By Christopher Farrell
Is it time to bail out of the stock market? With the Dow Jones industrial average down by some 40% since its 2000 peak, a growing number of individual investors are saying yes. Long-term Treasuries have trounced stocks by about 50% over the past 30 months, a dismal stock performance not seen since the pit of the Great Depression, according to James W. Paulson, chief investment officer at Wells Capital Management.
The bad news is unrelenting. Every day seems to bring another corporate accounting abuse, often by blue-chip stalwarts like Merck and Bristol-Myers Squibb. Corporate America's scandal reaches well inside the White House, with President Bush stumbling badly in explaining his profitable dealings at Harken Energy, and Vice-President Cheney disappearing into silence as the Securities & Exchange Commission investigates an accounting change that boosted revenues when he headed energy services company Halliburton.
Watching national, local, and business-news TV is dreary, with a daily parade of interviews with retirees deeply discouraged over the steep plunge in their portfolios. The economy appears to be running out of steam. Investment forecasts of negative stock market returns for the next decade or more are increasingly common. The turmoil in the Middle East and the ongoing battle against terrorism adds to the sense of gloom and doom.
In other words, it's a good time to buy stocks. No, I'm no fan of brokerage house bromides such as "markets climb a wall of worry." Yes, I know that timing a market upturn is always chancy. Odds are that stocks will fall further after this commentary has been published.
"Just as a euphoric high persisted for long months before the market peak finally was put in, so too might a despondent gloom persist for longer than economic and business conditions alone justify," warns James M. Griffin Jr., economic consultant at Aeltus Investment Management. "Broken trust is neither quick nor easy to restore."
That said, the time to start accumulating is when despair is all the rage and good companies are on sale. It's often true that when investors focus on a major problem, the path to recovery isn't far behind. Chief executives and directors may have played fast and loose with the numbers during the height of the stock market boom, but they aren't fools. It's a new environment, and corporate leaders are well aware that profitable malfeasance or even winking at skimming money at shareholder expense is over.
SPEAKING WITH MONEY.
Even politically connected giant mortgage financier Fannie Mae -- sporting a year-to-date return of -6.7%, despite the stupendous housing boom -- has embraced greater transparency by agreeing to register its securities with the SEC. "Investors are speaking clearly with their money, telling corporations, in essence, that conservative accounting practices will be rewarded, and aggressive or questionable practices will be severely punished," says Jim Gately, a 35-year market veteran and managing director of the Vanguard Group.
Adds Edward Yardeni, chief investment strategist at Prudential Securities: "The goods news is that the quality of earnings is now likely to improve dramatically as a consequence of the corporate accounting and governance crisis."
The momentum for reform is growing. The SEC is renewing its requirement that CEOs and CFOs of the 1,000 largest publicly traded companies personally sign off on all financial statements. The New York Stock Exchange proposes to increase the number of independent directors on corporate boards. The House and the Senate are negotiating to pass an accounting reform bill.
LISTEN TO ALAN.
It even seems inevitable that companies will be required to expense stock options, despite the hit to earnings. Coca-Cola, an American business icon, will start treating employee stock options as an expense. The Washington Post says it will follow suit. The rest of Corporate America likely won't be far behind, assuming management values a rising stock price.
The economic expansion is intact. As Federal Reserve Board Chairman Alan Greenspan emphasized in mid-July in his semiannual state of the economy testimony to Congress, inflation is tame and productivity growth strong. Corporate profits as measured by the Commerce Dept., which excludes one-time charges and includes options as an expense, have increased sharply since the third quarter of 2001.
Stocks are reasonably priced, too, at least according to the so-called Fed model. This valuation technique compares the forward earnings yield on the Standard & Poor's 500-stock index to the yield on the 10-year Treasury. With the 10-year bond around 4.6%, the model implies that the market is cheaper than at any time since 1980, according to economists at Merrill Lynch.
The simplest reason to start accumulating a bigger position in stocks is the most intriguing: It's usually profitable to go against the crowd. "Buy when everyone else is selling, and hold until everyone else is buying," said the oil billionaire J. Paul Getty. "This is not merely a catchy slogan. It is the very essence of successful investing." It's time for investment contrarians to shift some more money into stocks.
Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online
Edited by Beth Belton