Although it would be sheer folly to predict the stock market at present, the major indices have definitely moved up from their lows of a few weeks back. Another significant corporate scandal (or a war) could send things reeling, but otherwise we may (at least for a little while) get back to fretting over economic indicators, Federal Reserve whims, tax policy, and all of the other things that usually stress investors.
The most obvious reason for this turnabout is the “signoff” by hundreds of corporate chieftains on their financial reports (the recent corporate accountability bill signed into law likely helped some as well). There were no major surprises, a few minor restatements, and some requests for the automatic extension. Because restoring credibility is all about psychological response to a situation the likes of which we haven’t seen before, we can only speculate about what folks are thinking.
From what I can tell, comfort was taken not only from the disclosures themselves, but also from the minor adjustments and those that needed a little extra time. The idea was that (1) the vast majority of the numbers were fine; (2) changes were minor, reasonable, and of little consequence; and (3) everybody was really trying to get it right. The scandals now appeared more like aberrations and less like a pattern permeating the entire universe of public companies. It’s too early to say if this view will hold, but it is a refreshing change.
It’s easy to see how some could yield to the enormous temptations and allure of cooking the books. The market sets expectations, and those who meet or exceed them receive incredible financial rewards and superstar status. Those who don’t generally fall into oblivion. To make matters worse, the market is a very fickle master. It is only a slight exaggeration to say that the dot-com collapse occurred when the goal of “revenue, revenue, revenue” was quite suddenly abandoned for one of “profits, profits, profits.”
In such an environment, if the market wants ducks and you have a dog, you might find an almost irresistible urge to put feathers on your dog and call it a duck. (That little pearl of wisdom about those who would try to fool you is courtesy of my granddad.) If a desire for dogs subsequently emerges, the less scrupulous of the lot would pull the feathers off the dog and put some hair on their ducks.
This process obviously leads to some mad dogs and ducks, and even the best of dogs can’t quack and is not a very appetizing a l’orange. The key point is that an overly zealous desire to achieve growth and profit targets as they arch ever upward in a red hot market can ultimately lead to disaster. To make matters worse, the process becomes a self-reinforcing spiral. Each time a bar is cleared, it is set higher for the next quarter. The requirements increase dramatically, and the costs of failure escalate in tandem.
Based on what we know now, it appears that the overwhelming majority of firms did not fall prey to this dog and duck deception. Assuming this pattern holds (and I think it will), market integrity will likely return to what passes for normalcy in short order. If not, all bets are off. In the meantime (absent a war), keep the dogs at bay, get your ducks in a row, and buy quality.