"NO ONE IS BIGGER THAN THE MARKET"
By madis senner, CPA
TRADING TRUTH: One of the oldest axioms on the street is that; 'No one is bigger than the market.' Meaning that nothing or no one can impede, control or stop the markets course for long. Countless speculators from the Hunt Brothers to Ivan Boseky have tried to manipulate or control the market to suit their needs--they have all failed. Economists may espouse grandiose theories and create elaborate equations to explain and justify the market--But to those that deal in the market, whose reality is dollars and sense, know that no one is bigger than the market.
METHODOLOGY: The market's natural inclination is towards dominance and control as was the monopolists pursuits to dominate a particular industry in the latter nineteenth century--only today we have a giant 'collective' which permeates and controls much of our lives. Ralph Nader has said; "Corporations have taken over the government and turned it against its own people."; A lot of statistics and commentary has been generated on such. Our analysis will take another perspective--the market itself.
| There is value associated with all the benefits (corporate welfare/tariffs/perks/etc) government bestows upon business and its willingness to do whatever, at whatever cost it can to help business. | It is said that the stock market is a reflection of the opinions of its participants. It is also the ulimtate reality. |
ANALYSIS: By any appreciable measure the stock market appears overvalued, its price earnings has been in the 30's for some time (Price Earnings Ratio, or Multiple Stock = Price/Earnings) which is twice its historical average. (see Illustration 1 Click here to see).(The price earnings ratio may be broadly defined as investor optimism or pessimism of the overall stock market. The higher the multiple (PE) the more optimistic the participants are.) The current record high multiple may also be understating the actual market multiple given recent studies such at; 'Two Decades of Overstated Corporate Earnings', The Jerome levy Institute, September 2001, by Cadette, Levy and Thiruvadanthai, that found earnings were consistently over stated the last two decades:
'…The macroeconomic evidence indicates that corporate earnings for the Standard & Poor's 500 have been significantly exaggerated for nearly two decades--by about 10 percent or more early in this period and by over 20 percent in recent years. These figures are conservative--the magnitude of the overstatement may be considerably larger.'
Further clouding the water and raising the specter of even more helium in the bubble is the recent collapse of Enron and its questionable accounting practices. Given all this it could, and probably should be reasoned that the stock market is grossly over-valued and does not reflect fundamentals. Or does it?
What if we recognize for the moment that history has truly ended and the market has triumphed over us; it rules every aspect of our lives and even indirectly controls the government.
| Risk Free Rate of Return is considered the interest earned on short term government debt because there is no interest rate risk and the government is theoretically the best credit outstanding. But if businesses are subsidized and bailed out by the government should they fail--would that not make those businesses better credits than the government. | Think of it like organized crime that dominants a local area--you have to deal with it, it has the police in it's back pocket and the local government throws lucrative government contracts and business its way. How could you value such a business--in a sense it is risk free rate of return because the government supports it; arguably it is a better credit than the USA. |
THE SHIFT TO THE MARKET- Although, capitalism and business have been a feature of the USA for sometime it has only been recently that we begun to see what Luttwak in his book Turbocapitalism calls turbo-capitalism or a more hyper and more potent virulent form of capitalism. This shift began with the abandonment of fixed exchange rates in 1973 that marked the top in the government's influence and began the transfer of power towards the market and the private sector (See The Japanese Paradigm for more . By abandoning fixed exchange rates Government was acknowledging that it could no longer control exchange rates. Nipping at its heels was a burgeoning Eurobond and Eurodollar markets (US dollars held outside the USA and beholden to no one) unfettered by government control and a slap in the face in government's ability to control capital flows. Basically world governments threw in the towel--the power of money was too much. Governments were indirectly admonishing that the market was bigger than them.
