Posted on 10/26/2002 7:44:21 PM PDT by arete
NEW YORK (Reuters) - Wall Street is waiting for the next shoe to drop. The next smackdown may come from the big hole the stock market's crash has punched in corporate pension funds.
Corporate underfunding, as it's called, is a ticking time bomb that will cast more doubt on the profitability of the nation's largest companies and the market's rebound.
``In the years ahead, earnings are likely to be depleted by pension liabilities,'' says John Hussman, publisher of Hussman Econometrics and professor of economics at the University of Michigan.
``Many companies continue to make assumptions about the probable return on stocks that has no relationship with the rate of return that stocks are actually priced to deliver,'' he says.
Investors should wise up to the implications of companies clinging to expectations the stock market will deliver double-digit gains because what's left of their battered 401(k) retirement money is at risk, Hussman says.
By one account, 50 of the biggest American companies have seen 90 percent of their pension surpluses go up in smoke during the bear market.
BAD NEWS BELOW INVESTORS' RADAR
The sad truth is the companies will have to sweep up much of their already pencil-thin earnings to cover pension shortfalls.
While some companies have begun to infuse billions of dollars into their depleted pension funds, more than a hundred names in the Standard & Poor's 500 index have still not acknowledged the problem.
Credit Suisse First Boston estimates that a whopping 325 of the 360 companies in the S&P 500 index that have defined pension funds will have shortfalls this year.
In a sign that not much has changed since the fairy-tale days of the 1990s, UBS Warburg, the Swiss banking giant, says 118 companies in the S&P 500 continue to report a pension surplus on their balance sheets, even through they're running a deficit after the stock market sank more than 20 percent this year. The last time the pension deficit issue dogged the nation's biggest companies was during the 1993 bear market.
The list of companies includes big-cap names such as International Business Machines Corp.(IBM), Ford Motor Co. (F) and Ingersoll-Rand Co.(IR)
GM'S BIG BET
General Motors Corp., the world's largest car maker, this month warned 2003 earnings could be cut by $1 billion or more due to the cost of funneling cash into its $67.3 billion pension fund. In the last nine months, GM's pension fund shrank by 3 percent. GM (GM) had assumed the money would grow by an unrealistic 10 percent, which exceeds the stock market's historic return of 6 percent a year.
Earlier this month, Standard & Poor's chopped GM's credit rating to just a couple of notches above junk status, saying the company's worldwide pension obligations may be underfunded by a staggering $28 billion by the end of the year. On Friday, S&P also cut Ford's long-term debt ratings to -- you guessed it -- just two notches above junk-bond status.
On Friday, the stock of Cigna Corp. (CI), the third-biggest U.S. health insurer, lost almost $3.5 billion in market value -- a day after the company cut its earnings estimates because of higher costs for health benefits and pension funds. On Thursday, Cigna said shareholder equity would be cut by up to $700 million in the fourth quarter from increased liabilities to fund pensions.
In the roaring bull market of the late 1990s, few people worried about corporate pension funds. But the pendulum has swung back the other way after the 2-1/2-year-old bear market. Companies struggling to make money in the tough economic environment must now divert billions of dollars to get their pension funds up to snuff.
There is no getting around the problem.
Unless the stock market stages a dramatic recovery, corporate pension funds will no longer contribute to their earnings through recapture. The shortfalls will have to be made up from their earnings.
So the longer the bears hang around, the greater the damage to pension funds. If one study is to be believed, stocks may underperform for years.
Stocks will be viewed as a ``high-risk, low-return investment,'' says Deutsche Bank, which estimates there's only a 23 percent chance that U.S. stocks will outperform bonds over the next 20 years.
The big issue facing investors is this: The risk of being in stocks has climbed and remains in the danger zone even after the market's bone-jarring drop.
``More pain is to be expected for equity investors and more riches for their bond counterparts,'' Deutsche Bank says.
Stocks may be pricing in more bad news. Since the start of the year, the market has had a series of ``wonder'' rallies, which have been built chiefly on companies ``beating'' expectations of analysts with incredibly poor forecasting records, as opposed to just plain good earnings.
MORE SWINGS THAN TARZAN
``There have been four false 19 percent rallies in the Standard & Poor's 500 index and eight in the Nasdaq during this bear market,'' says James Stack of InvesTech Research. ``All have ended with the market going to new lows. That's not characteristic of a new bull market.''
The fundamentals of Corporate America are still not sound. Poor earnings continue to be the source of Wall Street's malaise even after the recession supposedly ended.
Typically, investors focus on the future, eager to put money on the table in anticipation of a turnaround. The market turns six months before earnings start to improve. But so far the bears have still not left the building, which suggests the good times won't be rolling until at least the middle of next year.
The pension fund issue is creating a newer and perhaps a bigger problem for the stock market.
Many investors are staying on the sidelines, preferring to focus on the market's probable sub-par return. And they're ignoring the bizarre assumption of companies like GM, which are not operating in the real world, with expectations that their pension investments will grow by 10 percent.
On Friday, the three major U.S. stock indexes finished higher for the third straight week -- the longest such stretch of gains since August. For the week, the Dow Jones industrial average rose 1.5 percent to close at 8,444, while the S&P 500 also gained 1.5 percent, finishing at 898, based on the latest available figures. The Nasdaq composite index jumped 3.4 percent to end at 1,331.
BTW, where is the little dude in the orange trenchcoat and the snazzy fedora?
Richard W.
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