Being Street Smart
The Tip of the Iceberg
By Sy Harding, editor
Street Smart Report Online
This
is getting too serious, folks. Adelphia, Enron, Global Crossing,
ImClone, Rite Aid, Tyco, Xerox and now WorldCom?
When it was just one
or two companies it could be explained away as a couple of bad
apples that got into the barrel and would be simply tossed out.
But corporate scandals are coming now at a rate of one every
couple of weeks.
This week's was the
most troublesome of the bunch. Not only because WorldCom's cooking
of its books is probably going to wind up with it being the largest
bankruptcy in U.S. history, but because it was so easily discovered
- yet wasn't discovered by those responsible for corporate governance.
The company's Board
of Directors, who apparently noticed nothing amiss in their oversight
and approvals of expenditures, did not discover WorldCom's fraud.
It wasn't even discovered in the expensive audits by the now
infamous Arthur Anderson Inc. We are asked to believe that the
major banks that provided WorldCom with its huge loans, turned
up nothing in the due diligence analysis they are required to
undertake before approving such loans. Regulators who have been
looking into the firm's accounting policies at least since the
company's long-time CEO was fired in April (in a controversy
over an unpaid $408 million corporate loan to cover his personal
stock losses), turned up nothing.
Yet, when WorldCom's
new CEO asked the company's comptroller for a financial review,
and an employee was assigned to `spot-check' the books, the connivance
was so evident and obvious that within a day or two the employee
was back with the details of the fraud.
David Scott, an economist
at UCF, says of the failure of those who were being well-paid
to oversee the company's accounting procedures, "These things
do not happen unless people are either asleep, or if they are
themselves colluding, or are ignorant."
If those responsible
for oversight failed to discover even the apparently obvious
deception at WorldCom, it certainly raises the odds that there
is still more undiscovered shocks to come.
After all, Enron, Tyco,
WorldCom; these were not the only companies that impressed Wall
Street with their ability to produce steadily improving earnings
in the late 1990s, even when involved in acquisitions and other
activities that would normally cause erratic earnings or even
temporary losses. The use of `one-time' write-offs that were
not one-time, but took place year after year, and other forms
of creative accounting, caused the rumor of `managed earnings'
to be coined concerning many companies, including some of the
largest blue-chips.
That does have me concerned
for the longer-term health of the market. My scenario for the
year has been for "a correction all the way down to the
lows of last September by the end of June, and then for a significant
summer rally in July and August but to be followed by a resumption
of the bear market to new lows in the October/November time frame".
Meanwhile, the situation has the Bush Administration between a rock and a hard place. It certainly can't appear to also be looking the other way. So President Bush (and Congress) have announced full-scale investigations, aimed at bringing honesty to corporate governance, and restoring the nation's trust in its financial institutions.
But with a serious bear market underway, the economy in a very fragile recovery, the U.S. dollar in decline, and investors, both here and abroad, already full of fear and distrust, the last thing needed is to uncover still more U.S. corporate scandals. Yet, once looked for, if they are as easy to find as in the WorldCom situation, it may be difficult to avoid discoveries of still more.
Meanwhile, the situation leaves the market vulnerable to sudden moves based solely on rumors. After all, every one of the companies where accounting irregularities have been uncovered, were first the subject of rumors for several months, rumors which the companies vehemently denied. This has not been lost on unscrupulous short-sellers, who see the opportunity for illicit profits of their own, if they can get a rumor started. So what do investors do when rumors pop up, like those on Thursday of accounting problems at General Motors and Xerox, vehemently denied by the companies? It is a newly opened can of worms that I don't think the market has yet fully recognized.
So, I do still expect the oversold conditions brought about by the market decline of the second quarter, and the improving economic numbers the market has been ignoring during its decline, will be enough to create a significant summer rally. But I also still believe investors are going to have to remain alert to the potential for the bear market to resume later, if not on concern for a double-dip in the economy, then on a wave of investor disgust and disillusionment with corporations, Wall Street, and the regulators whose job it is to prevent the accounting scandals, of which we have probably seen only the tip of the iceberg.
Editor's Note: Sy Harding is president of Asset Management Research Corp., 169 Daniel Webster Hwy, Suite 11, Meredith, NH 03253, publisher of The Street Smart Report, 1 year, 17 issues, $250 (now in its 15th year of exceptional market research for professionals and serious investors) and The Street Smart Report Online at www.StreetSmartReport.com, 1 year, $225. Mr. Harding has consistently ranked in the Top Ten Timers by Timer Digest for years. In March 1999, he authored the book, Riding the Bear How to Prosper in the Coming Bear Market, $12.95 (the Dow topped out just 9 months later). In Riding The Bear, Mr. Harding explains not only bear markets, but how bull and bear markets get started and end; how public investors can break their pattern of only becoming interested in bull markets in their final stage, get killed, and then are too scared when the next bull market begins. He explains in plain English how the market reacts, how cycles work, and how to take advantage of them to hold onto your bull market profits and actually increase them during a bear market. Harding also explains the Seasonal Timing System in detail. This highly recommended book is FREE as a bonus with a subscription to Sy Harding's Street Smart Report.
