. Corporate America is suffering from the same phenomenon. When you look at the current market slide in that light, it really doesn't seem so surprising.
Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column