According to Wall Street, well-established rating services are to corporations what Roger Ebert is to cinema. Few of us have the two hours and ten-plus bucks to waste on a bad movie and stale bag of popcorn. Even fewer can carry out the research of a company's inexhaustible details.
So, we leave the grunt work to Mr. Ebert AND the professional raters -- who -- after all, get paid to sit through the screenings, take notes on direction and acting, and deduce which films/companies will go straight to video (i.e. flop), vs. which will become Blockbuster sensations. Two thumbs up or AAA -- it's all the same.
Or is it?
Imagine that today's date is November 30, 2001. The world's largest seller of natural gas and electricity has gone from cash cow to dry bone. Its share price has plummeted 99% from a $90 peak to just under $1, with an estimated $68 Billion loss. Once "America's Most Innovative Company," it is now America's most insolvent one. YET--the company continues to enjoy an "INVESTMENT GRADE" rating.
The company's name: Enron. Four days later, it files for the largest bankruptcy in U.S. history. That, dear readers, isn't missing the boat. That's missing the Titanic sailing full speed ahead into a giant iceberg.
In his 2002 book Conquer the Crash, Bob Prechter observed the tendency of the hired prognosticators to "see" sea changes in the economy only after they have taken place. In Bob's words:
"The most widely utilized rating services are almost always woefully late in warning of problems within financial institutions. They often seem to get news about a company around the time that everyone else does…. In several cases, a company can collapse before the standard rating services know what hit it."
Enron may seem like a distant memory, but what about the recent Subprime mortgage debacle? To wit: Big name ranking service Moody's slashed the ratings of 131 subprime bonds due to higher than expected defaults… in July 2007 -- two years AFTER a distinct hissing sound started to come out of the market for non-traditional mortgages.
Flash ahead to today: We have the recent, white-knuckled fight to keep the AAA-rating of the two largest bond insurers: Ambac Financial Group Corp. and MBIA Inc. On February 29, the insurers defended their triple-A status with the help of the two "B" battalion: Buybacks and Bailouts.
And, as far as the "experts" can see, AAA spells premium-grade investment, despite a recent news item revealing the dying art of bond insurance: "Since the start of 2008, 39% of issued long-term municipal debt has carried credit insurance versus 65% during the first two months of 2007." (DJ MarketWatch)
If anything, history has taught that safety does not necessarily lie in the letters ascribed by rating services. Fortunately, the brand new March 2008 Elliott Wave Financial Forecast offers updated charts of both MBIA and Ambac. One look at this picture and you'll know whether the triple-A ratings truly reflect the companies' upside potential and underlying strength.
At the conclusion of his chapter on the un-reliability of rating services in Conquer the Crash, Bob Prechter wrote: "As an investor, you can not wait until the problems are obvious to act; by then it's too late. You have to anticipate problems and then get out of the way before they happen."
Here is the opportunity to do just that.