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RAY SUAREZ: There was little to cheer about on Wall Street today. The Dow Jones Industrials again traded lower, and the tech heavy NASDAQ posted a small gain, but continues to trade near five-year lows.
So what’s driving down the numbers? We put that to Lynn Stout, professor of securities regulation at the UCLA School of Law; Eric McKissack, vice chairman of Ariel Capital Management, a mutual fund and institutional investment firm; and Frank Werner, associate professor of finance at the Fordham Business Schools. And, Frank Warner, let’s start with you. What is driving the market down?
FRANK WERNER: Ray, I think what we’re seeing is the confluence of two things: First of all, we have the burst of the dot-com bubble, which is really running its course at the moment. Investors are seeing that the stocks that they thought were valuable didn’t have the legs underneath them. And it’s carrying over to many other things.
In addition, we’re seeing some very specific events right now that are worsening the market. One is the events of 9/11, the terrorist attack and what followed on, and that’s raised a lot of fears in people’s minds. We only have to look at last week, at the excitement on July 5 after nothing significant happened on July 4, and we had a huge rally on the 5th; beyond that, of course, the accounting scandals. Investors are losing faith in companies and starting to reassess whether or not these companies can earn money in the future; if they’ve not earned the money they’ve claimed in the past, perhaps the future doesn’t hold as much as investors thought it did.
RAY SUAREZ: Lynn Stout, are we finished?
LYNN STOUT: I think generally what we’ve got is a situation where investors have had a wild ride, you know, it was great when we were going up. Now suddenly we find ourselves back down to where we were five years ago. And I think a lot of it has to do with the fact that investors have woken up, and they now have more realistic expectations for the future. For all of the factors that have already been discussed, they all come together in a single lesson for investors, which just is that corporations are not going to be earning as much money as they thought they would.
RAY SUAREZ: But with those expectations that you’ve talked about, there’s been a couple of weeks where good news comes out, a very good economic number for an important indicator in the economy, consumer sales, income, spending, and the market goes down anyway. Why?
LYNN STOUT: Part of it is I think we have to recognize that investors learn from experience; you know, the latest fad in finance theory is what’s called behavioral finance and all that really does is recognize that, you know, people are learning animals. Essentially what investors have seen is that stocks can go down as well as up. That lesson is starting to sink in. And it’s taking away their taste for but thing a lot of money into corporate equities. That kind of learning process history shows, can go on for a long time.
RAY SUAREZ: Eric McKissack…
LYNN STOUT: And take a long time.
RAY SUAREZ: …Maybe you can give me a little of the mechanics of what we see happening. Are people getting out of stocks and staying out, getting in at lower values? When we see the indexes declining like this day after day after day, what actually is happening underneath that’s driving that? Who’s getting in and who’s getting out?
ERIC McKISSACK: Well, there are obviously more sellers in the marketplace these days, and there’s a lot less appetite for investing in the equity markets, and it’s such a complex equation nowadays because we have so players in the marketplace. We’ve got individual investors who can vote through their direct investments as well as through their 401k plans; we’ve got institutional investors who run mutual funds, as well as run portfolios for pension funds and the like, and we’ve got hedge funds and short sellers who have an interest in profiting from the downside. And we’ve got global investors who have perceived the U.S. markets as a good place to invest in the past, but may be less confident, as we’ve seen by the weakness of the dollar.
So all of these factors are coming together at a time that has been described earlier with a crisis of confidence in our markets and the confidence in the numbers that are being reported, in the leadership of our corporations, and all of these things have created a classic bear market for us.
RAY SUAREZ: Do large investors behave differently from small ones at a time like this?
ERIC McKISSACK: Well, in theory we’re supposed to be taking; that is, the professional investor is supposed to be taking a longer view, assuming that is the goal and purpose of what their customers are looking for, their clients are looking for. But you’ve got all different points of view in the marketplace. You’ve got people who are traders taking very short-term day positions, and you’ve got short sellers, and then you’ve got many institutional investors the vast majority who are looking a little longer. But our horizons have gotten shorter in recent years. Because the market has been so volatile, many investors who used to look multiyear, often look six to twelve months and they think of that as long term. And we’ve seen the market be so volatile that certainly the professional investor is probably feeling just as skittish as many individual investors at this time.
RAY SUAREZ: Frank Warner, let’s talk a little bit about how you know that this extra value that people keep talking about as part of the bubble has been wrung out? How do you know when the sponge is dry and it’s safe to go back in?
