The surging markets
Small investors waver while stocks climb
The old saying that greed and fear motivate stock markets has rarely been more accurate. On Jan. 24, the bellwether Dow Jones industrial average regained the last of the 508 points that it lost when it crashed on Oct. 19, 1987. The Toronto Stock Exchange’s (TSE) 300 Composite Index has also rebounded, smashing through a succession of postcrash highs. And the market could go higher because many large corporate investors still have record amounts of cash on hand. Some experts say that positive economic developments–such as a cut in interest rates–could spike those billions back into the markets and send prices spiralling upward. But other analysts say that the current rally will be limited by small investors who saw their holdings collapse on Black Monday and are still apprehensively staying on the sidelines
The global rally, which has also pushed markets higher in Tokyo, Hong Kong and London, is being propelled by people using other people’s money. They are primarily major institutional investors, including managers of pension funds–who are buying blue-chip stocks and securities in firms that they expect are trading too cheaply or are takeover targets. But to date, there is little evidence that small, individual investors are re-entering the market. And their concerns may be increased by the rising number of stock market scandals spreading through Canada, the United States, Europe and Japan. Said Larry Lunn, chairman of Connor, Clark & Lunn Investment Management Ltd., a Vancouver-based pension fund management firm: “Many small investors simply feel that the stock market is a rigged game, which can only be played by the professionals.”
The scandals began in the last months of the five-year-long bull market that ended in Black Monday’s spectacular collapse. In May, 1986, police arrested New York City arbitrager Ivan Boesky, who, in exchange for the relatively light sentence of three years in jail, gave investigators details of a vast web of insider trading. And last month, officers of New York City brokerage house Drexel Burnham Lambert Inc. pleaded guilty to six felony counts, five of them involving fraudulent transactions with Boesky, and the Securities and Exchange Commission fined the company $780 million. And Michael Milken, the firm’s leading high-interest bond salesman, is also expected to be charged. As well, last month, a sweeping U.S. Federal Bureau of Investigation operation uncovered widespread fraud on the Chicago futures exchange. At the same time, the insider trading controversy has touched one of Canada’s most famous families and has reached the top of the French and Japanese governments.
In Canada, former B.C. premier William Bennett was charged by both the Ontario and B.C. securities commissions with taking advantage of an illegal inside stock tip involving the major provincial forest products firm Doman Industries Ltd. The long list of stock market scandals may lengthen later this month, when the Ontario Securities Commission (OSC) is expected to lay criminal charges following its own two-year insider trading investigation. As a result of the scandals, some analysts say that many small investors are still apprehensive about returning to the market, despite the current surge.
But larger investors appear to be convinced that the three-month rally in stock prices is a clear indication that another full-fledged bull market is under way. U.S. investors have been purchasing large blocks of stock in blue-chip companies that appear to be undervalued in the postcrash market. And in Canada, the large professional investors have helped send TSE values higher by purchasing both securities in top firms and shares in companies that they believe will be taken over or merged. As well, they have been buying into firms including The Molson Cos. Ltd., Carling O’Keefe Breweries of Canada Ltd. and Consolidated-Bathurst Inc. Those firms have been involved in mergers and takeovers over the past three weeks and, as a result, are expected to show stronger profits in 1989.
Many experts say that the recent North American rally is an endorsement of Canadian and U.S. fiscal policy. Institutional investors in both countries evidently feel that the high interest rate policies of the Bank of Canada and the Federal Reserve Board have kept inflation under control, and, as a result, the seven-year economic expansion may slow but not collapse. Some stock portfolio managers say that large investors, who normally react negatively to interest rate increases, are taking the long-term view and have accepted tight interest rates as necessary to prolong economic expansion. Said Malvin Spooner, vice-president of Elliot and Page Ltd., a Toronto-based investment counselling firm: “Many professional investors have simply begun looking at the bright side of things rather than what could go wrong.”
