The Dow Jones industrial average fell more than 207 points on Monday, the latest in a series of severe daily declines that are prompting deep concern that the U.S. stock market has slid into a long-overdue "correction."
The sell-offs stem from the growing belief that Asia's economic woes will drag down U.S. corporate profits far more than initially estimated. Wall Street had long expected the Asian crisis to crimp profits in the first half of 1998, but investors are now facing the prospect that earnings could weaken through the rest of the year.
Some sectors of the U.S. stock market, such as stocks of smaller companies, already have slumped more than 10%, the standard definition of a correction. That has come despite a sharp decline in interest rates, which normally boosts stock prices, and signs that U.S. economic growth remains healthy.
The question now is how much longer can the sell-off go--a question about which there is a tug-of-war going on among investors. Bulls argue that the U.S. economy is vibrant, enabling earnings to withstand Asia's renewed weakness. Bears counter that profits were headed down even before Asia struck and that if earnings growth continues to peter out, stocks will lose a crucial support.
Monday's 207.01-point fall--or 2.3%--in the Dow, to 8,627.93, was the biggest single-day point loss since a 222-point slide Jan. 9, and put the widely watched index at its lowest close since March 13.
The loss represented the fifth largest point-drop ever and sliced this year's gain to 9%. Just a month ago, the Dow was up more than 16% for the year, peaking at a record 9,211.84 on May 13.
"This is a correction in the face of a ridiculously overvalued market," said Larry Rice, chief investment officer at Josephthal, Lyon & Ross, a New York investment firm. "You were up at these ridiculous [valuations] for stocks at the same time that profit expectations were being trimmed and the two are not compatible."
Tumble Blamed on Slipping Yen
The recent declines in U.S. stocks, and worsening outlook for Asia, stem largely from a steep drop in the value of the Japanese yen caused by that country's economic recession. The fall in the yen to an eight-year low against the U.S. dollar has set off worries that Hong Kong, China and other Asian countries could be forced to devalue their currencies to keep the prices of their goods competitive with those of Japan. Currency devaluations were at the heart of last year's Asian market meltdown.
In early trading in Tokyo today, however, the yen rallied more than 2% against the dollar on speculation the Japanese government intervened to prop up its faltering currency. But the concern remains that the yen will continue to fall.
U.S. investors fear devaluations for two reasons. First, lower-priced currencies reduce the prices of Asian exports in the U.S., potentially forcing American companies to lower their own prices. Second, further devaluations would only prolong Asia's financial mess, making it even tougher for U.S. companies to sell their products in the region.
To be sure, many prominent Wall Street experts maintain that profit worries are overblown. The American economy is hitting on all cylinders, they argue, and any weakness in Asia will be more than offset by strong home and retail sales domestically.
"The [domestic] economy is doing well and that is going to prove to be an elixir for earnings," said Peter Canelo, investment strategist at Morgan Stanley Dean Witter. "People love to panic and dream up stuff about the world ending, but it doesn't usually happen."
Even still, semiconductor and other technology concerns have topped a list of companies warning recently that Asia-related problems will cause their earnings to fall short of Wall Street projections.
Prominent technology companies such as Motorola Inc. and Applied Materials Inc. have said that debt-laden Asian nations are delaying or canceling orders for products ranging from semiconductors to chip-making equipment.
But companies as disparate as Northwest Airlines Corp. and Minnesota Mining & Manufacturing also have blamed profit shortfalls on Asia. Northwest, which generates about one-third of its sales from Asia, said business in the region has slowed. 3M, the maker of Post-It notes, warned Monday that a strong dollar and weak Asian sales would cause it to fall short of profit estimates.
Though Asia plays a key role, the earnings warnings and market queasiness come in part from the fact that the second quarter is coming to a close.
Rise in Negative 'Pre-Announcements'
At the end of each quarter and beginning of the next, companies that expect to report poor earnings often issue warnings to that effect. Though they don't release full earnings reports until the third or fourth week of the new quarter, the companies use so-called "pre-announcements" to warn investors.
The majority of pre-announcements are negative, though a bit more than one-third of companies pre-announce good news. Not surprisingly, the market is often weak during pre-announcement periods because investors are greeted each day by bad news from several companies.
Most companies whose profits exceed expectations wait to unveil their news several weeks into the new quarter. That normally gives the market a boost. For example, the stock market bottomed this year in mid-January, about the time that fourth-quarter pre-announcement season ended and good profit news began coming out.
What worries some investors about this quarter, however, is that the number of negative pre-announcements is rising.
In the second quarter of 1997, there were 352 pre-announcements, of which 59% were negative, according to First Call Corp., an earnings tracking firm in Boston. With half of June still to go this year, there already have been 236 second-quarter pre-announcements, of which 64% are negative.
"Obviously, with the biggest weeks to go . . . we're certainly going to exceed that 352 by a good margin," said Chuck Hill, First Call's research director.
The 64% figure also troubles Hill. The percentage of negative pre-announcements normally increases during the period, meaning that it could near or top 70% this year, Hill said.
Nearing 70% could send a clear signal that earnings will worsen before they improve.
Profits are expected to pick up only 4.7% this quarter, after improving 3.8% in the first quarter, according to First Call. That compares to the mid-double-digit quarterly gains of recent years.
More disturbing, current estimates envision profits growing 11.6% in the third quarter and 16.4% in the fourth quarter. If those numbers are too high--and many investors now suspect they are--stock prices theoretically would have to fall to mesh with the diminished expectations.
However, stock market bulls say that the earnings outlook is not that negative. They point out that profit growth is only slowing, not that earnings are falling or that companies are losing money.
"The key is we have earnings growth," said Elizabeth Mackay, chief investment strategist at Bear, Stearns & Co.
Investor psychology in the next several weeks could say a lot about the direction of the market, experts say.
Big Sell-Off Could Help Market
Despite Monday's 207-point drop, the market hasn't suffered a big break such as the 554-point tumble last October. Instead, though, the selling has come in relatively small amounts with modest losses and some small gains on most days.
"They're taking a little chunk out every day," said Barry Hyman, senior market strategist analyst at Ehrenkrantz King Nussbaum Inc. in New York.
Though the lack of a major sell-off may appear to be positive, the best thing for the market could be a notable crack that would "clear the air," Hyman said.
In recent years, investors have viewed corrections as "buying opportunities" to jump into stocks they previously considered too expensive. So far, that's been the case lately. But consistently down days could change the minds of some investors.
"People are just starting to get worried now," Mackay said. "There's been a fair amount of complacency and buying of the dips. [But] if the dips go on for a few more days, people may say, 'Hey, wait a minute.' "
* CRUDE AWAKENING
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