Judging by recent headlines about Richard Grasso's outlandish compensation, illicit mutual fund trading, and/or trials of various financial luminaries, the U.S. financial market looks like a scandal-ridden den of iniquity, run by thieves intent on pilfering an unsuspecting public.
And yet the rally rumbles on.
"The U.S. stock market has metamorphosed into something quite grotesque," Alan Newman, editor of
said recently. "A mania is highly dependent upon fraud to achieve the level ofinsanity required to accept stock prices that cannot otherwise be justified."
But recent scandals have seemingly had little effect on those most likely to be victimized. Clearly, investors were showing little hesitation Thursday, when better-than-expected jobless claims, strong September sales data from retailers such as
and better-than-expected earnings from Internet bellwether
helped send stock proxies soaring.
As of 1:45 p.m. EDT, major averages were on track to establish new 52-week closing highs, with the
Dow Jones Industrial Average
up 1.1% to 9740.31, the
higher by 1.0% to 1044.48 and the
up 1.8% to 1929.39.
The market's overall strength and the complexity of some of the alleged crimes have overcome investors' angst, according to experts in investor behavior. One might argue that the revelations have actually made investors feel better, because the headlines indicate that regulators -- led by New York Attorney General Eliot Spitzer -- are finally catching the bad guys. A less optimistic conclusion is that greed trumps everything and investors learned little from the postbubble bear market.
That, of course, is a very bearish conclusion, and skeptics such as Newman have long warned that revelations of widespread malfeasance would cause Americans to abandon the stock market, prompting massive redemptions from mutual funds and accompany forced selling by such institutions. Perhaps revelations that
, the nation's largest fund manager,
has been subpoenaed in the investigation of market-timing and late-day trading will trigger such upheaval. (Robert Adler, president of AMG Data Services, did note that there's been a slowdown in the rate of equity fund inflows in the past month, although he couldn't pin it on the scandals.)
But thus far, recent scandals have seemingly had little effect on retail investors' sentiment, as evinced by the following:
Equity mutual funds had taken in $75.6 billion of inflows through August, according to AMG Data, which put preliminary estimates for September monthly inflows in the $12 billion to $14 billion range.
Bullish sentiment in the American Association of Individual Investors' member survey has been above 50% since mid-August, recently peaking at 62.75% on Sept. 18, despite the imbroglio over compensation at the New York Stock Exchange. Figures out today show that bullishness rose to 57.6% from the 50% as of Oct. 2. (By contrast, only 35% of respondents to a recent poll here chose either "bullish" or "very bullish.")
The combined margin debt at brokerage firms registered with the NASD and Big Board reached $174 billion in July, up over 25% since the beginning of the year and the highest level since July 2001. (In August, the combined total was $167.2 billion.)
"Now that people are making money again, their sensitivity has gone down," said Meir Statman, the Glenn Klimek Professor of Finance at Santa Clara University, who noted a lot of people buy lottery tickets and visit casinos even when the odds are stacked against them. "I don't think people care much about scandals as long as their piece
of the pie is intact."
Revelations about the so-called spinning of IPOs first emerged back in 1997, "but nothing happened because the market was doing well," Statman recalled. Similarly, today's scandals are failing to rouse investors' ire because "people are making money again," he said.
Terrance Odean, associate professor at the Haas School of Business at the University of California, Berkeley, largely agreed. He also noted that investors don't feel a direct hit to their pocketbooks because of Richard Grasso's compensation or even the illegal late-day trading of mutual funds, which academic studies suggest cost investors as much as 2% annually.
"The thing that would scare off investors is the likelihood of losing a lot of money," Odean said, suggesting
unraveling -- when both investors and employees with 401(k) money in the company's stock got thrashed -- or
bankruptcy were "scary" events for individual investors. Not coincidentally, those events coincided with wicked market drops and hefty outflows from equity mutual funds in 2002.
By contrast, the mutual fund trading scandal "doesn't scare people out of markets," he said, while expressing disgust that "mutual funds would knowingly let people do this."
The NYSE scandal "is not a whole lot different than overpaid CEOs
where it's not clear it's costing individuals a lot," Odean continued.
To paraphrase a famous saying, the lack of apparent outrage over scandals that also include the alleged wrongdoing of Dennis Kozlowski and Frank Quattrone (each separately on trial this week) maybe shows investors aren't paying attention. It also belies the conventional wisdom that there's some sort of populist revolt among the investing class.
In retrospect, it seems any "revolt" may have been largely the creation of politicians bent on making political hay out of, most notably, the Grasso saga. Among politicians calling for Grasso's resignation, California Treasurer Peter Angelides has made no secret of his desire to someday be governor while New York State Comptroller Alan Hevesi can be forgiven for having "Spitzer envy."
"I don't think people are as mad as hell," Statman said. "People got really sad
and depressed enough not to open quarterly statements. Now that the market is reviving, people feel relieved and those issues of the past seem like issues of the past."
The relative absence of anger -- or, at least evidence of investors acting upon such feelings -- also reflects an observation made by several sources: Despite a brutal three-year bear market and revelations of mass fraud and illegal activity across myriad aspects of the financial industry, many Americans still feel as if the they have no choice but to invest in equities. "On the whole, people don't see an alternative," Statman said.
Giving limited options in many 401(k) plans, some investors really don't have much choice. But this idea that there's no alternative to stocks indicates that the notion about stocks' being the best long-run investment is deeply entrenched. That concept is based partially on historical performance (greatly enhanced by dividends, which were historically at levels well above today's still-low dividend yields) but also on continued faith in the "buy and hold" mantra.
Ironically, that mentality was promoted by the mutual fund industry, which proved to not always have acted in the best interest of shareholders, who seem to be in a very forgiving mood these days.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.