Skip to Content
Stock Analyst Update

Second Quarter in Stocks: Corporate Ethics Under Fire

Fallout from Enron continued to weigh on the market.

After the first quarter of 2002 ended on a cautiously positive note, hopes for a big market rally have been dashed over the past three months. All the market indexes posted double-digit losses: Between April 1 and June 24 the Dow Jones Industrial Average fell 11%, the S&P 500 index fell 13%, and the Nasdaq Composite fell 21%. While all Morningstar stock sectors except technology gained ground in the first quarter, nine of the 10 sectors lost ground in the second quarter.

One reason for this weak market performance has been conflicting but largely negative economic data that suggests the U.S. economy is still struggling to get on its feet. Perhaps a bigger reason, however, is the continuing fallout from the collapse of Enron and the resulting loss of investor confidence. Business headlines during much of the quarter were dominated by the trial of accounting firm Arthur Andersen for its role in the Enron debacle, which ended with Andersen's conviction for obstruction of justice. Accounting issues remained in the forefront of investor concerns, as the market continued to punish General Electric (GE), Tyco (TYC), and any other company with questionable financial statements.

On a broader scale, corporate ethics became a hot-button issue this quarter, as more and more examples of malfeasance at the top came to light. An astonishing number of chief executives of major companies were forced or pressured to step down, with two of them, Dennis Kozlowski of Tyco and Sam Waksal of ImClone (IMCL), actually being arrested for their alleged misdeeds. Other high-profile CEOs who stepped down include Bernie Ebbers of WorldCom (WCOM), Joe Nacchio of Qwest (Q), John Rigas of Adelphia (ADELA), Mickey Drexler of Gap (GPS), Chuck Watson of Dynegy (DYN), and Dennis Bakke of (AES). Martha Stewart of Martha Stewart Living Omnimedia (MSO) has come under fire for possible insider trading, though she hasn't stepped down and doesn't seem likely to.

Sector Roundup
Turning to specific stock sectors, there were a few bright spots amid the gloom. The best-performing of Morningstar's 10 stock sectors in the second quarter was consumer staples, whose 4.6% gain over the trailing three months through June 24 was led by such big names as Coca-Cola (KO) (up 9.0% through June 24), Kellogg (K) (up 6.0%), and Kraft Foods (KFT) (up 6.9%). This outcome wasn't too surprising, given that such stocks are seen as a safe haven in tough economic times. The only other sectors to come close to positive territory for the quarter were utilities and energy, another group of stocks perceived as safe places for cautious investors to put their money.

On the other end of the scale, the technology sector was once again the big loser, continuing its long downward slide with a 25% decline over the past three months. Not only are many key tech industries still in the doldrums, but formerly expensive tech stocks are among those getting hit the hardest by the market's newfound scrutiny of questionable accounting methods, just as they did in the first quarter. Among the big tech names to post losses of 25% or more were Oracle (ORCL) (down 33% through June 24), Nortel Networks (NT) (down 63%), and Apple Computer (AAPL) (down 27%).

Industries, Good and Bad
If we get more specific and look at which individual industries within the broader economic sectors have done well during the market malaise of the past three months, there are some surprises on the list. Two of the top-performing industries were automobile-related: repair services, up 30%, and auto retail, up 19% on the strength of such stocks as Autozone (AZO) and Advance Auto Parts (AAP). These industries did particularly well in the early part of the quarter, when the economy still seemed to be on the upswing, but faltered a bit in June, with some stocks falling into negative territory.

Several health-care-related industries were also among the best second-quarter performers: physicians (up 22% through June 24), hospitals (up 14%), home health (up 12%), and nursing (up 7%). With health-care costs and demand continuing to rise and many industries consolidating, such stocks as WellPoint Health Networks (WLP), HCA (HCA), and Universal Health Services (UHS) posted solid double-digit gains.

Some positive economic trends are reflected in the list of winning industries. A rally in the price of gold caused gold and silver stocks to jump 5.3% over the past three months, and the surprisingly resilient U.S. housing market helped home building (up 7.9%) and mortgages (up 7.8%).

However, there were also plenty of negative economic trends, reflected in the numerous industries that tanked this quarter. The brutal advertising downturn showed few signs of abating, causing such industries as online information, entertainment, and advertising to suffer double-digit losses. Among the hardest-hit were big names such as AOL Time Warner (AOL) (down 34% through June 24), Vivendi Universal (V) (down 49%), and Omnicom Group (OMC) (down 45%).

Anything telecom-related also continued to sink like a stone. Communications equipment (down 56%) and cable/wireless equipment (down 32%) were among the worst-performing industries for the second straight quarter, with wireless giants Qualcomm (QCOM), Nokia (NOK), and Ericsson (ERICY) all dropping 30% or more. The computer industry also remains in a world of hurt: computer storage, computer systems, and semiconductors were among the industries to decline more than 20% this quarter, including big drops by such giants as EMC (EMC) (down 43% through June 24), Intel (INTC) (down 36%), and Sun Microsystems (SUNW) (down 38%).

As 2002 reaches the halfway point, the market seems as jittery as ever, with the major indexes at or near their 52-week lows. With investor confidence being shaken almost daily by new revelations, it's hard to know whether we've hit bottom or not, but one thing is certain: the stock market bubble of 1999-2000 seems like ancient history.