Pondering the Year’s Mysteries

What were they thinking? Or were they thinking at all?

Those may be the questions by which we will best recall this year’s major events in financial markets.

Wall Street often exists in its own special reality, but even by that standard 2003 had some particularly mysterious turns. Here are some of them:

* What was up with the Federal Reserve’s deflation talk? The central bank has spent most of its 90-year existence fighting inflation, real and imagined. So it was a strange moment indeed on May 6 when Fed Chairman Alan Greenspan and his cohorts told the nation they were more worried about deflation than inflation.

They never used the D-word. Instead, as is customary with the Fed, the warning was in code. There was a chance, the Fed said, that the economy could face “an unwelcome substantial fall in inflation” -- which conjured images of poor Japan, racked by years of falling prices and their byproduct of eroded national confidence.

The Treasury bond market knew what the Fed meant: They’d be cutting their benchmark short-term interest rate again from an already rock-bottom 1.25%. Some investors also began to entertain notions of the central bank stepping directly into the market and buying long-term bonds to push yields down.

If one goal of deflation talk was to bolster financial markets with the prospect of still-lower interest rates, the Fed succeeded. The yield on the 10-year Treasury note plunged from 3.79% on May 6 to a 45-year low of 3.11% on June 13. The Dow Jones industrial average gained 735 points between May 6 and June 17.

But did the nation really need that last cut in the Fed’s key short-term rate, from 1.25% to 1% on June 25? The economy already was reviving in spring from the pre-war-induced freeze. The data of the last few months show business activity positively on a roll now, and virtually no one believes that’s a result of the final quarter-point rate cut.

As for deflation fears, it’s true that the consumer price index declined in November after blipping higher in summer. But commodity prices, home prices and stock prices, among others, all have been pointing due north, not south.

At its meeting on Dec. 9, the Fed declared deflation risk to be diminished. Was it ever really there?

* Why was anyone buying long-term Treasury bonds in mid-June? There is one place you can find significant deflation: in the prices of Treasury bonds since those mid-June lows in yields. As of Friday, the 10-year T-note yield was up a full percentage point from June 13, to 4.13%.

Unless you completely believed all of the Fed’s deflation hype, why would you have considered a 3.11% annual yield on a 10-year note to be an acceptable long-term return?

* Where was the New York Stock Exchange board? Here’s a question not just for 2003, but also for 2002, 2001, 2000 and several years before that.

The NYSE’s directors couldn’t seem to pay Richard Grasso enough to be their chairman. He earned $6 million in 1998, $21.8 million in 2000 and $25.6 million in 2001. His compensation rose dramatically even as excessive executive pay increasingly became a hot-button issue with average investors and workers in the aftermath of the wave of corporate scandals that began with Enron Corp. in 2001.

The NYSE, despite being considered an institution of the public trust, long refused to tell any outsiders what its executives were paid. Did anyone on the NYSE board ever imagine what the reaction might be if Grasso’s pay were divulged -- as finally happened in late summer, under pressure from the Securities and Exchange Commission?

The outrage over the pay numbers cost Grasso his job. One revelation that badly hurt his image was that he accepted a $5-million bonus from the board for guiding the NYSE after the 2001 terrorist attacks.

As some Grasso critics have since noted, thousands of NYSE workers braved the physical and emotional dangers inherent in returning to work on Wall Street after the attacks. Just one of them got a $5-million bonus for his efforts.

Where was the NYSE board, figuratively speaking? We may have to wait for one of them to write a tell-all book on their collective mental state. In the meantime, we know where nearly all of them are now: off the exchange board, thanks to interim Chairman John S. Reed’s house-cleaning.

* How could mutual fund company executives be so self-destructive? The fund industry scandal uncovered by New York Atty. Gen. Eliot Spitzer in September has turned the $7-trillion business on its head. Fund industry veterans who initially accused Spitzer of grandstanding now are aghast at the conduct since revealed at more than a dozen well-known fund firms.

Some portfolio managers were engaging in “market timing” in their own funds, trying to play short-term market swings at the expense of their long-term shareholders.

At other companies, executives were happy to permit hedge funds and other big-money players to engage in timing games in return for other fee-generating business.

At least one fund company allegedly gave its list of current shareholdings in certain portfolios to a hedge fund, so the latter could “short” the stocks, or bet on falling prices as part of a trading strategy.

Here was perhaps the last arm of Wall Street that Americans felt they could trust. In search of short-term profit, some fund executives have severely damaged that trust, if not destroyed it.

* Why have corporate insiders been so fast to unload their own shares? Executives and other insiders have been heavy sellers of their companies’ shares since May, when the market rebound still was in its infancy. And they’ve largely been unwilling to buy into the rally.

Data from research firm Thomson Financial show that, in the third quarter, insiders sold $36 of their own stock for every $1 they bought in the open market, the most lopsided sell-to-buy ratio in at least 10 years. And the trend has continued since September.

The numbers are derived from filings insiders must make with the Securities and Exchange Commission whenever they buy or sell their companies’ shares. The purchase data exclude buying via options. The idea behind tracking just open-market purchases is to see how willing insiders are to pay the same share prices as the public.

This year the answer is, not very. And as the market has continued to climb, insiders have been more inclined to dump personal shares.

In theory, insiders are supposed to have the best feel for how their companies will fare and whether their stocks are bargains. But this year, sellers have left a lot of money on the table by bailing out early, at least based on where stock prices are now.

Did they sell because they believed their stocks were overvalued? That’s the popular assumption, which could bode poorly for the market in 2004 if it proves to be prescient.

But some market veterans have suggested there’s another motivation behind insider selling that has nothing to do with relative share values or with the economic outlook.

This view holds that many executives failed to sell stock as prices soared in 1999 and early 2000, and they also held back as prices declined during the bear market because they figured a rebound was imminent any day.

This year, with the surprising gains in the market, insiders have been quick to take profits because they felt so burned by their inaction at the last bull market peak and in its aftermath. In other words, they aren’t taking chances this time around -- they’re taking money out.

According to this view, insiders’ timing was off at the bull market peak, and it’s off once again this year.

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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: www.latimes.com/petruno.