Back to Fundamentals

We are at the end of the long, three-day weekend that traditionally kicks off the summer season in America. We paused to remember all of the men and women who gave their lives to keep this the freest country in the world. And not a few of us looked around our houses and at our multiple cars and remembered what Nobel laureate economist Milton Friedman has taught: that freedom is an essential precondition for innovation, daring and the high standard of living that Americans enjoy and much of the world envies.

But as 35 million Americans piled into their cars and onto airplanes to visit friends and open their beach houses, and the rest of the nation merely took a breather from work, we became increasingly aware that we may be engaged in another long and bitter struggle to preserve the gains won for us by previous generations. And that awareness is starting to be reflected in the behavior of share prices.

In the end, of course, valuations put on companies’ shares will depend on the prospects for profits, and those seem to improving steadily. The economy is growing, productivity is increasing at a rapid rate, inflation is tame, the manufacturing sector is showing signs of life, auto sales in April were 3 percent up on last year’s very satisfactory figure, the housing market is a bit cooler but nevertheless robust, and consumers continue to spend. But this weekend other things were on everyone’s mind—or at least on the minds of many. A great American poet once lamented that “things are in the saddle and ride mankind.”

One of those “things” is the threat of another terror attack, an event Vice President Dick Cheney has assured the nation is almost certainly in its future. Just how this affects everyday life and the attitude of investors it is difficult to say. Karlyn Bowman, Washington’s preeminent analyst of the myriad polls taken almost daily to gauge attitudes here, says that only between 10 and 22 percent of Americans report themselves persistently anxious since September 11.

But those polls were taken before Cheney shared his appraisal of the latest intelligence data with the American public, before the government announced that the Statue of Liberty and the Brooklyn bridge might be targeted for destruction, and before landlords began notifying tenants that their friendly neighbor might be a homicide bomber intent on blowing himself and them to bits.

There is no question that stock markets, with little to drive them by way of earnings reports, are reacting to the possibility of future attacks, witness the jump in share prices last Wednesday when rumors that bin Laden had been killed or captured made their way onto the floor of the New York Stock Exchange. “The fear of another attack is keeping a lot of money out of the stock market,” Maria Bartiromo, a leading television commentator (attractive as well as extraordinarily able and known as “the money honey”), told her audience.

Remember: New York City, which considers itself the prime target for another attack, is the home of most of the traders and analysts whose attitudes affect the market’s tone. It must be difficult to whip up enthusiasm for buying shares if you expect a nuclear or chemical device to be detonated on the trading floor, or a neighbor to blow himself and your building to smithereens.

But nervousness about terrorism is only one of the things that seems to be in the saddle and driving events. Recent revelations about the less-than-candid reporting by securities analysts, eager to share in the profits of their investment banking colleagues, make investors wonder about all those “buy” recommendations they see. And the securities industry knows that settlement of New York State’s suit against Merrill Lynch is the beginning, not the end, of the industry’s tribulations. Plaintiffs’ lawyers have announced that Merrill’s willingness to pay $100 million to have state attorney Eliot Spitzer call off the watchdogs will be offered as proof of the firm’s misconduct in the private suits for restitution that they plan to file. And Merrill is only the first of the many firms that the lawyers have in their sights. Not a situation designed to produce an upbeat attitude on Wall Street.

Another thing that is on investors’ minds is a worry—no, a dawning certainty—that reported profits figures may not be what they seem. The Arthur Andersen scandal seems to be spreading, with the staff of the Securities and Exchange Commission now accusing Ernst & Young of being insufficiently independent of audit client PeopleSoft Inc. Energy companies are accused of creating valueless transactions by you-scratch-my-back-and-I’ll-scratch-yours deals that inflated sales figures and made anemic markets seems robust. Tales of executive siphoning off of telecom and cable company cash are as frequent as stories of market manipulation by energy companies.

Finally, there is the political dimension. The swing to protectionism by President Bush, and the threat that his steel and lumber tariffs and the massive new farm subsidies that he has approved will set off a trade war is unsettling to the free traders who predominate in the financial community. And the outbreak of partisan warfare and wild accusations by Democrats that the president knew that terror attacks were coming, but did nothing, is eroding the united, determined feeling of patriotism that so buoyed American spirits after September 11.

So all talk is of financial markets that will remain grumpy and nervous as the summer season, historically not a time noted for share-price rallies, begins. There may be a few short-lived summer rallies, say the experts, but all eyes are on the autumn, when it is expected that Americans will have learned to live a bit more comfortably with the new uncertainties, and earnings reports will be more meaningful.

With those “things” behind them, investors will be able to return to fundamentals, and try to decide whether the current recovery is merely a short-term restocking of inventories, or has induced a new round of investment in plant and equipment; where the dollar is headed; who might succeed Alan Greenspan; and whether profits will continue to move up as newly revised figures show they did in the first quarter. That’s quite a long enough list without adding to it wild guesses as to the health of Osama bin Laden.



This article originally appeared in London’s Sunday Times on May 26, 2002, and is reprinted with permission.