Tuesday, December 22, 2009

Manipulation of The United States' Stock Market

Is it possible that financial analysts from Wall Street have manipulated the U.S. Stock markets by setting low earnings estimates to make it appear that firms are performing better then they truly are?

There are many reasons why these financial firms would want investors’ perception of the U.S. markets to appear more attractive. The main reason is for improved investor confidence. If the economy appears to be worsening, many investors will hold more cash in risk free assets hurting the investments industry.  The other reason would be, returning favors for special interests. We know this happened for Enron when financial analysts were paid off and bribed to continue reporting favorably for Enron when the numbers lied.  

 The special interest in this case may be the federal government.  A very useful tracking poll is the end of month 401K statements. If people are losing money they become angry and quickly turn to blame the most plausible victim. In 2008 this victim was George W. Bush.  Through the beginning of 2009 the worsening economy caused the stock market to tumble. This blame was quickly passed from the new popular democratic president Barrack H. Obama to the former administration. In fact almost every appearance Obama has had with the economy the topic; he passed the blame back to Bush.

Obama did a good job passing the blame on Bush when the S&P 500 opened the day after the election on November 5, 2008 at $1,001.84 and dropped all the way to $666.79 on March 9, 2009. The decline was 50.25%. This could not have been caused by the Bush administration because the stock market is a leading economic indicator which points to things to come. The value of the stock market is a function of expected future cash flows discounted at a certain rate, not the results of past events.  The problem with this is only a fraction of U.S. voters understand economics and finance. Obama could easily pass the blame on the Bush Administration even though he probably had more influence over the stock market than anyone has given him credit for.

After successfully passing all blame for the stock market crash on the Bush Administration, Obama would lose his credibility if there were no recovery. To achieve this false sense of recovery the white house has continually put out rosy forecasts and jobs saved or created data that is impossible to prove. The white house has also received help from Wall Street as 80% of companies that make up the S&P 500 beat analysts’ estimates in the 3rd quarter of 2009. The S&P 500 is the best index for following the U.S. economy.

Although earnings can be manipulated to an extent something that cannot be manipulated is revenue. Using probability, 50% of firms should beat revenue estimates and 50% should miss. We find for the 3rd quarter of 2009 that 57% of firms beat revenue estimates compared to 47% last year the same time (Data Source: Thomson Reuters).

Although the majority of firms are beating estimates few are actually performing better than they had the previous year. Out of the 12 sectors only three had positive revenue growth from 2008’s 3rd quarter. Those sectors were financials with 14.3% growth, health care 2.8% and Services with the least at 0.6%. The worst performing sector for revenue growth was energy with a negative 40.7%.

If only 3 of 12 sectors performed better than last year why are 80% of firms beating analysts’ estimates?
Citi group got around $50 Billion in bailout, Goldman Sachs $12 Billion and J.P.Morgan and Chase received $25 Billion (bailout.propublica.org). Another interesting note if we look at political contributions all three of these companies rank in the top ten contributors to the Obama campaign. Goldman and Sachs ranks 2nd, Citigroup ranks 6th and J.P.Morgan and Chase ranks 7th. The total contributions from these companies were $2,391,217 (opensecrets.org).

Not only does the Wall Street owe the federal government a favor for the bailouts they want their choice for president to succeed. These two facts mixed together with the fact they make more money if the stock market goes up is a dangerous concoction for miss information and false perception to manipulate Wall Street by having low earnings and revenue estimates which can be easily beaten. If you can’t beat the standard lower the bar; and in doing so, you would achieve the perception that Wall Street is performing better than expected when it clearly is not.

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