The Meaning of "Is"

Do you want to make a mint as the Dow crashes time and time again? Christoph Amberger suggests looking no further than the former client list of Arthur Andersen.

Remember the 90s? An era in which complex philososophical conundrums were pondered in public, if there ever was one. Like: Is oral sex covered under "Sexual Relations"?

Or: What is the meaning of "is"?

Paradigms shifted without clutch and investors poured money into start-ups whose CEOs sported Maynard Crabbe goatees and ugly shoes as proud statements of perma- adolescent rebelliousness.

New Economy math supplanted earnings (let alone profits) with razor scooters and nose piercings. GNP grew, bolstered by unholy amounts of stock transactions and investment "gains." Watching the President of the greatest nation on earth sheepishly niggle his way out of yet another slippery affair made for prime time entertainment.

So who can really blame the Armani-suited crooks at Enron, WorldCom, Arthur Andersen if they, too, took their clue from popular culture? After all, finding creative new ways to redefine corporate "profits" is child’s play compared to the theological underpinnings required to paralocute extramarital frolics in the Oval Office.

Unfortunately for all of us, the market is still digesting the legacy of the 1990s-style pushing of legalistic envelopes. The can-do generation of the Clinton era sure did a number on the most hallowed precepts of capitalism.

Back in the early 1990s, when they were still selling pieces of the Berlin Wall and Boris Yeltsin was a fresh face on the happy hour circuit around Lenin’s tomb, I had the opportunity to interview two American entrepreneurs who were setting out to introduce a new entrepreneurial magazine to Eastern Europe.

Its name was "Profit." And within a year or so, its concept was deader than a doornail. You see, "Profit" was a dirty word in the newly reformed Eastern bloc countries. You might as well have tried selling a magazine called "Bazooms" to the Mormon Tabernacle Choir.

The two enterprising Americans were clearly ahead of their time. Today, Eastern Europe, save for some ne’er- do-well codgers, has fully embraced capitalism. The Moscow stock market is roaring while the American and Western European markets limp along. And the young Polish colleagues at the Krakow office of our German partners have impressed me far more than the U.S. trained academics I’ve had the questionable pleasure to work with in the past.

Capitalism, if you recall, is built around the concept of profit. Which is what you end up with if your expenses are less than your total revenues. If you want to have more profits, you need to increase revenues or cut expenses.

Or both.

But here’s exactly where the legalist philosophers at Arthur Andersen, Enron, and maybe even Merck came in (though the Merck case cannot be considered along the same lines as Enron).

The current accounting scandals are not at all the product of capitalism run rampant. By their very nature, they are clear affronts to the capitalist philosophy, creating profits not by increasing revenues or cutting costs, but by redefining the terminology.

The natterers and pundits who are "losing trust in the system" because of the recent crop of corporate scandals conveniently overlook that it is the very system that is purging the abuses as we watch. And, of course, there is no other viable system: In fact, all planned and state- run economies historically have been examples of the same undiluted corporate corruption we’re now seeing emerge in individual cases from the Arthur Andersen corporate client list.

Following the most recent scandals on Wall Street the Dow dropped so steeply it reduced the Dow to levels not seen since late 1998. In fact, the plunge in the week after July 4 saw the Dow slam on the breaks a mere 100 points away from our "High Probability" target at 8,500.

It blasted right past that target on July 15, before the morning coffee had a chance to cool down on the desks of disbelieving traders. But if we’re right the worst is yet to come: The "Potential Low" at 6800 still comes with a comparatively low probability. But it’s less than 1,800 points away from becoming reality.

We have watched the Dow shed more than that in the last three months!

Can it all be blamed on Osama bin Laden and Arthur Andersen? That would be too easy. In fact, these drops were ALREADY in the system. Just look at several interesting parallels between the two events.

By September 9, the NASDAQ was already off 3,463 points from its 2000 high. As gory and horrifying as the events of 9/11 were, when the market reopened, the NASDAQ "plunged" only another 282 points. By the time the clowns at WorldCom fessed up, the stock had already fallen from US$16.06 a share to less than a dollar. The news-driven plunge last month only took WCOM’s already- worthless paper down to about US$.80. Clearly, in both circumstances, the damage was done prior to the supposed triggering events.

