Samizdata

Remember Clinton’s “Don’t Ask, Don’t Tell” policy for admitting gays into the US military? It appears that Big Media has adopted a “Don’t Know, Don’t Care” approach to covering the tumultuous stock market. Cal-Berkeley journalism prof Orville Schell says that Big Media’s obliviousness to the looming financial scandals stemmed in part from the fact that they are part of the corporate world too.

Maybe that’s why Big Media failed on the investigative side, but that still doesn’t explain how it is that the largest and most reputable media outlets in the world are simply at a loss to tell their readers what is happening in the financial markets. Instead of providing answers, they rely on pop-culture cliches, psychobabble and a Rolodex full of self-serving “experts.” Here are three of the worst examples of the DK/DC mentality in recent days from three major news sources: MSNBC, the New York Times, and CNN.

Exhibit 1: MSNBC on Market timing

MSNBC wonders out loud whether it is possible to “time” the market — that is, can investors count on making extra money in the stock market by picking the optimal times to buy and sell? This is hardly a controversial issue in the finance community — the weakest version of the Efficient Market Hypothesis (EMH) says that you cannot forecast stock prices by extrapolating present trends or by overlaying historical cycles — that “market timing” is fool’s gold. Yet in an attempt to make the story “balanced,” MSNBC gives disproportionate weight to the crankish opinions of a “stock cycle” fetishist named Peter Eliades. The author of the story is totally unable to critically assess Eliades’ claims.

Never mind that stock cycle theory is the phrenology of the finance world — Peter Eliades is telling us that he can make money timing stocks. His “proof”: stock prices fluctuate, so it is critical to buy and sell at the right times. Gee, you mean I would make more money if I bought at a lower price and sold at a higher one? That is a tautology, not an argument; it is not proof that any valid strategy for forecasting the peaks and valleys of the market can be devised. The MSNBC author seems totally incapable of making this critical distinction.

As for Mr. Eliades, we are told that he “[has] his money in cash until the market shows clearer signs of its next move.” So he essentially concedes that he doesn’t know how to time the market either, but this point is also lost on the author of the piece. And why on earth is he in cash? Is cash the only alternative to corporate equities? But since MSNBC knows as much about securities markets as Mr. Eliades — next to nothing — he is their peer, and as such is taken at face value by clueless Big Media scribes.

If you are concerned about when to get out of the stock market, you can always hedge your bets by selling off your stock portfolio a little at a time, smoothing out the bumps in the ride. Market timing poses no crisis to smart, disciplined investors.

Exhibit 2: The NY Times on the recovery

I picked this next quote not because I felt like picking on the New York Times, but because I think that it is all too typical of pseudoscientific analysis of the stock market and the sheer pervasiveness of the DK/DC policy by Big Media in general. It could have come from any newspaper. This is how The Gray Lady attempts to explain Monday’s stock market rally:

Emboldened by the broad market’s ability last week to snap a three-week losing streak, investors jumped back into the market on Monday, scooping up stocks with beaten-down prices.

Stock prices rose because investors jumped back into the market? Hmmm … how did these investors “jump into” the stock market? By purchasing stocks from the Stock Market Fairy, right? No, they bought shares from willing sellers who were already in the market and wanted to reduce their exposure to those particular securities. Every share of stock that is traded on the NYSE is simultaneously bought and sold, by definition. Duh!

And what is with this psychobabble? In an absurd anthropomorphosis, the Times tells us that the market had the “ability” to snap a losing streak. Markets don’t have “abilities” — markets do not “struggle” to “find their level” or “seek to reverse their losses” or whatever other characteristics journalists assign; markets simply calculate the prices needed to avoid surplus or shortage conditions. If the buyers were “emboldened,” what does that say about the investors who sold their shares to the emboldened buyers? Are they wusses?

Exhibit 3: CNN on the scandals

This CNN piece is typical of the media’s DK/DC attitude toward the
corporate earnings scandals. Investors, we are told over and over again, have been “alarmed” and “shaken” by various scandals in which senior management “cooked the books” to overstate profits. Well, maybe rank amateurs and ham-fisted day traders allow measures like “earnings per share” drive their investment decisions, but as they tell you in accounting courses — profit is opinion, cash flow is fact.

If I am a CFO, which would I rather do: report higher earnings or lower earnings? Suppose that I have the option of valuing inventory in two ways, one of which would result in a higher cost of goods sold; or suppose that I can choose from two depreciation schedules for my fixed assets, one of which would cause me to take more depreciation expense sooner in the life of the asset. In either case, I’ll take the option that depresses current earnings, thus minimizing current tax liability and giving me more cash sooner. Tax reforms such as accelerated depreciation and LIFO (last in, first out) inventory modelling would allow corporations to report LESS taxable income while INCREASING their cash flow by decreasing their tax liability. Investors value a stock for the company’s ability to generate cash to pay dividends, not for its ability to enrich Uncle Sam.

A healthy firm is going to try to err on the low side when reporting earnings. For a struggling, nearly insolvent firm like MCI WorldCom or Enron, the incentives might be reversed if, for example, reporting very low or negative earnings would cause the firm’s bond rating to fall substantially. WorldCom and Enron were highly leveraged, which means (1) that they are extremely sensitive to the cost of financing their debt and (2) that they are extremely sensitive to downturns in the business cycle. Firms that are fighting for survival, and management that is trying to hold on to power, might try anything. But it is fatuous to treat every business as the exception to the rule.

Here is something that Big Media is not going to tell you: the outright majority of the value of the US stock market is owned by financial institutions (e.g. investing intermediaries such as mutual funds, and contractual intermediaries such as pension funds and life insurance.) Households are net sellers of individual stocks, but they are net buyers of mutual funds. In other words, households are still heavily vested in the stock market, but they are investing indirectly through professionally managed mutual funds and pension funds, etc. A pension fund manager is not going to be swayed by a cash flow statement that tries to shift $4 billion from operating activities to financing activities (as WorldCom did) — these people are just not duped that easily.

So is “shattered investor confidence” the reason the stock market is falling? Call me a heretic, but I think the scandals have relatively little to do with the declining US stock market. I think it has more to do with the EU Savings Tax Directive, which Perry has discussed below. The US stock market was fueled in the ’90s by massive foreign investment in American equities (British Petroleum buying Amoco, Daimler-Benz buying Chrysler, etc.) Europeans prefer to set up American holding companies to invest in the US, earning income on their investments that is taxed at (comparably low) American corporate tax rates.

The US attracts massive amounts of foreign investment (another way to say this is that the US has a massive current account deficit) because the US has relatively low tax rates, and relatively light regulatory burdens. But the EU considers this “unfair tax competition” and is trying to establish a tax cartel that would tax receipts of income earned in the US by Europeans at higher European rates. To the extent that such a thing would make investment in the US less profitable, it has reduced the global demand for American corporate equities. It’s just a theory, but at least it is a theory backed by some evidence, not just a bunch of tiresome cliches pastiched together into a jejune news story.