| The spiraling growth of the market. By committing to the market we have relinquished decision making for investments and projects to the market. But the markets can be fickle and its actions are guided by its own 'self interest' and opportunities in other places around the globe. This forces competition between projects around the globe--giving more power to the Buyer (the market). So the spiral Grows! | Thatcher and Reagan latched on to this trend and accelerated the process by privatization and the diminution of government services and oversight. Privatization served many functions; it transferred government functions to business, created a new class of wealthy financial investors that were thought better able to pick winners and losers and it provided fodder to feed the growing pool of money sloshing around the globe un-beholdineing to anyone. |
The trend of smaller government in favor of unfettered business is echoed by Daniel Yergin and Joseph Stansilaw in The Commanding Heights: The Battle Between Government and the Marketplace That Is Remaking the Modern World, (Simon & Schuster, 1998):
"Today, in response to the high costs of control and the dissillusionment with its effectiveness, governments are privatizing. It is the greatest sale in the history of the world. Governments are getting out of businesses but disposing of what amounts to trillions of dollars and assets." (page 13)
"In 1975, the economist Arthur Okun--a chairman of the President's Council of Economic advisors and, of course, a child of the great depression--would say,--'The market needs a place, and the market needs to be kept in its place…Given the chance, it would sweep away all other values, a establish a vending-machine society. I could not give it more than two cheers.' In the two decades since, real GDP in the United States has doubled; and that tone, and the mistrust that underlies it, sounds archaic. The contrast made all the more stark by examining the 1997 report of the Council of Economic Advisors, the main theme of which is the 'advantage of the markets'. Indeed the Council's focus on what it called the 'insufficiently appreciated property of markets'." (page 368-369)
"…the state continues to withdraw from the commanding heights, leaving it more and more to the realm of the market." (page 390)
Some would like to argue that the expanding multiple is a function of the vibrant USA economy. However, if this were the case we would expect to see commensurately high multiplies in the post WWII period, but we don't. The recent stock market multiple is a record compared to any other period. And the new paradigm argument was destroyed when the Internet bubble burst. It could also be argued that the USA stock market is a classic bubble--this argument although valid does not negate our argument. If money were too loose it would flow into commodities but it has not. Instead the money has flown into the stock market because participants are 'discounting' that the market, rules.
The premise for the market system is that it is best able to allocate resources effectively and efficiently. That society benefits from the free and uninterrupted actions of buyers and sellers. The free market's prophet Adam Smith best encapsulates the power and ability of the market. In The Wealth of Nations by Adam Smith (Random House, Modern Library Edition, 1937). Smith speaks of an "invisible hand" whose influence governs the workings of the market, presumably for the good of all, even though the motivations of those carrying out business transactions may simply be to make a profit, regardless of the impact on others. Smith describes the capitalist’s motivations(Page 423):
"…he [sic] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it has no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."
THE MARKET MONOPOLY RULES: However grand Smith's and other theorist's beliefs and premises may be--they fall painfully short in reality. Society is not benefiting from the market. What has transpired in the real world is that the market has begun to exert itself, as would a monopolist. In other words the market, has triumphed over all other systems whether they be the government, religious, democracy, etc.. And as has always been the case the inherent nature of the market motivated by self-interest it wants to dominant as would a monopolist that controlled a particular industry or commodity--as did the robber barons in their hey day of the Gilded Age. The Sherman anti-Trust Law and other such laws were created to protect us and prevent the inherent natural proclivity of the business towards monopolist rule. One has only to look the relationship of the government to the market to understand the government's focus is to serve business and help it maximize profits. The real beneficiary is the market and the handful, about 5% of Americans that own the bulk of corporate stocks, about 80%. The market rules the rest of us, as would a king!
MARKET FUNDAMENTALS- The underlying market fundamentals reflect the control of business over the government (aka democracy). Remember that there is value associated with the ability to control, manipulate and garner special favors and transfer payments. These may be broadly grouped as:
- A positive pro-business environment.
- Revenues--The government provides a host of revenues or corporate welfare for businesses.
- Risk--Government has taken out or at least significantly reduced risk for the market.
- Upside surprises--the potential for surprises and unexpected positives add to the value of the market.
- Status--The most telling statistic of the market rule is how government and citizens are considered subordinate to it!