The real reason that the market is groveling today, while certainly related to this latest accounting scandal, is simply the continuing wave pattern of more disgusted investors leaving the market at the bottom of each dip than enter it, hat in hand, during each forlorn, pathetic rally.

Investors have now suffered a compounded loss of market value of nearly US$7 trillion based on a 41+% decline since March 24, 2000. Just wrap your mind around this figure: 7 trillion!

And they could lose another trillion in the next four weeks simply based on an impending wave of new disclosures.

With earnings season approaching, I’d suggest that it might be worth any investor’s time to do a little digging for himself. And a great place to start is with a list of former Arthur Andersen clients.

Now that the SEC has published a list of companies ordered to certify their financials, those that aren’t keeping it clean are in a pinch. And the SEC’s certification order goes into effect immediately. Which means this earnings season could get really interesting.

As of August 14 the SEC will hold most corporate officers personally responsible for the accuracy of their financial filings. With earnings season upon us, many of the companies who report in the next few weeks won’t get their actual filings in until after the cutoff date. Those books better be squeaky clean!


Christoph Amberger,
for The Daily Reckoning
July 18, 2002

P.S. We’ve got a couple more of these "problem accounting" trades we’re looking at right now. But in the meantime, take a look at Oracle. It’s high on my list of potential bomb-droppers

Editor’s Note : As publisher of Taipan, J. Christoph Amberger’s role can be compared to that of a spider in the middle of the web. He is constantly in touch with all of Taipan’s sources, contacts, and correspondents, directs their research, and identifies new and promising investment opportunities. A frequent speaker at international conferences, he is the author of several books and scores of articles on topics including international politics and travel.

"How long can this go on?" asked a businessman we visited in Milan yesterday. His question referred to the drop in stock prices that has been headline news around the world for the last week or so.

"A lot longer," is our answer.

When will it stop?

"When people stop asking," we reply.

The average P/E is still more than twice it’s historical mean – near 40 by some measures. Bull markets do not begin when P/Es are near record levels and when people begin every conversation with a stock market update. They begin when people no longer care. This bear still has a lot of work to do, we guess.

But, we remind you, dear reader, that this is just our hypothesis. God has not yet revealed His Entire Plan to us. No, the HEP is unknown and always will be. Still, bear markets are supposed to lower stocks below their long-term level. If not, why bother to have them?

Stocks hit a high in 1966 and then began a bear market than lasted until ’75 or ’82, depending upon how you calculate it. During those years, they went up and they went down. Inflation complicated the picture, like snow on a windshield; it was impossible to see where stocks were headed. But by the time it was over…all the big winning stocks of ’66 were trading at much lower prices and the average P/E on Wall Street had dropped from 23 to around 8.

Smart investors have come to realize that stocks do not always go up. They’ve reluctantly lowered their expectations. Now, they’ve fallen in line with the few big names in the investment world that don’t draw sniggering when you mention them – Warren Buffett and Bill Gross. Both have said recently that the stock market may produce gains of only 6% to 7% for the next 5 to 10 years. But our guess is that even these modest expectations will be destroyed when Mr. Bear has completed his project.

A DR reader sent me a note to ask about gold stocks. He had lost money on them in recent weeks. "Where were they going?" he wanted to know.

"We don’t know," was our answer. But if we could tell you where stocks were going, we wouldn’t be making market forecasts.

Let’s turn to Eric to find out what happened yesterday…


Eric Fry in New York…

– Let’s have a round of applause for the Dow – the blue chip index scored its first win in the last eight sessions.

– Sadly, the Dow was unable to hang on to the 240 points it chalked up in the first five minutes of trading, but it still managed to gain 69 to 8,542. The Nasdaq rose 22 to 1,397, while the S&P 500 gained 5 points to 906 – one day after hitting a five-year low.

