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Perception vs. Reality

Yet when stock prices are allowed to slip away from their moorings of corporate value, a day of reckoning is never far away. The price of a stock is perception, but the value of a corporation is reality. And when perception soars far above reality, the gap must inevitably be reconciled in favor of reality. Given the nature of competitive capitalism, it was impossible for managers to build corporate value at the rapid rate at which the stock market bubble inflated. Over the long term, earnings of U.S. corporations have grown at an annual rate of about 6 percent, and they did just that during the great bull market of 1982–2000. Yet, the total return on the U.S. stock market soared to almost 20 percent per year. The bear market is now reconciling that gap.

Martin Howell is one of the few observers to note that mutual fund managers played a major role in the happy conspiracy, accurately describing them as “far from innocent spectators . . . (who) played the role of sirens luring investors onto the rocks.” The biggest failure of the funds was the metamorphosis from an own-a-stock industry to a rent-a-stock industry, focusing on the momentary precision of short-term stock prices rather than the eternal vagueness of long-term intrinsic corporate value.

Yet mutual fund managers could hardly have been ignorant of what was going on in corporate America. Even before the stock market bubble burst, the industry’s well-educated, highly trained, experienced professional analysts and portfolio managers must have been poring over company fiscal statements; evaluating corporate plans; and measuring the extent to which long-term corporate goals were being achieved, how cash flow compared with reported earnings, and the extent to which those ever-fallacious “pro forma” earnings diverged from the reality. Yet few, if any, voices were raised. Somehow our professional investors either didn’t understand, or understood but ignored, the house of cards that the stock market had become. And we have yet to accept our responsibility for that abject failure.

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