The following is the S&P 500’s chart in 2002.
*Read the entire history of the U.S. stock market here.
By the beginning of January, it was clear that the rate of economic deterioration had massively slowed down. The Employment Report, manufacturing indicators, and other economics indicators were all recovering rapidly.
Earnings reports for Q4 2001 (released in January 2002) also started to improve a little, just like the U.S. economy. Earnings started to bottom this quarter.
February 6, 2002: Worldcom accounting problems emerged. Throughout the rest of February, there were a lot of concerns about accounting practices at other big companies. Some of these concerns – like IBM’s – amounted to nothing.
Contrary to popular belief, the S&P had no medium term bearish reaction to the Worldcom and Enron (2001) account scandals. News of these scandals only caused tiny, 1-2 day negligible declines in the broad stock market.
The next big DOWN wave that brought the S&P 500 to our model’s bear market target began in April 2002. The selling really intensified mid-May to mid-July 2002.
The Q1 2002 earnings (released in April 2002) show that corporate earnings were definitely making a bottom (absolute dollar value and not just beating lowered expectations). Some big name companies started to see earnings increases, even though the broader market’s earnings were still falling a tiny bit (some of the tech companies’ and telecomm’s earnings and sales were still falling). Compared to analysts’ expectations, earnings this quarter were mixed. Some companies beat expectations, some companies missed.
The S&P still fell during earnings season in April 2002, purely because our model’s bear market target was not reached yet.
April 25, 2002: The SEC and other U.S. federal regulators said that they would start to look into financial analysts’ conflicts of interests. These analysts played a role in the internet boom and bust. State Attorney Generals around the U.S. were considering charging investment banks with conflicts of interest too. Many of these investment banks promoted stocks whose companies paid them handsome IPO and investment banking fees.
Like in most bear markets and recessions, the government always uses the banks as “scapegoats” for everyone’s problems. This happened in 2008 as well.
The S&P’s selloff really intensified by the end of May.
May 21, 2002: Merill Lynch settled a $100 million fine for its analysts’ conflicts of interests during the dot-com bubble. During this time, investors feared financial re-regulation.
By late-May 2002, it was clear that there were accounting problems across-the-board in Corporate America. There were news that a lot of smaller companies were being investigated by government agencies for corporate governance problems (e.g. improper accounting, bad business practices).
June 2, 2002: President Bush said that federal agencies like SEC and the Justice Department would start investigating Worldcom. Meanwhile more and more accounting problems and earnings restatements were announced.
Herein lies the problem with S&P 500 investors. The S&P often lags its problems. Enron and Worldcom problems came out in 2001. The S&P only started to go down months later in 2002 when problems were across-the-board and painfully clear.
June 28, 2002: Xerox restated $2 billion in revenue over the past 5 years (revenues that never really existed).
The key lesson is that the S&P doesn’t care about a few individual companies’ problems. It only cares when entire sector(s) or all of Corporate America is facing similar problem(s). The S&P will ignore an individual company’s problems, no matter how gigantic that company is. For example, the S&P still went up in early 2007 despite a few big mortgage company bankruptcies. The S&P only started to fall in late 2007 when banks across-the-board started having problems.
During the entire March/April – July 2002 down wave, the U.S. economy was recovering and earnings were improving.
July 8 – July 24, 2002: These were the steepest days of the S&P’s selloff. During this time, there was a lot of news stating that many executives, particularly telecomm executives, could be indicted for accounting fraud.
July 19, 2002: Johnson and Johnson announced that it was being investigated by the FDA for improper record keeping and other corporate governance issues.
July 21, 2002: Worldcom, the 2nd biggest telecomm, filed for bankruptcy.
July 22, 2002: A Senate investigation stated that big Wall Street banks like JPMorgan and Citigroup helped Enron and other fraudulent companies cook their books.
July 23, 2002: Key Adelphia executives were arrested for fraud (stealing corporate funds). Its ex-CEO was arrested on July 24. Adelphia was the 6th largest telecomm.
July 24, 2002: the S&P bottomed on this day. This was the first of the bear market’s triple bottoms. In terms of news, the Senate and House of Representative agreed on a plan to solve the corporate governance disaster.
Q2 2002 earnings season (released in July 2002) was ok vs expectations. Earnings for Corporate America as an aggregate officially bottomed and started to go up!
New accounting problems emerged after the S&P bottomed on July 24. The S&P often bottoms before the fundamental problems are over.
July 29, 2002: Qwest admitted that it would restate $1 billion worth of earnings that never really existed. The S&P still went up.
August 19, 2002: the SEC started investigating AOL Time Warner’s AOL division for falsified sales (revenues that never really existed).
August 23, 2002: This was the rally’s top. The S&P started to fall again and would later retest its July 2002 bottom. In terms of news, the SEC continued its investigation into Citigroup and AOL for illegal accounting activities.
September 5, 2002: First Boston and Goldman were being investigated by the SEC for improper IPO allocations. The investment banks gave IPO stock to their best clients unfairly. Many of these stocks soared on their IPO days, generating guaranteed profits.
September 12, 2002: Bush announces why the U.S. and other countries should invade Iraq at a UN Security Council meeting. This is the first sign that the U.S. might go to war. The S&P completely ignores this.
October 10, 2002: the S&P made a double bottom on this day with no reason/news.
October 16, 2002: Congress authorizes Bush to use “any means necessary” to stop Iraq. This basically gave Bush a blank cheque to go to war with Iraq. The S&P fell on this day, and the pace of the S&P’s rally drastically slowed after this.
The S&P rallied consistently throughout Q3 2002 earnings season (released in October 2002), in which most big companies beat expectations.
December 20, 2002: Citigroup’s Salomon Smith Barney, Goldman Sachs, Credit Suisse, and other banks settle with the SEC for $1.4 billion. This ended the government’s investigations into conflicts of interesting during the dot-com bubble. Hence, the whole corporate governance/false accounting disaster started to wind down.