PRO-BUSINESS POLICY ENVRIONMENT The Wall Street Journal has called the 1990's 'the Decade of Moral Hazard', Review & Outlook, September 25, 1998 for the continual bailout of institutions and speculators under the guise that they posed some sort of systemic risk to the market and the economy. Since taking over as head of the Federal Reserve Alan Greenspan has pursued an aggressive bailout policy. (For a discussion of the bailouts go to: The Enron Way: A Creation of the Federal Reserve
The pro business policy is also found in a tax policy that has seen a reduction in corporate taxes. As David R. Francis of the Christian Science Monitor noted in ‘ Bye-bye corporate tax revenues’, (November 3, 1999); ‘Corporate profits are sizzling. Wall Street is cheering. Stock prices are rising again. But Uncle Sam’s not getting his full cut. Corporate profits were up 8.9 percent in the fiscal year ended Sept. 30. Federal corporate tax revenues were down 2.5 percent.’ But 1999 was not unique the last few decades as noted by the Institute on Taxation and Economic Policy (ITEP) in 'Study Finds Resurgence in Corporate Tax Avoidance', October 19, 2000:
" ITEP's new report examines the U.S. profits and federal income taxes of 250 of the nation's largest and most profitable corporations over the 1996-98 period. Although big corporations ostensibly are supposed to pay 35 percent of their profits in taxes, the 250 companies in ITEP's survey paid only 20.1 percent in 1998. That was down from 22.9 percent in 1996, and far below the 26.5 percent that a similar group of large companies paid back in 1988, soon after passage of the loophole-closing 1986 Tax Reform Act.
"With significant help from Congress, corporations appear to be finding ways around the tax reforms adopted in 1986," said Robert S. McIntyre, a principal author of both the new study and previous corporate tax studies in the 1980s. "We hope our findings will encourage lawmakers to reexamine this important area of taxation."
The government also indirectly encourages a pro business policy by its continual subsidy of the wealthiest Americans that own the bulk of our country. Citizens for Tax Justice in their report, "Post-2001 Tax Cuts Offer Little to Most Americans, June 18, 2001, noted;
"For most Americans, the post-2001 Bush tax cuts offer little gain, but lots of pain," said Robert S. McIntyre, director of Citizens for Tax Justice. "That's because most people will get little more in tax reductions after the first year, while losing large amounts in public services as the remaining upper-income tax cuts are phased in."
But the real injustice in the government's pro business policy bias is seen when we consider government's willingness to go into debt to help business. Think of yourself, who would you lend to? Better yet who would you lend lots to even if it meant going into debt? Most of us would probably only do so for a child or loved one. But Washington is so committed to a pro business environment that it is willing to put all of us into debt to help business.
Only a year ago in the spring of 2001 we were looking at massive surpluses years out into the future according to the CBO now it all seems to have changed. Within a quick period of only three months at the end of 2001 we have apparently spend 40% of the surplus. On the surface it appears the war and defense spending and a slowing economy were the main culprits. But if we look at the actions of Congress and listen to the words of Ralph Nader in 'Corporate Patriotism', November 9, 2001 a different answer appears;
"U. S. corporations aren't even subtle about it. Waving a flag and carrying a big shovel, corporate interests are scooping up government benefits and taxpayer money in an unprecedented fashion while the public is preoccupied with the September 11 attacks and the war in Afghanistan.
Shamelessly, the Bush Administration and Congress have taken advantage of the patriotic outpouring to fulfill the wish lists of their most generous corporate campaign donors…
In most cases, such as the $15 billion airline bailout and corporate tax breaks, legislation has been pushed to the forefront with little or no hearings and only fleeting consideration on the floor of the Senate and the House of Representatives".
DEBT ASSUMPTION: In bond analysis there is the concept of credit ranking based upon financial and industry analysis. The better the credit the cheaper it is for a particular company to borrow. There is also a ranking of credit with the government being the best credit. But given the behavior of government towards the market one could argue that t that the market is a better credit--given the policy pursuits of the Federal Reserve and Federal Legislatures. But this distinction is even more evident when one considers the willingness of government go into debt to help business.
