Whither the Stock Market? There’s 2 Sides to This Story

Are things really that bad?

After another stock market sell-off Tuesday, that’s the natural question for investors to ask.

The 112-point drop in the Dow Jones industrial average was driven by mounting fears that Asia’s financial crisis will push the global economy into recession.

At the same time, however, the U.S. economy is humming along and critical factors such as inflation and interest rates remain positive.

What follows is an analysis of the major issues affecting the market from both bearish and bullish points of view.

World Economy

Bearish: To bears, signs point to severe economic problems throughout the world that are steadily taking their toll on U.S. companies.

As shown by a Japanese government report Tuesday, the recession in that nation appears to be deepening--and foreign investors doubt that Japan’s new prime minister has the resolve to push through needed reforms. That was on ample display Tuesday, when the U.S. dollar surged to an eight-year high against the Japanese yen.

Japan’s troubles have renewed concerns that the economies of other Asian countries, which are dependent on Japan to buy their goods, will worsen.

Asia’s woes, in turn, have fueled worries that other overseas economies will soon be affected. Concern is growing that China may be forced to devalue its currency, the yuan, thereby unleashing another round of crippling currency devaluations.

Bullish: Bulls acknowledge that Asia’s financial morass has lasted longer than they expected a year ago. But they argue that conditions aren’t as bad as feared.

They point out that the U.S. economy is growing steadily, and strong demand from U.S. consumers is negating the impact of Asia.

U.S. Economy

Bearish: Corrosion from the Asian economies is beginning to wash up on U.S. shores, bears argue. For proof, they point to America’s economic growth rate, which slowed to 1.4% in the second quarter from 5.5% in the first.

For years, the worry on Wall Street has been that the U.S. economy would grow too fast to keep inflation in check. Now, however, professionals fret that the U.S. economy will crumble under the weight of the world’s problems.

Bullish: Bulls reject such arguments. The twin boogeymen of the stock market--rising inflation and interest rates--are nowhere in sight, they say.

“If those things were to change, then I’d worry,” said Gail Bardin, manager of the Hotchkis & Wiley Equity Income fund.

The weakness emanating from Asia has restrained the otherwise vigorous U.S. economy and kept the Federal Reserve from boosting rates.

Earnings

Bearish: After uninspiring profit growth in the first half of this year, corporate profits are growing at their slowest pace since 1991. To bears, the writing on the wall couldn’t be clearer.

Earnings will continue to suffer for several reasons, they say. First, companies already have wrung out as many costs as they can through restructurings. Second, the U.S. hiring boom is causing salaries to rise and their profit margins to be squeezed. Finally, a strong U.S. dollar clips profits primarily because weak overseas currencies translate into fewer U.S. dollars, and U.S. goods simultaneously become more expensive overseas.

Bullish: Bulls expect company earnings to recover by the fourth quarter and finish 1998 with respectable annual gains averaging 6% to 8%.

Aside from the fact that U.S. companies dominate their markets, bulls argue that they are adept at satisfying Wall Street earnings estimates. They use sophisticated hedging strategies to offset the effect of the strong dollar and have the accounting legerdemain to help them notch the numbers Wall Street expects.

Technicals

Bearish: So-called technical analysts study stock charts to determine the market’s outlook. To the bears, the technical situation is dire.

For months, the breadth of the market--the number of stocks that are rising compared with those that are falling--has been horrible. It was only a matter of time before big-name stocks started to suffer like their smaller counterparts.

If anything, bears say, the picture has become more dismal lately. The Dow industrials fell almost 300 points a week ago on the second-largest volume ever. Tuesday, they fell on big volume again, undercutting last week’s lows.

If the Dow were to fall much lower, it could be the beginning of a steeper sell-off, some bears say.

Bulls: Bulls take heart in the fact that investors seem to be growing increasingly bearish. As odd as that might sound, it’s actually seen as a good sign for the market. It indicates that sellers may soon wear themselves out and that buyers may regain the upper hand.