Brimmer Financial Newsletter
First Quarter, 2002

During the first quarter of 2002, the U.S. stock market drove around in circles like a lost tourist stuck in the Hyannis Rotary, not knowing where to turn off. Stock prices meandered in a tight trading range that was held back by a number of negatives. Among them were 1) the psychological effects of acute ENRONitis, a condition resulting in widespread distrust of large-company financial reporting, 2) ARTHUR ANDERSENosis, the inability to fulfill the obligation to tell the truth while collecting huge consulting fees, 3) Mideast Misery, a continuing tragedy appearing nightly on television and daily in the newspapers, and 4) a slower-than-hoped-for recovery in corporate profits.

January 2002 began with the U.S. economy in mild recession. Corporate earnings were idling in neutral. Low inflation, although very good for consumers, kept companies from raising prices, thereby stalling earnings growth. Even so, by late January, signs of a recovery began to flicker on stock analysts' computer screens. At its January 30th meeting, the Federal Reserve left interest rates unchanged. The number of unemployed Americans dropped, further encouraging investors. In the first month of the year, personal income actually rose slightly and the market appeared ready to stage a sustainable rally.

But early in February the mood blackened. Value Line dropped coverage of Enron as news of that company's misdeed surfaced and its stock collapsed. From that time, the dominoes fell. Arthur Andersen, Enron's auditor (minus the shredded evidence) began losing important clients, threatening the very existence of that heretofore leading accounting and consulting firm. Stunned by the magnitude of this debacle, the question on the minds of investors and their advisors was, how could this happen? Prior to its collapse, Enron had been the seventh largest firm in the U.S. Suddenly, everyone was suspect. In late winter, 2002, the concern being voiced throughout the investor community was that if there's trouble with one big company, then there's probably trouble with others. Like cockroaches, if you see one, there must be more.

The Enron/Andersen mess was truly an embarrassment to the nation's thousands of honest and diligent CPAs, corporate officers, and industry consultants. As egregious a case of corporate lying and cheating as this was, however, it appears to have been an isolated event rather than a widespread problem. I'm sure there's more than a little creative accounting done each quarter in many corporate headquarters to help increase the odds that the numbers will gain Wall Street's approval. So it is not surprising that over the years a number of firms have been asked by federal and state regulators to recalculate their results. Almost always, the corrected financial results are revised downward. Where people are involved, there will never be perfection. The good news is that post-Enron, the folks in charge of counting the beans will have to be a lot more careful. The bar of ethical standards has been raised. And for that reason, the issue of conflict of interest will get much needed scrutiny.

One wonders how accounting firms can remain objective when they audit companies that pay them huge fees for consulting. It's much the same on Wall Street. Many of the largest brokerage firms also provide investment banking services, the process of selling new securities to the public. The two functions are supposed to be separated by an impenetrable wall, but the reality is that the wall often tends to be porous. Perhaps they should split the two functions into separate companies. In addition, one has to wonder about the possibility of bias in research coming from a company that is also selling that company's securities. I prefer outside research sold by independent organizations, such as Value Line or Morningstar, who do not profit from my clients' sales or purchases of the securities upon which they are commenting.

Filled with the enthusiasm for bad news that only short-sellers, news reporters and bears know, the gloom-and-doom crowd gorged itself on the feast of plummeting stock prices as facts and rumors of various corporate problems were plastered over the front pages of the financial press. Most of us think of making money in the financial markets when our stocks and funds go up in price. But there is another, far riskier way to profit. It's called short-selling and it's a bet that prices will fall. This is a highly speculative strategy. A short-seller borrows stock from the brokerage firm, sells the borrowed stock in a margin account, and waits (hopes) for the price to drop, at which point it is bought back at the lower price. The profit, if there is one, is the difference between the higher sold price and the lower bought price.

In most markets, short-selling is the superhighway to the poorhouse. I do not engage in this activity. The risks are too great. But there are a number of institutional investors who do practice this kind of financial sky diving. From time to time their selling activity keeps downward pressure on stock prices. Eventually, the short sellers "cover" their positions by buying back the borrowed shares. If their stocks suddenly begin to climb, the shorts are forced to buy back quickly, or suffer even greater losses. This is call a "short squeeze". It sounds uncomfortable, and it is.

Over the past few months, the media has been filled with news of companies having problems. Whether great or small, stocks fell in the face of a fusillade of Wall Street rumors of weaker earnings, media reports of these rumors that made them seem factual, and in some cases, actual earnings disappointments. K-Mart and Global Crossing made headlines with news of their difficulties. So did Bristol Myers Squibb and IBM. Even mighty General Electric felt Wall Street's wrath when word of a temporary slowdown in sales growth hit the newswire. Tyco, another large diversified corporation, suffered the slings and arrows of outrageous selling after it, too, was ground into the rumor mill. Ready. Fire. Aim.

Toward the end of the quarter, reason began to reassert itself. Rumors faded as the market started to sort out the facts from the hype, and anticipated the next earnings reporting season, which began in mid-April. At this writing, more than 50% of the major firms reporting have exceeded analysts' estimates. The market found further encouragement in Fed Chairman Greenspan's April 17th report to Congress citing continued strengthening of the U.S. economy, and no need to raise interest rates near term. Inflation remains in check and interest rates are holding near multi-decade lows.

An ocean of cash is parked on the sidelines. Earnings are improving. Confidence is slowly returning to the financial markets. It's all about psychology. If history is any indication, when the mood turns from pessimism to optimism, the market should continue its long-term upward advance. History is on the side of the bulls.

There is no subscription cost
You can receive the newsletter by postal mail or by email
We welcome your questions and suggestions

BRIMMER FINANCIAL
rbrimmer@nationalsecurities.com
P.O. Box 2806 - 19 Brewster Cross Road - Orleans, MA 02653
tel. 508-240-0320 fax 508-240-2309 toll free 800-237-9322
Disclosure · Privacy

Securities offered through National Securities Corporation, Member NASD / SIPC
Investment Advisory Services offered through National Asset management, Inc., a Registered Investment Adviser
Accounts carried by National Financial Services LLC, Member NYSE / SIPC