Meanwhile, many small investors are clearly not buying into the latest market rally. During 1987, Canadian net sales–sales minus redemptions–of Canadian common stock mutual funds were $1.6 billion. But during 1988, investors actually sold off more equity mutual fund shares than they bought. Said Thomas Stanley, national sales manager for Deacon Morgan McEwen Easson Ltd., a Toronto stock brokerage firm: “Most retail investors are depressed and scared.”
In fact, many analysts say that the army of nervous small investors should stay on the sidelines. Most professional market-watchers predict volatility in the period ahead–at least until the long-term economic picture clears, and the investment community has had a chance to examine how President George Bush will try to deal with his country’s bulging budget and trade deficits.
Until then, says Robert Krembil, chairman of the Toronto-based Trimark group of mutual funds, individual investors who want to get back into the stock markets should put their money in equity mutual funds, which give investors greater diversification and professional management. Others, including Toronto analyst Ian McAvity, the author of the influential stock market newsletter Deliberations, say that Krembil’s relatively safe strategy is still too aggressive for today’s scandal-scarred markets. McAvity said that small investors should stick with interest-yielding investments and avoid stocks altogether. He added: “The recent rally has served to lull investors into a state of complacency. Anyone who is in the stock market today should know where the exits are.”
The rush to those exits will be hastened by a new stock market scandal that is about to further hit small-investor confidence in the TSE. The OSC plans to charge six high-ranking investment industry officials later this month following its two-year-old insider trading investigation. When contacted by Maclean’s, the individuals believed to be involved refused to comment on the allegations.
But the OSC has had as many as 12 members of its staff working on the case full time since it broke in March, 1987, after Toronto real estate developer John Micallef–now living in Boca Raton, Fla.–complained to the commission about a share purchase that involved Michael Biscotti, former vice-president of Toronto-based Dominion Securities Inc.
Micallef said that he had received tips about impending large purchases of shares by major investors and that he and Biscotti used the information to buy in advance and reap the profits after share prices rose. The relationship soured after Micallef purchased a large shareblock in Dome Petroleum Ltd., the former Calgary oil company that has merged with Calgary-based Amoco Canada Petroleum Co. Ltd. A short time later, Dome share prices plummeted and Micallef complained to the OSC.
But the expected OSC charges and investigation are far less extensive than the two-year FBI undercover investigation into suspected fraud by traders at the world’s two largest futures exchanges–the Chicago Board of Trade and the Chicago Mercantile Exchange. The United States department of justice has issued subpoenas to almost 250 Chicago-area futures trading firms demanding that they produce all records dating back to 1983.
The investigation is focused on various types of prearranged trading at the
Mercantile Exchange and the Board of Trade. Five FBI agents apparently worked undercover on the floor of each exchange, tape-recording conversations on the trading floor and soliciting information from other traders over lunch at Chicago’s East Side Club and at lavish parties at their apartments. John Frazier, a trader with the Chicago-based futures trading firm of Balfour Maclaine Futures Inc., told Maclean’s that “there is a great deal of depression” among traders at the Chicago board as a result of the investigation. He added, “I’m sure they’re not spending all this money for nothing; they’ve got something.”
Another insider trading scandal is also threatening to engulf French Prime Minister Francois Mitterrand’s Socialist government. Last week, the French state prosecutor’s office opened a criminal inquiry into insider trading allegations against two prominent Socialist businessmen who made large insider trading profits by buying thousands of shares in Triangle Industries Inc., a New York City-based packaging company, the week before it was taken over by Peciney SA, a large aluminum company owned by the French government, sending Triangle’s shares soaring.
At the same time, in Japan, at least 16 influential politicians have admitted that they–or their aides–benefited by buying cheap, unlisted shares in a subsidiary of Recruit Co., an information and publishing conglomerate. The shares rocketed in value soon after public trading began. But in Canada, insider revelations are just beginning. And analysts say that the outcome of pending cases could make the country’s already-nervous investors even more circumspect–regardless of how high the market soars.
PHOTO : Wall Street brokers being arrested
PHOTO : Boesky: a light sentence
JOHN DeMONT with JOHN DALY in Toronto