– The implosion of credit card company Capital One (COF) was probably the biggest news of the session. The stock fell 40% yesterday. It seems that some banking regulators – perhaps in response to Capital One’s latest ad campaign – showed up one day at the company’s corporate offices and asked, "What’s in your wallet?" COF’s answer, unfortunately, was, "Not enough."

– The regulators required the company to agree to boost its loan-loss reserves, increase its capital base and implement more stringent risk controls. Ironically, this is a company that routinely boasted about its cutting- edge risk controls. But as the saying goes, "If something seems too good to be true…it usually is."

– In a critical examination of Capitol One that I produced for Grant’s Investor (now Apogee Research) more than one year ago I wrote, "COF, for its part, may believe that its proprietary ‘information-based strategy’ constitutes a nearly infallible, high- performance black box…No matter. In the upcoming recession, its credit card receivables portfolio may start to resemble a black hole."

– Dan Denning calls the stock’s collapse "a nice coup for Strategic Investments readers who shorted Capital One Financial at our suggested price of $64.30. Our short position is now up 53%."

– A nice coup indeed!…Dan explains: "The catalyst for the stock’s drop was a credit downgrade by Fitch with respect to COF’s capital reserve requirements. COF announced a memorandum of understanding between itself and regulators regarding certain ‘supervisory’ matters. Fitch said that ‘a mention by the regulators that the company needs to bolster internal controls and governance could be an indication that some enterprise risk management capabilities may have been lacking.’"

– "That’s putting it mildly," continues Dan, "especially in the new environment of profound distrust of Corporate America. It’s enough for me that COF is a sub-prime lender, lending money to those Americans least likely to pay the borrowed money back. Just goes to show you that owning somebody else’s promise to pay isn’t the best business to be in today."

– Individual investors aren’t the only ones suffering these days from the market’s endless tailspin. Government coffers are also feeling the effects. Sounds like Uncle Sam might be looking for some more handouts pretty soon.

– "Ink runs red from Sacramento to Washington, D.C., to Paris and points in between," observes Jim Grant. "On two continents, governments are back in the borrowing business…In the long boom, not only did investors seem smarter, but politicians looked wiser. Fiscal rectitude, the rarest of public virtues, suddenly blossomed in such unlikely settings as the New York City Council, the California Legislature and the U.S. Congress. However, it wasn’t rectitude that filled the exchequers but the bull stock market. Now the bear market (along with its many ramifications) is emptying them."

– Grant points out that during the first eight months of the fiscal year, October through May, the Federal government racked up a deficit of $147 billion compared to a prior-year surplus of $137 billion.

– Fittingly, therefore, a real estate executive here in New York City recently restarted the billboard-sized national "debt clock" near Time Square. The clock was shut down a couple of years back, when most folks believed that continuing government surpluses were just as certain as Dow 36,000. Now that the surpluses have been shown to be nothing more than flukes caused by the late bull market, the sign was switched back on.

– Just off of Time Square – not far from the multi- million dollar "Nasdaq Tower" that was completed just three months before the Nasdaq topped out – sits the large greenish sign that ticks off our country’s rapidly growing debt. At the moment, the debt clock displays a national debt of more than $6 trillion, or more than $65,000 for each U.S. family.

– Don’t be surprised if the bear market on Wall Street triggers a new bull market in taxation on Capitol Hill.


Back in Paris…

*** "It’s over…the year is over," said one of our associates in Milan yesterday. "There’s no point in trying to do anything before September, everyone’s gone."

*** After the middle of July, Europe shuts down. Paris is quiet. The metro is empty in the morning. With a 35- hour work week, and 6 weeks of vacation, people have a lot of free time on their hands. When the weather is so agreeable, who can blame them for using it?

*** But we Americans are still at our posts. Our superior model of capitalism lets us work all year long. *** Quotes of the day:

"I want you to know the economy, our economy, is fundamentally strong."

George Bush
July 15, 2002

"The fundamental business of the country…is on a sound and prosperous basis.

Herbert Hoover
October 25, 1929

*** A friend of ours, Fred Labyak, died Monday:

"Is it any wonder my face darkens when I think of the brave warriors who have disappeared from the mead halls that once knew them…and how, day by day, all the world ages, drooping unto death…"