FRANK WERNER: It’s very difficult to know that, Ray, because the numbers that we’re getting from corporate America are coming under suspicion. If the numbers could be trusted, and we had a sense of corporate earnings and believed them, then we could start taking a look at the relationship of stock prices to corporate earnings and make some judgment as to whether or not that relationship is rational. Stock prices should be a present value of the future– today’s worth of what companies are going to generate in the future. But not knowing what companies are going to generate in the future is making it very difficult to know whether those stock prices, those present values, are making sense. I think this is a particular situation where it’s going to be more difficult to know where that bottom is than it might have been in the past where we had better numbers, more trustworthy numbers from companies.
RAY SUAREZ: But does that cloud of suspicion that you’re talking about put companies that haven’t been cooking the books under that same shadow; in an artificial way, pulling them down along with everybody else?
FRANK WERNER: I think it does. I think, unfortunately, this is going to be an environment where companies are guilty until proven innocent. They’re going to be associated with other companies. And we see evidence already that some very solid companies are going out of their way to convince investors that they’ve done nothing wrong. General Electric comes to mind. Jeff Immelt is going the extra mile to make a point about how solid his accounting is, when you wouldn’t expect that under normal circumstances.
RAY SUAREZ: And Lynn Stout, how do you keep this kind of cycle from becoming self-perpetuating, bad news feeding on bad news until there’s a destruction of value that really isn’t warranted by the real underlying economy?
LYNN STOUT: Well, it’s a very difficult problem. One of the lessons that history teaches is that it’s better to move too quickly than to wait until it’s too late. We do see some signs coming from the Congress, some rhetoric from the President, that there may be some effort to make reforms in the market that are very psychologically important in terms of reassuring investors that at least for the future, they can rely on corporations to tell them the truth. But the question rises: Are investors going to believe in those reforms? Are they going to think that Congress and the President have credibility in light of all the scandals that have been unearthed in the last couple of years?
It’s a very difficult situation for the investor. I mean, interestingly enough, in many ways, the door was opened for systematic problems with fraud five or ten years ago. The courts have developed a number of doctrines over the past couple of decades that have made it much harder for investors to sue for fraud, and as a result, made it much easier for corporate executives to commit fraud. Congress has aided and abetted that by changing the securities laws several times, in a way that make it harder for investors to sue. The SEC has suffered under a reduced budget, and in a lot of ways, the chickens are really coming home to roost now. But the question is: What is it going to take to convince investors that that problem, which has been years in the making, is going to go away overnight?
RAY SUAREZ: And Eric McKissack, if regular people at home reading the business pages, perhaps calling their broker, maybe going online or checking their company’s 401-American materials, are having a tough time figuring out whether to trust companies, is it any easier for the pro? If there’s a perception that auditing documents are not for real, if there’s a suspicion that corporate reports aren’t telling the truth, how do people like you move ahead?
ERIC McKISSACK: Well, we move ahead, ultimately, on belief and faith in the system that is in place, recognizing that there are some concerns and valid issues that need to be addressed through changes in regulation and communication from companies. And we’re seeing at least some signs of that coming our way. That said, we as long-term investors have to take a long- term view. And fortunately for us, that’s how we look at the market, we try to take a longer view.
We recognize that the kind of extraordinary events that we’ve seen over the last year are going to take some time for the markets to grope with, whether it’s 9/11, the "geoterrorism" that still is a risk overhanging, and now corporate governance and concerns about accounting fraud. All of that is a big mouthful to swallow. But what we try to do in our work, and what we think investors should do, is take the longer view, look at their… the types of investments they have in terms of the risk profile, the weightings that they have in different kinds of things, and make sure that the weightings are reflective of their risks profile. Now, anyone who has equity exposure has been feeling a lot of pain, but if you’re investing for retirement or for things that are longer in the future, even with a protracted, extended period, there’s still some time to make it up. That doesn’t mean that you should go out and be a hero.
There was a motto a few years ago that you go buy on the dip and you’d be back in shape in no time flat. We’re not in that kind of environment anymore. This is not a time to speculate or gamble on the market. Instead, it’s… but it’s still a time to be an investor and to look at your weightings. Fixed income is still… bonds have still been doing pretty well, and maybe some people will be more comfortable adjusting their weightings accordingly. But equities have still been the best place over the long term.
RAY SUAREZ: Lynn Stout, do you share Eric McKissack’s optimism that, in the long view this is all going to work out/
LYNN STOUT: Yes, I do. In the long run, the stock market is a terrific investment, historically the best investment. On the other hand, you know, as economists say, in the long run, we’re all dead. So the question becomes: How long is the long run? If we’re talking about weak performance for a few quarters, that’s one thing. If we’re talking about weak performance for a few years, that’s quite another. And I think, you know, I wouldn’t want to be asked to predict which it’s going to be, but history does suggest that when you get situations where investors lose confidence in the market, it can take a long time to fix that problem. After the crash of ’29, markets didn’t get back to prior levels for almost two decades.
RAY SUAREZ: Guests, thanks a lot for helping us out tonight.