Security Analysis and Business Valuation on Wall Street,: A ... - lib

CHAPTER 28Asset Booms <strong>and</strong> BustsThe 2008 stock market crash exposed serious flaws in the security analysisprofession, the investment business, <strong>and</strong> the broader financial industry.Attempts to reform Wall Street will fall short, exposing economies to theprospect of another financial panic. <strong>Security</strong> analysts, <strong>and</strong> those individualsin business valuation, should try <strong>and</strong> learn from the lessons of this latestboom <strong>and</strong> bust.Over the past 10 years, there have been two bear markets in which stocks fell byat least 40 percent. The severity <strong>and</strong> the swiftness of the declines caught mostanalysts unaware, <strong>and</strong> laid waste to the claim that equities, by any account, aresuperior investments relative to corporate bonds or cash. Over long periods of time,a diversified stock portfolio outperforms bonds <strong>and</strong> cash, but in the intermediateterm, investors are subject to downturns that wipe them out, at least temporarily.This problem was compounded in 2008 because global indexes—the U.S., WesternEurope, <strong>and</strong> emerging markets—plunged in concert, so there was no place for theequity investor to hide. The interrelationships inherent in linked economies meanthat the performance of national stock markets correlate well, <strong>and</strong> U.S. investors arefrustrated in finding securities that move opposite to the domestic market. Besidesan illustration of the ebb <strong>and</strong> flow of capitalist economies, the 2008 crash broughtthe sense that government overseers failed the public.The manner in which the financial industry <strong>and</strong> the regulatory apparatus dealwith these issues in the future affects the investment evaluation process. The stakesare high—the savings <strong>and</strong> peace of mind of millions of ordinary citizens.THE 2008 CRASH: CONTRIBUTING CAUSESThe 2008 crash was fundamentally a credit bubble, housing bubble, <strong>and</strong> consumptionbubble, all rolled into one. Lax lending st<strong>and</strong>ards promoted a period of exuberancein real estate prices, <strong>and</strong> investors believed that housing prices would neverdecline (even though they had dropped in the 1990–1991 recession). The paper profitsin real estate drove sizable increases in consumer spending, which contributed toeconomic growth, corporate profits, <strong>and</strong> higher stock prices. The enhanced corporateperformance promoted record numbers of leverage buyouts, risky bank loans,369