The Daily Interview: A Voice For the Bulls

In the midst of the current stock shock, Harvard investment banking professor Samuel L. Hayes believes the market is overdoing it.

Samuel L. Hayes Professor of Investment Banking Harvard University

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Pointing to a low unemployment rate, a lack of inflation, further interest rate cuts and the strong possibility of a tax cut, the professor maintains that the U.S. economy is showing clear signs of resilience that do not warrant such punishing market declines. Hayes, who has taught at the Harvard Business School since 1971, says investors are simply behaving irrationally on the downside and maintains that a recovery by year-end is not the pipe dream some critics are beginning to call it.

TSC: Are you concerned about the Nasdaq Composite Index falling below 2000 and the S&P 500 reaching bear-market territory?

Hayes: The market's movement, in significant part, is unrelated to the economy but to an overexuberant flight from reality. The correction is bringing prices down below the prices that should prevail in an equilibrium, given the underlying economic facts.

High employment persists, inflation continues to be low, interest rates are falling and gross domestic product continues to grow at the 2.5%-plus level. These facts tell me that the economy is sound and is, in fact, a safety net for stock prices.

Further, the new Republican administration is a bullish factor for Wall Street because it signals a predisposition for lower taxes, for less regulation and historically it's always been a proponent of free trade. The Bush administration has been in sync with those precepts.

Assuming that the underlying economy remains sound, this cascade in stock prices cannot go on for a significant period because the facts of the economy are bound to act as a brake on the free fall. Within six months we ought to see a bounce back to more realistic prices, both on the upside and the downside.

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TSC: While these positive economic indications may be true, we continue to see steep selloffs amid a continuing barrage of earnings warnings and stock downgrades. These warnings are seriously concerning investors. Don't they concern you?

Hayes: No, because I view them simply as corrections to last year's overoptimistic assessments and cavalier assumptions. Investor expectations got too high and it is necessary to bring them back to earth. Just as we saw this flight to fantasy with the Nasdaq at 5000, we are seeing the same irrational pessimism pushing the Nasdaq below 2000.

There is a tendency for some parts of the investing public -- and that includes some institutional investors -- to become euphoric about the prospects for stock price advances and to lose sight of the underlying fundamentals of value which over the long run will dictate the prices at which stocks will trade.

Investors are overreacting on the downside just as they did on the upside.

TSC: So you believe that the market has overcorrected itself?

Hayes: Yes, I think the market has overcorrected itself on a cumulative basis. But some prices and P/Es on certain stocks may still be too high, while other stocks may have been pulled down too far by too low a level of confidence among the investing public.

Investors should look at the individual prices making up the Nasdaq Composite to see where there might still be mispricing, particularly in technology and Internet stocks. This is not true of all of the stocks in the Nasdaq or the S&P 500.

TSC: Turning to the Internet, which was a big driver of the Nasdaq's climb, it began to attain real credibility in 1998 and 1999 when the financial services sector began to embrace the Internet and electronic commerce. Stalwart asset management firms like Merrill Lynch, for example, startled the business world when they announced they would begin offering online trading in spite of resistance from their brokers. Do financial service firms still see any value in the Internet?

Hayes: Yes. It's very convenient for investors to do transactions and oversee their investments online. The fundamental premise for the surge in online investing is sound. However, as has been true of the dot-com and e-commerce mania in general, the expectations soared way above what could reasonable have been expected. The exuberance got way ahead of reality. The pessimism we see right now is directly related to the overexuberance of the past several years.

That will clear itself over the next year or so. Online investing will resume its importance to main line investment firms because they will want to protect themselves and their customer base through this convenience.

TSC: You have been particularly critical of investment firms that provide analysis for the same firms that they underwrite. You've even denounced the practice as Wall Street's "dirty little secret." Will this ever be resolved?

Hayes: There seems to be an unwillingness on the part of the regulators to curb it, and with that lack of goad, I am afraid that there will be a continuing mixing of the investment backing and the security analysis sides of the business to the detriment of many investors.

TSC: Why aren't regulators interested in correcting this?

Hayes: There's generally a feeling that hands-on regulation is a drag on the market, like friction against a spinning wheel, that one should leave the market to assess its own penalties of relying on analysis from underwriters. Eventually, I suspect that this will be resolved by the appearance of some independent vendors such as Sanford Bernstein that don't have this conflict of interest. But it may take a considerable period of time.

TSC: How can Wall Street analysts possibly remain competitive now that Regulation Fair Disclosure precludes them from having private conversations with the chief investment and financial officers of the firms they cover?

Hayes: It certainly makes the job of a security analyst much tougher, but they are seeking other ways to obtain the information they need. For example, they are talking more with customers, with suppliers, with industry specialists. They are going to a number of peripheral sources and trying to glean whatever information they can get to try to recreate a picture of the companies they cover.

If, for instance, they see that the collection period has increased by 15 days or that inventory turnover has deteriorated, this new, circuitous method is not as good as speaking to the CFO, but a dedicated analyst who is willing to spend some shoe leather going around and schmoozing with those companies or individuals who interact with the target firms can pick up a good bit of information.