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Commentary: Nice Speech, Mr. President, But...


So the Big Guy spoke, and the market has been sinking like an anchor in a fishpond. Although President George W. Bush's July 9 speech was designed to restore investor confidence, major stock indexes continued their free fall. Now, both the Nasdaq Composite Index and the Standard & Poor's 500-stock index have crashed through their depressed post-September 11 levels to hit five-year lows. The next day, the Dow Jones industrial average plummeted more than 3%.

Sorry, Mr. President, even after your speech, investors still aren't confident. In fact, the term "confidence" doesn't apply in the current climate--investors are mad as hornets. Truth is, even the grand pooh-bah himself can't bring a quick end to the sour mood of investors or their mistrust. "We really need concrete examples from CEOs that they're not tone deaf to what's going on, along with real changes in corporations that address compensation and accounting," says Richard E. Cripps, chief equity strategist at Legg Mason. Also, many investors say that the President isn't going far enough. "He's afraid if he pushes for too many reforms, he'll spook the stock market further. But he's spooking it by not calling for meaningful, quick action," says New York Attorney General Eliot Spitzer, who has been pressing for concrete rules to tame analysts.

Even so, Bush's requirement that CEOs and chief financial officers must vouch for their companies' annual financial reports by Aug. 14--and be personally held accountable if the numbers are fudged--will whack the stock market. "CEOs know that they better get their ducks in a row, so they're going to start to move faster and be more conservative when reporting," says Charles L. Hill, research director at earnings research firm Thomson Financial/First Call.

Indeed, if companies come clean about their accounting practices and stop managing earnings, stocks may suffer a prolonged drag. According to several strategists and economists, companies have been overstating earnings by as much as 15% annually over the past five years. The New Economy "was, in the end, mostly hype," says Robert J. Barbera, chief economist at Hoenig & Co. Adds a prominent hedge-fund manager: "It's not possible for companies to meet the numbers they've been reporting without the aid of accounting tricks, especially in a recession."

The stock market is almost certain to become more volatile and risky as new negative surprises and restatements of earnings roil investors. "I call this the Year of Final Purge & Healing. It could take months for all of this to shake out," says Charles Pradilla, chief investment strategist at SG Cowen Securities Corp. Once that has happened, the market would be on a more solid footing as stocks become realistically valued.

Meantime, investors have been parking cash on the sidelines and pouring equity into their homes and other hard assets such as gold. No wonder. They were still reeling over Enron (ENRNQ) and Tyco International (TYC) when a whole host of other companies were brought into question, including Qwest Communications (Q), WorldCom (WCOM), and Merck (MTK). And foreign investors, who hold $5 trillion in American securities, have become much less enthusiastic. According to a report recently issued by Banc of America Securities, foreign purchases of U.S. stocks are off to a much slower start than they were in previous years.

Even so, the news isn't all bad. The economy continues to gain ground. Earnings of S&P 500 companies are expected to rise 3% this quarter from a year ago, 17% in the third quarter, and 28% in the fourth, according to First Call. "The recovery is real, and we're in an important cyclical rebound for earnings," says Hoenig's Barbera. However, investors won't act on those numbers until they actually see them--anticipation of improving profits, always a big market driver in the past, is no longer enough. Says Edward M. Kerschner, UBS/PaineWebber's chief global strategist: "If you don't know whether to believe those numbers, do you believe they will turn up?"

Bottom line: A soothing speech, a treasure trove of good ideas, a solid game plan to preserve financial integrity are all a good start. But, Mr. President, only an improving economy coupled with a strengthening profit picture will send this troubled market into bull territory. By Marcia Vickers

With David Henry in New York


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