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Stock slump is no mystery

Any company with a hint of Enronitis will be hit hard by skittish investors.

Early last week, the Wall Street Journal (WSJ) ran a story about how the stock market is lagging behind several leading economic indicators. This puzzled the analysts interviewed for the story. Some of these analysts said the market’s recent malaise is an early sign of a double-dip recession. Others rightly pointed out that a struggling stock market doesn’t necessarily mean tough economic times ahead. One analyst quipped, “The stock market has predicted 11 of the last six recessions.”

Naturally, the state of the economy–especially the tech economy–is of intense interest to our readers and, thus, I’ve been pondering this issue for a week. I continue to be optimistic about a slow but steady recovery in the tech sector and I see signs of it all around. An example is IDC’s recent report that the PC industry will grow by 4.7 percent this year after its first slowdown in 2001. Not double-digit growth, mind you, but encouraging just the same. So, most of my thoughts focus on why the stock market should be ignored as an indicator of a double-dip recession.

I don’t have to think that hard to come up with the reason. The Enron scandal and subsequent stonewalling by the accounting industry have investors worried that the problem is more widespread than anyone is willing to admit. Sure enough, every day since the first Enron story was printed, the WSJ has run stories of alleged questionable dealings by CEOs of major corporations. First it was ad giant Omnicom, which has been on an extended buying spree and has not reported many of the costs associated with its acquisitions, especially Internet ventures that have tanked. The story was about how the head of its audit committee resigned after a disagreement with CEO John Wren over reporting. The next day, Omnicom’s stock took a nosedive, and the company agreed to do a better job of reporting losses associated with its many recent acquisitions.

Then there’s ImClone, whose ex-CEO was arrested last Wednesday for alleged insider trading, as reported on our site. Sure, insider trading is not the same as hiding losses in acquisitions or other shady accounting practices, but when a CEO does it, it has the same effect on the investment community. CEOs are supposed to be good corporate citizens, not only for investors but for employees, and other concerned parties as well. Illegal or unethical behavior by CEOs doesn’t do concerned parties any good. And when CEOs refuse to testify before Congress about such behavior, as ImClone’s former CEO John Waksal did when hepulled a Ken Lay last Thursday, it brings the whole Enron thing back.

Each new scandal that echoes Enron jolts investor confidence, not just for the company involved but for the whole market. Concerned parties, myself included, wonder who’s next. And what consequences do companies face for betraying public confidence, besides downgraded analyst forecasts and deflated shareholder value? Microsoft recently agreed to stop padding profits in its reports, but received a slap on the wrist for doing so. Analysts have questioned Cisco’s reporting related to its slew of acquisitions. Enron partner Qwest has received similar scrutiny in the way it accounts for some of its partnerships. These are just the companies we know about. What of companies we don’t know about? If leading analysts, CEOs, and auditors can’t be trusted, who can we trust? This lack of investor trust is the primary reason why the market lags behind other economic indicators.

The market will continue to buck economic trends until major meaningful reforms are put in place. The very people who don’t trust corporate information (because they know all too well how things work) are the ones who fight reform the loudest. Here there are no easy answers. It’s one big tangle of conflicts of interest that will require nothing short of a complete overhaul of the financial sector before people start making money the old-fashioned way again.

Unless and until reforms happen, I’m going to continue take the stock market with a grain of salt and instead look at things like tech spending, tech inventories, job creation, and the like as my economic crystal balls. In these areas right now we see pockets of good news amidst some permanent corrections. Telecom will stay down until demand for pure IP gradually picks up steam. Semiconductors will be flat for some time. Software will hit bottom soon, and bounce back once the antitrust case is resolved and Web services take hold. But demand for services and equipment will grow steadily in the coming months and we will continue to see pockets of growth throughout the sector heading into 2003, when a full-scale recovery will commence. I’ll check back with you in Q1 of 2003 and grade out my predictions. If I’m wrong, I’ll give you full disclosure.

James Mathewson is editor of ComputerUser magazine and

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