INVESTMENT INSIDER

Martin Weiss on the future of Wall Street

Meaningful reform may come slowly, this controversial investor advocate says, and that doesn't bode well for stocks.

Wall Street systematically fleeced small investors while the regulators who were supposed to protect them looked the other way, says Martin D. Weiss, chairman of Weiss Ratings ( www.weissratings.com), based in Palm Beach Gardens, FL.

Weiss, the son of successful Depression-era investor J. Irving Weiss, is a leading advocate for reform in the investment, banking, and insurance industries. His company, which has been lauded by the General Accounting Office, generally provides tougher reviews and earlier warnings than rivals AM Best, Moody's, and Standard & Poor's. Weiss' firm also provides ratings for thousands of stocks and mutual funds.

Never one to mince words, Weiss has testified before Congress and appeared as a guest on ABC's Nightline and NBC Nightly News. He's also a popular speaker at major investment seminars worldwide and the author of the newly released book, Crash Profits: Make Money When Stocks Sink and Soar!

Weiss spoke recently with Medical Economics' Senior Editor Dennis Murray.

Are the fines levied against brokerage firms, and the efforts to separate analysts from a firm's investment-banking business, good news for investors?

They're definitely steps in the right direction. That includes the recent $1.4 billion settlement that (New York Attorney General) Eliot Spitzer negotiated with 10 investment banks. However, I'm disappointed by the low amount of money from the settlement—$85 million—that's going to be allocated for investor education. Second, I don't think the size of the fines is going to radically change Wall Street's business model.

So the deck remains stacked against most small investors?

For now, Yes. But I'm optimistic; I think we'll see even more significant reforms down the road. For instance, I'm hopeful that we'll see a more streamlined system for allowing investors to bring claims against individual brokers and brokerage firms. Depending on the egregiousness of their malfeasance and the extent of the litigation, some of these companies will suffer severe earnings declines. Several may go out of business.

Did the scandals that rocked companies like Adelphia Communications, Enron, and WorldCom surprise you?

No. Actually, I'm amazed that more companies haven't been exposed. The headline of our Safe Money Report for September 1999 was "28 Percent of US Companies Are Telling Half-truths or Outright Lies About Their Earnings." In that report, we detailed many accounting gimmicks and warned that the problems would escalate. We published a list of 100 companies that seemed to have the biggest discrepancies between actual cash flow and reported earnings. In April 2001, Enron appeared on a similar list that we published—six months before the company hit the news.

We haven't seen the end of the accounting troubles. Currently, dozens of other companies are suspected of accounting irregularities.

In dollar terms, the largest manipulation of all is with employee pension funds, and yet it's considered perfectly legal under current rules. Based on annual reports filed with the Securities and Exchange Commission, we determined that 234 companies in the S&P 500 owed a total of $78 billion to their employee pension funds. That was at the end of 2001. The data for year-end 2002 isn't in yet, but with the market down still further I have to assume that the total liabilities to the pension funds have increased significantly. This will likely have a negative impact on the companies' stock prices in 2003 and beyond.

Won't the SEC come to investors' rescue?

The SEC is well-intentioned, but it's understaffed and underfunded. Investors shouldn't rely on it, the states, or anyone else to rescue them. The best protection investors can get is to empower themselves with reliable, unbiased information.

Let's take a closer look at the stock market. You feel that investors shouldn't trust any of Wall Street's forecasts of an imminent turnaround. Why not?

People on Wall Street and in the media would tell you that because the slump has lasted three years, it couldn't possibly go a fourth. That's what they said after the first year of the downturn, and again, after the second year. Instead, they should be viewing these three years as a trend. Until I see hard evidence that shows this new era of volatility has ended, I'll assume it's going to continue.

What could exacerbate things?

President Bush's proposed tax cuts. The federal deficit is far worse than economists and politicians are letting on. A tax cut could trigger a decline in bond prices and higher interest rates. In turn, the cost of higher interest rates, spread across thousands of corporations and millions of consumers, could easily wipe out any benefits from tax initiatives.

Many brokers have advised their clients not to sell their losing investments. Be patient, they say, and you'll be rewarded down the road. Good advice?

No. Unfortunately, it's in the brokers' benefit, not the investor's. Their agenda is to keep their clients in the stock market. Many of the so-called golden rules of investing have their origins in that agenda. For example, the idea that people should always "invest for the long term." That doesn't necessarily work in a significant bear market like the one we've seen over the past three years. Another so-called golden rule is to buy more of an investment when prices are low. That'll only double your trouble in a bear market.

With very few exceptions, it's not a good idea to hang on to losing investments. If the market is moving against you and your portfolio is going south, sell. If it turns out to be a false alarm, you can always repurchase the investment—probably at a similar price or a better one.

Certainly, though, lots of folks held blue-chip stocks for decades and did quite well for themselves.

Yes, but that was during an era when it was assumed that companies wouldn't go bankrupt, the investment advice would be honest, the accounting would be solid, and the economy would be fundamentally stable. In that environment, a buy-and-hold strategy works quite well. In today's environment, however, we're seeing much more volatility, hard evidence of accounting problems, and serious questions raised about the honesty of the advice investors are getting. A strict buy-and-hold approach doesn't work under these circumstances. In fact, investors who do it these days could be committing financial suicide.

Sounds like you're recommending that investors time the market, a risky strategy.

Not at all. My philosophy is that you get rid of losing investments quickly, and add gradually and prudently to winning investments. Granted, a sell decision might vary by the type of investment and the person's tolerance for risk. For instance, a somewhat conservative investor might unload a volatile small-cap stock after it loses 20 percent, and a blue-chip stock after it loses 10 percent.

Say I'm a first-time investor. Stock prices look cheap to me. Isn't this a good time to jump in?

No. I think the market could drop a lot further. Don't ever fall for the pitch that stocks are so cheap they couldn't possibly get any cheaper. And even if you disagree with my view of the market, you must admit that stocks are very speculative right now. There are safer, less-volatile vehicles available.

Such as?

Treasury securities and other fixed-income investments. The yields are low, but I'm willing to accept that because of the lower risk. The whole subject of risk was very unpopular in the mid-to-late 1990s. People forgot how important risk can be.

You're not precluding a return to stocks at some point?

Definitely not. One of the great benefits of stashing your money away in a safe place right now is that it will give you the ability to pick up some of America's best companies for a fraction of their current value. But be patient. Reaching a bottom in the market could take longer than most people think.

 

Dennis Murray. Investment Insider: Martin Weiss on the future of Wall Street. Medical Economics Mar. 7, 2003;80:43.