REVENUES Not only does government provide a pro business market friendly, or as Herbert Hoover said, 'The business of America is business' attitude it gives corporations lucrative contracts, orders, etc. Corporate welfare is pure gravy for corporations. In 1998 Time Magazine in 'Corporate Welfare', November 9, 1998 noted that; 'The Federal Government alone shells out $125 billion a year in corporate welfare'. Yet as enormous as this number is it grossly understates the amount of corporate welfare. The problem is what do you include as being corporate welfare: giveaways?, contracts?, tariffs?, protective or exclusive legislation, etc. The Cato Institute('There's no Conceivable Reason to Preserve Corporate Welfare', Doug Bandon, July 23, 1997) estimates that the government spends $75 billion annually on 125 programs, directly enriching businesses. It cannot be emphasized enough that the Cato study only pertains to government programs. Not only is Corporate Welfare an enormous albatross at the national level it exists at the state and local level as well. For more on corporate welfare go to: http://www.jubileeinitiative.org/welfare.html
RISK--One of the key factors in valuing securities is balancing the risk reward equation. Investors expect to be compensated for their investment and they weigh the investment decision by balancing the risk of an investment versus its reward. In other words the greater the risk the greater the potential for profit should be, conversely the less risk the less the potential return. The United States government has greatly reduced risk for the market and its participants.
It is assumed that stocks are a risky investment and one should be compensated for this increased risk with a higher return. But with the stock market trading at such high multiples(PE) it is difficult to argue that there is great upside from multiple expansion and that there is great risk for a contraction of multiples, which would lead to losses.
But if one assumes that the risk has been reduced or taken out of the market the higher multiple is a reflection of this because the government has reduced the risk to the stock market at many levels. So an investor is much more willing to sit with a stock trading at record high levels because they know that the government has removed many of the risks.
MARKET RISK: As we noted before the overall risk to the market and companies in general has been greatly reduced by the bailout policy of Federal Reserve Chief Chairman Alan Greenspan and the legislative and executive branches of government.
INDUSTRY RISK: Washington politicians have taken to supporting whole industries and thereby reducing the risk to the industry overall. The government has an arsenal of tools by which it can protect industries such as tariffs on foreign goods, quotas, special legislation and even bailing out whole industries. President Bush' imposition of steel tariffs in early 2002 was an aid to and reduction in risk to the steel industry. The $15 billion bailout of the Airline industry in 2001 is prime example of the might and power of the market. The Congressional Digest in its April 2001 in an article on the Airline Industry noted that many in congress were concerned about recent mergers and consolidations in the industry and the potentially negative repercussions for consumers. Worse even before September 11th, the industry was in a tailspin and suffering the consequences of a 'business decision' to raise business class tickets in 2000 which in 2001 led to a backlash from corporate customers as noted in the Wall Street Journal in 'Airline-Industry Tailspin Continued in Second Quarter', Sonoko Setaishi, July 9,2001:
The reality is the airlines are badly underperforming the economy," said Mr. Buttrick(airline analyst at UBS Warburg LLC in New York.), who expects the group to have a loss of between $900 million and $1 billion on a net basis for 2001. "The second quarter was an absolutely dismal quarter for the U.S. airlines."
Instead of allowing airlines to suffer the consequences of making bad business decisions and a slowing economy Washington decided to bail them out. The airline industry bailout demonstrates that large structural changes in the world which would theoretically mean wholesale changes in things such as in this example air travel and transportation overall are not happening--this risk has been removed. But the worst irony may be according to some on the street that the loan bailout money may be used by some airlines to fund the takeovers many in Washington were concerned about.
COMPANY RISK: The risk to individual companies, particularly if they are large, or in strategic industries and or in the home of powerful politicians stand an excellent chance of garnering tremendous perks. The Chrysler bailout quickly comes to mind. Consider some recent actions to help Boeing:
"Such members of Congress inserted a provision in the Defense Appropriations bill requiring the Air Force to lease Boeing 767s. Under the Boeing lease provision, the Air Force will lease 100 Boeing 767s for use as tankers, over a 10-year period. Follow the bouncing ball to see exactly how outrageous this deal is. First off, these are planes even the Air Force doesn't want, or least not enough to include in a list of its top 60 priorities. The request for the planes did not appear in the president's budget, or in the bill considered by the relevant congressional appropriations subcommittees...
Second, the lease arrangement will be far more expensive than an
outright purchase would be. The Air Force will lease the planes at a
pricetag of $20 million per plane per year, for a $20 billion
expenditure (100 planes, 10 years). There are laws prohibiting lease
arrangements that are more expensive than direct purchases, but Congress
waived those rules in appropriating the money for the Boeing 767s.
Third, the government will accrue extra expenses to convert the
commercial aircraft to military configurations. The cost will be about
$30 million a plane (total cost: $3 billion). There's more: Because the
planes are to be acquired through lease, rather than sale, the
government has to return the planes to Boeing …-- a project worth
a tidy $200 billion."
The Boeing Boondoggle By Russell Mokhiber and Robert Weissman Essential Information.org
LIABILITY RISK: Removing liability/ atonement / not having to pay for your sins. Corporations are vulnerable to being sued or penalized by the government for polluting, breaking the law etc. But to a great degree business gets away with a lot--in many ways there are no costs associated with actions that should have costs. By not having to pay the costs of ones actions the government is directly subsidizing business. Because it will eventually have to pay for hazardous clean up, pollution, worker health etc. Ralph Estes in Tyranny of the Bottom Line- Why Corporation Make Good People Do Bad Things estimated the hidden costs of pollution, not having to pay for long term worker injuries, etc. in 1994 at $2.6 Trillion.
And even when a corporation may be targeted to pay for its sins Congress may step in to the rescue:
With little debate, lawmakers agreed to relieve the company, Homestake Mining, of any legal liability that it might have for damage done to the environment in digging gold from the Black Hills over the last 125 years.
The company, which has excellent political connections and high- powered lobbyists, had been planning to close the mine this month. Scientists said it would be a good site for an underground physics laboratory. But Homestake, now owned by Barrick Gold of Toronto, insisted that it first had to be protected against lawsuits.
Senator Tom Daschle of South Dakota, the Democratic leader, was the chief sponsor of the bill under which the federal government will assume liability for any environmental damage. Representative John Thune, Republican of South Dakota, also claims credit for the legislation. President Bush has recruited Mr. Thune to run against South Dakota's other senator, Tim Johnson, a Democrat, as part of the Republicans' effort to regain control of the Senate….
Scientists and federal officials said the total cost to the government over 10 years could reach $500 million to $1 billion. That includes the cost of buying a neutrino detector and other equipment and conducting experiments. A spokesman for Mr. Daschle, Jay Carson, said the cost of the bill covering liability protection had been estimated at $50 million.
"Mining Company gets Protection in Legislation Pushed by Daschle', New York Times, January 3, 2002.
GOVERNMENT KICKBACKS: Accountants call them extraordinary items and they appear as separate line items at the end of the income statement. They are called extraordinary because they are non-recurring (maybe not the case here) and they were generally not planned for and may be a function of some action outside the normal business operations of the company.
Extraordinary is the only way to describe the initial Republican Budget proposal in 2001: Citizens for Tax Justice in; 'House GOP "Stimulus" Bill Offers 16 Large, Low-Tax Corporations $7.4 Billion in Instant Tax Rebates-IBM alone is slated for a $1.4 billion rebate check', October 26,2001, noted;
'The "stimulus" tax-cut bill just approved by the House Ways and Means Committee calls for some $25 billion in immediate tax rebates to large profitable corporations that paid the low-rate "alternative minimum tax" over the past decade and a half because loopholes cut their regular income tax bills to little or nothing.
Some $7.4 billion of these corporate rebate checks would be made out to just 16 tax-avoiding Fortune 500 companies—each of which would get more than $100 million in rebates. (These companies reported a total of more than $42 billion in pretax U.S. profits last year.)
Topping the list is IBM, slated to get a $1.4 billion rebate check. Ford is next at $1 billion, followed by General Motors at $833 million, General Electric at $671 million, TXU (Texas Utilities) at $608 million, DaimlerChrysler at $600 million, and ChevronTexaco at $572 million.
The 16 low-tax companies that would get more than $100 million each under the GOP-backed bill include five in the energy business, along with the three largest U.S. automakers. Two companies are in the airline industry, which is receiving $15 billion in grants and loans under already passed legislation."
VALUING KICKBACKS--Options theory tells us that there is a value to surprises--particularly in this example when the surprises are mostly upside gains. In other words companies are in effect holding an option that they to may benefit from government largesse and get kickbacks as well. Think of it like a free lottery ticket that never expires and holds the chance of paying millions if not billions of dollars some day. Although the chances may be low as long as they are there, the mere chance that it could happen creates value for the corporation. Rocket scientists could put a value on such kickbacks. But for our purposes here it is enough to say there is value to kickbacks and it is reflected in higher stock prices.
CREDIT RANKING AND STATUS The totality of the market and its invisible hand rule may best be represented in its pecking order. For a long time many have made hay of the special status corporations have in the world--the benefits that accrue from being like a person but not having the responsibilities. What many may not know also is that a business or the market may or may not depending how you see it have another special status compared to governments and citizens.
The recent financial debacle of Argentina highlights the difficulty of bankruptcy for governments compared to companies as seen with the recent failure of Enron. There is prescribed format for businesses under reorganization and it does not necessarily sit well with creditors. Whereas there is no protocol for governments. One could argue that govenrments would be forced to give up assets or submit financial tribunals. Others would argue the IMF is not much better and the country would be better off-the creditors would lose out as they do with business bankruptcy.
William Greider of 'The Nation' in 'Sovereign Corporations', April 30,2001 notes the special status granted corporations under the 1993 NAFTA and chapter 11 ruling:
"Eight years later, it's the smoking gun in the intensifying argument over whether globalization trumps national sovereignty,,,,,NAFTA has enabled multinational corporations to usurp the sovereign powers of government, not to mention the rights of citizens and communities."
CONCLUSION: The market rules. No one is bigger than the market. The stock market is not overvalued but rather reflects the underlying fundamental that the government and we the people serve it! One need only look at the surge from the post September 11th lows to realize that the stock market was reflecting that Greenspan had turned the spigot on and a host of new goodies was coming from Washington.
Can the market continue to rule us from its Commanding Heights! Most certainly so! But we are not so pessimistic on democracy and we the people. At some point we the people will wake up and the beast (the market) still runs the risk of devouring so much and going to even greater excesses that it may fall from its own weight or put our country's finances at risk.
Clearly the biggest risk to the market's demise is democracy! But before we return to democracy we have to reduce the power of the market--that is why we continue to protest the Federal Reserve asking the Federal Reserve Chairman Alan Greenspan be stripped of his independence and made answerable to the people. Given that the government is submissive and under the power of the market, legislation and other such measures cannot bring democracy back. First we must remove the power base of the beast, one silver and one gold, we have created. For more on our actions to do such go to: Good Works to Bring about Liberty: http://www.jubileeinitiative.org/Works.htm
joanne shenandoah, from her CD 'Eagle Cries', 'One Silver, One Gold';
"Among the Haudenosaunee there is ancient prophecy which is, in abbreviated form, as follows: Two young men were traveling by canoe in the great salt sea on the eastern shores of Anowara:kowa (Great Turtle) Island when they saw in the distance an unusual light sparkling across the water. As they got closer they saw that the glow was coming from two serpents, one silver and one gold. The men were so mesmerized by the serpents they put them in their canoes and brought them back to the village for all to see. Everyone gathered around the serpents, pushing each other aside in their haste to see the serpents. The animals had great appetites and quickly outgrew the pens in which they had been placed. Soon, the entire community was burdened with the task of feeding the serpents, stripping the woods of game and the fields of all crops. The serpents broke free from their cage then began to hunt and eat the children, then the adults. The survivors fled and watched in horror as the serpents devoured the plants, trees and the earth itself. Their hunger cased them to strip the lands on the east and move on to the west, leaving polluted streams, decimated forests and blackened skies in their wake. The silver serpent went towards the northwest while the golden one trekked to the southwest until they reached the edge of Anowara: kowa before, having destroyed the Earth, they twill back to the east to hunt the last remaining Onkwehonwe (human beings). At that perilous time, a boy armed with willow arrows tipped with white flint and a bow made of hickory will weave a bowstring of the Clanmother's hair. He will approach the serpents, and as they arise to strike him, he will let fly the arrows which will pierce the hearts of the serpents, killing them. Then the people will once again become united and strong."
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